UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
.
Commission file number 0-16882
The Commerce Group, Inc.
(Exact name of registrant as specified in its charter)
Massachusetts
04-2599931
(State or other jurisdiction (IRS
Employer Identification No.)
of incorporation)
211 Main Street
01570
Webster, Massachusetts (Zip
Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (508) 943-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each
Exchange
Title of each Class on
Which Registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.50 Par Value Per Share
(Title of Class)
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. [ ]
The aggregate market value of the voting stock held by non-
affiliates of the registrant as of March 1, 1997, was approximately
$605,044,000.
As of March 1, 1997, the number of shares outstanding of the
registrant's common stock (exclusive of treasury shares) was 36,042,652.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II of this Form 10-K incorporate by reference
information from the registrant's annual report to stockholders for the
fiscal year ended December 31, 1996 (the "1996 Annual Report"). The
1996 Annual Report, except for portions thereof which have been
specifically incorporated by reference, shall not be deemed "filed" as
part of this Form 10-K.
Portions of the registrant's definitive Proxy Statement for its
special meeting in lieu of the annual meeting of stockholders which the
Company intends to file within 120 days after the end of the
registrant's fiscal year ended December 31, 1996 are incorporated by
reference into Part III hereof as provided therein.
<PAGE>
TABLE OF CONTENTS
Page
Glossary of Selected Insurance
Terms................................................ 3
<TABLE>
Part I
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Item 1.
Business..........................................................
...... 7
A.
General...........................................................
9
B. Commonwealth Automobile
Reinsurers................................ 11
C.
Marketing.........................................................
13
D.
Underwriting......................................................
15
E.
Reinsurance.......................................................
16
F. Settlement of
Claims.............................................. 17
G. Loss and Loss Adjustment Expense
Reserves......................... 18
H. Operating
Ratios.................................................. 21
I.
Investments.......................................................
22
J.
Regulation........................................................
24
K.
Competition.......................................................
29
L. Other
Matters..................................................... 30
Item 2.
Properties........................................................
...... 30
Item 3. Legal
Proceedings.......................................................
30
Item 4. Submission of Matters to a Vote of Security
Holders..................... 31
Item 4A. Executive Officers of the
Registrant.................................... 31
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters.... 33
Item 6. Selected Financial
Data................................................. 33
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of
Operations.................................................. 33
Item 8. Financial Statements and Supplementary
Data............................. 34
Item 9. Changes in and Disagreements with Independent Accountants on
Accounting
and Financial
Disclosure............................................... 34
Part III
Item 10. Directors and Executive Officers of the
Registrant...................... 34
Item 11. Executive
Compensation.................................................. 34
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......... 34
Item 13. Certain Relationships and Related
Transactions.......................... 34
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......... 35
Signatures........................................................
...... 36
Index to Financial Statement
Schedules.................................. 38
Index to
Exhibits....................................................... 49
</TABLE>
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GLOSSARY OF SELECTED INSURANCE TERMS
Assumed premium.................... Premiums acquired or allocated to an
insurer other than
through its independent agencies.
Best's............................. A.M. Best Company, Inc. is a rating
agency reporting on
the financial condition of insurance
companies. The Best's statistics
cited in this Form 10-K are based
upon information voluntarily
submitted to it by insurers. The
Company is aware of at least one
domestic insurer that has not
submitted data to Best's and
therefore may not be reflected in
Best's market share statistics.
Casualty insurance................. Insurance which is primarily
concerned with the losses
of the insured due to injuries to
other persons and to the property of
others, and the legal liability
imposed on the insured resulting
therefrom.
Catastrophe, catastrophic loss..... A severe loss, usually involving
many risks such as
conflagration, earthquake,
windstorm, explosion and other
similar events.
Combined ratio..................... A combination of the underwriting
expense ratio and the
loss and LAE ratio determined in
accordance with SAP. The
underwriting expense ratio measures
the ratio of underwriting expenses
to net premiums written, determined
in accordance with SAP. The loss
and LAE ratio measures the ratio of
incurred losses and LAE to earned
premiums, determined in accordance
with SAP.
Commissioner....................... The Commissioner of the Division
of Insurance of the
Commonwealth of Massachusetts.
Commonwealth Automobile
Reinsurers ("C.A.R.").............. C.A.R. is a Massachusetts mandated
reinsurance mechanism,
under which all premiums, expenses
and losses on ceded business are
shared by all insurers. It is
similar to a joint underwriting
association because a number of
insurers (41 in 1996) act as
Servicing Carriers for the risks it
insures.
Direct............................. Refers to premiums, losses, LAE and
expenses on policies
which a company writes before
accounting for business ceded and
assumed through reinsurance.
Direct loss ratio.................. The ratio of direct incurred losses
and LAE to direct
earned premiums.
Direct premiums written............ Total premiums for insurance
sold to insureds, as
opposed to, and not including,
reinsurance premiums.
Domestic insurer................... An insurance company that operates
in the state which it
is licensed.
Earned premiums.................... The portion of net premiums written
that is equal to the
expired portion of policies
recognized for accounting purposes
as income during a period. Also
known as premiums earned.
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Excess of loss reinsurance.........
Reinsurance which indemnifies the
reinsured against all
or a specified portion of losses
under reinsured policies in excess
of a specific dollar amount or
"retention".
Exclusive representative
producer ("ERP")................... A Massachusetts automobile
insurance agency which does
not have a voluntary agency
automobile insurance relationship
with an insurer, and which is
assigned by C.A.R. to an insurer who
is a Servicing Carrier.
Exposure........................... An insurable unit defined as an
automobile.
Group Marketing Program............ A "group marketing program" is any
system, design or
plan whereby motor vehicle or
homeowner insurance is afforded to
employees of an employer or to
members of a trade union,
association or organization in
accordance with those provisions of
M.G.L. c. 175, s. 193R,
distinguishing such plans from a
"mass merchandising plan".
Specifically, a group marketing
program contemplates the issuance of
such insurance through other than
standard policies that preclude
individual underwriting, contains an
option to continue coverage by a
standard policy upon termination of
employment or membership, restricts
cancellation, requires the
continuance of certain
participation, in ways not
applicable to standard policies, and
provides for the modification of
rates based upon the experience of
the insured group.
Hard Market........................ An insurance market in which the
demand for insurance
exceeds the readily available supply
and premiums are relatively high.
Incurred but not reported
("IBNR") reserves.................. Reserves for estimated losses which
have been incurred
by insureds but not yet reported to
the insurer.
Incurred losses.................... The total losses sustained by an
insurance company under
a policy or policies, whether paid
or unpaid. Incurred losses include a
provision for IBNR.
Inland marine insurance............ As used by the Company, insurance
that provides protec-
tion for specific types of personal
property, such as jewelry, coins and
fine arts, over the limits covered
in a standard homeowners insurance
policy.
Loss adjustment expenses ("LAE")... The expense of settling claims,
including legal and
other fees and the portion of
general expenses allocated to claim
settlement costs.
LAE ratio.......................... The ratio of LAE, net of
reinsurance recoveries, to
earned premiums.
Loss ratio......................... The ratio of incurred losses and
loss adjustment ex-
penses, net of reinsurance
recoveries, to earned premiums.
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Loss reserves...................... Liabilities established by insurers
to reflect the esti-
mated cost of claims payments and
the related expenses that the
insurer will ultimately be required
to pay in respect of insurance it
has written. Reserves are
established for losses and for LAE.
Net premiums written............... Direct premiums written for a given
period less premiums
ceded to reinsurers during such
period plus premiums assumed during
such period.
Participation ratio................ A Massachusetts insurer's share of
the C.A.R. deficit
based upon the insurer's market
share of automobile risks not
reinsured through C.A.R., adjusted
for utilization of C.A.R. credits
for voluntarily writing less
desirable business and ceded
exclusions.
Premium-to-surplus ratio........... The ratio of net premiums written
to policyholders'
surplus.
Property insurance................. Insurance that indemnifies a
person with an insurable
interest in tangible property for
loss related to damage to or loss of
use of the subject property.
Pure loss ratio.................... The ratio of net incurred losses,
excluding LAE, to pre-
miums earned.
Quota share reinsurance............ Reinsurance in which the reinsured
shares a proportion
of the original premiums and losses
under the reinsured policy. Also
known as pro rata reinsurance.
Rate deviation..................... A specific state approved departure
from an otherwise
applicable state set rate level
provided to safe drivers.
Rate discount...................... A specific state approved discount
from an otherwise
applicable state set rate level
provided to members of group
marketing programs.
Reinsurance........................ The acceptance by one or more
insurers, called rein-
surers, of all or a portion of the
risk underwritten by another insurer
who has directly written the
coverage. However, the legal rights
of the insured generally are not
affected by the reinsurance
transaction and the insurance
company issuing the insurance policy
remains liable to the insured for
payment of policy benefits.
Safe Driver Insurance Plan ("SDIP") A program mandated by state law
that encourages safe
driving by rewarding drivers who do
not cause an accident, or incur a
traffic law violation and by making
sure that high-risk drivers pay a
greater share of insurance costs.
Servicing Carrier.................. An automobile insurer writing
business in
Massachusetts which can reinsure
risks through C.A.R. while remaining
responsible for servicing the
related policies and which must
provide a market for ERPs assigned
to it by C.A.R.
Soft Market........................ An insurance market in which the
supply of insurance
exceeds the current demand and
premiums are relatively low.
5
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Statutory accounting practices
("SAP")............................ Recording transactions and
preparing financial state-
ments in accordance with the rules
and procedures prescribed or
permitted by an insurer's state
insurance regulatory authority for
the purposes of financial reporting
to regulators, which in general
reflect a liquidating, rather than
going concern, concept of
accounting.
Statutory surplus.................. The excess of admitted assets
over total liabilities
(including loss reserves),
determined in accordance with SAP.
Take-all-comers.................... A phrase used to characterize the
Massachusetts auto-
mobile regulatory system under which
all insurers are required to
underwrite virtually all risks
submitted to them.
Underwriting....................... The insurer's process of reviewing
applications submit-
ted for insurance coverage, deciding
whether to accept all or part of the
coverage requested and determining
the applicable premiums.
Underwriting expenses.............. The aggregate of policy
acquisition costs, including
commissions, and the portion of
administrative, general and other
expenses attributable to
underwriting operations.
Underwriting expense ratio......... The ratio of underwriting expenses
to net premiums writ-
ten determined in accordance with
SAP.
Unearned premiums.................. The portion of a premium
representing the unexpired
amount of the contract term as of a
certain date.
6
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PART I
ITEM 1. BUSINESS
The Commerce Group, Inc. (the "Company"), was incorporated in
1976. The Company is engaged principally in providing personal and
commercial property and casualty insurance in Massachusetts
primarily through it's subsidiary, The Commerce Insurance Company
("Commerce"), which was incorporated in 1971. The Company's
principal insurance line is motor vehicle insurance, primarily
covering personal automobiles. The Company also offers commercial
automobile, homeowners, inland marine, fire, general liability and
commercial multi-peril insurance. The Company also writes insurance
in the state of California through Western Pioneer Insurance Company
("Western Pioneer"), a personal automobile insurer located in
Pleasanton, California, which was acquired on August 31, 1995. In
addition, the Company originates residential and commercial
mortgages on a limited basis primarily within Massachusetts and
operates an insurance agency dealing in a full line of insurance
products, including those of the Company.
The Company's business strategy is to focus its insurance
activities primarily on the personal automobile market. Presently,
the Company has over 719,000 policies in force, 695,000 of which are
in force throughout the state of Massachusetts. The Company,
through Commerce and Citation Insurance Company ("Citation"),
wholly-owned subsidiaries of Commerce Holdings, Inc. ("CHI") which
is a wholly-owned subsidiary of the Company, has been the largest
writer of personal property and casualty insurance in Massachusetts
in terms of market share of direct premiums written since 1990. At
year end 1996 and 1995, the Company's Massachusetts private
passenger automobile market share was 20.8% and 16.4%, respectively.
The Company is also one of the leading writers of commercial
automobile insurance in the state. During 1996, 97.8% of the
Company's $731,823,000 in direct premiums written were derived from
personal automobile (including Western Pioneer's direct premiums
written of $27,380,000), commercial automobile and homeowners
insurance, its three core lines of business. These lines
represented $622,849,000, $40,441,000 and $52,377,000, or 85.1%,
5.5%, and 7.2% respectively, of the Company's direct premiums
written.
The Company attributes its success primarily to its strong
relationships with professional independent agencies that provide
quality business for the Company. Other factors that have been
important to its success include an in-depth understanding of the
Massachusetts regulatory and underwriting environments, advanced
information systems, an extensive underwriting data base and
beginning in 1995, the ability to compete in a group marketing
environment.
Because the Company offers its product lines only through
independent agencies, its relationships with those agencies are
critical to its continued success. The Company believes that it is
the preferred provider for most of its agencies and that as a result
of such position it has gained access to policyholders with average
or above-average underwriting profit characteristics in its personal
and commercial automobile insurance lines. The Company carefully
selects and retains agencies whose premium growth and loss ratio
experience meet the Company's agency criteria, and devotes
substantial resources to fostering and maintaining strong
relationships with its existing agencies. The Company pays its
agencies significant compensation in the form of profit sharing
payments which are based in part on the underwriting profits of the
agency's business written with the Company. Based upon agency
surveys conducted several times a year, the Company believes it is
attentive to the needs and requirements of its agencies. The
Company emphasizes its commitment to the Massachusetts insurance
market, its responsiveness in servicing claims and its internal
support for agency operations, including direct billing of insureds,
on-line inquiry systems for its agents and by providing
competitively priced automobile insurance.
The Company's focus on automobile and homeowners insurance
primarily in Massachusetts has also been a factor in its success.
The terms, conditions and rates of personal automobile insurance are
subject to extensive regulation by the Massachusetts Commissioner of
Insurance ("Commissioner"). Because the Company has primarily
served the Massachusetts market, it has both an in-depth
understanding of this market and the ability to respond effectively
to shifts in the state's regulatory and underwriting environments.
Currently, the Company is required to accept virtually all
automobile insurance business submitted to it by its agencies. The
Company's ability to underwrite this business profitably, however,
depends on its understanding of the risks in the business as well as
its management of reinsurance through C.A.R.
7
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Beginning in the latter part of 1995, the Company began to
actively pursue group marketing programs. The primary purpose of group
marketing programs is to provide participating groups with a convenient
means of purchasing automobile insurance through associations and
employee groups. Billing is primarily through direct billing with
payroll deduction available. Emphasis is placed on writing larger
groups, although accounts with as few as 25 participants are considered.
Groups are eligible for rate discounts which must be filed annually with
the Division of Insurance. In general, the Company looks for groups
with mature/stable membership, favorable driving records, and below
average turnover ratios. Participants who leave the sponsoring group
during the term of the policy are allowed to maintain the policy until
expiration. At expiration, a regular Commerce policy may be issued at
the insured's option.
During the latter part of 1995, Commerce signed group marketing
agreements with the five American Automobile Association Clubs of
Massachusetts ("AAA Clubs") offering a 10% discount on automobile
insurance to the clubs' members who reside in Massachusetts. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
29.8% increase in the number of personal automobile exposures written by
Commerce. In addition, in 1996, total direct premiums written
attributable to the AAA group business was $344,297 or 47% of the
Company's total direct premiums written. Of this amount, 9% was written
through the AAA clubs and 91% was written through the Company's network
of independent agents.
Also in 1995, the Company received state regulatory approval to
eliminate interest based premium finance fees on new and renewal
personal automobile insurance policies with effective dates on or after
January 1, 1996. As a result, premium finance fees as a source of the
Company's revenues have been reduced by 50.0% in 1996. As policies
effective in 1995 favorably impacted finance fee income in 1996, the
full effect of the elimination will not be felt until 1997 with the
expectation of further reductions. The change was initiated in direct
response to competitive forces that occurred in the Massachusetts
marketplace.
In January, 1996, the Company was granted approval, for the 1996
calendar year, to offer safe driver deviations of 10 percent to
customers with SDIP classifications of either Step 9 or 10. These are
the two best SDIP driver classifications in Massachusetts, representing
drivers with no at fault accidents or not more than one minor moving
vehicle violation in the last six years. For drivers that qualify, the
Company's automobile discounts and SDIP deviations can be combined for
up to a 19% reduction from the state mandated rates. In March 1997,
approval of SDIP deviations was granted for the 1997 calendar year.
The Company's other than personal automobile products tend to be
derived from its other two core product lines and therefore have had
relatively predictable risk profiles. The Company offers a preferred
risk homeowners product through Citation, which has an alternative
pricing and commission schedule for selected insureds meeting more
restrictive underwriting guidelines. Citation also provides a separate
rating tier for preferred commercial automobile business. Approximately
22% of the commercial automobile premium produced by its voluntary
agents in 1996 was written by Citation. The Company expects that this
secondary rating tier will continue to assist the Company in retaining
its better commercial automobile accounts, while also further increasing
the percentage of commercial automobile business that can be retained
voluntarily by the Company in 1997 and beyond.
The Company's long-term commitment to providing consistent markets
for Massachusetts independent agencies, coupled with the withdrawal by
several national companies from the Massachusetts personal automobile
market in past years, has been a significant factor in enabling the
Company to increase its market share by adding agencies which meet its
agency criteria. The Company believes that Massachusetts agencies are
more likely to seek to develop and expand relationships with domestic
insurers, which, like the Company, have a long-term commitment to the
Massachusetts personal automobile market.
Although the Company is not actively pursuing acquisitions, in an
effort to enhance future growth potential, the Company continues to
monitor acquisition opportunities with regard to smaller automobile
insurance companies that are in need of capital, have established
management in place and present significant growth opportunities in
their market areas. On August 31, 1995, the Company completed the
acquisition of Western Pioneer, a personal automobile insurer, located
in Pleasanton, California.
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The Company's long term growth objective is to expand its writings
outside of Massachusetts. To achieve this objective, during 1996 the
Company was granted licenses in the states of Connecticut and Rhode
Island. License approval in the state of Vermont was received in
January 1997. License applications were filed by the Company and are
pending in the states of Maine and New Hampshire. Concurrent with these
filings, the Company has entered into an agreement with Policy
Management Services Corporation ("PMSC") and has purchased software
which will allow for the development of internal operating systems which
will enable the Company to process policies in these five states and
Massachusetts. To facilitate this development to provide the necessary
systems capable of supporting continued growth and to address the year
2000 processing issue facing computer system users, the Company has
established the Team 2000 project. Team 2000 will provide for a
complete integration of databases serving our three main functions;
claims, underwriting and premium accounting. The Team 2000 systems
implementation will be multi-phased with the first phase scheduled to be
in place for contiguous states during the latter part of 1997. As a
result, Management is not expecting to start marketing in the states
contiguous to Massachusetts until that time. Through the year 2001, the
Company expects to incur over $40 million in costs with the
implementation of the PMSC systems. This amount includes the purchase
of a main frame computer, license fees, and the costs associated with
programming, implementation and training. In 1996, the Company paid
$10.5 million, of which, $4.9 million was expensed during the year.
In the past, the Company has devoted substantial time and
resources to the development of its current information systems, which
enhanced both its underwriting and its agency support. Through the use
of several customized software programs, the Company has the ability to
analyze its internal historical underwriting data and use such
information in making, in the Company's belief, more informed
underwriting decisions. In particular, the Company believes that the
amount and extent of detail data accumulated as a result of its share of
the personal automobile market gives the Company a competitive advantage
in determining which automobile risks to reinsure through C.A.R. The
Company's information systems also enable it to provide extensive
support to its agencies. This support includes a direct billing system,
which covers over 90% of the Company's policyholders, an on-line inquiry
system, which allows agencies to ascertain the status of pending claims
and direct bill information, and a system which allows Company agencies
to quote premiums for the Company's three core product lines directly to
policyholders. Because the Company emphasizes its commitment to
enhancing and expanding the role of its information systems, it also
recognizes that current systems may not provide the distinct competitive
advantage when looking beyond Massachusetts into the five remaining New
England states. The Team 2000 project will enable the Company to
produce management and agency information necessary to establish similar
competitive advantages as it expands.
A. General
Insurance Lines
Commerce and Citation currently have a combined Best's rating of A
(Excellent). Western Pioneer currently has a Best's rating of A-
(Excellent). According to Best's, an insurer with an Excellent rating
has demonstrated, in Best's opinion, excellent overall performance when
compared to standards developed by Best's.
Direct premiums written totalled approximately $731,823,000 in
1996, of which motor vehicle insurance accounted for approximately
$663,290,000, homeowners insurance accounted for approximately
$52,377,000 and commercial multi-peril insurance accounted for
approximately $9,244,000. During 1995, direct premiums written totalled
approximately $626,666,000, of which motor vehicle insurance accounted
for approximately $559,821,000, homeowners insurance accounted for
approximately $50,256,000 and commercial multi-peril insurance accounted
for approximately $10,471,000. Earned premiums are included in total
revenues of the Company and represent the net earned premiums remaining
after assumed and ceded reinsurance. In 1996 and 1995, total revenues
included insurance premiums earned of approximately $668,716,000 and
$592,590,000, respectively. Motor vehicle insurance accounted for
approximately 94.6% and 92.7%, homeowners insurance accounted for
approximately 4.0% and 5.3% and commercial multi-peril insurance
accounted for approximately 1.0% and 1.5% of total earned premiums, in
1996 and 1995, respectively.
9
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The Company's principal insurance line is personal automobile
insurance. The Company offers automobile policyholders the following
types of coverage: bodily injury liability coverage, including
underinsured and uninsured motorist coverage, property damage liability
coverage and physical damage coverage, including fire, theft and other
hazards specified in the policy. Policies are usually written for one
year terms. The Company's published liability limits are $500,000 per
person for bodily injury, $1,000,000 per accident and $100,000 for
property damage. Liability limits of $100,000 per person injured,
$300,000 per accident and $100,000 for property damage are the limits
most commonly purchased from the Company.
Personal automobile insurance is completely regulated by The
Commonwealth of Massachusetts. Marketing and underwriting strategies
for companies operating in this state continue to be dominated by
automobile premium rates and commission levels which are mandated by the
Massachusetts Division of Insurance and by current and prospective
legislation affecting the industry. Automobile premium rates in
Massachusetts are among the highest in the nation as a direct result of
high costs incurred by companies which provide this type of protection.
Claims, the costs associated with the processing and settling of claims,
assessments required to subsidize the involuntary market mechanism,
accident rates, bodily injury claims, and medical care costs remain
among the highest in the nation. Additionally, traffic density, as
defined by vehicle miles divided by highway miles, is among the highest
in the nation.
During the three-year period from 1994 to 1996, Massachusetts
personal automobile insurance premium rates decreased an average of 2.6%
per year. The Commissioner approved an average 6.2% decrease in
personal automobile premiums for 1997, the third decrease in three
years, as 1996 average rates were cut by 4.5%, and 1995 average rates
were decreased by 6.1%. According to the Commissioner's office, the
current rate environment is the result of continued consumer cooperation
by driving safely, obeying traffic laws, reporting fraud, wearing
seatbelts and individuals locking their autos.
Also, the 1997 decrease was partially driven by corrections to an
industry error impacting prior year rate decisions. The industry error
resulted from a miscaluation of industry expense allowances that had the
effect of overstating rates for 1991 through 1996. Rates for 1997
include an adjustment to recoup this error from the industry equal to
40% of the error with 40% reducing 1998 rates and 20% reducing 1999
rates.
Additionally, 1997 rates were decreased as a result of the
reconciliation of the SDIP which is designed to be revenue neutral. In
most recent past years, the SDIP reconciliation resulted in a deficit
which was then added into the rates for the subsequent years. The 1996
SDIP reconciliation, however, resulted in a surplus. Fifty percent of
this surplus is being used to decrease rates in both 1997 and 1998.
The Company has performed an analysis of the rate decision and has
estimated the impact of the above two items on its results assuming its
market share remains the same as it was at the end of 1996. The earned
premium impact is estimated to be approximately $15.3 million for 1997,
$23.0 million for 1998 and $13.5 million for 1999. The earnings per
share after-tax impact resulting from the lower earned premiums for
1997, 1998 and 1999 is estimated to be $0.28, $0.41 and $0.23,
respectively. If the Company's future market share increases
(decreases), a larger (smaller) financial impact would result.
The Automobile Insurers Bureau of Massachusetts ("AIB") has filed
an appeal with the Massachusetts Supreme Judicial Court challenging the
Commissioner's decision to prospectively decrease future rates for the
miscalculation of the industry expense allowance. (The SDIP
reconciliation component is not being challenged.) The AIB's argument
is that, according to statute, there is a prohibition against
retroactive rate making in Massachusetts which effectively bars the
examination of past year's data once all involved parties have agreed to
the rate decision. One insurer has filed a suit with the Massachusetts
Supreme Judicial Court alleging that the prospective nature of the rate
reduction will have an unfair adverse impact on it. This is due to the
fact that the company filing suit believes it should not be adversely
impacted solely because its market share is greater now than during
those years in which the errors occurred. It is not possible to predict
the outcome of these legal actions or the potential effects thereof on
the Company.
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In addition, the Massachusetts Association of Insurance Agents
("MAIA") has also filed a suit with the Massachusetts Supreme Judicial
Court with respect to the Commissioner's ruling on 1997 commissions.
The Commissioner ruled that agents' commissions on the 1997 premiums,
subject to safe driver deviations, will be based on the discounted net
premium amounts. The 1996 commissions were based on the gross premium
amounts. The Commissioner's ruling will result in agents receiving
fewer commission dollars on a per policy basis. The Company is unable
to predict the possible outcome of this suit at this time.
The Company also offers homeowners insurance except in designated
coastal areas. The Company's standard homeowners policy is an all risk,
replacement cost insurance policy covering a dwelling and the contents
contained therein. The Company's published limits of liability for
property damage to a dwelling are a minimum coverage of $60,000 and a
maximum coverage of $600,000, although some policies over this amount
are written on an exception basis. For personal liability, the minimum
coverage is $100,000 and the maximum coverage is $1,000,000. The
average property damage coverage amount per policy is approximately
$135,000, and generally, the average amount of contents coverage is 70%
of the amount of coverage for the dwelling, with limitations on the
amount of coverage per item placed on securities, cash, jewelry, furs,
silverware and firearms. However, additional coverage for such items
can be purchased on a scheduled personal property basis. The Company
also offers $1,000,000, $2,000,000 and $3,000,000 personal liability
umbrella coverage for homeowners policies requiring certain specified
underwriting coverages which are reinsured through American Reinsurance
Corporation.
The Company offers a preferred homeowners product through Citation
which has higher policy limits and a lower premium and agency commission
structure and is designed primarily for homes with above-average market
values. The Company also applies more stringent underwriting criteria
by, among other things, limiting the product to homes with modern
electrical systems.
The Company also offers inland marine, fire, general liability and
commercial multi-peril insurance.
Mortgage Operations
Insurance companies are authorized to invest in mortgages and the
Company formed Bay Finance Company, Inc. ("Bay Finance") to originate
and service residential and commercial mortgages primarily in
Massachusetts. During fiscal 1996, 1995, and 1994 the mortgage
operations accounted for approximately $4,249,000, or 0.6%, $3,804,000,
or 0.6% and $3,972,000 or 0.6% of the Company's consolidated total
revenues, respectively.
As announced in October, 1995, and in order to focus resources
more directly on the Company's main line of business, private passenger
automobile insurance, the operations of Bay Finance were substantially
reduced. Effective January 1, 1996, Bay Finance no longer actively
originates mortgage loans through the use of outside originators and
extensive regional marketing. As a result, Bay Finance's staffing
levels were substantially reduced and the remaining employees focus on
servicing the Company's existing mortgage portfolio. Bay Finance has
retained its lending licenses and continues to make a small number of
various types of mortgage loans.
Insurance Agency
Clark-Prout Insurance Agency, Inc. ("Clark-Prout") is a wholly-
owned insurance agency that writes both for the Company and for other
insurance companies. During fiscal 1996, 1995 and 1994, Clark-Prout
revenues amounted to $930,000, or 0.1%, $1,203,000 or 0.2% and
$1,194,000 or 0.2% of the Company's consolidated total revenues,
respectively.
B. Commonwealth Automobile Reinsurers
A significant aspect of the Company's automobile insurance
business relates to its interaction with C.A.R. C.A.R. is a state-
mandated reinsurance mechanism, which enables the Company and
approximately 40 other writers of automobile insurance in Massachusetts
("Servicing Carriers") to reinsure any undesirable automobile risk.
