UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 1998 Commission File Number 0-16882
THE COMMERCE GROUP, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2599931
(State or other (IRS Employer
jurisdiction Identification
of Incorporation) No.)
211 Main Street Webster, Massachusetts 01570
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 943-9000
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
As of November 1, 1998, the number of shares outstanding of the
registrant's common stock (excluding Treasury Shares) was
36,042,652
Page 1 of 24
<PAGE>
The Commerce Group, Inc.
Table of Contents
<TABLE>
<CAPTION>
Page No.
Part I - Financial Information
<S> <C>
Consolidated Balance Sheets at
September 30, 1998 (Unaudited) and December 31,
1997.......................................... 3
Consolidated Statements of Earnings for the
Three and Nine Months Ended September 30, 1998 and