Servicing Carriers, which are responsible for over 99.0% of total direct
premiums written for personal automobile insurance in Massachusetts, are
required to offer automobile insurance coverage to all eligible
applicants pursuant to "take-all-comers" regulations, but may reinsure
undesirable business with C.A.R. In addition, Servicing Carriers are
obligated to accept involuntary agencies, known as ERPs, from C.A.R. and
to provide an automobile insurance market in Massachusetts for those
agencies.
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C.A.R. maintains separate pools for liability and physical damage
coverage in personal and commercial automobile risks. All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines,
whether or not they are Servicing Carriers. Since its inception, C.A.R.
has annually generated multi-million dollar underwriting losses in both
the personal and commercial pools. Accordingly, each automobile insurer
attempts to develop and implement underwriting strategies that will
minimize its relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not reinsured through C.A.R.
In general, the C.A.R. reinsurance mechanism operates as follows.
Within established time frames, a Servicing Carrier must identify which
policies it wishes to retain and which policies it wishes to cede to
C.A.R. A Servicing Carrier pays to C.A.R. all of the premiums generated
by the policies it has ceded and also reimburses C.A.R. for the reduced
premium resulting from affinity group marketing discounts. C.A.R.
reimburses Servicing Carriers for all losses incurred on account of
ceded policies, although, as with reinsurance generally, reinsurance of
a policy through C.A.R. does not legally discharge the Servicing Carrier
from its liability to the policyholder for the full amount of the
policy. In addition, Servicing Carriers also receive fees for servicing
ceded policies based upon the expense structure established by C.A.R.
An insurer's proportionate share of the C.A.R. deficit is
allocated on the basis of a formula called a participation ratio, which
can vary significantly between the personal and commercial pools, and
between different policy years. Under current regulations, an insurer's
share of the C.A.R. deficit is based upon its market share for retained
automobile risks for the particular pool, adjusted by a utilization
formula, such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
reinsurance exceeds that of the Massachusetts industry and favorably
affected if its relative use of C.A.R. reinsurance is less than that of
the Massachusetts industry. At year end 1996 and 1995, the Company's
Massachusetts private passenger automobile market share was 20.8% and
16.4%, respectively. The current formula also contains a provision
whereby certain high risk business, if reinsured through C.A.R., is
excluded in determining an insurer's participation ratio. Finally, for
the personal automobile C.A.R. pool, an insurer's participation ratio
may be affected by credits received for not reinsuring through C.A.R.
automobile risks in selected underpriced classes and territories. An
insurer's participation ratio will be favorably affected if its relative
use of credits exceeds the Massachusetts industry's.
The Company's objective is to develop and implement underwriting
strategies to obtain the optimum balance between its C.A.R.
participation ratio and the loss ratios on automobile risks not
reinsured through C.A.R. For each automobile risk, the Company makes a
judgment as to whether the projected impact on the Company's
profitability from retaining the risk outweighs the incremental cost of
reinsuring the risk through C.A.R. In determining the incremental cost
of reinsuring a risk through C.A.R., the Company estimates its
participation ratio for a given period by modeling the anticipated
Massachusetts industry-wide C.A.R. trends. Once the Company estimates
its participation ratio, it is then able to compare the incremental
effect on the Company's share of the C.A.R. deficit of either reinsuring
or retaining the particular automobile risks. Finally, the Company
utilizes its internal underwriting database and internally-developed
actuarial reporting and analysis systems to develop for each risk a
projected underwriting loss ratio. It then compares the impact of the
automobile risk on the Company's participation ratio in order to
estimate whether, after taking all C.A.R. and other factors into
account, the Company's profitability will be enhanced by reinsuring or
retaining such risk. The Company believes that, because of its leading
share of the Massachusetts automobile insurance market, it can utilize
statistically credible data for a greater array of underwriting factors
than its competitors, which in turn gives it a competitive advantage in
deciding which automobile risks to reinsure through C.A.R.
The C.A.R. utilization-based participation ratio has been in place
since 1993, and individual companies in the marketplace make minor
yearly changes to find the optimum balance between voluntary and ceded
writings. Significant changes in the industry-wide private passenger
cession percentage are not expected for 1997.
A phase-in of a utilization-based participation formula was
implemented in the Massachusetts commercial automobile market. The
phase-in began in 1992 and ended in 1995. Although commercial
automobile insurance is a relatively smaller portion of the Company's
total insurance writings, the related commercial automobile risk
selection decisions remain an important element in determining
profitability.
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C.A.R. rule changes occur, as C.A.R. adjusts the operations of the
personal and commercial reinsurance mechanisms to address the needs of
the Massachusetts automobile insurance market. Any material change to
the C.A.R. rules in the future will affect the Company. The Company is
not currently aware of any likely future rule changes that could have a
material impact on the Company, but there can be no assurance that such
rule changes will not occur.
C. Marketing
The Company markets its insurance products through a network of
672 licensed independent agencies, 539 throughout Massachusetts (of
which 155 are ERPs) and 133 are in California. These independent
agencies may also represent other insurance companies, some of which may
compete directly with the Company. The independent insurance agencies
are under contract with the Company's subsidiaries and must conduct
their business according to the provisions of their contract. Contracts
for Massachusetts agencies may be terminated by the Company upon 180
days' notice to the agency or at will by the agency.
The Company seeks to establish long-term relationships with
agencies that can generate a sizable volume of business with profitable
underwriting characteristics and for which the Company will be among the
top two or three preferred writers of its core products. The Company
also assesses whether the mix of a prospective agency's business will
expand the Company's presence in one or more of its core product lines.
In 1996, each agency representing the Company in Massachusetts produced
an average of approximately $1,307,000 of Company direct premiums
written. Also in Massachusetts during 1996, 171 agencies produced in
excess of $1.0 million of direct premiums written, an additional 51
agencies produced over $2.0 million, an additional 22 agencies produced
over $3.0 million and lastly, an additional 11 agencies produced over
$4.0 million. The Company's three largest agencies produced
approximately $22.9, $13.9 and $11.3 million of Company direct premiums
written, respectively, or approximately 3.1%, 1.9% and 1.5%, of the
Company's total direct premiums written in 1996. Total direct premiums
written attributable to the AAA group business was $344,297 or 47% of
the Company's total direct premiums written. Of this amount, 9% was
written through the AAA clubs and 91% was written through the Company's
network of independent agents.
Once appointed, each agency's performance is carefully monitored.
An Agency Evaluation Committee, comprised of representatives of the
Company's Marketing, Underwriting and Premium Accounting departments,
utilizes a host of pre-established criterion (loss ratio, premium
volume, etc.) to continuously evaluate agencies. Generally, the Company
will counsel an agency on how to improve its underwriting and
profitability before any agency will be terminated.
Company agencies receive commissions on policies written for the
Company and are eligible to receive contingent commissions through a
profit sharing arrangement. The Commissioner annually establishes a
minimum average direct commission for personal automobile insurance,
which in 1996 was 13.8%. With respect to policies reinsured through
C.A.R., the maximum amount of commissions that C.A.R. will reimburse the
Company is fixed at that prescribed rate. Consequently, there is an
incentive for insurers not to permit their direct commission rate to
vary materially from the prescribed rate. The Company's contingent
commissions are tied to the underwriting profit on policies written by
an agency based upon a rolling three year experience method. The
Company generally pays up to 45% of the underwriting profit attributable
to the agency's business; generally, if the agency's loss ratio for its
policies exceeds 50% in a year, the agency will not receive any
contingent commission for that year. In 1996, total commissions paid by
the Company to its agencies amounted to 15.6% of direct premiums
written, of which direct commissions and contingent commissions
constituted 14.4% and 1.2%, respectively. Direct commissions paid are
higher than the personal automobile rates primarily due to higher
commission rates paid on other lines of business. In 1996, the
Company's expense for contingent commissions was $9.0 million versus
$18.5 million in 1995. The Company also sponsors incentive award
programs to encourage and reward agency profitability and growth.
During 1996, the Company ran such a program resulting in 315 Agents
earning incentives at a total cost of approximately $4.3 million. Much
of the success of this program is attributable to affinity group
marketing programs.
13
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The Company's information systems enable it to provide extensive
support to its agencies. This support includes a direct billing system,
which covers over 90% of the Company's policyholders, an on-line inquiry
system which allows agents to ascertain quickly the status of pending
claims or direct bill information and a system which allows Company
agents to quote many premiums directly to policyholders. The Company
also emphasizes its commitment to enhancing and expanding the role of
its information systems. The Company has provided agencies with the
ability to generate personal automobile policies from their own offices
and will continue to explore new options in light of the Team 2000
project.
The Company believes that because of its compensation arrangements
and providing a consistent market with emphasis on service, an
increasing number of the Company's agencies will rely on it as their
principal supplier of insurance products. The Company believes that it
is the preferred provider for most of its agencies. Although the
Company believes, based on annual surveys of its agencies, that its
relationships with its independent agencies are excellent, any
disruption in these relationships could adversely affect the Company's
business.
Beginning in the latter part of 1995, the Company began to
actively pursue Group Marketing programs. The primary purpose of group
marketing programs is to provide participating groups with a convenient
means of purchasing automobile insurance through associations and
employee groups. Billing is primarily through direct billing with
payroll deduction available. Emphasis is placed on writing larger
groups, although accounts with as few as 25 participants are considered.
Groups of 100 or more participants could be eligible for a rate
discounts. In general, the Company looks for groups with mature/stable
membership, favorable driving records, and below average turnover
ratios. The sponsoring entities must be in sound financial condition
and have stable employment or membership. Participants who leave the
sponsoring group during the term of the policy are allowed to maintain
the policy until expiration. At expiration, a regular Commerce policy
may be issued at the insured's option.
During the latter part of 1995, Commerce signed group marketing
agreements with the five AAA Clubs offering a 10% discount on automobile
insurance to the clubs' members who reside in Massachusetts. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
29.8% increase in the number of personal automobile exposures written by
Commerce. In addition, in 1996, total direct premiums written
attributable to the AAA group business was $344,297 or 47% of the
Company's total direct premiums written. Of this amount, 9% was written
through the AAA clubs and 91% was written through the Company's network
of independent agents.
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members participate in a
group marketing program within the first year. Accordingly, Commerce
and AAA aggressively pursued AAA members for the AAA Group Marketing
Program. At December 31, 1996, Commerce had achieved the objective of
writing more than 35% of the AAA members within the first year, as over
300,000 AAA members joined the program. The particular portion of the
statute, dealing with achieving the 35% penetration level in one year,
was amended by the Legislature in early 1997 to allow two years to reach
the required penetration level. In 1997, Commerce and AAA intend to
continue to increase the penetration of the eligible AAA membership.
Commerce and the AAA Clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA Clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
Also in 1995, the Company received state regulatory approval to
eliminate interest based premium finance fees on new and renewal
personal automobile insurance policies with effective dates on or after
January 1, 1996. As a result, premium finance fees as a source of the
Company's revenues have been reduced by 50.0% in 1996. As policies
effective in 1995 favorably impacted finance fee income in 1996, the
full effect of the elimination will not be felt until 1997 with the
expectation of further reductions. The change was initiated in direct
response to competitive forces in the Massachusetts marketplace.
During 1996, the Company was granted licenses in the states of
Connecticut and Rhode Island. License approval in the state of Vermont
was received in January 1997. Applications were filed by the Company
and are pending in the states of Maine and New Hampshire. Concurrent
with these filings, the Company has entered into an agreement with PMSC
and has purchased software which will allow for the development of
internal operating systems which will enable the Company to process
policies in these five states and Massachusetts. These systems are not
scheduled to be in place for contiguous states until the latter part of
1997 and, as a result, Management is not expecting to start marketing in
the states contiguous to Massachusetts until that time.
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In January, 1996, Commerce was granted approval, for the 1996
calendar year, to offer safe driver deviations of 10% to customers with
SDIP classifications of either Step 9 or 10. These are the two best
SDIP driver classifications in Massachusetts, representing drivers with
no at fault accidents and not more than one minor moving vehicle
violation in the last six years. For drivers that qualify, the
Company's automobile discounts and SDIP deviations can be combined for
up to a 19% reduction from the state mandated rates. In March 1997,
approval of SDIP deviations was granted for the 1997 calendar year.
D. Underwriting
The Company seeks to achieve an underwriting profit, as measured
by a statutory combined ratio of less than 100, in each of its three
core product lines in both hard and soft markets. The strategy is
designed to achieve consistent profitability with substantial growth in
net premiums written during hard markets and more modest growth during
soft markets. All of the Company's policies have been written on a
"claims incurred basis," meaning that the Company covers claims based on
occurrences that take place during the policy period.
Agencies are authorized to bind the Company on risks as limited by
the Company's written underwriting rules and practices, which set forth
eligibility rules for various policies and coverages, unacceptable
risks, and maximum and minimum limits of liability. With respect to
non-automobile policies, other than umbrella policies, the Company's
agencies have the ability to bind the Company for a limited period,
typically 60 days, during which time the Company reviews all risks to
determine whether it will accept or reject the policy. During this
review period, the Company is obligated to pay any claim which would be
covered under the policy. Violation of the Company's underwriting rules
and practices is grounds for termination of the agency's contract with
the Company.
The Company and each of the approximately 40 other Servicing
Carriers must write all automobile risks submitted to them.
Massachusetts personal automobile insurance rates are fixed annually by
the Commissioner. All companies writing personal automobile policies
are required to use such rates, unless they have received prior approval
from the Commissioner to offer a lower rate. The actual premium paid by
a particular policyholder, however, is adjusted, either up or down,
based upon the SDIP record of the insured operator. Moving violations
and accidents for which the insured was at fault within the most recent
six year period are used to determine each operator's SDIP surcharge or
credit. The Massachusetts personal automobile insurance market became
more competitive in late 1995 and throughout 1996 with the advent of
affinity group marketing programs and safe driver rate deviations.
Prices for Massachusetts commercial automobile insurance policies
that are not reinsured through C.A.R. are set competitively subject to
the Commissioner's authority to disapprove such prices. The rate for
commercial automobile risks reinsured through C.A.R. is mandated by the
Commissioner, except for private passenger type non-fleet business. The
Company's rates for other product lines, including homeowners and
commercial lines of general liability and property insurance, are based
in part on loss cost data from the Insurance Services Office ("ISO"),
which is an industry bureau providing policy forms and rate making data,
and in part, on the Company's own experience and industry price levels.
The Company is not obligated by statute to accept every homeowners
risk submitted to it. Accordingly, risks meeting the Company's
underwriting guidelines are accepted, and all other risks are declined
or not renewed. The Company has established an independent rate level
for its homeowners product line, based on its own loss experience and
recognizing the price levels available in the competitive marketplace.
The Company uses ISO policy forms and has added special coverage
features to meet its product needs. Rates and forms are filed with the
Commissioner.
Under Massachusetts law, residential property owners are strictly
liable for damages caused by lead poisoning in children under age six
residing in the premises. The Company has reduced its exposure to lead
poisoning claims by (i) excluding from coverage all interfamilial claims
for bodily injury or medical expenses brought by minors living in an
insured's household, (ii) revising its underwriting standards for new
and renewal business to avoid insuring properties with lead poisoning
hazards and (iii) excluding from coverage all lead poisoning perils for
bodily injury to children under age six under homeowners policies on
one-to-four family residences built prior to 1965 where at least one
unit is rented. With regard to the exclusion described in (iii),
policyholders may buy a reinstatement of the excluded coverage through a
policy endorsement for an additional premium, but very few such
endorsements have been written. As a result of these remedial steps and
its historical claims experience, the Company does not believe that its
exposure to lead poisoning claims is material.
15
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The Company believes that its information systems give it a
competitive advantage in making underwriting decisions, particularly in
deciding which personal automobile risks should be reinsured through
C.A.R. Utilizing data the Company accumulates as a result of its major
market presence in the Massachusetts personal automobile line, the
Company believes that its information systems allow it to make informed
risk assessments and to respond effectively to shifts in the automobile
insurance markets and regulatory environment.
The Company's long term growth objective is to expand its writings
outside of Massachusetts. To achieve this objective, during 1996 the
Company was granted licenses in the states of Connecticut and Rhode
Island. License approval in the state of Vermont was received in
January 1997. Applications were filed by the Company and are pending in
the states of Maine and New Hampshire. Concurrent with these filings,
the Company has entered into an agreement with PMSC and has purchased
software which will allow for the development of internal operating
systems which will enable the Company to process policies in these five
states and Massachusetts. To facilitate this development to provide the
necessary systems capable of supporting continued growth and to address
the year 2000 processing issue facing computer system users, the Company
has established the Team 2000 project. Team 2000 will provide for a
complete integration of databases serving our three main functions;
claims, underwriting and premium accounting. The Team 2000 systems
implementation will be multi-phased with the first phase scheduled to be
in place for contiguous states during the latter part of 1997. As a
result, Management is not expecting to start marketing in the states
contiguous to Massachusetts until that time. Through the year 2001, the
Company expects to incur over $40 million in costs with the
implementation of the PMSC systems. This amount includes the purchase
of a main frame computer, license fees, and the costs associated with
programming, implementation and training. In 1996, the Company paid
$10.5 million, of which, $4.9 million was expensed during the year.
E. Reinsurance
In addition to participating in C.A.R., the Company reinsures with
other insurance companies on a claims incurred basis, a portion of its
potential liability under the policies it has written, protecting itself
against severe loss under individual policies, or catastrophic
occurrences where a number of claims can produce an extraordinary
aggregate loss. Reinsurance does not legally discharge the Company from
its primary liability to the insured for the full amount of the
policies, but it does make the reinsurer liable to the Company to the
extent of the reinsured portion of any loss ultimately suffered. The
Company seeks to utilize reinsurers which it considers adequately
capitalized and financially able to meet their respective obligations
under reinsurance agreements with the Company. The Company utilizes a
variety of reinsurance mechanisms to protect itself against loss as
described above.
Property and Catastrophe Reinsurance
From the inception, on September 30, 1993, through the third
quarter of 1995, the Company's combined property quota share and excess
loss reinsurance contract was written with five domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnified the Company for 36% of the loss and LAE, and paid
a commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company paid to the reinsurers 40% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement was $40.0 million and the maximum annual aggregate
occurrence loss reimbursement was $60.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsured each
risk, retaining $125,000 and reinsuring 100% of the next $875,000.
Effective September 30, 1995, the Company increased its coverage
under the combined property quota share and excess loss reinsurance
contract. The contract is now written with six domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnify the Company for 45% of the loss and LAE, and pay a
commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company pays to the reinsurers 49% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement is $50.0 million and the maximum annual aggregate
occurrence loss reimbursement is $75.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsures each
risk, retaining $125,000 and reinsuring 100% of the next $875,000. This
reinsurance contract is continuous, cancelable quarterly with ninety
days notice.
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Effective March 1, 1995, through February 29, 1996, the Company
had catastrophe reinsurance coverage for that portion of the loss not
covered under the property quota share arrangement. Catastrophe
reinsurance coverage was in force for approximately 88.0% of the amounts
incurred for all property claims arising from a single event or
occurrence up to a maximum loss of $100.0 million, after first
subtracting property quota share losses. Coverage under the catastrophe
program was as follows: a net retention of $5.0 million; 50.0% of the
next $5.0 million; and, 95.0% of the next $90.0 million. Including the
Company's retention, total catastrophe coverage was $100.0 million.
This coverage was placed with a number of reinsurers, both foreign and
domestic.
Effective March 1, 1996 through February 28, 1997 the Company's
catastrophe reinsurance program has been tailored in conjunction with
the property quota share arrangement to provide catastrophe reinsurance
protection at varying levels of losses. The table below provides
information depicting the approximate combined recoveries of all
property reinsurance programs (catastrophe and quota share) at various
loss scenarios if a catastrophe were to strike:
<TABLE>
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
<CAPTION>
<S> <C> <C>
$ 25,000,000 $ 11,300,000 $13,700,000
50,000,000 35,000,000 15,000,000
75,000,000 58,800,000 16,200,000
100,000,000 82,500,000 17,500,000
125,000,000 105,000,000 20,000,000
150,000,000 110,000,000 40,000,000
</TABLE>
The Company will have no reinsurance recoveries for total loss
amounts in excess of $150.0 million. The Company is currently
renegotiating its primary catastrophe reinsurance program to become
effective May 1, 1997. This renegotiation does not affect the property
quota share arrangement or one other non-primary catastrophe reinsurance
program.
Casualty Reinsurance
Through December 31, 1996, casualty reinsurance was on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$4.0 million over a net retention of $1.0 million. Effective January 1,
1997, casualty reinsurance is on an excess loss basis for any one event
or occurrence with a maximum recovery of $9.0 million over a net
retention of $1.0 million. This coverage is placed with Swiss
Reinsurance America Corporation, formerly North American Reinsurance
Corporation (rated A by A.M. Best).
Effective January 1, 1995, personal and commercial liability
umbrella policies are reinsured on a 95% quota share basis in regard to
limits up to $1.0 million and 100% quota share basis for limits in
excess of $1.0 million but not exceeding $5.0 million for policies with
underlying automobile coverage of $250,000/$500,000 or more. Effective
January 1, 1996, the Company added personal liability umbrella
reinsurance coverage for policies with underlying automobile coverage of
$100,000/$300,000, on a 65% quota share basis in regards to limits up to
$1.0 million and 100% quota share basis for limits in excess of $1.0
million but not exceeding $3.0 million. These coverages are placed with
American Reinsurance Corporation (rated A+ by A.M. Best).
The Company believes that the terms of its reinsurance contracts
are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limits, retentions,
arbitration and occurrence. Based on its review of its reinsurers'
financial statements and their reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially
sound. The Company had no amount of reinsurance receivables more than
90 days past due at December 31, 1996.
F. Settlement of Claims
Claims under insurance policies written by the Company are
investigated and settled primarily by claims adjusters employed by the
Company. The Company employs a staff of 584 people at its claims
department, located in Webster, Massachusetts. In addition to these
individuals, the Company utilizes the services of approximately 24
independent appraisal firms and 10 independent property adjusting
companies who are strategically located throughout the state. The
Company also has a special unit which investigates suspected insurance
fraud and abuse. If a claim or loss cannot be settled and results in
litigation, the Company retains outside counsel to represent it.
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The Company believes that through its claims staff of experienced
adjusters, appraisers, managers, and administrative staff, it has
achieved lower LAE than the industry average and higher customer
satisfaction than many of its competitors. All claims office staff
members work closely with agents and claimants with a goal of settling
claims fairly, rapidly and cost effectively.
Certain of the Company's Massachusetts agencies have settlement
authority for claims for other than automobile property losses which are
less than $2,500. The settlement authority of agencies under automobile
policies is limited to claims for towing.
The Massachusetts Unfair Claims Settlement Practices Act ("Chapter
176D") prohibits insurers from engaging in certain claim settlement
practices, including failing to acknowledge and act reasonably promptly
upon communications with respect to claims arising under insurance
policies, refusing to pay claims without conducting a reasonable
investigation based upon all available information, failing to
effectuate prompt, fair and equitable settlements of claims in which
liability has become reasonably clear, and compelling insureds to
institute litigation to recover amounts due under an insurance policy by
offering substantially less than the amounts ultimately recovered in
actions brought by such insureds. An insurer's violation of any of
these obligations expressly violates the Massachusetts Consumer
Protection Act ("Chapter 93A"). Any party, including claimants and
insureds, whose rights are affected by an insurer's violation of Chapter
176D, is entitled to bring a claim against the insurer under Chapter
93A.
The damages available under Chapter 93A may not necessarily be
related to the harm caused by the insurer's violation of Chapter 176D.
Chapter 93A provides in effect that the party bringing the Chapter 93A
claim will be entitled, at a minimum, to the amount of the judgment on
all claims arising out of the same underlying occurrence, regardless of
the limits of the policy issued by insurer. Moreover, Chapter 93A
permits the court to double or triple the party's damages if the
insurer's violation of Chapter 176D was willful or knowing. If the
underlying policy risk was ceded to C.A.R., the Company may seek
reimbursement from C.A.R. for the damages it will be obligated to pay if
it is found liable under Chapter 93A or amounts paid in settlement of
such claim. Such reimbursement is discretionary and C.A.R. may not
reimburse an insurer if C.A.R. determines that the insurer was negligent
in the handling of such claim and such negligence was the cause of
Chapter 93A liability. Additionally, certain time notification
restrictions apply to these judgments, which if not met, could preclude
an insurer from seeking reimbursement from C.A.R. Accordingly, there
can be no assurance that the Company will be reimbursed by C.A.R. in any
particular instance involving a Chapter 93A claim.
In March 1996, the Company began providing an after hours claim
reporting service available to third party claimants and insureds of
certain agencies. The service ensures complete twenty-four (24) hour
service including weekends and holidays.
G. Losses and Loss Adjustment Expense Reserves
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. The Company's reserving policy is intended to result in
a small redundancy. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to obtain annually a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
When a claim is reported to the Company, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon a case-by-
case evaluation of the type of claim involved, the circumstances
surrounding each claim and the policy provisions relating to the type of
loss. The estimate reflects the informed judgment of such personnel
based on general insurance reserving practices and on the experience and
knowledge of the claims person. During the loss adjustment period, these
estimates are revised as deemed necessary by the Company's claims
department based on subsequent developments and periodic reviews of the
cases.
In accordance with industry practice, the Company also maintains
reserves for estimated losses incurred but not yet reported ("IBNR").
IBNR reserves are determined on the basis of historical information and
the experience of the Company. Adjustments to IBNR are made
periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims
processing and other items that can be expected to affect the Company's
liability for losses and LAE over time.
18
<page
When reviewing reserves, the Company analyzes historical data and
estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes in political
attitudes and trends in general economic conditions, including the
effects of inflation. This process assumes that past experience,
adjusted for the effects of current developments and anticipated trends,
is an appropriate basis for predicting future events. There is no
precise method, however, for subsequently evaluating the impact of any
specific factor on the adequacy of reserves, because the eventual
development of reserves is affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company estimates
the ultimate net liability for losses and LAE. After taking into
account all relevant factors, management believes that the provision for
losses and LAE at December 31, 1996 is adequate to cover the ultimate
net cost of losses and claims incurred as of that date. The ultimate
liability may be greater or lower than reserves. Establishment of
appropriate reserves is an inherently uncertain process, and there can
be no certainty that currently established reserves will prove adequate
in light of subsequent actual experience. The Company does not discount
to present value that portion of its loss reserves expected to be paid
in future periods. The Company's loss and LAE reserves also includes
its share of the aggregate loss and LAE reserves of all Servicing
Carriers.
For a reconciliation of beginning and ending reserves for losses
and LAE, net of reinsurance, see Note E to the Company's 1996
Consolidated Financial Statements, which is incorporated herein by
reference from pages 29 through 31 of the Company's 1996 Annual Report.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known and
unknown losses. Because of the Company's limited exposure to these
types of claims, Management believes they will not have a material
impact on the consolidated financial position of the Company. Loss
reserves on environmental related claims amounted to $8,783,000 and
$10,708,000 in 1996 and 1995, respectively.
The following table represents the development of reserves, net of
reinsurance, for 1986 through 1996. The top line of the table shows the
reserves at the balance sheet date for each of the indicated years.
This represents the estimated amounts of losses and LAE for claims
arising in all years that were unpaid at the balance sheet date,
including losses that had been incurred but not yet reported to the
Company. The upper portion of the table shows the cumulative amounts
paid as of successive years with respect to that year's current reserve
liability expressed as a percentage. The lower portion of the table
shows the re-estimated amount as a percentage of the previously recorded
reserves based on experience as of the end of each succeeding year,
including cumulative payments made since the end of the respective year.
The estimate changes as more information becomes known about the
frequency and severity of claims for individual years. Favorable loss
development exists when the original reserve estimate is greater than
the re-estimated reserves at December 31, 1996.
19
<page
In evaluating the cumulative information in the table, it should
be noted that each year's amount includes the effects of all changes in
amounts for prior periods. This table does not present accident or
policy year development data. Conditions and trends that have affected
development of the liability in the past may not necessarily occur in
the future. Accordingly, it is not appropriate to extrapolate future
development based on this table.
<TABLE>
Year ended December 31,
1996 1995 1994 1993 1992
1991 1990 1989 1988 1987 1986
($ in thousands)
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
<C> <C> <C> <C> <C>
Reserves for
losses and loss
adjustment
expenses........ $521,061 $486,673 $448,331 $415,613 $316,261
$228,657 $177,657 $138,456 $100,882 $70,457 $49,069
Paid (cumulative)
as a percentage
of current re-
serves as of:
One year later.. 42.0 44.5 51.3 49.4
45.6 45.6 46.4 41.7 40.4 41.8
Two years later. 63.7 70.0 74.3
70.2 67.6 68.7 67.9 60.0 65.1
Three years
later.......... 80.0 83.2
86.0 83.5 81.1 82.3 80.5 78.7
Four years
later.......... 88.1
89.9 94.5 89.5 89.2 89.0 94.4
Five years later
92.0 95.1 97.3 92.4 92.3 99.6
Six years later.
94.5 97.2 99.5 93.6 102.2
Seven years
later..........
96.1 99.8 101.4 103.2
Eight years
later..........
97.7 101.8 103.4
Nine years
later..........
98.8 103.7
Ten years later.
98.9
Reserves re-estimated
as a percentage of
initial reserves as of:
One year later.. 82.0 83.4 83.7 87.2
82.3 84.5 92.7 96.9 99.4 95.3
Two years later. 72.7 75.5 78.6
82.8 74.6 82.8 87.7 98.9 91.7
Three years
later.......... 69.0 73.0
77.1 75.1 76.7 80.5 90.1 91.8
Four years later 68.8
72.2 71.7 78.2 76.3 86.2 85.0
Five years later
68.7 68.2 75.6 80.2 83.9 83.5
Six years later.
65.5 74.0 78.0 90.8 83.0
Seven years
later.........
71.8 77.3 88.5 82.5
Eight years
later.........
75.4 87.9 82.3
Nine years later
85.2 82.0
Ten years later.
78.2
Redundancy expressed as a
percent of yearend
reserves......... 18.0 27.3 31.0 31.2
31.3 34.5 28.2 24.6 14.8 21.8
</TABLE>
<page
H. Operating Ratios
Loss and Underwriting Expense Ratios
Loss and underwriting expense ratios are used to interpret the
underwriting experience of property and casualty insurance companies.
Losses and LAE are stated as a percentage of premiums earned because
losses may occur over the life of a policy. Underwriting expenses on a
statutory basis are stated as a percentage of net premiums written
rather than premiums earned because most underwriting expenses are
incurred when policies are written and are not spread over the policy
period. Underwriting profit margins are reflected by the extent to
which the combined loss and underwriting expense ratios, the combined
ratio, is less than 100%. The combined ratio is considered the best
simple index of current underwriting performance of an insurer. The
Company's loss ratio, underwriting expense ratio and combined ratio, and
the industry combined ratio, on a statutory basis, are shown in the
following table. The Company's ratios include lines of insurance other
than automobiles as do the industry combined ratios for all writers.
Data for the property and casualty industry generally may not be
directly comparable to Company data. This is due to the fact that the
Company conducts its business primarily in Massachusetts.
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Company Statutory Ratios (unaudited):
Loss Ratio...................... 70.9% 62.0% 64.6%
68.0% 66.2%
Underwriting Expense Ratio...... 27.1 29.0 27.1
25.7 28.1
Combined Ratio................. 98.0% 91.0% 91.7%
93.7% 94.3%
Industry combined ratio
(all writers)(1)............... 103.1% 102.5% 103.0%
102.9% 107.4%
</TABLE>
(1) Source: Best's Review (January, 1997), as reported by A.M. Best for
all property and casualty insurance companies and weighted to reflect
the Company's product mix. The 1996 industry information is estimated by
A.M. Best.
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the
Company's and the industry's statutory ratios of net premiums written to
policyholders' surplus. While there is no statutory requirement
applicable to the Company which establishes a permissible net premiums
to surplus ratio, guidelines established by the National Association of
Insurance Commissioners ("NAIC") provide that this ratio should be no
greater than 300%.
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
(dollars in
thousands)
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Net premiums written by the
Company........................... $711,570 $603,421 $589,197
$563,416 $508,847
Policyholders' surplus of the
Company........................... 464,739 440,110 349,775
284,631 221,434
The Company's ratio................ 153.1% 137.1% 168.5%
197.9% 229.8%
Industry ratio(1).................. 100.0% 120.0% 134.7%
132.5% 139.5%
</TABLE>
__________________________________
(1) Source: Best's Review (January, 1997), for all property and
casualty insurance companies. The 1996 industry information is
estimated by A.M. Best.
21
<page
I. Investments
Investment income is an important source of revenue for the
Company and the return on its investment portfolio has a material effect
on its net earnings. The Company's investment objective is to maintain
high quality diversified fixed maturity investments structured to
maximize after-tax investment income while minimizing risk. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" incorporated herein by reference from pages 4 through 15
of the Company's 1996 Annual Report.
The Company's investment portfolio carried at market value as of
December 31, 1996, was $1,027,136 excluding cash and cash equivalents.
Of that amount, 69.8% was invested in fixed maturities, 22.8% was
invested in equity securities, 7.4% was invested in mortgage loans and
other investments.
Investments in fixed maturities, which include bonds and
redeemable preferred stocks, and investments in equity securities, which
include common stocks, non-redeemable preferred stocks and preferred
stock mutual funds, are carried at fair market value. Unrealized
investment gains and losses on equity securities and fixed maturities,
to the extent that there is no permanent impairment of value, are
credited or charged directly to stockholders' equity, net of any tax
effect. When investment securities are sold, the realized gain or loss
is determined based on sales proceeds less book value.
The Company's bond portfolio is comprised of Government National
Mortgage Association ("GNMA") mortgage backed bonds (31.5%) and
municipal bonds (68.5%). Of the Company's bonds, 100.0% are rated in
the two highest quality categories provided by the NAIC.
The Company's investment policy, determined in accordance with
guidelines established by the Company's Board of Directors, emphasizes
investment yield while maintaining investment quality. The Board of
Directors reviews and ratifies management's investment decisions on a
quarterly basis. State insurance laws also impose restrictions on the
nature and extent of investments by the Company.
The table below sets forth investments (at cost) and the income
thereon for the five years ended December 31, 1996.
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
(dollars in
thousands)
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Average net investments.......... $1,060,538 $996,169 $889,700
$749,821 $520,890
Net realized gains (losses) on
investments.................... (7,574) 712 45,612
7,506 1,537
Unrealized gains (losses) on
fixed maturities............... 16,191 13,969 (56,366)
27,477 -
Unrealized gains (losses) on
equity securities.............. 19,315 11,422 (8,887)
13,199 22,279
Net investment income............ 77,402 71,313 62,901
53,068 39,223
Net investment income as a
percentage of total average
investments..................... 7.30% 7.16% 7.07 %
7.08% 7.53%
</TABLE>
22
<page
The following table sets forth an analysis of carrying value by
the type of investment at December 31, 1992 at cost and 1993 through
1996 at fair market value:
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
(dollars in
thousands)
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Type of Investment
GNMA mortgage-backed bonds...... $ 225,552 $ 221,373 $233,287
$202,403 $102,873
Tax exempt state and municipal
bonds.......................... 491,150 593,904 511,723
447,088 402,692
Redeemable preferred stocks..... - - -
- - 2,261
Total fixed maturity
investments................ 716,702 815,277 745,010
649,491 507,826
Mortgages and collateral loans
(net of allowance for possible
loan losses)................... 74,586 75,609 58,590
63,301 69,948
Preferred stock mutual funds.... 29,087 - -
- - -
Common stocks................... 56,954 40,359 9,656
65,863 53,345
Non-redeemable preferred stocks. 147,680 111,220 85,574
80,058 -
Other investments............... 2,127 1,648 716
1,304 2,351
Total investments........... $1,027,136 $1,044,113 $899,546
$860,017 $633,470
</TABLE>
The table below sets forth as of December 31, 1996 the composition
of the Company's fixed maturity investments, excluding short-term
investments, by time to maturity at the dates indicated:
<TABLE>
Percent
of
Amount
Portfolio
(dollars in thousands)
<CAPTION>
<S> <C>
<C>
Period from December 31, 1996 to maturity:
One year or less................................. $
517 0.1%
More than one year to five years.................
102 -
More than five years to ten years................
1,681 0.2
More than ten years..............................
714,402 99.7
$716,702 100.0%
</TABLE>
At December 31, 1996, the Company's fixed income portfolio, which
represented 69.8% of the Company's total invested assets, had an average
stated maturity of approximately 26.5 years. The calculation of average
stated maturity utilizes the dollar weighted average of the actual
maturity date for a security. In contrast, the Company's weighted
average duration can be significantly less. At December 31, 1996, the
Company's fixed income portfolio had a weighted average duration of 5.4
years. The "duration" of a security is the time-weighted present value
of the security's expected cash flows and is used to measure a
security's price sensitivity to changes in interest rates. The weighted
average duration is short compared to the average stated maturity
because of the relatively large percentage of GNMA's in the fixed
maturity portfolio. The duration of GNMA's reflects industry prepayment
assumptions. With respect to GNMA's, investors are compensated
primarily for reinvestment risk rather than credit quality risk. During
periods of significant interest rate volatility, the underlying
mortgages may prepay more quickly or more slowly than anticipated. If
the repayment of principal occurs earlier than anticipated during
periods of declining interest rates, investment income may decline due
to the reinvestment of these funds at the lower current market rates. In
regards to municipal bonds, the Bloomberg Financial System utilizes
optional call dates, sinking fund requirements and assumes a non-static
prepayment pattern in deriving these averages.
23
<page
J. Regulation
General
The Company's primary business is subject to extensive regulation
by the Commissioner who is appointed by the Governor of Massachusetts.
The Commissioner has broad authority to fix and establish maximum policy
rates and minimum agent commission levels on personal automobile
insurance. In addition, the Commissioner grants and revokes licenses to
write insurance, approves policy forms, sets reserve requirements,
determines the form and content of statutory financial statements and
establishes the type and character of portfolio investments. The
Commissioner also approves company submissions regarding group insurance
programs and corresponding discounts along with SDIP deviations.
Consequently, the policies and regulations set by the Commissioner are
an important element of writing insurance in Massachusetts.
During the three-year period from 1994 to 1996, Massachusetts
personal automobile insurance premium rates decreased an average of 2.6%
per year. The Commissioner approved an average 6.2% decrease in
personal automobile premiums for 1997, the third decrease in three
years, as 1996 average rates were cut by 4.5%, and 1995 average rates
were decreased by 6.1%. According to the Commissioner's office, the
current rate environment is the result of continued consumer cooperation
by driving safely, obeying traffic laws, reporting fraud, wearing
seatbelts and individuals locking their autos.
Also, the 1997 decrease was partially driven by corrections to an
industry error impacting prior year rate decisions. The industry error
resulted from a miscaluation of industry expense allowances that had the
effect of overstating rates for 1991 through 1996. Rates for 1997
include an adjustment to recoup this error from the industry equal to
40% of the error with 40% reducing 1998 rates and 20% reducing 1999
rates.
Additionally, 1997 rates were decreased as a result of the
reconciliation of the SDIP which is designed to be revenue neutral. In
most recent past years, the SDIP reconciliation resulted in a deficit
which was then added into the rates for the subsequent years. The 1996
SDIP reconciliation, however, resulted in a surplus. Fifty percent of
this surplus is being used to decrease rates in both 1997 and 1998.
The Company has performed an analysis of the rate decision and has
estimated the impact of the above two items on its results assuming its
market share remains the same as it was at the end of 1996. The earned
premium impact is estimated to be approximately $15.3 million for 1997,
$23.0 million for 1998 and $13.5 million for 1999. The earnings per
share after-tax impact resulting from the lower earned premiums for
1997, 1998 and 1999 is estimated to be $0.28, $0.41 and $0.23,
respectively. If the Company's future market share increases
(decreases), a larger (smaller) financial impact would result.
24
<page
The AIB has filed an appeal with the Massachusetts Supreme
Judicial Court challenging the Commissioner's decision to prospectively
decrease future rates for the miscalculation of the industry expense
allowance. (The SDIP reconciliation component is not being challenged.)
The AIB's argument is that, according to statute, there is a prohibition
against retroactive rate making in Massachusetts which effectively bars
the examination of past year's data once all involved parties have
agreed to the rate decision. One insurer has filed a suit with the
Massachusetts Supreme Judicial Court alleging that the prospective
nature of the rate reduction will have an unfair adverse impact on it.
This is due to the fact that the company filing suit believes it should
not be adversely impacted solely because its market share is greater now
than during those years in which the errors occurred It is not possible
to predict the outcome of these legal actions or the potential effects
thereof on the Company.
In addition, the MAIA has also filed a suit with the Massachusetts
Supreme Judicial Court with respect to the Commissioner's ruling on 1997
commissions. The Commissioner ruled that agents' commissions on 1997
premiums, subject to safe driver discounts, will be based on the
discounted net premium amounts. The 1996 commissions were based on the
gross premium amounts. The Commissioner's ruling will result in agents
receiving fewer commission dollars on a per policy basis. The Company
is unable to predict the possible outcome of this suit at this time.
The State Divisions of Insurance are responsible for conducting
periodic examinations of insurance companies. Both Commerce and
Citation were last examined for the five year period ended December 31,
1993. Western Pioneer was last examined for the three year period ended
December 31, 1991. These examinations produced no material findings.
Massachusetts Division of Insurance regulations provide that insurance
companies will be examined every five years or more frequently as deemed
prudent by the Commissioner. California Division of Insurance
regulations provide that insurance companies will be examined every
three years.
Automobile Insurance Regulation Overview
Massachusetts has required compulsory automobile insurance
coverage since 1925. Under current law, all motorists are required to
carry certain minimum coverages mandated by the state. The Commissioner
fixes and establishes, among other things, the maximum rates insurers
may charge for the compulsory personal automobile coverages. With very
limited exceptions, each insurer writing automobile insurance in
Massachusetts must accept all risks submitted to it for the compulsory
coverage, but is permitted to reinsure these risks (including group
insurance risks) through C.A.R.
Compulsory Coverage. Compulsory coverage includes no-fault
coverage, limited bodily injury coverage, property damage coverage and
coverage against uninsured or hit and run motorists. The Massachusetts
no-fault statute provides for personal injury protection ("PIP")
coverage, which entitles a party to be reimbursed directly by the
party's own insurer for certain medical expenses, lost wages and other
defined expenses arising from an automobile accident, up to a specific
amount, even if another party caused the accident.
Rates and Commissions. All Massachusetts personal automobile
insurance rates are fixed and established annually by the Commissioner.
Group insurance programs and rate deviations must be approved by the
Commissioner. For Massachusetts commercial automobile insurance, the
rates for the voluntary market are competitive, with insurers filing
rates for review by the Commissioner based on their own experience. The
rates for the Massachusetts commercial automobile risks reinsured
through C.A.R. are fixed and established by the Commissioner except for
non-fleet, private passenger-type automobiles.
25
<page
In fixing classifications of risks and establishing rates, the
Commissioner must consider numerous factors including driver and
automobile characteristics and the claim rate in the state's designated
geographical territories. These factors are based upon data which are
two or more years old. The insurer adjusts the premiums it charges to a
policyholder based upon the SDIP record of the operator. Moving
violations and at-fault accidents affect each driver's SDIP record. In
addition, the Extra Risk Rating regulations permit insurers to deny or
charge surcharged rates for physical damage coverage to both high risk
vehicles and insureds with excessive prior loss or violation activity.
The Commissioner sets an average minimum direct agency commission
rate for personal automobile insurance, which in 1996 was 13.8%. With
respect to risks reinsured through C.A.R., the maximum amount of
commissions that C.A.R. will reimburse is fixed at that prescribed rate.
Mandatory Underwriting. Massachusetts law specifies that all
individuals holding a valid driver's license are entitled to purchase
the mandatory automobile insurance regardless of their driving
experience or accident record. The Massachusetts Legislature has also
placed certain restraints on insurers' discretion to refuse to renew
automobile insurance policies. Policyholders are entitled to renew
except in cases of fraud, material misrepresentation, revocation or
suspension of an operator's license or nonpayment of premiums. With
very limited exceptions, Servicing Carriers writing automobile insurance
in Massachusetts must accept every automobile risk submitted to them.
Under the Massachusetts system of rate regulation, it is intended
that some personal automobile insurance risks are underpriced at the
maximum rate permitted by the Commissioner, and therefore, absent state-
intervention, insurers would not ordinarily choose to write those risks.
The C.A.R. reinsurance program described below is intended to mitigate
the burden imposed by the Massachusetts take-all-comers system by
allowing insurers to transfer the exposure for undesirable risks to an
industry pool.
Commonwealth Automobile Reinsurers
General. C.A.R. is a state-mandated reinsurance mechanism, under
which all premiums, expenses and losses on ceded business are shared by
all insurers. It is similar to a joint underwriting association because
a number of insurers (approximately 41, including the Company) act as
Servicing Carriers for the risks it insures.
Agencies. In general, agencies licensed to issue automobile
insurance policies are entitled to be assigned to at least one Servicing
Carrier. There are two categories of agencies: those who have voluntary
agreements with one or more Servicing Carriers and those who do not.
The latter are assigned by C.A.R. to a single Servicing Carrier and are
known as ERPs.
C.A.R. Operations. All companies writing automobile insurance in
Massachusetts share in the underwriting results of the C.A.R. business
for their respective product line or lines, whether or not they are
Servicing Carriers. An insurer's share of the C.A.R. deficit is
allocated on the basis of a formula called a participation ratio, which
can vary significantly between the personal and commercial pools, and
between different policy years. See "Business--Commonwealth Automobile
Reinsurers" for a detailed discussion of the method of calculating the
participation ratio.
An insurer may terminate its participation in C.A.R. as of the
close of C.A.R.'s fiscal year by surrendering its license to write
automobile policies in Massachusetts. Termination does not discharge or
otherwise affect liability of an insurer incurred prior to termination.
A withdrawing insurer is assessed a share of C.A.R.'s projected deficits
for future years based on the insurer's prior years' participation in
C.A.R. The assessment paid by the withdrawing insurer is redistributed
to the remaining insurers based upon their participation ratios.
26
<page
An insurer can transfer its obligations for its personal insurance
policies to another insurer who formally agrees to assume these
obligations. The transferring insurer is thereby relieved of future
C.A.R. obligations which otherwise would have arisen as a consequence of
the business transferred. See "Business--Commonwealth Automobile
Reinsurers."
Insurance Holding Company Structure
As an insurance holding company, the Company is subject to
regulation under the insurance holding company statutes of the states in
which they are domiciled. Because the Company's subsidiaries are
members of an insurance holding company system, they are required to
register with their respective Divisions of Insurance and to submit
reports describing the capital structure, general financial condition,
ownership and management of each insurer and any person or entity
controlling the insurer, the identity of every member of the insurance
holding company system and the material outstanding transactions between
the insurer and its affiliates.
Each member of the insurance holding company system must keep
current the information required to be disclosed by reporting all
material changes or additions within 15 days of the end of the month in
which it learns of such change or addition.
Massachusetts law prohibits a party which is not a domestic
insurer from acquiring "control" of a domestic insurer or of a company
controlling a domestic insurer without prior approval of the
Commissioner. Control is presumed to exist if a party directly or
indirectly holds, owns or controls more than ten percent of the voting
stock of another party, but may be rebutted by a showing that control
does not exist.
In the event of the insolvency, liquidation or other
reorganization of any of the Company's insurance subsidiaries, the
creditors and stockholders of the Company will have no right to proceed
against the assets of those subsidiaries, or to cause the liquidation or
bankruptcy of any company under federal or state bankruptcy laws. State
laws govern such liquidation or rehabilitation proceedings and the
Division of Insurance would act as receiver for the particular company.
Creditors and policyholders of the insurance subsidiaries would be
entitled to payment in full from such assets before the Company, as a
stockholder, would be entitled to receive any distribution therefrom.
Payment of Dividends
Under Massachusetts law, insurers may pay cash dividends only from
earnings and statutory surplus, and the insurer's remaining surplus must
be both reasonable in relation to its outstanding liabilities and
adequate to its financial needs.
As Massachusetts domestic insurance companies, neither Commerce
nor Citation may pay an extraordinary dividend or distribution unless
the insurer gives the Commissioner at least 30 days' prior notice of the
declaration and the Commissioner does not disapprove of the plan of
payment prior to the date of such payment. An extraordinary dividend or
distribution is one whose fair market value, together with that of other
dividends or distributions within the preceding twelve-month period
(excluding pro rata distribution of any class of the insurer's own
securities) exceeds the greater of (i) ten percent of the insurer's
statutory surplus as of the preceding December 31, or (ii) the statutory
net investment income for the twelve-month period ending on the
preceding December 31. See "Market for Registrant's Common Stock and
Related Stockholder Matters."
27
<page
Protection Against Insurer Insolvency
All of the insurers writing the types of insurance covered by The
Massachusetts Insurers Insolvency Fund ("M.I.I.F.") are M.I.I.F.
members. M.I.I.F. is obligated to pay any unpaid claim, up to $300,000,
against an insolvent insurer if the claim existed prior to the
declaration of insolvency or arose within 60 days thereafter. M.I.I.F.
assesses members the amounts necessary to pay both its obligations and
the expenses of handling covered claims. Subject to certain
limitations, assessments are made in the proportion that each member's
net written premiums for the preceding calendar year for all property
and casualty lines of business bore to the corresponding net written
premiums for all members for the same period. The statute that
established M.I.I.F. also provides for the recoupment by insurers of
amounts paid to M.I.I.F. Historically, the Commissioner has allowed
insurers to recoup the amounts they paid M.I.I.F. through rate
increases.
Consistent with industry practice in Massachusetts, it is the
Company's policy to record all assessments when they are assessed.
M.I.I.F. assessed Commerce and Citation an aggregate of $742,000 in
1996, $338,000 in 1995 and $331,000 in 1994. The Company anticipates
that there will be additional assessments. By statute, no insurer may
be assessed in any year an amount greater than two percent of that
insurer's net direct written premiums for the calendar year preceding
the assessment. The Company believes that any such additional
assessments should not have a material adverse effect on the
consolidated financial position of the Company, although the timing and
amounts of any such assessments cannot be presently ascertained.
NAIC Guidelines
Insurance Regulatory Information System Ratios. The NAIC Insurance
Regulatory Information System ("IRIS") was developed by a committee of
state insurance regulators and is intended primarily to assist state
insurance regulators in executing their statutory mandates to oversee
the financial condition of insurance companies operating in their
respective states. IRIS identifies eleven industry ratios and specifies
"usual values" for each ratio. Departure from the usual values on four
or more of the ratios can lead to inquiries from individual state
insurance commissioners as to certain aspects of an insurer's business.
For the year ended December 31, 1996, the Company's consolidated
property and casualty operations had no ratios outside the "normal"
range.
Risk-Based Capital ("RBC"). In order to enhance the regulation of
insurer insolvency, the NAIC developed a formula and model law to
implement RBC requirements for property and casualty insurance companies
which are designed to assess capital adequacy and to raise the level of
protection that statutory surplus provides for policyholder obligations.
The RBC model for property and casualty insurance companies measures
three major areas of risk facing property and casualty insurers: (i)
underwriting, which encompasses the risk of adverse loss development and
inadequate pricing; (ii) declines in asset values arising from credit
risk; and, (iii) other business risks from investments. Insurers having
less statutory surplus than required by the RBC calculation will be
subject to varying degrees of regulatory action, depending on the level
of capital inadequacy.
28
<page
The Company's subsidiaries, Commerce and Citation, have RBC
amounts at December 31, 1996 of $52 million and $4 million,
respectively, and they have statutory surplus of approximately $394
million and $71 million, respectively. The Statutory surplus of
Commerce and Citation at December 31, 1996 exceeded the RBC Company
Action Levels of $103 million and $8 million by approximately $291
million and $63 million. The RBC model formula proposes four levels of
regulatory action. The extent of regulatory intervention and action
increases as the level of surplus to RBC falls. The first level, the
Company Action Level, requires an insurer to submit a plan of corrective
actions to the regulator if surplus falls below 200% of the RBC amount.
The Regulatory Action Level (as defined by the NAIC) requires an insurer
to submit a plan containing corrective actions and permits the
Commissioner to perform an examination or other analysis and issue a
corrective order if surplus falls below 150% of the RBC amount. The
Authorized Control Level (as defined by the NAIC) allows the regulator
to rehabilitate or liquidate an insurer in addition to the
aforementioned actions if surplus falls below 100% of the RBC amount.
The fourth action level is the Mandatory Control Level (as defined by
the NAIC) which requires the regulator to rehabilitate or liquidate the
insurer if surplus falls below 70% of the RBC amount.
K. Competition
The property and casualty insurance industry is highly cyclical,
characterized by periods of increasing premium rates and limited
underwriting capacity, followed by periods of intensive price
competition and abundant underwriting capacity. This industry also is
highly competitive, with a large number of companies, many of which
operate in more than one state, offering automobile, homeowners,
commercial property and other lines of insurance. Some of the Company's
competitors have larger volumes of business and greater financial
resources. Some sell insurance directly to policyholders rather than
through independent agents.
In 1995, several insurers within the Massachusetts Insurance
Industry began pursuing group marketing programs as a means of shifting
market share. Arising from this pursuit, additional programs such as
safe driver deviations and the elimination of finance fees have
followed. Commerce's group automobile discounts and SDIP deviations can
be combined for up to a 19% reduction from the state mandated rates.
The Company has actively pursued each of these endeavors in 1996 and
will continue to do so in 1997.
Because the Company's insurance products are marketed exclusively
through independent agencies--most of whom represent more than one
company--the Company faces competition within each agency. The Company
competes for business from independent agencies by paying them
significant compensation in the form of profit sharing payments which
are based in part on the underwriting profits of the agency business
written with the Company, providing a consistent market, promptly
servicing policyholder claims, providing agency support services and by
providing competitively priced personal automobile products. Although
the Company believes, based upon regular surveys of its agencies, its
relationships with its independent agencies are excellent, any
disruption in these relationships could adversely affect the Company's
business.
The Company believes the Massachusetts regulatory environment,
which fixes maximum personal automobile insurance rates, apportions
losses incurred by C.A.R. and establishes minimum agency commissions,
has discouraged certain companies with more diverse geographic markets
and interests from establishing a presence or expanding their market
share in Massachusetts.
29
<page
L. Other Matters
Human Resources
As of December 31, 1996, the Company and its subsidiaries employed
1,380 people. The Company is not a party to any collective bargaining
agreements and believes its relationship with employees to be good.
The Company offers benefits, compensation and employee relations
programs to assure a productive and positive working environment. The
Company monitors job grades and salary scales of peer companies to
assure that its compensation levels and benefits are competitive both
within the property and casualty industry and geographically within
Central Massachusetts. The Company has been recognized for its
progressive programs designed to meet the needs of a modern-day
workforce. On-site child care has been offered to employees since 1986.
Commerce was one of the first businesses in the region to offer this
benefit. The child care center can currently accommodate over 130
children of our employees.
The Company maintains an Employee Stock Ownership Plan
("E.S.O.P."), for the benefit of all employees and former employees
still participating in the E.S.O.P. There were a total of 1,385
participants at December 31, 1996.
ITEM 2. PROPERTIES
The Company conducts its operations from approximately 277,000
square feet of space in several buildings which it owns in Webster,
Massachusetts, which is located approximately 50 miles west of Boston.
The Company's principal administrative offices in Webster consist of
recently rehabilitated and newly constructed buildings. Its data
processing and operational departments are housed in modern office
buildings on a separate nine acre site. The Company's new acquisition,
Western Pioneer, currently leases approximately 12,000 square feet of
office space in Pleasanton, California. For additional information
concerning property, see Note D to the Company's 1996 Consolidated
Financial Statements, which is incorporated herein by reference from
page 29 of the Company's 1996 Annual Report.
ITEM 3. LEGAL PROCEEDINGS
As is common with property and casualty insurance companies, the
Company is a defendant in various legal actions arising from the normal
course of its business, including claims based on Chapter 176D and
Chapter 93A. See "Business - Settlement of Claims". These proceedings
are considered to be ordinary and incidental to operations or without
foundation in fact. Management is of the opinion that these actions
will not have a material adverse effect on the consolidated financial
position of the Company.
30
<page
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders
during the fourth quarter of 1996.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's executive officers are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Name Age Position with
Company
Arthur J. Remillard, Jr. 66 Chief Executive Officer,
Director
Gerald Fels 54 Executive Vice
President,
Chief Financial Officer,
Director
Arthur J. Remillard, III 41 Senior Vice President--
Policyholder
Benefits, Assistant Clerk, Director
Regan P. Remillard 33 Senior Vice President--
General Counsel,
Director
David H. Cochrane 43 Senior Vice President--
Underwriting of
Commerce and Citation
Mary M. Fontaine 40 Senior Vice President--
Human Resources
Robert E. Longo 62 Senior Vice President--
Marketing of
Commerce and Citation
Joyce B. Virostek 54 Senior Vice President--
Management
Information Systems of Commerce and
Citation
</TABLE>
Arthur J. Remillard, Jr. has been the Chief Executive Officer of
the Company since 1972 and has been in the insurance business for more
than 30 years. Mr. Remillard, Jr. is also a member of the Governing
Committee, Chairman of the Actuarial Committee, Vice Chairman of the
Governing Committee Review Panel, and is a member of the Budget and
Personnel Committees of C.A.R.
Gerald Fels, a certified public accountant, was elected Executive
Vice President of the Company in 1989. From 1981 to 1989, Mr. Fels had
been Senior Vice President of the Company. Mr. Fels was the Treasurer
of the Company from 1975 to 1994. Mr. Fels has also been Chief
Financial Officer since 1975. Mr. Fels also serves on the C.A.R. Audit
Committee.
Arthur J. Remillard, III was elected Senior Vice President--
Policyholder Benefits in 1988. From 1981 to 1988, Mr. Remillard, III had
been Vice President--Mortgage Operations. In addition, Mr. Remillard,
III has also served on the Board of Governors of the Insurance Fraud
Bureau of the A.I.B. since January, 1991, the C.A.R. Claims Advisory
Committee since June 1990 and the A.I.B. Claims Committee since April
1991.
Regan P. Remillard was elected President of Western Pioneer
Insurance Company in 1996. Mr. Remillard was elected Senior Vice
President--General Counsel in 1995. From 1994-1995, Mr. Remillard was a
practicing attorney at Hutchins, Wheeler & Dittmar, a Massachusetts law
firm specializing in corporate law and litigation. From 1989-1993, Mr.
Remillard was Government Affairs Monitor of the Company. Mr. Remillard
is a member of the Massachusetts Bar.
31
<page
David H. Cochrane has been the Senior Vice President--Underwriting
of Commerce and Citation since 1988. For approximately four years prior
to that, Mr. Cochrane was the Vice President of Financial Services of
C.A.R. Mr. Cochrane has also served on the C.A.R. Market Review
Committee since 1988.
Mary M. Fontaine has been the Senior Vice President--Human
Resources of the Company since 1988. From 1982 to 1988, Ms. Fontaine
was Assistant Vice President--Human Resources of Commerce and Citation.
Robert E. Longo has been the Senior Vice President--Marketing of
Commerce and Citation since 1988. From 1985 to 1988, Mr. Longo served
as Marketing Manager of Commerce and Citation.
Joyce B. Virostek has been the Senior Vice President--Management
Information Systems of Commerce and Citation since 1988. From 1981 to
1988, Ms. Virostek had been Vice President of Commerce and Citation in
charge of data processing.
The executive officers are elected to hold office until their
successors are elected and qualify.
The only family relationship among the executive officers is that
Arthur J. Remillard, III and Regan P. Remillard are the sons of Arthur
J. Remillard, Jr.
32
<page
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Beginning March 31, 1995, the Company's common stock began trading
on the New York Stock Exchange, under the symbol "CGI". Previously, the
Company's common stock had been traded on Nasdaq under the symbol
"COMG".
The high, low and close prices for shares of the Company's common
stock for 1996 and 1995 were as follows:
<TABLE>
1996
1995
High Low Close High
Low Close
<CAPTION>
<S> <C> <C> <C> <C>
<C> <C>
First Quarter............ $20-3/4 $17-3/4 $19-3/4 $17
$14-3/4 $16-3/4
Second Quarter........... 22-1/2 18-1/2 20-7/8 17-
7/8 16-1/4 17-7/8
Third Quarter............ 22-1/4 20-1/2 22 19-
7/8 16-3/4 19-5/8
Fourth Quarter........... 25-3/4 22 25-1/4 21-
7/8 19-1/2 20-5/8
</TABLE>
As of March 1, 1997, there were 1,294 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name" or
held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $.81 per share
and $.23 per share in 1996 and 1995, respectively. On May 17, 1996, the
Board voted to increase the quarterly stockholder dividend from $.06 to
$.25 per share to stockholders of record as of June 7, 1996. Prior to
that declaration, the Company had paid quarterly dividends of $.06 per
share dating back to May 19, 1995 when the Board voted to increase the
dividend from $.05 to $.06 per share. The $.05 cash dividend per share
was first declared by the Board on May 20, 1994.
The purchase of Treasury Stock under the stock buyback program
increased by 673,915 shares during 1996 to 1,937,348 shares at December
31, 1996. The stock buyback program, authorized by the Board in May
1995, enables the Company to purchase up to three million shares of the
Company's common stock. The program is now approximately two-thirds
complete.
The Company's cash flow consists primarily of dividends received
from CHI, which receives dividends from Commerce and Citation. The
payment of any cash dividends to holders of common stock by the Company
therefore depends on the receipt of dividend payments from CHI. To the
extent Commerce and Citation are restricted from paying dividends to
CHI, CHI will be limited in its ability to pay dividends to the Company.
The payment of dividends by Commerce and Citation is subject to
limitations imposed by Massachusetts law, as discussed under the caption
"Payment of Dividends" in Item 1J of this report.
ITEM 6. SELECTED FINANCIAL DATA
The five-year financial information under the caption "Selected
Consolidated Financial Data" on page 40 of the Company's 1996 Annual
Report is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 4 through 15 of the Company's 1996 Annual
Report is incorporated herein by reference.
33
<page
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements for the years
ended December 31, 1996, 1995 and 1994 and the report of its independent
accountants on pages 17 through 39 of the Company's 1996 Annual Report
are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item and not provided in Item
4A will be contained in the Company's Proxy Statement which the Company
intends to file within 120 days after the end of the Company's fiscal
year ended December 31, 1996 and such information is incorporated herein
by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1996
and such information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1996
and such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1996
and such information is incorporated herein by reference.
34
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
<S><C> <C>
<C>
A. (1) The following financial statements have been incorporated
herein by reference
from the pages indicated below of the Company's 1996 Annual
Report:
Page
Report of Independent
Accountants................................ 17
Consolidated Balance Sheets as of December 31, 1996 and
1995..... 18
Consolidated Statements of Earnings for the years ended
December 31, 1996, 1995 and
1994................................ 19
Consolidated Statements of Stockholders' Equity for the
years
ended December 31, 1996, 1995 and
1994........................... 20
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and
1994................................ 21
Notes to Consolidated Financial
Statements....................... 22
(2) The financial statement schedules are listed in the Index
to Consolidated
Financial Statement Schedules.
(3) The exhibits are listed in the Index to Exhibits.
B. No Reports on Form 8-K were filed during the quarter ended
December 31, 1996.
</TABLE>
35
<page
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.
Dated: March 26, 1997
THE COMMERCE GROUP, INC.
By
ARTHUR J.
REMILLARD, JR.
(Arthur J.
Remillard, Jr.)
(President, Chief Executive
Officer and Director)
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
Signature Title
<CAPTION>
<S> <C>
ARTHUR J. REMILLARD, JR. President, Chief
Executive Officer and (Arthur J. Remillard, Jr.)
Director
GERALD FELS Executive Vice
President, Chief Financial
(Gerald Fels) Officer and Director
ARTHUR J. REMILLARD, III Senior Vice President--
Policyholder (Arthur J. Remillard, III)
Benefits, Assistant Clerk and Director
REGAN P. REMILLARD Senior Vice President,
General Counsel and
(Regan P. Remillard) Director
JOHN W. SPILLANE Clerk and Director
(John W. Spillane)
RANDALL V. BECKER Treasurer and Chief
Accounting Officer
(Randall V. Becker)
HERMAN F. BECKER Director
(Herman F. Becker)
JOSEPH A. BORSKI, JR. Director
(Joseph A. Borski, Jr.)
Director
(Eric G. Butler)
HENRY J. CAMOSSE Director
(Henry J. Camosse)
36
<page
DAVID R. GRENON Director
(David R. Grenon)
ROBERT W. HARRIS Director
(Robert W. Harris)
ROBERT S. HOWLAND Director
(Robert W. Howland)
JOHN J. KUNKEL Director
(John J. Kunkel)
RAYMOND J. LAURING Director
(Raymond J. Lauring)
ROGER E. LAVOIS Director
(Roger E. Lavoie)
NORMAND R. MAROIS Director
(Normand R. Marois)
SURYAKANT M. PATEL Director
(Suryakant M. Patel)
ANTRANIG A. SAHAGIAN Director
(Antranig A. Sahagian)
GURBACHAN SINGH Director
(Gurbachan Singh)
</TABLE>
37
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULES*
<TABLE>
Page
<CAPTION>
<S>
<C>
Reports of Independent Accountants on Financial Statement
Schedules...... 39
</TABLE>
Schedules
<TABLE>
<CAPTION>
<S> <C>
<C>
II Condensed Financial Information of the Registrant as of and
for the
years ended December 31, 1996, 1995 and
1994...................... 40
III Supplementary Insurance Information for the years ended
December 31, 1996, 1995 and
1994.................................. 45
IV Reinsurance for the years ended December 31, 1996, 1995 and
1994... 46
V Valuation and Qualifying Accounts for the years ended
December 31, 1996, 1995 and
1994.................................. 47
X Supplemental Information Concerning Property-Casualty
Insurance
Operations for the years ended December 31, 1996, 1995 and
1994... 48
</TABLE>
* Financial statement schedules other than those listed are omitted
because they are not required, not applicable or the required
information has been included elsewhere.
38
<page
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
Our report on the consolidated financial statements of The
Commerce Group, Inc. and Subsidiaries as of December 31, 1996 and 1995,
and for each of the three years in the period ended December 31, 1996,
has been incorporated by reference in this Form 10-K from Page 17 of the
1996 Annual Report to Stockholders of The Commerce Group, Inc. In
connection with our audits of such financial statements, we have also
audited the related financial statement schedules as of December 31,
1996 and 1995 and for each of the three years in the period ended
December 31, 1996, listed in the index on Page 38 of this Form 10-K.
In our opinion, the financial statement schedules referred to
above, when considered in relation to the basic financial statements
taken as a whole, present fairly, in all material respects, the
information required to be included therein.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
January 24, 1997
39
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
BALANCE SHEETS
December 31,
(Thousands of Dollars)
<TABLE>
1996
1995 1994
ASSETS
<CAPTION>
<S> <C>
<C> <C>
Investments:
Investment in Commerce Holdings, Inc................... $551,490
$513,966 $379,259
Investment in Bay Finance Company, Inc................. 33,061
30,932 29,283
Investment in the Clark-Prout Insurance Agency, Inc.... 1,282
1,156 824
Other investments...................................... 2,000
1,300 500
Total investments.................................. 587,833
547,354 409,866
Cash and cash equivalents................................ 2
6 142
Property and equipment, net of accumulated depreciation.. 1,345
1,465 1,450
Receivable from affiliates............................... 3,767
5,746 5,385
Current income taxes..................................... 3,468
1,459 20
Other assets............................................. 2,411
1,811 1,234
Total assets....................................... $598,826
$557,841 $418,097
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses.................. $ 9,506
$ 5,096 $ 3,804
Deferred income taxes.................................. 1,831
752 500
Other liabilities...................................... 450
2,279 204
Total liabilities.................................. 11,787
8,127 4,508
Stockholders' equity:
Capital stock:
Common stock......................................... 19,000
19,000 19,000
Paid-in capital........................................ 29,621
29,621 29,621
Retained earnings...................................... 576,618
525,452 364,968
625,239
574,073 413,589
Treasury stock, 1,937,348, 1,263,433 and 0 shares in
1996, 1995 and 1994, at cost........................... (38,200)
(24,359) -
Total stockholders' equity......................... 587,039
549,714 413,589
Total liabilities and stockholders' equity......... $598,826
$557,841 $418,097
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
40
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF EARNINGS
Years ended December 31,
(Thousands of Dollars)
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C>
<C> <C>
Revenues
Dividends received from subsidiaries................... $ 43,470
$ 34,650 $ 23,625
Rent income............................................ 357
287 1,674
Investment income...................................... 8
11 5
Realized investment gains.............................. -
- - 2,073
Total revenues...................................... 43,835
34,948 27,377
Expenses
Depreciation........................................... 257
157 854
Administrative expenses................................ 5,698
3,571 3,115
Total expenses...................................... 5,955
3,728 3,969
Earnings before income tax benefits and equity in
net earnings of subsidiaries over amounts distributed... 37,880
31,220 23,408
Income tax benefits...................................... (2,880)
(1,211) (106)
Earnings before equity in net earnings of subsidiaries
over amounts distributed................................ 40,760
32,431 23,514
Equity in net earnings of subsidiaries over amounts
distributed............................................. 33,204
77,770 99,069
Net earnings........................................ $ 73,964
$110,201 $122,583
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
41
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF CASH FLOWS
Years ended December 31,
(Thousands of Dollars)
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C>
<C> <C>
Cash flows from operating activities:
Net earnings............................................. $ 73,964
$110,201 $122,583
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Dividends received from consolidated subsidiaries...... 43,470
34,650 23,625
Equity in earnings of consolidated subsidiaries........ (76,674)
(112,420) (122,694)
Depreciation and amortization.......................... 257
157 854
Other liabilities and accrued expenses................. 1,281
1,990 (3,152)
Balances with affiliates............................... 1,979
(361) (9,552)
Income taxes (benefits)................................ (930)
(1,187) 395
Other--net............................................. (83)
(185) (7,006)
Net cash provided by operating activities............ 43,264
32,845 5,053
Cash flows from investing activities:
Proceeds from sale of common stock....................... -
- - 18,400
Purchase of property and equipment for company use....... (186)
(285) (841)
Proceeds from sale of property and equipment............. 132
298 8,091
Net cash provided by (used in) investing activities.. (54)
13 25,650
Cash flows from financing activities:
Capital contribution to subsidiaries..................... -
- - (25,000)
Dividends paid to stockholders........................... (29,373)
(8,635) (5,700)
Purchase of treasury stock............................... (13,841)
(24,359) -
Net cash used in financing activities................ (43,214)
(32,994) (30,700)
Increase (decrease) in cash and cash equivalents........... (4)
(136) 3
Cash and cash equivalents at beginning of year............. 6
142 139
Cash and cash equivalents at end of year................... $ 2
$ 6 $ 142
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
42
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the
accompanying notes thereto in the Annual Report.
NOTE A--Dividends
The amounts of cash dividends paid to The Commerce Group, Inc.
(Parent only) were as follows:
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C>
<C> <C>
Consolidated insurance subsidiaries................. $43,470
$34,650 $23,625
</TABLE>
See Note K to the Consolidated Financial Statements in the Annual
Report for a description of dividend restrictions applicable to the
Company's subsidiaries.
NOTE B--Federal Income Tax Allocation
As a member of a consolidated group for tax purposes, the Company
and its subsidiaries (said parties constituting an "Affiliated Group" as
defined in and for purposes of the Internal Revenue Code) are jointly
and severally liable for federal income taxes of the Affiliated Group
and have entered into an agreement establishing an allocation of tax
liability and for compensation of the respective members of the
Affiliated Group for use of their tax losses and credits.
The method of allocation, as approved by the Board of Directors,
calls for current taxes to be allocated among all affiliated companies
based on a written tax-sharing agreement. Under this agreement,
allocation is made primarily on a separate return basis with current
payment for losses and other tax items utilized in the consolidated
return. However, to the extent that a payor member of the group has
future net operating losses which it cannot absorb in the year incurred,
other members within the group will refund payments to the payor.
NOTE C--Capital Contributions to Subsidiaries
During 1994, the Company made a capital contribution to Bay
Finance in the amount of $10,000,000. As part of this capital
contribution, $4,100,000 of furniture and equipment, net of accumulated
depreciation, was transferred by the Company to Bay Finance.
Also during 1994, the Company made a capital contribution to
Citation in the amount of $15,000,000.
43
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
NOTE D--Consolidated Financial Statements
In preparing the consolidated financial statements of the Company
and its subsidiaries, the following amounts have been eliminated:
<TABLE>
At December 31,
Balance Sheet 1996 1995 1994
<CAPTION>
<S> <C> <C> <C>
Investment in subsidiaries......... $585,833 $546,054 $409,366
Receivable from affiliates......... 3,767 5,746 5,385
At December 31,
Statement of Earnings 1996 1995 1994
Dividends from subsidiaries........ $ 43,470 $ 34,650 $ 23,625
Rent income........................ 357 287 1,674
</TABLE>
44
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
Future
Policy
Other Benefits, Amortization
Deferred Benefits,
Policy Claims, of Deferred
Policy Claims and
Claims and Net Losses and Policy Other Net
Acquisition Loss Unearned
Benefits Premium Investment Settlement Acquisition Operating
Premiums
Segment Costs Expenses
Premiums Payable Revenue Income(1) Expenses Costs
Expenses Written
<CAPTION>
<S> <C> <C>
<C> <C> <C> <C> <C> <C>
<C> <C>
1996
Property and casualty insurance.......... $ 82,968 $649,913
$367,991 None $668,716 $ 69,852 $475,231 $181,013
NONE $711,570
Real estate and commercial lending....... - -
- - - 4,249 - -
- -
Corporate and other...................... - -
- - - 3,301 - -
- -
Total.............................. $ 82,968 $649,913
$367,991 $668,716 $ 77,402 $475,231 $181,013
$711,570
1995
Property and casualty insurance.......... $ 67,160 $618,791
$330,454 None $592,590 $ 64,495 $367,552 $166,741 NONE
$603,421
Real estate and commercial lending....... - -
- - - 3,804 - -
- -
Corporate and other...................... - -
- - - 3,014 -
- -
Total.............................. $ 67,160 $618,791
$330,454 $592,590 $ 71,313 $367,552 $166,741
$603,421
1994
Property and casualty insurance.......... $ 59,066 $592,373
$314,719 None $572,053 $ 55,316 $369,660 $157,415
NONE $589,197
Real estate and commercial lending....... - -
- - - 3,972 - -
- -
Corporate and other...................... - -
- - - 3,613 - -
- -
Total.............................. $ 59,066 $592,373
$314,719 $572,053 $ 62,901 $369,660 $157,415
$589,197
</TABLE>
(1) The allocation of net investment income is based upon the specific
identification of activity within the various segments.
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV
REINSURANCE
Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
Assumed
Percentage
Ceded to From
of Amount
Gross Other
Other Net Assumed
Insurance Premiums Earned Amount Companies
Companies Amount to Net
<CAPTION>
<S> <C> <C> <C>
<C> <C>
1996
Property and casualty insurance.. $693,199 $117,147 $ 92,664
$668,716 13.9%
1995
Property and casualty insurance.. $622,455 $120,720 $ 90,855
$592,590 15.3%
1994
Property and casualty insurance.. $609,767 $115,863 $ 78,149
$572,053 13.7%
</TABLE>
46
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
Net
addition
(reduction)
Balance charged to
Balance
beginning costs and
at end
of year expenses
Deductions(1) of year
<CAPTION>
<S> <C> <C> <C>
<C>
1996
Allowance for losses on mortgage loans
and collateral notes receivable........ $3,173 $ (135) $
(278) $2,760
Allowance for doubtful premium
receivables............................ $1,103 $1,942
$(1,545) $1,500
1995
Allowance for losses on mortgage loans
and collateral notes receivable........ $3,324 $ (151) $
- - $3,173
Allowance for doubtful premium
receivables............................ $1,120 $ 136 $
(153) $1,103
1994
Allowance for losses on mortgage loans
and collateral notes receivable........ $3,644 $ (277) $
(43) $3,324
Allowance for doubtful premium
receivables............................ $1,100 $ 638 $
(618) $1,120
</TABLE>
(1) Deductions represent net write-offs of amounts determined to be
uncollectible.
47
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE X
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
Claims and Claim
Paid
Adjustment Expenses
Claims
Affiliation Incurred Related to
and Claim
with Current Prior
Adjustment
Registrant Year Years
Expenses
<CAPTION>
<S> <C> <C>
<C>
1996
Consolidated property-casualty entities...... $562,997 $(87,766)
$440,843
1995
Consolidated property-casualty entities...... $442,027 $(74,475)
$329,210
1994
Consolidated property-casualty entities...... $435,713 $(66,053)
$336,942
</TABLE>
48
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO EXHIBITS(A)
<TABLE>
Exhibit
Number Title
<CAPTION>
<S> <C>
3.1 Articles of Organization, as amended(B)
3.2 By-Laws(B)
4 Stock Certificate(B)
10.1 Loan Agreement, Mortgage and Assignment and Trust Agreement
dated February 20,
1981 between Town of Webster, The Commerce Insurance Company
and Mechanics Bank,
as Trustee(B)
10.2 First Supplemental Loan Agreement, Mortgage, Assignment and
Trust Agreement
dated as of August 1, 1984 between Town of Webster, The
Commerce Insurance
Company and Mechanics Bank as Trustee(B)
10.3 Second Supplemental Loan Agreement, Mortgage, Assignment and
Trust Agreement
dated as of October 1, 1985 between Town of Webster, The
Commerce Insurance
Company and Mechanics Bank as Trustee(B)
10.4 Loan Agreement dated December 4, 1985 among Bay Finance
Company, Inc., The
Commerce Group, Inc. and The First National Bank of Boston,
as modified by
Modification No. 1 dated December 18, 1986(B)
10.4A Loan Agreement dated December 4, 1985 among Bay Finance
Company, Inc., The
Commerce Group, Inc. and The First National Bank of Boston,
as modified by
Modification No. 2 dated March 18, 1988(C)
10.5 Loan Agreement dated December 18, 1986 between The Commerce
Group, Inc. and
The First National Bank of Boston(B)
10.6* Form of Stock-Appreciation Right Agreement(B)
10.7* 1996 Stock-Appreciation Right and Book Value Award
Agreement.
10.8* 1994 Management Incentive Plan(F)
10.9 Property Combination Reinsurance Agreement(F)
10.10 Owner-Contractor Agreement dated April 20, 1988 between The
Commerce Group,
Inc. and Lauring Construction Co., Inc.(D)
10.11 Asset Transfer Agreement between Commerce Insurance and
Providence Washington
Insurance Company dated December 23, 1991.(E)
10.12 Asset and Liability Transfer Agreement between Commerce
Insurance and
American Hardware Mutual Insurance Company and American
Merchants Casualty
Company dated November 8, 1991.(E)
10.13 Asset Transfer Agreement between Commerce Insurance and The
Continental
Insurance Company dated October 24, 1991.(E)
49
<page
10.14 Asset Transfer Agreement between Commerce Insurance and Home
Insurance
Company dated October 3, 1991.(E)
10.15 Asset and Liability Transfer Agreement between Commerce
Insurance and New
Hampshire Insurance Company dated August 12, 1991.(E)
10.16 Asset Transfer Agreement between Commerce Insurance, Utica
Mutual Insurance
Company and Graphic Arts Mutual Insurance Company dated June
24, 1991.(E)
13.1 Annual Report for the year ended December 31, 1996 to
Security Holders.
22.1 Subsidiaries of the Registrant filed herewith.
24.1 Power of Attorney(B)
28.1 Information from Reports Furnished to State Insurance
Regulatory
Authorities--1996 Consolidated Schedule P of Annual
Statement provided to state
regulatory authorities filed herewith. During 1989, the use
of Schedule O was
discontinued by State Insurance Regulatory Authorities and
all information which was previously contained in this schedule
has now been combined into Schedule P.
</TABLE>
(A) Exhibits other than those listed are omitted because they are not
required or are not
applicable. Copies of exhibits are available without charge by
writing to the Assistant
to the President at 211 Main Street, Webster, MA 01570.
(B) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Registration Statement on Form S-18
(No. 33-12533-B).
(C) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Registration Statement on Form 8-A.
(D) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December
31, 1988.
(E) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December
31, 1993.
(F) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December
31, 1994.
* Denotes management contract or compensation plan or arrangement.
50
<page
1996
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
<page
INDEX TO 1996 ANNUAL REPORT
<TABLE>
Page
<CAPTION>
<S> <C>
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 4
Common Stock Price and Dividend Information..................... 15
Report of Management............................................ 16
Report of Independent Accountants............................... 17
Consolidated Balance Sheets at December 31, 1996 and 1995....... 18
Consolidated Statements of Earnings for the Years Ended
December 31, 1996, 1995 and 1994............................... 19
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994......................... 20
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994............................... 21
Notes to Consolidated Financial Statements...................... 22
Selected Consolidated Financial Data............................ 40
Management's Discussion of Supplemental Information on
Insurance Operations........................................... 41
Directors....................................................... 46
Officers........................................................ 48
Stockholder Information......................................... 49
</TABLE>
<page
FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share Amounts)
<TABLE>
1996 1995
1994
<CAPTION>
<S> <C> <C>
<C>
Net premiums written........................... $ 711,570 $
603,421 $ 589,197
Earned premiums................................ $ 668,716 $
592,590 $ 572,053
Net investment income.......................... 77,402
71,313 62,901
Premium finance fees........................... 9,713
19,420 18,497
Net realized investment gains (losses)......... (7,574)
712 45,612
Total revenues........................... $ 748,257 $
684,035 $ 699,063
Earnings before income taxes................... $ 92,013 $
149,742 $ 171,988
Income taxes................................... 18,049
39,541 49,405
Net earnings............................. $ 73,964 $
110,201 $ 122,583
Net earnings per common share.................. $ 2.04 $
2.93 $ 3.23
Cash dividends paid per share.................. $ 0.81 $
0.23 $ 0.15
Weighted average number of common shares
outstanding.................................. 36,311,887
37,632,236 38,000,000
Total investments.............................. $1,027,136
$1,044,113 $ 899,546
Total assets................................... 1,676,799
1,564,175 1,382,226
Total liabilities.............................. 1,089,760
1,014,461 968,637
Total stockholders' equity..................... 587,039
549,714 413,589
Total stockholders' equity per share........... 16.28
14.96 10.88
Certain Statutory Financial Ratios (Unaudited):
Loss ratio................................... 70.9%
62.0% 64.6%
Underwriting expense ratio................... 27.1
29.0 27.1
Combined ratio........................... 98.0%
91.0% 91.7%
Net premiums written to policyholders'
surplus.................................... 153.1%
137.1% 168.5%
</TABLE>
1
<page
THE COMMERCE GROUP, INC.
March 26, 1997
To Our Stockholders:
In 1996, your Company experienced satisfactory financial results
for the 21st consecutive year. From the very first day the funding of
The Commerce Insurance Company was accomplished (April 3, 1972), through
December 31, 1996, we have achieved underwriting profit of $202.6
million on total premiums written of $5.3 billion. This underwriting
profit represents 3.9% of total premiums written. These results
continue to stand out in a year that brought change and innovation to
our industry.
In Massachusetts, the personal automobile insurance industry saw
the 1997 state mandated auto insurance rates drop for the third
consecutive year this past January. Coupled with affinity group
marketing programs and safe driver rate deviations, the Massachusetts
marketplace has become extremely competitive. In spite of these
conditions, your Company saw its share of the Massachusetts personal
automobile market increase to 20.8% in 1996 versus 16.4% at the end of
1995.
In California, Western Pioneer Insurance Company has completed its
first full year as a subsidiary of The Commerce Insurance Company with
stable results and a bright future. Plans have been implemented to
strengthen the agency force and establish an attractive but competitive
rate structure.
Looking to the future, your Company was granted licenses in the
states of Connecticut, Rhode Island and Vermont. In addition,
applications were filed and are pending in the states of Maine and New
Hampshire. Through new technology and internal operating systems, we
envision beginning expansion into these states during the latter part of
1997.
Through it all, your Company has continued to grow and prosper.
The Commerce Insurance Company continues to be the largest writer of
Massachusetts private passenger automobile insurance, as well as the
second largest writer of Massachusetts homeowners insurance. Written
premium, earned premium, investment income, total assets, total
stockholders' equity and total stockholders' equity per share, as
illustrated in the bar graph on the facing page, are all at new highs.
For those of you who are interested in the details, I draw your
attention to the pages in this report labeled "Management's Discussion
and Analysis of Financial Condition and Results of Operations". Behind
these numbers are an extremely dedicated group of people, both in
Massachusetts and California: Our Policyholders (represented by over
719,000 policies in force); Agents (672); Employees (1,350); Officers
(31); Directors (19); and of course, our Stockholders (over 3,800, not
including our Employee Stock Ownership Plan participants who now number
1,385).
Property-liability insurance remains a good business to be in--and
The Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to
believe that owners' interests are its primary constituency.
Our sincere thanks to those who have helped in this building
process--especially our Agents, Employees, Officers and Board of
Directors. This diverse force of committed, ethical and professional
people will continue to build on our past successes and look to the
future with excitement and opportunity. Their individual creativity,
energy and professionalism will continue to serve our shareholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J.
Remillard, Jr.
President
Caring in everything we do.
2
<page
The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders'
equity per share value including cumulative cash dividends paid per
share on December 31, over the most recent fifteen year period. The X
axis lists the years beginning with 1982 through 1996. The Y axis lists
the dollar values starting at $0.00 and increasing in one dollar
increments to $18.00. The graph depicts a total stockholders' equity
per share value in 1982 of $0.38; 1983 of $0.50, 1984 of $0.67, 1985 of
$0.81, 1986 of $0.95, 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990
of $3.36, 1991 of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88,
1995 of $14.96, and 1996 of $16.28. The graph also depicts the total
stockholders' equity per share value including and cumulative dividends
paid per share in 1983 of $0.50, 1984 of $0.67, 1985 of $0.81, 1986 of
$0.95, 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991
of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $11.03, 1995 of $15.34
and 1996 of $17.47.
3
<page
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty industry has been highly cyclical in
nature. The financial results of property and casualty insurance
companies are impacted both quarterly and annually by many forces unique
to the market. Market forces include the frequency and severity of
losses resulting from weather conditions, the state of the economy and
the general regulatory environment in those states in which an insurer
operates. Until 1995, The Commerce Group, Inc. ("the Company") wrote
insurance solely in the State of Massachusetts. During 1995, the
Company began operations in the State of California when it completed
the acquisition of Western Pioneer Insurance Company ("Western
Pioneer"), a personal automobile insurer located in Pleasanton,
California, on August 31, 1995.
The Company's business strategy remains focused on activities
primarily related to personal automobile insurance. The Company has
been the largest writer of personal property and casualty insurance in
the state of Massachusetts in terms of market share of direct premiums
written since 1990. The Company's share of the Massachusetts personal
automobile market increased in 1996 to approximately 20.8% from 16.4% in
1995.
During 1996, direct premiums written totalled $731,823, a 16.8%
increase over 1995. Direct premiums written in Massachusetts, written
through The Commerce Insurance Company ("Commerce") and Citation
Insurance Company ("Citation") both wholly-owned subsidiaries of
Commerce Holdings, Inc. ("CHI"), which is a wholly-owned subsidiary of
the Company, amounted to $704,439. Direct premiums written in
California, written through Western Pioneer, a wholly-owned subsidiary
of Commerce, amounted to $27,384. Of the total direct premiums written,
direct personal automobile premiums written during 1996 totalled
$622,849, an increase of 21.0% over 1995, and direct homeowners
insurance premiums written totalled $52,377, an increase of 4.2% over
1995. The Company is also the fourth largest writer of commercial
automobile insurance in Massachusetts based on direct premiums written.
During 1996, direct commercial automobile premiums written totalled
$40,441, a 10.5% decrease compared to 1995.
Personal automobile insurance is subject to extensive regulation
in Massachusetts and California. Every owner of a registered automobile
is required to maintain certain minimum automobile insurance coverages.
In Massachusetts, with very limited exceptions, automobile insurers
operating within those states are required by law to issue a policy to
any applicant seeking to obtain such coverages. Marketing and
underwriting strategies for companies operating in Massachusetts are
limited by maximum automobile premium rates and minimum agency
commission levels for personal automobile insurance which are mandated
by the Massachusetts Commissioner of Insurance ("Commissioner"). In
Massachusetts, accident rates, bodily injury claims, and medical care
costs continue to be among the highest in the nation.
During the three-year period from 1994 to 1996, Massachusetts
personal automobile insurance premium rates decreased an average of 2.6%
per year. The Commissioner approved an average 6.2% decrease in
personal automobile premiums for 1997, the third decrease in three
years, as 1996 average rates were cut by 4.5%, and 1995 average rates
were decreased by 6.1%. According to the Commissioner's office, the
current rate environment is the result of continued consumer cooperation
by driving safely, obeying traffic laws, reporting fraud, wearing
seatbelts and individuals locking their autos.
Also, the 1997 decrease was partially driven by corrections to an
industry error impacting prior year rate decisions. The industry error
resulted from a miscalculation of industry expense allowances that had
the effect of overstating rates for 1991 through 1996. Rates for 1997
include an adjustment to recoup this error from the industry equal to
40% of the error with 40% reducing 1998 rates and 20% reducing 1999
rates.
4
<page
Additionally, 1997 rates were decreased as a result of the
reconciliation of the Safe Driver Insurance Plan ("SDIP") which is
designed to be revenue neutral. In most recent past years, the SDIP
reconciliation resulted in a deficit which was then added into the rates
for the subsequent years. The 1996 SDIP reconciliation, however,
resulted in a surplus. Fifty percent of this surplus is being used to
decrease rates in both 1997 and 1998.
The Company has performed an analysis of the rate decision and has
estimated the impact of the above two items on its results assuming its
market share remains the same as it was at the end of 1996. The earned
premium impact is estimated to be approximately $15.3 million for 1997,
$23.0 million for 1998 and $13.5 million for 1999. The earnings per
share after-tax impact resulting from lower earned premiums for 1997,
1998 and 1999 is estimated to be $0.28, $0.41 and $0.23, respectively.
If the Company's future market share increases (decreases), a larger
(smaller) financial impact would result.
The Automobile Insurers Bureau of Massachusetts ("AIB") has filed
an appeal with the Massachusetts Supreme Judicial Court challenging the
Commissioner's decision to prospectively decrease future rates for the
miscalculation of the industry expense allowance. (The SDIP
reconciliation component is not being challenged.) The AIB's argument
is that, according to statute, there is a prohibition against
retroactive rate making in Massachusetts which effectively bars the
examination of past year's data once all involved parties have agreed to
the rate decision. One insurer has filed a suit with the Massachusetts
Supreme Judicial Court alleging that the prospective nature of the rate
reduction will have an unfair adverse impact on it. This is due to the
fact that the company filing suit believes it should not be adversely
impacted solely because its market share is greater now than during
those years in which the errors occurred. It is not possible to predict
the outcomes of these legal actions or the potential effects thereof on
the Company.
In addition, the Massachusetts Association of Insurance Agents
("MAIA") has also filed a suit with the Massachusetts Supreme Judicial
Court with respect to the Commissioner's ruling on 1997 commissions.
The Commissioner ruled that agents' commissions on 1997 premiums,
subject to safe driver deviations, will be based on the discounted net
premium amounts. The 1996 commissions were based on the gross premium
amounts. The Commissioner's ruling will result in agents receiving
fewer commission dollars on a per policy basis. The Company is unable
to predict the possible outcome of this suit at this time.
The Company's performance in its personal and commercial
automobile insurance lines is integrally tied to its participation in
the Commonwealth Automobile Reinsurers ("C.A.R."). All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines.
Since its inception, C.A.R. has annually generated multi-million dollar
underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or
commercial deficit (its participation ratio) is based upon its market
share of the automobile risks for the particular pool, adjusted by a
utilization formula such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
exceeds that of the industry, and favorably affected if its relative use
of C.A.R. is less than that of the industry. Automobile insurers
attempt to develop and implement underwriting strategies that will
minimize their relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not insured through C.A.R.
Significant changes in the utilization of the C.A.R. private
passenger pooling mechanism are not expected for 1997, as the various
C.A.R. participation formula changes have been fully implemented since
1993. The marketplace is expected to make minor yearly adjustments to
find the optimum balance between voluntary and ceded writings.
5
<page
Starting in 1991, and concluding in 1995, reforms were implemented
into the C.A.R. commercial automobile pooling mechanism. The primary
change was the gradual phase-in of a C.A.R. commercial utilization-based
participation formula, so as to reduce the percentage of commercial
business being ceded to C.A.R. The percentage of commercial premiums
ceded to C.A.R. by the industry has decreased (from 56% in 1990 to
approximately 31% in 1996, as estimated by the Company). This also
resulted in significant decreases in the percentage of commercial
automobile business ceded to C.A.R. by the Company, from 68% in 1990 to
approximately 32% in 1996. Continued industry-wide gradual decreases in
the percentage of ceded commercial premiums are expected for 1997, as
companies look to increase their voluntary retention levels.
The Company intends to continue to respond to the incentives and
disincentives provided by C.A.R. rules, by further adjusting the
percentage of personal and commercial business ceded to C.A.R. in 1997.
The Company provides a separate rating tier for preferred
commercial automobile business through Citation. Approximately 22% of
the commercial automobile premium produced by its voluntary agents in
1996 was written by Citation. The Company expects that this secondary
rating tier will continue to assist the Company in retaining its better
commercial automobile accounts, while also further increasing the
percentage of commercial automobile business that can be retained
voluntarily by the Company in 1997 and beyond.
Beginning in the latter part of 1995, the Company began to
actively pursue group marketing programs. The primary purpose of group
marketing programs is to provide participating groups with a convenient
means of purchasing automobile insurance through associations and
employee groups. Billing is primarily through direct billing with
payroll deduction available. Emphasis is placed on writing larger
groups, although accounts with as few as 25 participants are considered.
Groups are eligible for rate discounts which must be filed annually with
the Division of Insurance. In general, the Company looks for groups
with mature/stable membership, favorable driving records, and below
average turnover ratios. Participants who leave the sponsoring group
during the term of the policy are allowed to maintain the policy until
expiration. At expiration, a regular Commerce policy may be issued at
the insured's option.
During the latter part of 1995, Commerce signed group marketing
agreements with the five American Automobile Association Clubs of
Massachusetts ("AAA clubs") offering a 10% discount on automobile
insurance to the clubs' members who reside in Massachusetts. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
29.8% increase in the number of personal automobile exposures written by
Commerce. In addition, in 1996, total direct premiums written
attributable to the AAA group business was $344,297 or 47% of the
Company's total direct premiums written. Of this amount, 9% was written
through the AAA clubs and 91% was written through the Company's network
of independent agents.
Initially, the Massachusetts statute, governing group marketing
programs, required that 35% of the eligible members must participate in
a group marketing program within the first year. Accordingly, Commerce
and AAA aggressively pursued AAA members for the AAA Group Marketing
Program. At December 31, 1996, Commerce had achieved the objective of
writing more than 35% of the AAA members within the first year, as over
300,000 AAA members joined the program. The particular portion of the
statute, dealing with achieving the 35% penetration level in one year,
was amended by the Legislature in early 1997 to allow two years to reach
the required penetration level. In 1997, Commerce and AAA intend to
continue to increase the penetration of the eligible AAA membership.
Commerce and the AAA clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
6
<page
During 1996, the Company was granted licenses in the states of
Connecticut and Rhode Island. License approval in the state of Vermont
was received in January 1997. Applications for licenses were filed by
the Company and are pending in the states of Maine and New Hampshire.
Concurrent with these filings, the Company has entered into an agreement
with Policy Management Services Corporation ("PMSC") and has purchased
software which will allow for the development of internal operating
systems which will enable the Company to process policies in these five
states and Massachusetts. Additionally, a significant investment in new
computer hardware is being made to support this effort. These systems
are not scheduled to be in place for the contiguous states until the
latter part of 1997 and, as a result, Management is not expecting to
start marketing in the states contiguous to Massachusetts until that
time.
Underwriting profit margins are reflected by the extent to which
the combined ratio is less than 100%. This ratio is considered the best
simple index of current underwriting performance of an insurer. During
the five year period ended December 31, 1996, the property and casualty
industry's combined ratio, as reported by A.M. Best and weighted to
reflect the Company's product mix ("weighted industry average"), has
ranged from a low of 102.5% in 1995 to a high of 107.4% in 1992
(including the impact of Hurricane Andrew) on a statutory accounting
principles basis. During this same period of time, the Company's
combined ratio has consistently remained below the weighted industry
average, ranging from as low as 91.0% in 1995 to a high of 98.0% in
1996. On an average basis, the Company's combined ratio was 93.9% for
the five year period ended December 31, 1996 compared to a weighted
industry average of 103.8%.
The Company's total revenues were supplemented in fiscal 1996,
1995 and 1994 by net investment income of $77,402, $71,313 and $62,901,
respectively. Additionally, the Company had realized investment losses
in 1996 of $7,574 and realized investment gains in 1995 and 1994 of $712
and $45,612, respectively.
Regulatory Matters
Automobile insurance reform continues to be debated in the
Massachusetts Legislature. New regulations and legislation are often
proposed with the goal of reducing the need for premium increases. For
further details, please refer to the general discussion on insurance
regulation and premium rates beginning on page 4.
As previously mentioned, in 1995, the Company received approval to
offer 10 percent group discounts to members of the AAA Clubs as
previously described. Membership in these clubs is estimated to
represent approximately one-third of the Massachusetts motoring public.
The Company increased its Massachusetts private passenger automobile
insurance writings by 17.5% in 1996 primarily as a result of this
program, ending the year with approximately 20.8% of the Massachusetts
private passenger automobile market as compared to 16.4% in 1995.
Also in 1995, the Company received state regulatory approval to
eliminate interest based premium finance fees on new and renewal
personal automobile insurance policies with effective dates on or after
January 1, 1996. As a result, premium finance fees as a source of the
Company's revenues have been reduced by 50.0% in 1996. As policies
effective in 1995 favorably impacted finance fee income in 1996, the
full effect of the elimination will not be felt until 1997 with the
expectation of further reductions. The change was initiated in direct
response to competitive forces that occurred in the Massachusetts
marketplace.
In January, 1996, the Company was granted approval, for the 1996
calendar year, to offer their customers safe driver deviations of 10
percent to drivers with SDIP classifications of either Step 9 or 10.
These are the two best driver SDIP classifications in Massachusetts,
representing drivers with no at fault accidents and not more than one
minor moving vehicle violation in the last six years. For drivers that
qualify, the Company's automobile discounts and SDIP deviations can be
combined for up to a 19% reduction from the state mandated rates. In
March 1997, approval of SDIP deviations was granted for the 1997
calendar year.
7
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In May, 1996, state legislation was passed offering insurers
incentives to write more inner city and coastal homeowners insurance.
The legislation, which arose over concerns of availability and
allegations of redlining, expands coverages and provides various credits
under the Massachusetts Property Insurance Underwriting Association
("Massachusetts Fair Plan"). The Company is considering its
alternatives and expects the legislation to stimulate increased
availability of homeowners insurance in the areas mentioned previously.
Although the U.S. federal government does not directly regulate
the insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies are investigating the
current condition of the insurance industry (encompassing both life and
health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Congress is continuing to
conduct a variety of hearings relating, in general, to the solvency of
insurers and federal legislation has been proposed from time to time on
this and other subjects. The Company is unable to predict whether or in
what form initiatives will be implemented and what the possible effects
on the Company would be.
In December 1996, a United States District Court, acting on a suit
filed in October 1996, ordered the Massachusetts Division of Insurance
to disregard the existing stated ban on bank sales of life, health and
accident insurance. The decision cited U.S. Supreme Court decisions in
the Barnett and VALIC cases that essentially preempt the State of
Massachusetts ban on the licensing of bank-owned insurance agencies.
Also, in December 1996, a bill was filed in the Massachusetts
Legislature that would allow banks to become licensed agents of an
insurance company or brokers of insurance, permitting such things as the
sale of insurance products in distinctly designated bank branch areas
separate and apart from retail deposit areas. The Company is unable to
predict the possible impacts of these issues at this time.
Congressional initiatives directed at repeal of the McCarran-
Ferguson Act (which exempts the "business of insurance" from certain
federal laws, including antitrust laws, to the extent it is subject to
state regulation) and judicial decisions narrowing the definition of
"business of insurance" for McCarran-Ferguson Act purposes may limit the
ability of insurance and reinsurance companies in general to share
information with respect to rate-setting, underwriting and claims
management practices. It is not possible to predict the outcome of any
such congressional activity or the potential effects thereof on the
Company.
Beginning in 1994 and continuing through 1996, there was increased
debate in the U.S. Congress regarding reforms to the Superfund law, the
federal mechanism designed to clean-up toxic waste sites, as well as the
nation's environmental and pollution policy in general. Management
believes that, because of the types of business written by the Company,
the outcome of the Superfund debate will not significantly affect the
Company.
In order to enhance the regulation of insurer insolvency, the
National Association of Insurance Commissioners ("NAIC") developed a
formula and model law to implement Risk-Based Capital ("RBC")
requirements for property and casualty insurance companies which are
designed to assess capital adequacy and to raise the level of protection
that statutory surplus provides for policyholder obligations. The RBC
model for property and casualty insurance companies measures three major
areas of risk facing property and casualty insurers: (i) underwriting,
which encompasses the risk of adverse loss development and inadequate
pricing; (ii) declines in asset values arising from credit risk; and,
(iii) other business risks from investments. Insurers having less
statutory surplus than required by the RBC calculation will be subject
to varying degrees of regulatory action, depending on the level of
capital inadequacy.
8
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The Company's subsidiaries, Commerce and Citation, have RBC
amounts at December 31, 1996 of $52 million and $4 million,
respectively, and they have statutory surplus of approximately $394
million and $71 million, respectively. The Statutory surplus of
Commerce and Citation at December 31, 1996 exceeded the RBC Company
Action Levels of $103 million and $8 million by approximately $291
million and $63 million. The RBC model formula proposes four levels of
regulatory action. The extent of regulatory intervention and action
increases as the level of surplus to RBC falls. The first level, the
Company Action Level, requires an insurer to submit a plan of corrective
actions to the regulator if surplus falls below 200% of the RBC amount.
The Regulatory Action Level (as defined by the NAIC) requires an insurer
to submit a plan containing corrective actions and permits the
Commissioner to perform an examination or other analysis and issue a
corrective order if surplus falls below 150% of the RBC amount. The
Authorized Control Level (as defined by the NAIC) allows the regulator
to rehabilitate or liquidate an insurer in addition to the
aforementioned actions if surplus falls below 100% of the RBC amount.
The fourth action level is the Mandatory Control Level (as defined by
the NAIC) which requires the regulator to rehabilitate or liquidate the
insurer if surplus falls below 70% of the RBC amount.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Direct premiums written during 1996 increased $105,157, or 16.8%
to $731,823 as compared to 1995. The increase was primarily
attributable to a $108,212, or 21.0% increase in direct premiums written
for personal automobile insurance to $622,849. This increase was the
result of an $88,527 increase in direct premiums written for
Massachusetts personal automobile insurance and an increase of $19,685
which was derived from the Company's California subsidiary, Western
Pioneer, which was acquired August 31, 1995. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from an increase of 29.8% in the number of personal automobile
exposures written, offset by a 9.2% decrease in the average personal
automobile premiums written per exposure (each vehicle insured). This
was primarily the result of the Company's affinity group marketing
programs, safe driver rate deviations and the effect of the 1996 state
mandated average rate decrease of 4.5%. In January 1996, the Company
was granted approval to offer their customers safe driver deviations of
10%. For drivers who qualify, the Company's group discount and safe
driver deviations can be combined for up to a 19% reduction from state
mandated rates. Direct premiums written for commercial automobile
insurance decreased by $4,763, or 10.5%, due primarily to a decrease of
approximately 5.6% in the number of policies written, with the remainder
due to a decrease in the average commercial automobile premium per
policy. Direct premiums written for homeowners insurance (excluding the
Massachusetts Fair Plan) increased by $1,926, or 4.0% due primarily to
an increase in the number of policies written.
Net premiums written during 1996 increased $108,149, or 17.9% as
compared to 1995. The increase in net premiums written was due to the
growth in direct premiums written as described above, as well as to the
effects of reinsurance. Written premiums assumed from C.A.R. increased
$1,454, or 1.6% and written premiums ceded to C.A.R. increased $47 as
compared to 1995, both as a result of changes in the industry's and the
Company's utilization of C.A.R. reinsurance. Premiums ceded to
reinsurers other than C.A.R. decreased $1,602 or 4.9% as compared to
1995.
Earned premiums increased $76,126 or 12.8% during 1996 as compared
to 1995. The increase in earned premiums was primarily due to changes
in direct premiums written and net premiums written as described above.
Earned premiums assumed from C.A.R. increased $1,860 or 2.1% during 1996
compared to 1995. Earned premiums attributable to Western Pioneer
increased $18,794 to $27,628 for 1996 compared to $8,834 for the four
months ended December 31, 1995. The Company acquired Western Pioneer on
August 31, 1995.
Net investment income increased $6,089, or 8.5%, compared to 1995,
principally as a result of an increase in average invested assets (at
cost) of 6.5% when compared to the year ended 1995. Net investment
income as a percentage of total average investments was 7.3% in 1996
compared to 7.2% in 1995.
9
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Premium finance fees decreased $9,707 or 50.0% during 1996. The
decrease was primarily attributable to a change from interest based
finance fees to a "late payment" based system for personal automobile
policies with effective dates of January 1, 1996 and forward. The
change was initiated in direct response to competitive forces that
occurred in the Massachusetts marketplace.
The market value of the Company's property and casualty investment
portfolio totaled $1,027,136, at December 31, 1996 compared to
$1,044,113 at December 31, 1995. Management's investment philosophy is
to emphasize investment yield while maintaining investment quality.
Fixed maturities comprised 69.8% of the portfolio at December 31, 1996
compared to 78.1% at December 31, 1995. Equity investments comprised
22.8% at December 31, 1996 compared to 14.5% at December 31, 1995.
The market value of the fixed maturities, which totaled $716,702
at December 31, 1996, is comprised of 68.5% tax-exempt and 31.5% taxable
investments as compared to total fixed maturities of $815,277, comprised
of 72.8% tax-exempt and 27.2% taxable investments at December 31, 1995.
The market value of equity investments, which totaled $233,721 at
December 31, 1996, is comprised of 63.2% preferred stocks and 36.8%
common stocks as compared to total equity investments of $151,579,
comprised of 73.4% preferred stocks and 26.6% common stocks at December
31, 1995. The increase of equity investments and decrease of fixed
maturities at December 31, 1996 compared to December 31, 1995 is
primarily attributable to a change in the mix of investments from
municipal bonds to higher yielding preferred stocks and preferred stock
mutual funds.
Gross realized gains and losses on fixed maturity investments
amounted to $487 and $7,851, respectively, for the year ended December
31, 1996 compared to gross realized gains and losses on fixed maturity
investments of $2,389 and $1,912, respectively, for the year ended
December 31, 1995. Gross realized gains and losses on equity
investments amounted to $478 and $371, respectively, for the year ended
December 31, 1996 compared to gross realized gains and losses on equity
investments of $984 and $579, respectively, for the year ended December
31, 1995. Net realized investment losses totalled $7,574 during 1996 as
compared to net realized investment gains of $712 for 1995. The realized
gains in 1996 were primarily the result of sales of municipal bonds and
common stocks, offset by realized losses on sales of Government National
Mortgage Association ("GNMA") mortgage backed bonds, municipal bonds and
preferred stocks. Also included were realized losses on mortgage
activity of $317 in 1996 compared to $215 in 1995.
Gross unrealized gains and losses on fixed maturity investments
totalled $17,890 and $1,699, respectively, at December 31, 1996 compared
to gross unrealized gains and losses on fixed maturity investments of
$18,626 and $4,657, respectively, at December 31, 1995. The unrealized
gain on fixed maturities remained fairly consistent with 1995 as a
result of stable interest rates during 1996. Gross unrealized gains and
losses on equity investments totaled $22,339 and $3,024, respectively,
at December 31, 1996 compared to gross unrealized gains and losses on
equity investments of $13,430 and $2,008, respectively, at December 31,
1995. The increase in unrealized gain on equity investments was
primarily due to the increase in equity investments, as described
earlier, and the performance of the stock market during 1996 favorably
impacting the market values of common stocks.
Losses and loss adjustment expenses ("LAE") incurred as a
percentage of insurance premiums earned ("loss ratio") was 70.9% in 1996
compared to 62.0% in 1995. The ratio of net incurred losses, excluding
LAE, to premiums earned ("pure loss ratio") on personal automobile
increased to 63.9% in 1996 compared to 56.6% in 1995. This increase was
primarily due to the adverse impact of severe weather conditions
experienced in the northeast during the first half of 1996, adverse loss
experience on personal automobile business assumed from C.A.R., and a
decrease in the personal automobile average earned premium per exposure
of approximately 7.9%. This decrease was due to the effects of affinity
group marketing programs, safe driver rate deviations and the 1996 state
mandated average rate decrease of 4.5%. These factors were offset by
improved loss development during 1996. The commercial automobile pure
loss ratio decreased to 46.7% in 1996 compared to 57.4% in 1995. This
decrease was primarily due to improved loss experience on commercial
automobile business assumed from C.A.R and better loss development on
voluntary business. For homeowners, the pure loss ratio increased to
72.4% in 1996 compared to 49.6% in 1995. This increase was due
primarily to the severe weather during the first half of 1996, compared
to the mild weather experienced during 1995.
10
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Policy acquisition costs increased by 8.6% in 1996, compared to
5.9% in 1995. This increase was primarily due to the increase in net
premiums written as described previously, offset by a decrease of $9.5
million in the agents profit sharing compensation resulting from the
impact of adverse weather conditions on the Company's loss ratio and the
impact of affinity group marketing service fee income. Agents' profit
sharing compensation is based in part, on the underwriting profits of
agency business written with the Company. As a percentage of net
premiums written, underwriting expenses (on a statutory basis) were
27.1% for 1996, compared to 29.0% in 1995. This decrease was primarily
attributable to the reasons as mentioned above.
The Company's effective tax rate was 19.6% and 26.4% for the years
ended December 31, 1996 and 1995, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income. The lower 1996 effective tax rate was
primarily due to tax-exempt interest income comprising a higher
percentage of net income before taxes, the dividends received deduction
and lower capital gains in 1996 versus 1995.
Net earnings decreased $36,237 to $73,964 or 32.9%, during 1996 as
compared to net earnings of $110,201 in 1995, as a result of the factors
previously mentioned.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Direct premiums written during 1995 increased $1,643, or 0.3% to
$626,666 as compared to 1994. The increase was primarily attributable
to a $2,612, or 0.5% increase in direct premiums written for personal
automobile insurance to $514,637. This increase resulted from direct
premiums written of $7,592, for the four months ended December 31, 1995
from Western Pioneer, offset by a decrease in personal automobile direct
premiums written by Commerce of $4,980, or 1.0%, compared to 1994. This
decrease resulted primarily from a 3.6% decrease in the average personal
automobile premiums written per exposure (each vehicle insured). This
was a direct result of the impact on Commerce's business of the 6.1%
overall average rate decrease in the Massachusetts insurance industry's
1995 personal automobile premiums approved by the Commissioner. This
was partially offset by a 2.6% increase in the number of personal
automobile exposures written. Direct premiums written for commercial
automobile insurance decreased by $1,251, or 2.7% due primarily to a
4.9% decrease in the number of policies written, partially offset by a
2.2% increase in the average commercial automobile premium per policy.
Direct premiums written for homeowners insurance excluding the
Massachusetts Fair Plan increased by $1,021, or 2.2% due primarily to a
4.6% increase in the average premium per homeowners policy, partially
offset by a 2.4% decrease in the number of policies written.
Net premiums written during 1995 increased $14,224, or 2.4% as
compared to 1994. The increase in net premiums written was due to the
growth in direct premiums written as described above, as well as to the
effects of reinsurance. Written premiums assumed from C.A.R. decreased
$1,536, or 1.6% and written premiums ceded to C.A.R. decreased $17,769,
or 17.7% as compared to 1994, as a result of changes in the industry's
and the Company's utilization of C.A.R. reinsurance. Premiums ceded to
reinsurers other than C.A.R. increased $3,652, or 12.6% as compared to
1994.
Earned premiums increased $20,537, or 3.6% during 1995 as compared
to 1994. Motor vehicle premiums earned increased $17,959, or 3.4%
compared to 1994 including earned premiums assumed from C.A.R. which
increased $12,777, or 16.4%. Earned premiums also increased $2,578, or
6.3% on all other business.
Net investment income increased $8,412, or 13.4%, compared to
1994, principally as a result of an increase in average invested assets
(at cost) of 12.0% when compared to the year ended 1994. Net investment
income as a percentage of total average investments was 7.2% in 1995
compared to 7.0% in 1994.
11
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Premium finance fees increased $923, or 5.0%, to $19,420 in 1995
compared to 1994. The increase was primarily attributable to the net
effect of the increase in policies on direct bill and changes in the
direct bill payment program, offset by decreases in direct premiums
written and premium finance fees refunded due to the personal automobile
rate decrease.
Gross realized gains and losses on fixed maturity investments
amounted to $2,389 and $1,912, respectively, for the year ended December
31, 1995 compared to gross realized gains and losses on fixed maturity
investments of $9,696 and $2,310, respectively, for the year ended
December 31, 1994. Gross realized gains and losses on equity
investments amounted to $984 and $579, respectively, for the year ended
December 31, 1995 compared to gross realized gains and losses on equity
investments of $36,845 and $73, respectively, for the year ended
December 31, 1994. Net realized investment gains totalled $712 during
1995 as compared to $45,612 for the same period in 1994. The realized
gains in 1995 were primarily the result of sales of municipal bonds and
preferred stocks, offset by realized losses on sales of GNMA's and
common stocks. Included in the net realized gains for 1994 was $34,287
realized on the sale of common stock in three New England area bank
holding companies. These bank holding companies were acquired by other
banks in 1994. Also included were realized losses on mortgage activity
of $215 in 1995 compared to $1,203 in 1994.
Gross unrealized gains and losses on fixed maturity investments
totalled $18,626 and $4,657, respectively, at December 31, 1995 compared
to gross unrealized gains and losses on fixed maturity investments of
$1,233 and $57,599, respectively, at December 31, 1994. The unrealized
gain on fixed maturities was the result of a decline in interest rates
during 1995 favorably impacting market values. Gross unrealized gains
and losses on equity investments totaled $13,430 and $2,008,
respectively, at December 31, 1995 compared to gross unrealized gains
and losses on equity investments of $2,287 and $11,174, respectively, at
December 31, 1994. The increase in unrealized gain on equity
investments was primarily due to the performance of the stock market
coupled with declining interest rates during 1995 favorably impacting
the market values of common stocks.
The loss ratio was 62.0% in 1995 compared to 64.6% in 1994. The
personal automobile pure loss ratio increased to 56.6% compared to 54.3%
in 1994. This increase was primarily due to adverse loss experience on
personal automobile business assumed from C.A.R., partially offset by
improved loss experience in the liability component of the personal
automobile book of business. The commercial automobile pure loss ratio
decreased to 57.4% compared to 58.4% in 1994. This decrease was
primarily due to improved loss experience on commercial automobile
business assumed from C.A.R. For homeowners, the pure loss ratio
decreased to 49.6% compared to 91.8% in 1994. This decrease was due
primarily to the relatively mild weather during 1995, compared to the
adverse weather experienced during 1994, especially during the first
quarter of 1994.
Policy acquisition costs increased by 5.9% in 1995, compared to
4.8% in 1994. This increase was due to an increase in the accrual for
agents profit sharing compensation as a result of the impact of the mild
weather during 1995 on the Company's loss ratio. Agent's profit sharing
compensation is based in part on the underwriting profits of agency
business written by the Company. In addition, the Commissioner approved
an increase in the 1995 commission rate for personal automobile to 15.3%
compared to 13.5% in 1994, which also had the effect of increasing
policy acquisition costs.
The Company's effective tax rate was 26.4% and 28.7% for the years
ended December 31, 1995 and 1994, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income. The lower 1995 effective tax rate was due
to the higher amount of tax-exempt interest income coupled with lower
capital gains in 1995 versus 1994.
While net earnings decreased $12,382, during 1995 as compared to
an increase of $47,267 during 1994, net earnings exclusive of the after
tax impact of net realized investment gains increased $16,803. These
changes were the result of the factors previously mentioned.
12
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Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is
on the Consolidated Balance Sheets on page 18 and the Consolidated
Statements of Cash Flows on page 21. Stockholders' equity increased by
$37,325, or 6.8%, in 1996 as compared to 1995. Growth stemmed from
$73,964 in net earnings combined with the change in net unrealized
gains, net of income taxes, on fixed maturities and equity securities of
$6,575, partially offset by dividends paid to stockholders of $29,373
and Treasury Stock purchased of $13,841. Total assets at December 31,
1996 increased by $112,624, or 7.2%, to $1,676,799 as compared to total
assets of $1,564,175 at December 31, 1995. The increase in total assets
was primarily due to cash provided by operations and the increase in
cash due to proceeds from the maturities and sales of fixed maturities.
The majority of this growth was reflected in an increase of $30,910, or
24.3% in premiums receivable and in an increase in cash and cash
equivalents of $87,870 or 166.8% as compared to December 31, 1995. Of
the cash and cash equivalents total of $140,535, $118,015 is held in a
U.S. Government Repurchase Agreement at The First National Bank of
Boston. The Company intends to invest these proceeds through Salomon
Brothers Asset Management, Inc. until such time that the Company
believes longer term investments are appropriate.
The Company's fixed maturity portfolio is comprised of GNMA's
(31.5%) and municipal bonds (68.5%). Of the Company's bonds, 100.0% are
rated in either of the two highest quality categories provided by the
NAIC.
As announced in October, 1995, and in order to focus corporate
resources more directly on the Company's main line of business, private
passenger automobile insurance, the operations of the Company's mortgage
subsidiary, Bay Finance Company, Inc. ("Bay Finance"), were
substantially reduced. Effective January 1, 1996, Bay Finance no longer
actively originates mortgage loans with the use of outside originators
and extensive regional marketing. As a result, Bay Finance's staffing
levels were substantially reduced and the remaining employees focus on
servicing the Company's existing mortgage portfolio. Bay Finance has
retained its lending licenses and will continue to make a small number
of various types of mortgage loans.
The Company's liabilities totalled $1,089,760 at December 31, 1996
as compared to $1,014,461 at December 31, 1995. The $75,299, or 7.4%,
increase was comprised primarily of a $31,122, or 5.0%, increase in
losses and loss adjustment expense reserves, an increase of $37,537, or
11.4%, in unearned premiums and a increase of $6,640, or 10.2% in all
other liabilities. The primary reason for the changes in these
liabilities during 1996 was the increased level of personal automobile
insurance business written by the Company attributable to affinity group
marketing programs.
The primary sources of the Company's liquidity are funds generated
from insurance premiums, premium finance fees, net investment income and
maturing of investments as reflected in the Consolidated Statements of
Cash Flows on page 21.
The Company's operating activities provided cash of $115,651 in
1996 as compared to $135,282 in 1995. These cash flows were primarily
impacted by the fact that while net premiums written increased 17.9% in
1996 as compared to 2.4% in 1995, losses and LAE incurred increased
29.3% in 1996 as compared to a 0.6% decrease in 1995 and policy
acquisition costs increased 8.6% in 1996 as compared to 5.9% in 1995.
The increases were primarily the result of severe weather during the
first half of 1996 coupled with a decrease in the personal automobile
premium rate. The average rate decrease was due to the effects of
affinity group marketing programs, safe driver rate deviations and the
1996 state mandated rate decrease of 4.5%. The cash flows provided by
investing activities were primarily the result of proceeds from the
maturities and sales of fixed maturities offset by the purchases of
fixed maturities and equity securities. Investing and financing
activities were funded by the cash provided by operating activities.
Cash flows used in financing activities totalled $43,214 in 1996
compared to $32,994 in 1995. The increase was primarily attributable to
an increase in dividends paid to stockholders of $20,738 offset by a
decrease in Treasury Stock purchases of $10,518.
13
<page
The Company's funds are generally invested in securities with
maturities intended to provide adequate funds to pay claims without the
forced sale of investments. The carrying value (at market) of total
investments at December 31, 1996 was $1,027,136. At December 31, 1996,
the Company held cash and cash equivalents of $140,535. These funds
provide sufficient liquidity for the payment of claims and other short-
term cash needs. The Company relies upon dividends from its
subsidiaries for its cash requirements. Every Massachusetts insurance
company seeking to make any dividend or other distributions to its
stockholders must file a report with the Commissioner. An extraordinary
dividend is any dividend or other property, whose fair value together
with other dividends or distributions made within the preceding twelve
months exceeds the greater of ten percent of the insurer's surplus as
regards to policyholders as of the end of the preceding year, or the net
income of a non-life insurance company for the preceding year. No pro-
rata distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has
not objected. No extraordinary dividends were paid in 1996, 1995 and
1994.
Periodically, sales have been made from the Company's fixed
maturity investment portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to
realize gains. This practice will continue in the future.
Although the Company is not actively pursing acquisitions, in an
effort to enhance future growth potential, the Company continues to
monitor acquisition opportunities with regard to smaller automobile
insurance companies that are in need of capital, have established
management in place and present significant growth opportunities in
their market areas. On August 31, 1995, the Company completed the
acquisition of Western Pioneer Insurance Company, a personal automobile
insurer, located in Pleasanton, California.
The Company's long term growth objective is to expand its writings
outside of Massachusetts. To achieve this objective, during 1996 the
Company was granted licenses in the states of Connecticut and Rhode
Island. License approval in the state of Vermont was received in
January 1997. License applications were filed by the Company and are
pending in the states of Maine and New Hampshire. Concurrent with these
filings, the Company has entered into an agreement with PMSC and has
purchased software which will allow for the development of internal
operating systems which will enable the Company to process policies in
these five states and Massachusetts. To facilitate this development
and, at the same time, address the year 2000 processing issue facing
computer system users, the Company has formed Team 2000. Team 2000 will
provide for a complete integration of databases serving our three main
functions; claims, underwriting and premium accounting. Through the
year 2001, the Company expects to incur over $40 million in costs with
the implementation of the PMSC systems. This amount includes the
purchase of a main frame computer, license fees and the costs associated
with programming, implementation and training. In 1996, the Company
paid $10.5 million for the equipment and services previously mentioned,
of which $4.9 million was expensed during the year. These systems are
not scheduled to be in place for contiguous states until the latter part
of 1997 and as a result, Management is not expecting to start marketing
in the states contiguous to Massachusetts until that time.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.53 to 1.00 and 1.37 to 1.00
for the years ended December 31, 1996 and 1995, respectively.
Recent Accounting Developments
In February, 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per
Share". This statement is effective for financial statements issued for
periods ending after December 15, 1997, (including interim periods) with
earlier application not permitted. The statement specifies the
computation, presentation and disclosure requirements for earnings per
share. The Company believes that the adoption of this statement will
not have a material impact on the Consolidated Financial Statements.
14
<page
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation
in its personal automobile insurance line since the premiums it charges
are subject to state regulation. The premium rates charged by the
Company for personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in
premium rates may lag behind related cost increases. Economic
recessions will also have an impact upon the Company, primarily through
the policyholder's election to decrease non-compulsory coverages
afforded by the policy and decreased driving, each of which tends to
decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these
environments affect current market rates of return, previously committed
investments may rise or decline in value depending on the type and
maturity of investment.
Inflation and recession must also be considered by the Company in
the creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of
continually adjusting reserves is even more pronounced in periods of
changing economic circumstances.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
On March 31, 1995, the Company's common stock began trading on the
NYSE under the symbol "CGI". Previously, the Company's common stock was
traded on Nasdaq under the symbol "COMG". The high, low and close
prices for shares of the Company's common stock for 1996 and 1995 were
as follows:
<TABLE>
1996
1995
High Low Close High
Low Close
<CAPTION>
<S> <C> <C> <C> <C>
<C> <C>
First Quarter........... $20-3/4 $17-3/4 $19-3/4 $17
$14-3/4 $16-3/4
Second Quarter.......... 22-1/2 18-1/2 20-7/8 17-
7/8 16-1/4 17-7/8
Third Quarter........... 22-1/4 20-1/2 22 19-
7/8 16-3/4 19-5/8
Fourth Quarter.......... 25-3/4 22 25-1/4 21-
7/8 19-1/2 20-5/8
</TABLE>
As of March 1, 1997, there were 1,294 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name" or
held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $.81 per share
and $.23 per share in 1996 and 1995, respectively. On May 17, 1996, the
Board voted to increase the quarterly stockholder dividend from $.06 to
$.25 per share to stockholders of record as of June 7, 1996. Prior to
that declaration, the Company had paid quarterly dividends of $.06 per
share dating back to May 19, 1995 when the Board voted to increase the
dividend from $.05 to $.06 per share. The $.05 cash dividend per share
was first declared by the Board on May 20, 1994.
Treasury Stock purchased under the stock buyback program increased
by 673,915 shares during 1996 to 1,937,348 shares at December 31, 1996.
The stock buyback program, authorized by the Board in May 1995, enables
the Company to purchase up to three million shares of the Company's
common stock. The program is now approximately two-thirds complete.
15
<page
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
generally accepted accounting principles determined by management to be
appropriate in the circumstances and include amounts based on
management's informed estimates and judgments. Financial information
presented elsewhere in this Annual Report is consistent with the
financial statements. The appropriateness of data underlying such
financial information is monitored through internal accounting controls,
an internal audit department, independent accountants and the Board of
Directors through its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are executed
in accordance with management's authorization and recorded properly.
The system of internal accounting controls is supported by the selection
and training of qualified personnel combined with the appropriate
division of responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to
the highest standards of personal and corporate conduct. Management
encourages open communication within the Company and requires the
confidential treatment of proprietary information and compliance with
all domestic laws, including those relating to financial disclosure.
The 1996 consolidated financial statements were audited by the
Company's independent accountants, Coopers & Lybrand L.L.P., in
accordance with generally accepted auditing standards. Management has
made available to Coopers & Lybrand L.L.P., all the Company's financial
records and related data, as well as the minutes of stockholders' and
directors' meetings. Furthermore, management believes that all
representations made to Coopers & Lybrand L.L.P., during its audit were
valid and appropriate.
16
<page
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheets of
The Commerce Group, Inc. and Subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of earnings, stockholders'
equity and cash flows for each of the three years in the period ended
December 31, 1996. 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 in accordance with generally accepted
auditing standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
The Commerce Group, Inc. and Subsidiaries as of December 31, 1996 and
1995, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996,
in conformity with generally accepted accounting principles.
COOPERS &
LYBRAND L.L.P.
Boston, Massachusetts
January 24, 1997
17
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars Except Per Share Data)
<TABLE>
1996 1995
ASSETS
<CAPTION>
<S>
<C> <C>
Investments (notes A2 and B)
Fixed maturities, at market (cost: $700,511 in 1996 and $801,308
in 1995).......................................................... $
716,702 $ 815,277
Equity securities, at market (cost: $214,406 in 1996 and $140,157
in 1995)..........................................................
233,721 151,579
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $2,760 in 1996
and $3,173 in 1995)...............................................
74,586 75,609
Other investments..................................................
2,127 1,648
Total investments..............................................
1,027,136 1,044,113
Cash and cash equivalents (note A3)..................................
140,535 52,665
Accrued investment income............................................
12,819 14,686
Premiums receivable (less allowance for doubtful receivables of
$1,500 in 1996 and $1,103 in 1995).................................
158,153 127,243
Deferred policy acquisition costs (notes A4 and C)...................
82,968 67,160
Property and equipment, net of accumulated depreciation
(notes A5 and D)...................................................
32,100 30,981
Residual market receivable (note F)..................................
195,213 200,124
Due from reinsurers (note F).........................................
19,659 21,897
Deferred income taxes (notes A8 and G)...............................
- - 1,415
Other assets.........................................................
8,216 3,891
Total assets...................................................
$1,676,799 $1,564,175
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses (notes A6, E and F)............ $
649,913 $ 618,791
Unearned premiums (note A7)........................................
367,991 330,454
Current income taxes (notes A8 and G)..............................
171 1,180
Deferred income taxes (notes A8 and G).............................
4,223 -
Deferred income (notes A9 and F)...................................
7,974 8,954
Contingent commissions accrued.....................................
25,712 32,550
Other liabilities and accrued expenses.............................
33,776 22,532
Total liabilities..............................................
1,089,760 1,014,461
Stockholders' Equity (notes B, J, K and L)
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 1996 and 1995......................................
- - -
Common stock, authorized 100,000,000 shares at $.50 par value;
issued and outstanding 38,000,000 shares in 1996 and 1995.........
19,000 19,000
Paid-in capital....................................................
29,621 29,621
Net unrealized gains on fixed maturities and equity securities,
net of income taxes of $12,427 in 1996 and $8,887 in 1995.........
23,079 16,504
Retained earnings..................................................
553,539 508,948
625,239 574,073
Treasury Stock, 1,937,348 shares in 1996 and 1,263,433 shares in
1995, at cost (note A11)..........................................
(38,200) (24,359)
Total stockholders' equity.....................................
587,039 549,714
Total liabilities and stockholders' equity.....................
$1,676,799 $1,564,175
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
18
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Per Share Data)
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Revenues
Earned premiums (notes A7 and F)..................... $ 668,716 $
592,590 $ 572,053
Net investment income (note B)....................... 77,402
71,313 62,901
Premium finance fees................................. 9,713
19,420 18,497
Net realized investment gains (losses) (note B)...... (7,574)
712 45,612
Total revenues.................................. 748,257
684,035 699,063
Expenses
Losses and loss adjustment expenses
(notes A6, E and F)................................. 475,231
367,552 369,660
Policy acquisition costs (notes A4 and C)............ 181,013
166,741 157,415
Total expenses.................................. 656,244
534,293 527,075
Earnings before income taxes.................... 92,013
149,742 171,988
Income taxes (notes A8 and G).......................... 18,049
39,541 49,405
NET EARNINGS.................................... $ 73,964 $
110,201 $ 122,583
NET EARNINGS PER COMMON SHARE (primary and
fully diluted) (note A10)...................... $ 2.04 $
2.93 $ 3.23
CASH DIVIDENDS PAID PER SHARE................... $ 0.81 $
0.23 $ 0.15
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING............................. 36,311,887
37,632,236 38,000,000
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
19
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
<TABLE>
Net
Common Paid-in Unrealized Retained
Treasury
Stock Capital Gains/Losses Earnings
Stock Total
<CAPTION>
<S> <C> <C> <C> <C>
<C> <C>
Balance December 31, 1993.... $19,000 $29,621 $44,228 $290,499
$ - $383,348
Net earnings................ 122,583
122,583
Change in unrealized gains
(losses), net of taxes..... (86,642)
(86,642)
Stockholder dividends....... (5,700)
(5,700)
Balance December 31, 1994.... 19,000 29,621 (42,414) 407,382
- - 413,589
Net earnings................ 110,201
110,201
Change in unrealized gains
(losses) net of taxes...... 58,918
58,918
Stockholder dividends....... (8,635)
(8,635)
Treasury stock purchased....
(24,359) (24,359)
Balance December 31, 1995.... 19,000 29,621 16,504 508,948
(24,359) 549,714
Net earnings................ 73,964
73,964
Change in unrealized gains
net of taxes............... 6,575
6,575
Stockholder dividends....... (29,373)
(29,373)
Treasury stock purchased....
(13,841) (13,841)
Balance December 31, 1996.... $19,000 $29,621 $23,079 $553,539
$(38,200) $587,039
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
20
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C>
<C> <C>
Cash flows from operating activities:
Net earnings.............................................. $ 73,964
$ 110,201 $ 122,583
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable..................................... (30,910)
(24,714) (7,267)
Deferred policy acquisition costs....................... (15,808)
(8,094) (3,122)
Residual market receivable.............................. 4,911
14,694 5,494
Due to/from reinsurers.................................. 2,238
(5,005) (4,024)
Losses and loss adjustment expenses..................... 31,122
26,418 24,576
Unearned premiums....................................... 37,537
15,735 31,193
Current income taxes.................................... (1,009)
(8,637) 6,256
Deferred income taxes................................... 2,098
4,651 (4,878)
Deferred income......................................... (980)
(1,497) 3,100
Contingent commissions.................................. (6,838)
8,100 2,724
Other liabilities and accrued expenses.................. 11,244
5,705 (147)
Net realized investment (gains) losses.................. 7,574
(712) (45,612)
Other-net............................................... 508
(1,563) 6,716
Net cash provided by operating activities............. 115,651
135,282 137,592
Cash flows from investing activities:
Proceeds from maturity of fixed maturities................ 170,646
28,479 55,671
Proceeds from sale of fixed maturities.................... 122,431
72,287 123,127
Purchase of fixed maturities.............................. (200,113)
(100,689) (351,260)
Purchase of equity securities............................. (85,480)
(50,418) (26,155)
Proceeds from sale of equity securities................... 11,326
14,784 59,722
Payments received on mortgage loans and collateral notes
receivable.............................................. 8,311
9,892 8,524
Mortgage loans and collateral notes receivable originated. (7,446)
(28,667) (16,562)
Mortgages sold to investors in the secondary market....... 36
2,287 10,725
Proceeds from sale of real estate acquired by
foreclosures............................................. 92
318 2,120
Purchase of property and equipment........................ (4,477)
(3,664) (5,786)
Proceeds from sale of property and equipment.............. 107
283 250
Net cash provided by (used in) investing activities... 15,433
(55,108) (139,624)
Cash flows from financing activities:
Dividends paid to stockholders............................ (29,373)
(8,635) (5,700)
Purchase of treasury stock................................ (13,841)
(24,359) -
Net cash used in financing activities................. (43,214)
(32,994) (5,700)
Increase (decrease) in cash and cash equivalents............ 87,870
47,180 (7,732)
Cash and cash equivalents at beginning of year.............. 52,665
5,485 13,217
Cash and cash equivalents at end of year.................... $ 140,535
$ 52,665 $ 5,485
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
21
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc.
(the "Company") have been prepared in accordance with generally accepted
accounting principles ("GAAP").
The consolidated financial statements include The Commerce Group,
Inc., and its wholly-owned subsidiaries, Bay Finance Company, Inc.,
Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI").
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation") are wholly-owned subsidiaries of Commerce Holdings,
Inc. Western Pioneer Insurance Company ("Western Pioneer") is a wholly-
owned subsidiary of Commerce. All intercompany transactions and
balances have been eliminated in consolidation. Certain prior year
account balances have been reclassified to conform to 1996 presentation.
The insurance subsidiaries, Commerce, Citation and Western Pioneer
prepare statutory financial statements in accordance with accounting
practices prescribed by the National Association of Insurance
Commissioners ("NAIC"), the Commonwealth of Massachusetts, and the State
of California.
The preparation of financial statements in conformity with
generally accepted accounting principles 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 could differ
from those estimates.
2. Investments
All investment transactions have credit exposure to the extent
that a counterparty may default on an obligation to the Company. Credit
risk is a consequence of carrying investment positions. The financial
instruments that potentially subject the Company to credit risk consist
primarily of cash and cash equivalents, premium receivables,
investments, and mortgage loans on real estate. Concentrations of
credit risk with respect to premiums receivable result from the fact
that the Company's policyholders are concentrated primarily in one
geographic area, as the Company, the largest writer of personal
automobile insurance in the state of Massachusetts, writes primarily in
Massachusetts. To manage credit risk, the Company focuses on higher
quality fixed-income securities, reviews the credit strength of all
companies which it invests in, limits its exposure in any one investment
and monitors the portfolio quality, taking into account credit ratings
assigned by recognized statistical rating organizations.
Investments in fixed maturities, which include bonds and
redeemable preferred stocks, and investments in equity securities, which
include common and non-redeemable preferred stocks, all classified as
available for sale, are carried at fair market value. Unrealized
investment gains and losses on equity investments and fixed maturities,
to the extent that there is no permanent impairment of value, are
credited or charged to a separate component of stockholders' equity
until realized, net of any tax effect. When investment securities are
sold, the realized gain or loss is determined based upon specific
identification. Fair market value of fixed maturities and equity
investments is based on quoted market prices. For other securities held
as investments, fair market value equals quoted market price, if
available. If a quoted market price is not available, fair market value
is estimated using quoted market prices for similar securities. The
Company has not invested more than 7% of fixed maturities in any one
state or political subdivision.
22
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
The Company originates and holds mortgage loans on real estate
primarily on properties located in the state of Massachusetts. The
Company controls credit risk through credit approvals, credit limits and
monitoring procedures. The Company performs in-depth credit evaluations
on all new customers. Bad debt expenses have not been material in
recent years.
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by Management. Factors considered in
evaluating the adequacy of the allowance include previous loss
experience, current economic conditions and their effect on borrowers
and the performance of individual loans in relation to contract terms.
The provision for possible loan losses charged to operating expenses is
based upon Management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses
are charged against the allowance when Management believes the
collectibility of the principal is unlikely and recoveries are credited
to the allowance when received.
Interest on mortgage loans is included in income as earned based
upon rates applied to principal amounts outstanding. Accrual of
interest on mortgage loans is discontinued either when reasonable doubt
exists as to the full, timely collection of interest or principal, or
when a loan becomes contractually past due more than ninety days. When
a loan is placed on nonaccrual status, all unpaid interest previously
accrued is reversed against current period earnings.
3. Cash and Cash Equivalents
Cash and cash equivalents include cash currently on hand and
short-term investments with original maturities, when purchased, of
three months or less. The carrying amount approximates fair value. The
Company holds $118,015 in a U.S. Government Repurchase Agreement at The
First National Bank of Boston. When the Company enters into a
repurchase agreement through its custodian, it receives delivery of the
underlying collateral. The amount of collateral, at the time of
purchase and each subsequent business day, is required to be maintained
at such a level that market value is equal to 102% of the resale price.
The Company intends to invest these proceeds through Salomon Brothers
Asset Management, Inc. until such time that the Company believes longer
term investments are appropriate.
4. Deferred Policy Acquisition Costs
Policy acquisition costs relating to unearned premiums, consisting
of commissions, premium taxes and other underwriting expenses incurred
at the policy issuance, are deferred and amortized over the period in
which the related premiums are earned, the amount being reduced by any
potential premium deficiency. If any potential premium deficiency
exists, it represents future estimated losses, loss adjustment expenses
and amortization of deferred acquisition costs in excess of the related
unearned premiums. There was no premium deficiency in 1996, 1995 and
1994. In determining whether a premium deficiency exists, the Company
considers anticipated investment income on unearned premiums.
23
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
5. Property and Equipment
Property and equipment are stated at cost and are depreciated on
the straight line method over the estimated useful lives of the assets
using the following rates:
<TABLE>
Percent
Asset Classification
Per Annum
<CAPTION>
<S>
<C>
Buildings....................................... 2.5
Building improvements (prior to 1992)........... 2.5
Building improvements (1992 and subsequent)..... 5.0
Equipment and office furniture.................. 10.0
EDP equipment and copiers....................... 20.0
Automobiles..................................... 33.3
</TABLE>
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon are eliminated from the related
property and accumulated depreciation accounts and any resulting gain or
loss is credited or charged to income.
6. Losses and Loss Adjustment Expenses
The liability for unpaid losses and LAE represents the
accumulation of individual case estimates for reported losses and
estimates for incurred but not reported ("IBNR") losses and LAE.
Assumed losses and LAE are recorded as reported by the ceding
organization with additional adjustments for IBNR. The liability for
losses and LAE is intended to cover the ultimate net cost of all losses
and loss adjustment expenses incurred through the balance sheet date.
Liability estimates are continually reviewed and updated, and therefore,
the ultimate liability may be more or less than the current estimate.
The effects of changes in the estimates are included in the results of
operations in the period in which the estimates are revised.
7. Premiums
Insurance premiums are recognized as income ratably over the terms
of the policies. Unearned premiums are determined by prorating policy
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's premiums written is derived through the five
American Automobile Association Clubs of Massachusetts group marketing
program. In 1996, total direct premiums written attributable to the AAA
group business was $344,297 or 47% of the Company's total direct
premiums written. Of this amount, 9% was written through the AAA clubs
and 91% was written through the Company's network of independent agents.
8. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized.
9. Deferred Income
Income consisting of group marketing service fees and expense
reimbursements which include servicing carrier fees from Commonwealth
Automobile Reinsurers ("C.A.R."), a state-mandated reinsurance
mechanism, on policies written for C.A.R., are deferred and amortized
over the term of the related insurance policies (see note F).
24
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
10. Net Earnings Per Common Share
Net earnings per common share is computed by dividing net earnings
by the weighted average number of common shares outstanding. The
weighted average number of common shares outstanding for the years ended
December 31, 1996, 1995 and 1994 was 36,311,887, 37,632,236 and
38,000,000, respectively.
11. Treasury Stock
On May 19, 1995, the Board of Directors of the Company, announced
the approval of a stock buyback program of up to three million shares.
Through December 31, 1996, the Company purchased 1,937,348 shares of
Treasury Stock under this program.
NOTE B-Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market values of investments
in fixed maturities are as follows:
<TABLE>
Gross
Gross Estimated
Amortized Unrealized
Unrealized Fair Market
Cost Gains
Losses Value
<CAPTION>
<S> <C> <C> <C>
<C>
At December 31, 1996:
GNMA mortgage-backed bonds........... $223,590 $ 2,589 $
(627) $225,552
Obligations of states and
political subdivisions.............. 476,921 15,301
(1,072) 491,150
Totals.......................... $700,511 $ 17,890 $
(1,699) $716,702
At December 31, 1995:
GNMA mortgage-backed bonds........... $220,589 $ 2,422 $
(1,638) $221,373
Obligations of states and
political subdivisions.............. 580,719 16,204
(3,019) 593,904
Totals.......................... $801,308 $ 18,626 $
(4,657) $815,277
</TABLE>
<TABLE>
Proceeds from sales of investments in fixed maturities, gross
gains, and gross losses realized on those sales were as follows:
Proceeds
Gross Gross
From
Realized Realized
Sales
Gains Losses
<CAPTION>
<S> <C> <C>
<C>
For the year ended December 31, 1996:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 122,431
367 (3,685)
Totals........................................ $122,431 $
367 $ (3,685)
For the year ended December 31, 1995:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 72,287
2,340 (695)
Totals........................................ $ 72,287 $
2,340 $ (695)
For the year ended December 31, 1994:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 123,127
9,509 (58)
Totals........................................ $123,127 $
9,509 $ (58)
</TABLE>
25
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
The amortized cost and approximate fair market value of fixed
maturities at December 31, 1996 and 1995, by contractual maturity, are
as follows:
<TABLE>
1996
1995
Fair
Fair
Amortized Market
Amortized Market
Cost Value
Cost Value
<CAPTION><S> <C>
<C> <C> <C>
Obligations of states and political subdivisions:
Due in one year or less.......................... $ 508 $ 517
$ - $ -
Due after one year through five years............ 94 102
1,130 1,149
Due after five years through ten years........... 1,669 1,681
19,956 20,183
Due after ten years.............................. 474,648 488,847
559,633 572,572
476,919 491,147
580,719 593,904
GNMA mortgage-backed bonds....................... 223,592 225,555
220,589 221,373
Total fixed maturities........................... $700,511 $716,702
$801,308 $815,277
</TABLE>
Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations.
2. Equity Securities
The cost and approximate fair market value of equity securities at
December 31, 1996 and 1995, are as follows:
<TABLE>
1996
1995
Fair
Fair
Market
Market
Cost Value
Cost Value
<CAPTION>
<S> <C> <C>
<C> <C>
Non-redeemable preferred stocks............. $148,481 $147,680
$111,597 $111,220
Preferred stock mutual funds................ 28,553 29,087
- - -
Common stocks............................... 37,372 56,954
28,560 40,359
$214,406 $233,721
$140,157 $151,579
</TABLE>
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 1996 and 1995, mortgage loans on real estate and
collateral notes receivable consisted of the following:
<TABLE>
December 31,
1996
1995
<CAPTION>
<S> <C>
<C>
Residential (1st Mortgages)............ $58,263
$59,575
Residential (2nd Mortgages)............ 1,077
847
Commercial (1st Mortgages)............. 15,805
15,804
Commercial (2nd Mortgages)............. 196
217
75,341
76,443
Collateral notes receivable............ 2,005
2,339
77,346
78,782
Allowance for possible loan losses..... (2,760)
(3,173)
Mortgage loans on real estate and
collateral notes receivable....... $74,586
$75,609
</TABLE>
26
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities.
The future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work
out arrangements or the disposition of collateral. The fair value of
mortgage loans on real estate and collateral notes receivable at
December 31, 1996 and 1995, prior to the allowance for possible loan
losses, was $78,920 and $81,200, respectively, which was estimated by
discounting the future cash flows of the mortgages.
At December 31, 1996 and 1995, mortgage loans which were on
nonaccrual status were
$2,095 and $2,727, respectively. The reduction in interest income
associated with nonaccrual loans was $152, $287 and $223 for the years
ended December 31, 1996, 1995 and 1994, respectively.
The Company originates and services residential and commercial
mortgages primarily in Massachusetts and generally its exposure is 80%
or less of the appraised value of any collateralized real property. The
ability and willingness of residential and commercial borrowers to honor
their repayment commitments is generally dependent upon the level of
overall economic activity and real estate values.
A summary of the changes in the allowance for possible loan losses
follows:
<TABLE>
Year Ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Balance, beginning of year.............. $ 3,173 $
3,324 $ 3,644
Decrease in provision for possible
loan losses......................... (135)
(151) (277)
Loans charged off..................... (278)
- - (43)
Balance, end of year.................... $ 2,760 $
3,173 $ 3,324
</TABLE>
The following table describes mortgage principal balances by
maturity and discloses over 90 days past due and foreclosure
information:
<TABLE>
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Fixed Rate Mortgages Maturing:
One year or less...................... $ 632 $
512 $ 307
More than one year to five years...... 2,248
640 412
More than five years to ten years..... 4,700
5,500 5,452
Over ten years........................ 42,902
40,807 24,407
Total Fixed Mortgages............ $50,482
$47,459 $30,578
Adjustable Rate Mortgages Maturing:
One year or less...................... $ - $
- - $ -
More than one year to five years...... 43
79 183
More than five years to ten years..... 569
455 385
Over ten years........................ 24,247
28,450 28,644
Total Adjustable Mortgages....... $24,859
$28,984 $29,212
Past due over 90 days................... $ 2,095 $
2,727 $ 2,395
Mortgages in Foreclosure................ $ 938 $
795 $ 700
</TABLE>
27
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
4. Net Investment Income
The components of net investment income were as follows:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Interest and dividends on fixed maturities... $ 56,034 $
56,467 $ 50,000
Dividends on equity securities............... 12,765
8,486 7,426
Interest on short-term investments........... 4,022
2,466 1,629
Interest on mortgage loans................... 6,737
6,141 6,097
Other........................................ 105
478 208
Total investment income............. 79,663
74,038 65,360
Investment expenses.......................... 2,261
2,725 2,459
Net investment income............... $ 77,402 $
71,313 $ 62,901
</TABLE>
5. Net Realized and Unrealized Investment Gains (Losses)
Net realized investment gains and the net increases (decreases) in
unrealized investment gains or losses, less applicable income tax
expense, were as follows:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Net realized investment gains (losses):
Fixed maturities................................. $ (7,364) $
477 $ 7,386
Equity securities................................ 107
405 38,845
Other............................................ (317)
(170) (619)
Total........................................ $ (7,574) $
712 $ 45,612
Net increase (decrease) in unrealized gains (losses):
Fixed maturities................................. $ 2,222 $
70,335 $(83,843)
Equity securities................................ 7,893
20,308 (49,687)
Related tax benefit (expense).................... (3,540)
(31,725) 46,888
Total........................................ $ 6,575 $
58,918 $(86,642)
</TABLE>
A summary of accumulated unrealized gains and losses on equity
securities and fixed maturity investments in 1996, 1995 and 1994
follows:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Unrealized gains....................... $ 40,227 $
32,056 $ 3,520
Unrealized losses...................... (4,721)
(6,665) (68,773)
Tax benefit (expense).................. (12,427)
(8,887) 22,839
Net unrealized gains
(losses)........................ $ 23,079 $
16,504 $(42,414)
</TABLE>
NOTE C-Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Balance, beginning of year............. $ 67,160 $
59,066 $ 53,647
Costs deferred during the year......... 196,821
174,835 162,834
Amortization charged to expense........ (181,013)
(166,741) (157,415)
Balance, end of year................... $ 82,968 $
67,160 $ 59,066
</TABLE>
28
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE D-Property and Equipment
A summary of property and equipment at December 31, is as follows:
<TABLE>
1996
1995
<CAPTION>
<S> <C>
<C>
Buildings................................. $ 27,506
$ 27,077
Equipment and office furniture............ 24,993
21,436
Building improvements..................... 811
623
53,310
49,136
Less accumulated depreciation....... 22,015
18,953
31,295
30,183
Land...................................... 805
798
$ 32,100
$ 30,981
</TABLE>
Depreciation expenses incurred were $3,202, $3,151 and $3,093 for
the years ended December 31, 1996, 1995 and 1994, respectively.
Depreciation expense is allocated between losses and loss adjustment
expenses and policy acquisition costs.
NOTE E-Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at
December 31, consist of:
<TABLE>
1996
1995
<CAPTION>
<S> <C>
<C>
Unpaid loss and LAE reserves.............. $705,674
$662,591
Salvage and subrogation recoverable.......
(55,761) (43,800)
$649,913
$618,791
</TABLE>
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to obtain annually a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
When a claim is reported to the Company, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon a case-by-
case evaluation of the type of claim involved, the circumstances
surrounding each claim and the policy provisions relating to the type of
loss. The estimate reflects the informed judgment of such personnel
based on general insurance reserving practices and on the experience and
knowledge of the claims person. During the loss adjustment period,
these estimates are revised as deemed necessary by the Company's claims
department based on subsequent developments and periodic reviews of the
cases.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR. IBNR reserves are determined on the basis
of historical information and the experience of the Company.
Adjustments to IBNR are made periodically to take into account changes
in the volume of business written, claims frequency and severity, the
mix of business, claims processing and other items that can be expected
to affect the Company's liability for losses and LAE over time.
29
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
When reviewing reserves, the Company analyzes historical data and
estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes in political
attitudes and trends in general economic conditions, including the
effects of inflation. This process assumes that past experience,
adjusted for the effects of current developments and anticipated trends,
is an appropriate basis for predicting future events. There is no
precise method, however, for subsequently evaluating the impact of any
specific factor on the adequacy of reserves, because the eventual
development of reserves is affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company estimates
the ultimate net liability for losses and LAE. After taking into
account all relevant factors, management believes that the provision for
losses and LAE at December 31, 1996 is adequate to cover the ultimate
net cost of losses and claims incurred as of that date. The ultimate
liability, however, may be greater or lower than reserves.
Establishment of appropriate reserves is an inherently uncertain
process, and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience.
The Company does not discount to present value that portion of its loss
reserves expected to be paid in future periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known and
unknown losses. Because of the Company's limited exposure to these
types of claims, management believes they will not have a material
impact on the consolidated financial position of the Company in the
future. Loss reserves on environmental related claims amounted to
$8,783, $10,708 and $11,151 in 1996, 1995 and 1994, respectively.
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expenses, net of
reinsurance deductions from all reinsurers including C.A.R., as shown in
the Company's consolidated financial statements for the periods
indicated.
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Reserves for losses and loss adjustment
expenses, beginning of year......................... $486,673
$448,331 $415,613
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 562,997
442,027 435,713
Decrease in provision for insured events of
prior years...................................... (87,766)
(74,475) (66,053)
Total incurred losses and loss adjustment
expenses....................................... 475,231
367,552 369,660
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 273,334
184,182 188,002
Losses and loss adjustment expenses attributable
to insured events of prior years................. 167,509
145,028 148,940
Total payments.................................. 440,843
329,210 336,942
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 521,061
486,673 448,331
Ceded reinsurance recoverable..................... 128,852
132,118 144,042
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $649,913
$618,791 $592,373
</TABLE>
30
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
The increases in payments and incurred losses primarily resulted
from increased business volume in 1996 coupled with an increase in
collision frequency.
The Company's loss and LAE reserves reflect its share of the
aggregate loss and LAE reserves of all Servicing Carriers. The Company
is a defendant in various legal actions arising from the normal course
of its business. These proceedings are considered to be ordinary and
incidental to operations or without foundation in fact. Management is
of the opinion that these actions will not have a material adverse
effect on the consolidated financial statements of the Company.
NOTE F-Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses
from a single occurrence or event. The Company also has a combined
quota share and excess loss reinsurance contract on its other than
automobile property business.
Property and Catastrophe Reinsurance
From the inception, on September 30, 1993, through the third
quarter of 1995, the Company's combined property quota share and excess
loss reinsurance contract was written with five domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnified the Company for 36% of the loss and LAE, and paid
a commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company paid to the reinsurers 40% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement was $40.0 million and the maximum annual aggregate
occurrence loss reimbursement was $60.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsured each
risk, retaining $125 and reinsuring 100% of the next $875.
Effective September 30, 1995, the Company increased its coverage
under the combined property quota share and excess loss reinsurance
contract. The contract is now written with six domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnify the Company for 45% of the loss and LAE, and pay a
commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company pays to the reinsurers 49% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement is $50.0 million and the maximum annual aggregate
occurrence loss reimbursement is $75.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsures each
risk, retaining $125 and reinsuring 100% of the next $875. This
reinsurance contract is continuous, cancelable quarterly with ninety
days notice.
Effective March 1, 1995, through February 29, 1996, the Company
had catastrophe reinsurance coverage for that portion of the loss not
covered under the property quota share arrangement. Catastrophe
reinsurance coverage was in force for approximately 88.0% of the amounts
incurred for all property claims arising from a single event or
occurrence up to a maximum loss of $100.0 million, after first
subtracting property quota share losses. Coverage under the catastrophe
program was as follows: a net retention of $5.0 million; 50.0% of the
next $5.0 million; and, 95.0% of the next $90.0 million. Including the
Company's retention, total catastrophe coverage was $100.0 million.
This coverage was placed with a number of reinsurers, both foreign and
domestic.
31
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
Effective March 1, 1996 through February 28, 1997, the Company's
catastrophe reinsurance program has been tailored in conjunction with
the property quota share arrangement to provide catastrophe reinsurance
protection at varying levels of losses. The table below provides
information depicting the approximate combined recoveries of all
property reinsurance programs (catastrophe and quota share) at various
loss scenarios if a catastrophe were to strike:
<TABLE>
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
<CAPTION>
<S> <C> <C>
$ 25,000 $ 11,300 $13,700
50,000 35,000 15,000
75,000 58,800 16,200
100,000 82,500 17,500
125,000 105,000 20,000
150,000 110,000 40,000
</TABLE>
The Company will have no reinsurance recoveries for total loss
amounts in excess of $150.0 million. The Company is currently
renegotiating its primary catastrophe reinsurance program to become
effective May 1, 1997. This renegotiation does not affect the property
quota share arrangement or one other non-primary catastrophe reinsurance
program.
Casualty Reinsurance
Through December 31, 1996, casualty reinsurance was on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$4.0 million over a net retention of $1.0 million. Effective January 1,
1997, casualty reinsurance is on an excess loss basis for any one event
or occurrence with a maximum recovery of $9.0 million over a net
retention of $1.0 million. This coverage is placed with Swiss
Reinsurance America Corporation, formerly North American Reinsurance
Corporation (rated A by A.M. Best).
Effective January 1, 1995, personal and commercial liability
umbrella policies are reinsured on a 95% quota share basis in regard to
limits up to $1.0 million and 100% quota share basis for limits in
excess of $1.0 million but not exceeding $5.0 million for policies with
underlying automobile coverage of $250,000/$500,000 or more. Effective
January 1, 1996, the Company added personal liability umbrella
reinsurance coverage for policies with underlying automobile coverage of
$100,000/$300,000, on a 65% quota share basis in regard to limits up to
$1.0 million and 100% quota share basis for limits in excess of $1.0
million but not exceeding $3.0 million. These coverages are placed with
American Reinsurance Corporation (rated A+ by A.M. Best).
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the
Company and approximately 40 other writers of automobile insurance in
Massachusetts ("Servicing Carriers") to reinsure any automobile risk
that the insurer perceives to be underpriced at the premium level
permitted by the Massachusetts Insurance Commissioner (the
"Commissioner"). Servicing Carriers, which are responsible for over
99.0% of total direct premiums written for personal automobile insurance
in Massachusetts, are required to offer automobile insurance coverage to
all eligible applicants pursuant to "take-all-comers" regulations, but
may reinsure undesirable business with C.A.R.
The Company pays to C.A.R. all of the premiums generated by the
policies it has ceded and C.A.R. reimburses the Company for all losses
incurred on account of ceded policies. In addition, the Company
receives a fee for servicing ceded policies based on the expense
structure established by C.A.R. For the years ended December 31, 1996,
1995 and 1994, these servicing fees amounted to $17,127, $21,669 and
$14,282, respectively.
32
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
C.A.R. has annually generated multi-million dollar underwriting
losses in both the personal and commercial pools since its inception.
The Company is required to share in the underwriting results of C.A.R.
business for its respective product lines. Under current regulations,
the Company's share of C.A.R. personal or commercial deficit is based
upon its market share for retained automobile risks for the particular
pool, adjusted by a "utilization" concept, such that, in general, the
Company is disproportionately and adversely affected if its relative use
of C.A.R. reinsurance exceeds that of the industry, and favorably
affected if its relative use of C.A.R. reinsurance is less than that of
the industry. During 1996, 1995 and 1994, the Company's net
participation in the C.A.R. personal automobile pool approximated 19.0%,
16.0% and 16.0%, respectively.
Written premiums, earned premiums, losses incurred and the
liabilities for unearned premiums, unpaid losses ceded to and assumed
from C.A.R. and other receivables from C.A.R. were as follows:
<TABLE>
Year ended December 31,
1996 1995
1994
Ceded Assumed Ceded Assumed
Ceded Assumed
<CAPTION>
<S> <C> <C> <C> <C> <C>
<C>
Income Statement
Written premiums... $ 82,861 $ 93,703 $ 82,814 $ 92,249
$100,583 $ 93,785
Earned premiums.... 85,977 92,469 92,664 90,609
87,585 77,832
Losses incurred.... 84,074 93,278 75,475 87,786
81,217 63,842
Balance Sheet
Unearned premiums.. $ 36,042 $ 46,681 $ 39,158 $ 45,446 $
49,008 $ 43,806
Unpaid losses...... 123,092 117,237 126,555 110,003
138,356 95,290
Other receivables
from C.A.R........ 36,079 N/A 34,411 N/A
27,454 N/A
Residual Market
Receivable......... $195,213 N/A $200,124 N/A
$214,818 N/A
</TABLE>
In accordance with SFAS No. 113, "Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts", the company
presents assets and liabilities gross of reinsurance. The Residual
Market Receivable represents the gross amount of reinsurance recoverable
from C.A.R. including unpaid losses, unearned premiums, paid losses
recoverable and unpaid ceded and assumed premiums.
The current C.A.R. utilization-based participation ratio has been
in place for the personal automobile market since 1993. During 1996,
1995 and 1994, the Company's amount of personal automobile risks it
reinsured through C.A.R. approximated 8.0%, 11.0% and 14.0%,
respectively.
Earned premiums and losses and loss adjustment expenses are stated
in the accompanying consolidated financial statements after deductions
for ceded reinsurance. Those deductions for reinsurance other than
C.A.R. are as follows:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Earned premiums ceded.................................. $36,261
$28,056 $28,278
Losses and loss adjustment expenses ceded.............. 22,453
21,454 17,936
</TABLE>
The Company, as primary insurer, would be required to pay losses
in their entirety in the event that the reinsurers were unable to
discharge their obligations under the reinsurance agreements.
33
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE G-Income Taxes
The Company and its subsidiaries file a consolidated federal
income tax return.
The Federal income tax expense (benefit) consisted of the
following:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Current............................ $ 15,951 $
34,891 $ 54,181
Deferred........................... 2,098
4,650 (4,776)
$ 18,049 $
39,541 $ 49,405
</TABLE>
Deferred taxes arise from temporary differences in the bases of
assets and liabilities for tax and financial statement purposes. The
sources of these differences and the related tax effects consisted of
the following:
<TABLE>
Year ended
December 31,
1996
1995 1994
<CAPTION>
<S> <C> <C>
<C>
Deferred policy acquisition costs.................. $ 6,022 $
5,087 $ (1,683)
Unearned premiums.................................. (3,695)
(1,469) (488)
Salvage and subrogation recoverable................ 425
151 356
Discounting of loss reserves....................... (2,954)
(370) (983)
Tax depreciation in excess of book depreciation.... 192
205 108
Book value rights/book value awards/stock
appreciation rights............................... 1,686
334 773
Bad debt expense................................... 131
92 145
Deferred items not included above.................. 291
620 (3,004)
Deferred income tax (benefit)................ 2,098
4,650 (4,776)
Change in unrealized gains (losses)................ 3,540
31,726 (46,888)
Change in deferred tax liability(asset)...... $ 5,638 $
36,376 $(51,664)
</TABLE>
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, management believes it is more likely than not that all of the
deferred 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 reduced. Deferred tax
liabilities (assets) were comprised of the following components at
December 31, 1996 and 1995:
<TABLE>
1996
1995
<CAPTION>
<S> <C>
<C>
Deferred policy acquisition costs.............................. $
24,535 $ 18,513
Unearned premiums..............................................
(19,839) (16,144)
Salvage and subrogation recoverable............................
2,407 1,982
Discounting of loss reserves...................................
(23,800) (20,846)
Tax depreciation in excess of book depreciation................
2,705 2,513
Book value rights/book value awards/stock appreciation rights..
3,287 1,601
Bad debt allowances............................................
(901) (1,032)
Unrealized gains...............................................
12,427 8,887
Deferred items not included above..............................
3,402 3,111
Deferred tax liability (asset)........................... $
4,223 $ (1,415)
</TABLE>
34
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE G-Income Taxes - (continued)
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 1996, 1995 and
1994 for the following reasons:
<TABLE>
Year ended December 31,
1996 1995
1994
<CAPTION>
<S> <C> <C> <C> <C>
<C> <C>
Tax at statutory rate.. $ 32,205 35.0% $52,410 35.0%
$60,196 35.0%
Tax exempt interest.... (10,062) (10.9) (11,067) (7.4)
(8,836) (5.2)
Dividends paid to ESOP
participants......... (1,169) (1.3) - -
- - -
Dividends received
deduction............ (3,167) (3.4) (2,038) (1.4)
(1,819) (1.1)
Other.................. 242 0.2 236 0.2
(136) -
Tax at effective rate.. $ 18,049 19.6% $39,541 26.4%
$49,405 28.7%
</TABLE>
NOTE H-Related Party Transactions
The Company has made loans to insurance agencies with which the
Company transacts business on a regular basis. At December 31, 1996,
eleven of these loans which had an aggregate outstanding principal
balance of $2,384 were collateralized by the assets of the agencies. At
December 31, 1995, thirteen of these loans which had an aggregate
outstanding principal balance of $2,138 were collateralized by the
assets of the agencies. Mortgage loans to agents collateralized by real
estate had an aggregate outstanding balance of $317 and $323 at December
31, 1996 and 1995, respectively.
During 1992, the Company insured a mortgage note in the principal
amount of $28,750 issued by a corporation to a bank. Two directors of
the Company, were, with others, guarantors of this note. The Company's
liability under this insurance policy, which expired on October 15,
1995, was $12,000. For this insurance, the Company received the full
premium of $1,080 in 1992, which was earned pro-rata through the
expiration date of the policy.
One Director of the Company was a principal of several independent
insurance agencies which are licensed to write various lines of
insurance on behalf of the Company. This Director sold these agencies
during 1994. The agencies received a standard commission for the
premiums written in an amount determined by the Company on a competitive
basis. Total commissions paid to the agencies during the year ended
December 31, 1994, were $1,010. The Company also purchased certain
insurance coverages through one of the agencies and paid premiums for
these policies of $217 in 1994.
NOTE I-Employee Stock Ownership Plan
The Company offers an Employee Stock Ownership Plan for the
benefit of substantially all employees, including those of the Company's
subsidiaries. The E.S.O.P. is noncontributory on the part of
participants and contributions are made at the discretion of the Board
of Directors. The Company is under no obligation to make contributions
or maintain the Plan for any length of time, and may completely
discontinue or terminate the Plan at any time without liability.
Contributions by the Company and subsidiaries to the Plan for the
years ending December 31, 1996, 1995 and 1994 were $6,216, $5,729 and
$5,430, respectively.
35
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars Except Per Share Data)
NOTE J-Stockholders' Equity
Book Value Rights, Book Value Awards and Stock Appreciation Rights
Program
The Board of Directors authorized a Book Value Rights Program
which provided for the payment of awards in cash to key employees based
upon increases in the book value of the Company at the end of the
program period, which is December 31st of the third year after the
rights have been granted. The Board of Directors authorized advance
payments of $1,888 in December, 1995 applicable to Book Value Rights
maturing in 1996 and $1,929 in December, 1994 applicable to Book Value
Rights maturing in 1995. Expenses relating to this Book Value Rights
Program were $234, $3,738 and $4,579 in 1996, 1995 and 1994,
respectively.
The Management Incentive Plan approved by the Company's
stockholders in May, 1994 provides for the award of up to 2,500,000
shares of common stock or equivalent units (subject to anti-dilution
adjustments) in the form of incentive stock options, non-qualified stock
options, book value awards, stock appreciation rights, restricted stock
and performance stock units. All directors, officers and other senior
management employees of the Company or any of its subsidiaries are
eligible to participate in this Management Incentive Plan. Book value
awards issued relating to this Plan totalled 481,671, 623,649 and
336,236 in 1996, 1995 and 1994, respectively. Stock appreciation rights
issued also relating to this Plan totalled 533,910, 689,919 and 613,435
in 1996, 1995, and 1994, respectively. Expenses relating to book value
awards were $2,140, $714 and $0 in 1996, 1995 and 1994. Expenses
relating to stock appreciation rights were $6,224, $366 and $0 in 1996,
1995 and 1994.
NOTE K-Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established
by their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders must file a report with the Commissioner. An
extraordinary dividend is any dividend or other property, whose fair
value together with other dividends or distributions made within the
preceding twelve months exceeds the greater of ten percent of the
insurer's surplus as regards policyholders as of the end of the
preceding year, or the net income of a non-life insurance company for
the preceding year. No pro-rata distribution of any class of the
insurer's own securities is to be included. No Massachusetts insurance
company shall pay an extraordinary dividend or other extraordinary
distribution until thirty days after the Commissioner has received
notice of the intended distribution and has not objected. No
extraordinary dividends were paid in 1996, 1995 and 1994.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to
its stockholders is limited. During 1996 Commerce and Citation paid
$37,130 and $6,600 in dividends, respectively, to CHI; CHI then paid
$43,470 to the Company in March 1996. During 1995, Commerce and
Citation paid $29,845 and $4,950 in dividends, respectively, to CHI; CHI
then paid $34,650 to the Company in March 1995.
36
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE K-Net Capital Requirements (continued)
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $.81 per share
and $.23 per share in 1996 and 1995, respectively. On May 17, 1996, the
Board voted to increase the quarterly stockholder dividend from $.06 to
$.25 per share to stockholders of record as of June 7, 1996. Prior to
that declaration, the Company had paid quarterly dividends of $.06 per
share dating back to May 19, 1995 when the Board voted to increase the
dividend from $.05 to $.06 per share. The $.05 cash dividend per share
was first declared by the Board on May 20, 1994.
Treasury Stock purchased under the stock buyback program increased
by 673,915 shares during 1996 to 1,937,348 shares at December 31, 1996.
The stock buyback program, authorized by the Board in May 1995, enables
the Company to purchase up to three million shares of the Company's
common stock. The program is now approximately two-thirds of the way
complete.
NOTE L-Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings
and policyholders surplus for the combined operations of Commerce,
Citation and effective August 31, 1995, Western Pioneer.
<TABLE>
1996 1995
1994
Earnings Equity Earnings Equity
Earnings Equity
<CAPTION>
<S> <C> <C> <C> <C>
<C> <C>
GAAP............................ $ 74,432 $550,151 $110,450
$512,875 $113,892 $378,301
Deferred income taxes........... 929 2,165 4,152
(2,650) (10,051) (38,180)
Deferred acquisition costs...... (15,808) (82,968) (8,094)
(67,160) (5,419) (59,066)
Bonds-book versus market........ - (16,194) -
(14,432) - 56,366
Preferred stock-market versus
book........................... - (331) -
(1,607) - (1,081)
Deferred income................. (963) 7,768 (1,496)
6,766 4,321 11,575
Deferred service fee income..... 1,538 1,538 - -
- - -
Deferred reinsurance
commissions.................... 2,082 5,796 2,060
5,614 (1,257) 2,297
Statutory reserve over statement
reserves....................... - (5,397) -
(1,940) - (437)
Goodwill in subsidiary.......... (270) 2,515 (97)
2,806 - -
Difference in GAAP to statutory
net income in subsidiary....... 416 - (74) -
- - -
Other........................... 4 (304) (4)
(162) - -
(12,072) (85,412) (3,553)
(72,765) (12,406) (28,526)
Statutory....................... 62,360 464,739 106,897
440,110 101,486 349,775
Less subsidiary net loss from
January 1, 1995 through
August 30, 1995................ - - 429 -
- - -
Adjusted statutory.............. $ 62,360 $464,739 $107,326
$440,110 $101,486 $349,775
</TABLE>
37
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE M-Segment Information
Selected information by industry segment for 1996, 1995 and 1994 is
summarized as follows:
<TABLE>
Earnings
Before Identifiable
Revenue Income
Taxes Assets
<CAPTION>
<S> <C> <C>
<C>
1996
Property and casualty insurance............ $740,707 $ 91,242
$1,590,695
Real estate and commercial lending......... 4,249 4,249
75,255
Corporate and other........................ 3,301
(3,478) 10,849
Consolidated........................... $748,257 $ 92,013
$1,676,799
1995
Property and casualty insurance............ $677,217 $147,378
$1,479,898
Real estate and commercial lending......... 3,804 3,804
76,642
Corporate and other........................ 3,014
(1,440) 7,635
Consolidated........................... $684,035 $149,742
$1,564,175
1994
Property and casualty insurance............ $691,478 $167,738
$1,315,100
Real estate and commercial lending......... 3,972 3,972
59,452
Corporate and other........................ 3,613 278
7,674
Consolidated........................... $699,063 $171,988
$1,382,226
</TABLE>
NOTE N-Supplement to Consolidated Statements of Cash Flows
<TABLE>
Disclosure of cash flow information:
Year
ended December 31,
1996
1995 1994
<CAPTION>
<S> <C>
<C> <C>
Cash paid during the year for:
Federal and state income taxes........................ $17,007
$43,658 $48,140
State premium and related taxes of insurance
subsidiaries......................................... 17,859
15,592 15,517
</TABLE>
During the years ended December 31, 1996, 1995 and 1994, the
Company acquired property through foreclosure of mortgages held with
remaining principle balances at the time of foreclosure of $245, $641
and $1,930, respectively.
NOTE O-Insolvency Fund Assessments
As provided in the statutes, insurance companies which write
business in Massachusetts are assessed for losses attributable to the
insolvency of other insurance companies by the Massachusetts Insurers
Insolvency Fund ("M.I.I.F."). From its inception, on August 2, 1972
through December 31, 1996, the M.I.I.F. has approved assessments
totaling $138,489, of which the Company's share was approximately
$7,823. It is anticipated that there will be additional assessments
from time to time relating to various insolvencies. By statute, no
insurer may be assessed in any year an amount greater than two percent
of that insurer's net direct written premiums for the calendar year
preceding the assessment. Although the timing and amounts of any such
assessments are not known, management is of the opinion that such
assessments will not have a material effect on the consolidated
financial position of the Company. The Company's policy is to record
these assessments as assessed. According to statute, the assessed
insurance companies have the right to recoup amounts paid to the
M.I.I.F., over a reasonable length of time, through premium rates
approved by the Commissioner. The Company's policy is to record the
recovery of the assessed amounts as received. Assessments by the
M.I.I.F. for the years ended December 31, 1996, 1995 and 1994 were $742,
$338 and $331, respectively.
38
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE P-Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 1996 and 1995 quarterly
performance is as follows:
<TABLE>
1996 FIRST SECOND
THIRD FOURTH
QUARTER QUARTER
QUARTER QUARTER
<CAPTION>
<S> <C> <C>
<C> <C>
Total revenues................................. $173,802 $186,448
$192,333 $195,674
Net earnings................................... 14,593 16,265
21,436 21,670
Net earnings per weighted average common
share (primary and fully diluted)............ .40 .45
.59 .60
1995
Total revenues................................. $164,462 $167,374
$174,259 $177,940
Net earnings................................... 22,271 29,287
28,847 29,796
Net earnings per weighted average common
share (primary and fully diluted)............ .59 .77
.77 .80
</TABLE>
NOTE Q-Subsequent Events
On January 24, 1997, the Massachusetts Commissioner of Insurance
issued 1997 Private Passenger Automobile rates. The overall rate
decrease from 1996 rates was 6.2%. This decrease was partially driven
by corrections to an industry error impacting prior year rate decisions.
The industry error resulted from a miscalculation of industry expense
allowances that had the effect of overstating rates for 1991 through
1996. Rates for 1997 include an adjustment to recoup this error from
the industry equal to 40% of the error with 40% reducing 1998 rates and
20% reducing 1999 rates.
Additionally, 1997 rates were decreased as a result of the
reconciliation of the Safe Driver Insurance Plan ("SDIP") which is
designed to be revenue neutral. In most recent past years, the SDIP
reconciliation resulted in a deficit which was then added into the rates
for the subsequent years. The 1996 SDIP reconciliation, however,
resulted in a surplus. Fifty percent of this surplus is being used to
decrease rates in both 1997 and 1998.
The Company has performed an analysis of the rate decision and has
estimated the impact of the above two items on its result assuming its
market share remains the same as it was at the end of 1996. The earned
premium impact is estimated to be approximately $15.3 million for 1997,
$23.0 million for 1998 and $13.5 million for 1999. The earnings per
share after-tax impact resulting from the lower earned premiums for
1997, 1998 and 1999 is estimated to be $0.28, $0.41 and $0.23,
respectively. If the Company's future market share increases
(decreases), a larger (smaller) financial impact would result.
The Company was notified in January 1997 that its application for
license in the State of Vermont was approved. Applications for licenses
in the states of Maine and New Hampshire remain pending.
39
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be
read in conjunction with the consolidated financial statements of the
Company and the notes thereto. This financial data has been extracted
from financial statements audited by Coopers & Lybrand L.L.P. All
dollar amounts set forth in the following tables are in thousands except
per share data.
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Statement of Earnings Data:
Net premiums written........... $ 711,570 $ 603,421 $ 589,197
$ 563,416 $ 508,847
Increase in unearned premiums.. (42,854) (10,831) (17,144)
(14,856) (98,353)
Earned premiums................ 668,716 592,590 572,053
548,560 410,494
Net investment income.......... 77,402 71,313 62,901
53,068 39,223
Premium finance fees........... 9,713 19,420 18,497
16,666 13,916
Net realized investment gains
(losses)...................... (7,574) 712 45,612
7,506 1,537
Total revenues............ 748,257 684,035 699,063
625,800 465,170
Losses and loss adjustment
expenses...................... 475,231 367,552 369,660
373,959 271,789
Policy acquisition costs....... 181,013 166,741 157,415
150,195 117,833
Total expenses............ 656,244 534,293 527,075
524,154 389,622
Other income
Withdrawing companies'
settlements................... - - -
- - 43,168
Earnings before income taxes... 92,013 149,742 171,988
101,646 118,716
Income taxes................... 18,049 39,541 49,405
26,330 34,411
Net earnings.............. $ 73,964 $ 110,201 $ 122,583
$ 75,316 $ 84,305
Per Share Data:
Net earnings per share.... $ 2.04 $ 2.93 $ 3.23
$ 1.98 $ 2.23
Cash dividends paid per
share................... $ 0.81 $ 0.23 $ 0.15
$ - $ -
Weighted average number of
shares outstanding.............. 36,311,887 37,632,236 38,000,000
38,000,000 37,852,108
</TABLE>
<TABLE>
Year Ended
December 31,
1996 1995 1994
1993 1992
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Balance Sheet Data:
Total investments.............. $1,027,136 $1,044,113 $ 899,546
$ 860,017 $ 633,470
Premiums receivable............ 158,153 127,243 102,529
95,262 68,724
Total assets................... 1,676,799 1,564,175 1,382,226
1,298,371 1,097,304
Unpaid losses and loss
adjustment expenses........... 649,913 618,791 592,373
567,797 495,800
Unearned premiums.............. 367,991 330,454 314,719
283,526 264,567
Stockholders' equity........... 587,039 549,714 413,589
383,348 281,933
Stockholders' equity per share 16.28 14.96 10.88
10.09 7.42
</TABLE>
40
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following exhibits depict the progress of the insurance
operations of the Company over the past fifteen years. For these years
of operation, net premiums written amounted to $4,066,668. During this
period, the average statutory financial ratios were 66.9% for losses and
loss expenses and 27.2% for underwriting expenses resulting in an
average combined ratio of 94.1%. Total net investment income amounted
to $437,553 or 10.8% of net premiums written. Net realized gains were
$65,117. Stockholders' equity was $8,384 at the beginning of 1982 and
$550,151, at the end of 1996, resulting in an average annual increase of
33.1%. The progress of the insurance operations during the most recent
five year period, compared to the two previous five year periods, can
best be illustrated by the following comparison:
<TABLE>
5 Year
Period
1992-96
1987-91 1982-86
<CAPTION>
<S> <C> <C>
<C>
Direct premiums written............................ $3,110,296
$1,710,049 $346,678
Net premiums written............................... 2,976,451
895,364 194,853
Net investment income.............................. 303,546
106,790 27,217
Net realized gains................................. 50,290
13,942 885
Stockholders' equity at end of period.............. 550,151
177,225 31,461
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned...... 66.5%
66.8% 74.5%
Underwriting expenses to net premiums written.... 27.4
26.6 27.0
Combined ratio............................... 93.9%
93.4% 101.5%
Increase in Stockholders' Equity................... 210.5%
462.5% 275.3%
</TABLE>
The insurance operations of the Company include the operating results of
Commerce, its subsidiary company Western Pioneer and Citation. Citation
commenced business in 1981 as a wholly-owned subsidiary of Commerce. On
December 31, 1989 the ownership of Citation was transferred to The
Commerce Group, Inc. Capital stock, paid-in capital and retained
earnings of Commerce and Citation as of January 1, 1989 were combined
due to the effect of the transfer in ownership of Citation to The
Commerce Group, Inc. on December 31, 1989. In September 1993, ownership
of both Commerce and Citation was transferred from The Commerce Group,
Inc. to CHI, a subsidiary of The Commerce Group, Inc. Results of
Western Pioneer are included since its acquisition by Commerce on August
31, 1995. The combined balance sheets of these insurance subsidiaries
appear on pages 42 and 43. The combined statements of earnings of
insurance operations appear on pages 44 and 45.
41
<PAGE>
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
<TABLE>
1996 1995 1994
1993 1992
ASSETS
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Cash and short-term investments.... $ 140,102 $ 52,308 $ 4,560
$ 12,615 $ 25,809
Bonds, at market (at amortized cost
prior to 1993).................... 716,702 815,277 745,010
649,491 505,565
Preferred stocks, at market (at
amortized cost prior to 1993)..... 147,680 111,220 85,574
80,059 2,261
Common stocks, at market........... 86,041 40,359 9,656
47,462 43,545
Mortgage loans on real estate...... 45,398 31,404 35,715
42,042 60,697
Premium balances receivable........ 157,673 126,090 101,529
94,333 67,876
Investment income receivable....... 12,655 14,440 13,285
10,205 9,710
Residual market receivable......... 195,213 200,124 214,818
220,312 274,426
Reinsurance receivable............. 19,659 21,897 16,892
12,868 365
Deferred acquisition costs......... 82,968 67,160 59,066
53,647 55,442
Current income taxes............... - - -
- - -
Deferred income taxes.............. - 2,100 38,180
- - -
Real estate, furniture and equipment 26,138 24,642 25,246
22,371 23,183
Total assets................ $1,630,229 $1,507,021 $1,349,531
$1,245,405 $1,068,879
LIABILITIES
Unpaid losses and loss expenses.... $ 649,913 $ 618,791 $ 592,373
$ 567,797 $ 495,800
Unearned premiums.................. 367,991 330,454 314,719
283,526 264,567
Notes payable...................... - - -
- - -
Deferred income.................... 7,974 8,954 10,451
7,351 8,384
Accounts payable, accrued and other
liabilities....................... 49,309 34,351 43,433
16,564 20,863
Current income taxes............... 2,726 1,596 10,254
4,867 9,249
Deferred income taxes.............. 2,165 - -
13,669 4,400
Total liabilities........... 1,080,078 994,146 971,230
893,774 803,263
STOCKHOLDERS' EQUITY
Capital stock...................... 3,600 3,450 3,450
3,450 3,450
Paid-in capital.................... 45,050 23,700 23,700
8,700 8,700
Retained earnings
Balance, January 1............... 485,725 351,151 339,481
253,466 165,075
Net earnings..................... 74,432 110,450 113,892
79,837 91,980
Unrealized gains (losses) on
investments..................... 6,574 58,919 (77,622)
21,928 9,811
Dividends paid................... (65,230) (34,795) (24,600)
(15,750) (13,400)
Balance, December 31............... 501,501 485,725 351,151
339,481 253,466
Total stockholders' equity.. 550,151 512,875 378,301
351,631 265,616
Total liabilities and
stockholders' equity...... $1,630,229 $1,507,021 $1,349,531
$1,245,405 $1,068,879
</TABLE>
42
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
<TABLE>
1991 1990 1989 1988 1987 1986 1985
1984 1983 1982
ASSETS
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
<C> <C>
$ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051 $ 10,048 $ 11,802 $
7,953 $ 3,864 $ 6,557
329,935 242,735 153,621 133,867 116,220 88,755 56,985
34,422 22,352 14,054
869 1,010 1,324 1,606 2,295 6,755 9,956
10,837 7,986 4,759
30,055 4,869 2,900 1,921 1,438 149 134
1,494 1,540 1,507
66,122 56,124 52,244 42,882 15,931 - -
7,825 5,860 3,555
55,510 57,733 56,713 33,727 19,329 11,817 8,194
6,028 5,430 2,810
6,063 4,235 3,093 2,889 2,370 2,485 1,722
1,286 887 523
277,196 290,440 268,951 198,177 132,725 87,178 50,327
29,187 20,513 13,000
- - - - - - -
- - - -
33,981 27,273 22,702 15,699 10,898 7,129 5,417
3,968 3,057 1,731
- - 341 266 - 2,209 1,294
- - - 260
883 1,666 - - - - -
- - - -
24,163 25,046 23,118 9,684 8,356 7,370 5,648
3,136 2,799 2,590
$835,967 $749,785 $669,315 $501,603 $330,613 $223,895 $151,479
$106,136 $74,288 $51,346
LIABILITIES
$439,551 $403,752 $345,020 $270,628 $169,539 $113,513 $ 71,525 $
44,425 $32,860 $23,154
192,785 175,334 174,345 118,079 84,876 55,378 36,024
23,585 14,190 9,496
- 1,662 1,837 2,013 2,204 3,772 4,140
2,858 1,313 1,388
12,918 20,264 23,689 23,307 11,058 7,503 4,208
3,173 1,658 1,302
7,677 21,065 27,513 19,350 14,532 8,532 4,162
4,479 2,482 2,731
5,811 3,542 - - 470 - -
418 1,487 -
- - 1,623 1,021 1,853 3,736 3,623
2,610 2,079 1,582
658,742 625,619 574,027 434,398 284,532 192,434 123,682
81,548 56,069 39,653
STOCKHOLDERS' EQUITY
3,450 3,450 3,450 2,350 2,350 2,350 2,350
2,350 2,250 2,000
8,700 8,700 8,700 6,500 6,500 6,500 6,500
6,500 5,500 4,000
112,016 83,138 62,877 37,231 22,611 18,947 15,738
10,469 5,693 4,084
55,214 32,414 21,966 21,837 15,614 4,362 4,025
6,033 5,213 1,819
2,545 (86) 645 321 (54) 7 (158)
(179) 63 198
(4,700) (3,450) (2,350) (1,034) (940) (705) (658)
(585) (500) (408)
165,075 112,016 83,138 58,355 37,231 22,611 18,947
15,738 10,469 5,693
177,225 124,166 95,288 67,205 46,081 31,461 27,797
24,588 18,219 11,693
$835,967 $749,785 $669,315 $501,603 $330,613 $223,895 $151,479
$106,136 $74,288 $51,346
</TABLE>
43
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
<TABLE>
1996 1995 1994
1993 1992
<CAPTION>
<S> <C> <C> <C>
<C> <C>
Underwriting
Direct premiums written.............. $731,823 $626,666 $625,023
$601,289 $525,495
Net premiums written................. $711,570 $603,421 $589,197
$563,416 $508,847
Increase in unearned premiums........ 42,854 10,831 17,144
14,856 98,353
Earned premiums.................. 668,716 592,590 572,053
548,560 410,494
Expenses
Losses and loss expenses............. 474,173 367,258 369,764
373,243 271,848
Underwriting expenses................ 194,873 171,892 162,446
147,290 138,669
(Increase) decrease in deferred
acquisition costs................... (15,809) (5,723) (5,420)
1,796 (21,462)
Total expenses................... 653,237 533,427 526,790
522,329 389,055
Underwriting income (loss)............. 15,479 59,163 45,263
26,231 21,439
Net investment income.................. 76,867 71,007 63,119
52,868 39,685
Premium finance fees................... 9,666 19,246 18,315
16,486 13,734
Net realized investment gains (losses). (7,863) 720 32,025
13,040 12,368
Earnings before Federal income
taxes and withdrawing companies'
settlements...................... 94,149 150,136 158,722
108,625 87,226
Other income
Withdrawing companies' settlements... - - -
- - 43,168
Earnings before Federal income taxes... 94,149 150,136 158,722
108,625 130,394
Federal income taxes (benefits)........ 19,717 39,686 44,830
28,788 38,414
Earnings before cumulative effect of
change in accounting principle........ 74,432 110,450 113,892
79,837 91,980
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes.......................... - - -
- - -
NET EARNINGS..................... $ 74,432 $110,450 $113,892
$ 79,837 $ 91,980
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned..................... 70.9% 62.0% 64.6%
68.0% 66.2%
Underwriting expenses to net
premiums written.................... 27.1 29.0 27.1
25.7 28.1
Combined ratio................... 98.0% 91.0% 91.7%
93.7% 94.3%
Underwriting profit (loss)....... 2.0% 9.0% 8.3%
6.3% 5.7%
</TABLE>
44
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
<TABLE>
1991 1990 1989 1988 1987 1986 1985
1984 1983 1982
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
<C> <C>
$429,780 $401,077 $366,492 $306,469 $206,231 $131,807 $85,000
$65,699 $37,318 $26,854
$310,999 $219,936 $140,313 $124,923 $ 99,193 $ 60,808 $49,229
$33,943 $25,817 $25,056
30,193 34,692 12,655 9,678 13,428 6,775 6,392
2,137 2,258 1,902
280,806 185,244 127,658 115,245 85,765 54,033 42,837
31,806 23,559 23,154
173,901 125,219 88,564 80,203 65,299 44,205 33,548
19,567 15,242 15,923
85,655 55,551 44,181 33,115 25,882 18,460 15,177
11,241 6,532 9,000
(6,708) (4,571) (7,003) (4,801) (3,769) (1,712) (1,448)
(911) (1,327) (811)
252,848 176,199 125,742 108,517 87,412 60,953 47,277
29,897 20,447 24,112
27,958 9,045 1,916 6,728 (1,647) (6,920) (4,440)
1,909 3,112 (958)
32,661 25,978 21,256 15,999 10,896 7,554 6,835
5,684 4,108 3,036
11,165 10,074 8,095 4,592 3,021 1,436 531
324 39 -
7,529 74 618 2,298 3,423 185 336
(108) 314 158
79,313 45,171 31,885 29,617 15,693 2,255 3,262
7,809 7,573 2,236
- - - - - - -
- - - -
79,313 45,171 31,885 29,617 15,693 2,255 3,262
7,809 7,573 2,236
24,099 12,757 9,919 7,780 2,987 (2,107) (763)
1,776 2,360 417
55,214 32,414 21,966 21,837 12,706 4,362 4,025
6,033 5,213 1,819
- - - - 2,908 - -
- - - -
$ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614 $ 4,362 $ 4,025 $
6,033 $ 5,213 $ 1,819
61.9% 65.7% 68.0% 69.5% 79.4% 83.5% 79.7%
63.6% 63.8% 69.8%
30.0 26.7 26.3 22.0 22.5 24.4 28.1
27.8 23.9 33.5
91.9% 92.4% 94.3% 91.5% 101.9% 107.9% 107.8%
91.4% 87.7% 103.3%
8.1% 7.6% 5.7% 8.5% (1.9%) (7.9%) (7.8%)
8.6% 12.3% (3.3%)
</TABLE>
45
<PAGE
THE COMMERCE GROUP, INC.
DIRECTORS
<TABLE>
<CAPTION>
<S> <C>
Herman F. Becker......................... President and owner, Sterling
Realty and Huguenot Development
Corporation
Joseph A. Borski, Jr..................... Self-employed Certified Public
Accountant
Eric G. Butler........................... Retired Vice President-General
Claims Manager of Commerce and
Citation
Henry J. Camosse......................... Retired President, Henry
Camosse & Son Co., Inc., a
building and masonry supplies company
Gerald Fels.............................. Executive Vice President and
Chief Financial Officer of
the Company
David R. Grenon.......................... Assistant Clerk and Chairman
of the Advisory Board
of The Protector Group
Insurance Agency, Inc., a
property and casualty
insurance agency.
Robert W. Harris......................... Retired Treasurer, H.C.
Bartlett Insurance Agency, Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett
Insurance Agency, Inc.
John J. Kunkel........................... Retired President and
Treasurer, Kunkel Buick and
GMC Truck, retired Treasurer,
Kunkel Bus Company
Raymond J. Lauring....................... Retired President, Lauring
Construction Company
Roger E. Lavoie.......................... Retired President and
Treasurer, Lavoie Toyota-
Dodge, Inc.
Normand R. Marois........................ Retired Chairman of the Board,
Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Physician specializing in
internal medicine
Arthur J. Remillard, Jr.................. President, Chief Executive
Officer, and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and
Assistant Clerk of
the Company, Senior Vice
President of Commerce
and Citation in charge of
Policyholder Benefits
Regan P. Remillard....................... Senior Vice President -
General Counsel
of the Company, President and
Secretary of
Western Pioneer Insurance
Company
Antranig Sahagian........................ Retired Owner, A. Sahagian
Service Center
Gurbachan Singh.......................... Physician specializing in
general surgery
John W. Spillane......................... Clerk of the Company and
practicing attorney
</TABLE>
46
<PAGE>
DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Western Pioneer Insurance Company
Citation Insurance Company
<TABLE>
<CAPTION>
<S> <C>
Arthur J. Remillard, Jr................ President, Chief Executive
Officer and Chairman
of the Board
Gerald Fels............................ Executive Vice President and
Chief Financial
Officer
Arthur J. Remillard, III (1)........... Senior Vice President and
Clerk
Regan P. Remillard..................... Senior Vice President -
General Counsel, President and
Secretary of Western Pioneer Insurance Company
David R. Grenon (1).................... Assistant Clerk and Chairman
of the Advisory
Board of The Protector Group
Insurance Agency
John M. Nelson (1)..................... Chairman and Chief Executive
Officer of Wyman-
Gordan Company
Suryakant M. Patel (1)................. Physician specializing in
internal medicine
William G. Pike (1).................... Executive Vice President and
Chief Financial
Officer of Granite State
Bankshares, Inc.
DIRECTORS OF
BAY FINANCE COMPANY, INC.
Arthur J. Remillard, Jr................ President and Chairman of the
Board
Gerald Fels............................ Executive Vice President and
Chief Financial
Officer
John W. Spillane....................... Clerk and practicing attorney
Arthur J. Remillard, III............... Assistant Clerk
Regan P. Remillard..................... Senior Vice President
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
Arthur J. Remillard, Jr................ President and Chairman of the
Board
Gerald Fels............................ Executive Vice President and
Chief Financial
Officer
John W. Spillane....................... Clerk
Arthur J. Remillard, III............... Assistant Clerk
Elizabeth M. Edwards................... Vice President
</TABLE>
(1) Commerce Holdings, Inc., The Commerce Insurance Company and Citation
Insurance Company
only.
47
<PAGE>
THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Western Pioneer Insurance Company
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF
THE COMMERCE GROUP, INC.
<TABLE>
<CAPTION>
<S> <C>
President, Chief Executive Officer and Chairman of the Board... Arthur
J. Remillard, Jr.
Executive Vice President and Chief Financial Officer........... Gerald
Fels
Senior Vice President and Assistant Clerk...................... Arthur
J. Remillard, III
Senior Vice President and General Counsel...................... Regan
P. Remillard
Senior Vice President.......................................... Mary
M. Fontaine
Clerk.......................................................... John
W. Spillane
Treasurer and Chief Accounting Officer.........................
Randall V. Becker
Assistant Treasurer............................................ Thomas
A. Gaylord
Assistant Vice President....................................... Robert
E. McKenna
* Officers of Subsidiaries
President, Chief Executive Officer and Chairman of the Board... Arthur
J. Remillard, Jr.
Executive Vice President and Chief Financial Officer........... Gerald
Fels
Senior Vice Presidents......................................... David
H. Cochrane
Mary
M. Fontaine
Robert
E. Longo
Arthur
J. Remillard, III
Joyce
B. Virostek
Senior Vice President and General Counsel...................... Regan
P. Remillard
Vice Presidents................................................ Peter
J. Dignan
Elizabeth M. Edwards
Michael J. Richards
Angelos Spetseris
Henry
R. Whittier, Jr.
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
Assistant Vice Presidents..............Burton C. Aaronson Ronald
J. Lareau
Robert M. Blackmer Karen
A. Lussier
Stephen R. Clark Donald
G. MacLean
Raymond J. DeSantis Robert
E. McKenna
Warren S. Ehrlich Robert
L. Mooney
John V. Kelly
Kenneth E. Morrison
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Treasurer and Chief Accounting Officer.........................
Randall V. Becker
Assistant Treasurer............................................ Thomas
A. Gaylord
Officers of Western Pioneer Insurance
President and Secretary........................................ Regan
P. Remillard
Chief Financial Officer........................................ Albert
E. Peters
Assistant Vice President....................................... Robert
M. Keppel
Treasurer and Controller....................................... Joan
M. Kelly
* Officers often hold positions with several operating subsidiaries.
The titles listed
represent their primary office as of March 1, 1997.
</TABLE>
48
<PAGE
Stockholder Information
Special Meeting in Lieu of the Annual Meeting
A special meeting in lieu of the annual meeting of stockholders will be
held at 9:00 a.m. on Friday, May 30, 1997 at the Company's Underwriting
Building, 11 Gore Road (Route 16), Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in the
Company's annual report on Form 10-K, as filed with the Securities and
Exchange Commission, may obtain a copy without charge, by writing to the
Assistant to the President at 211 Main Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o The First National Bank of Boston
Boston EquiServe, L.P.
Investor Relations
Mail Stop: 45-02-09
P.O. Box 644
Boston, MA 02102-0644
(617) 575-3100
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Trading of Common Stock
The Company's Common Stock began trading on the NYSE on March 31, 1995
under the symbol "CGI". Prior to that, the Company's Common Stock was
traded on Nasdaq under the symbol "COMG".
Independent Accountants
Coopers & Lybrand L.L.P.
One Post Office Square
Boston, MA 02109
(617) 478-5000
49
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 0 0
<DEBT-CARRYING-VALUE> 700,511 801,308
<DEBT-MARKET-VALUE> 716,702 815,277
<EQUITIES> 233,721 151,579
<MORTGAGE> 74,586 75,609
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 1,027,136 1,044,113
<CASH> 140,535 52,665
<RECOVER-REINSURE> 19,659 21,897
<DEFERRED-ACQUISITION> 82,968 67,160
<TOTAL-ASSETS> 1,676,799 1,564,175
<POLICY-LOSSES> 649,913 618,791
<UNEARNED-PREMIUMS> 367,991 330,454
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 0 0
0 0
0 0
<COMMON> 19,000 19,000
<OTHER-SE> 568,039 530,714
<TOTAL-LIABILITY-AND-EQUITY> 1,676,799 1,564,175
668,716 592,590
<INVESTMENT-INCOME> 77,402 71,313
<INVESTMENT-GAINS> (7,574) 712
<OTHER-INCOME> 9,713 19,420
<BENEFITS> 475,231 367,552
<UNDERWRITING-AMORTIZATION> 181,013 166,741
<UNDERWRITING-OTHER> 0 0
<INCOME-PRETAX> 92,013 149,742
<INCOME-TAX> 18,049 39,541
<INCOME-CONTINUING> 73,964 110,201
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 73,964 110,201
<EPS-PRIMARY> 2.04 2.93
<EPS-DILUTED> 2.04 2.93
<RESERVE-OPEN> 486,673 448,331
<PROVISION-CURRENT> 562,997 442,027
<PROVISION-PRIOR> (87,766) (74,475)
<PAYMENTS-CURRENT> (273,334) (184,182)
<PAYMENTS-PRIOR> (167,509) (145,028)
<RESERVE-CLOSE> 649,913 618,791
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
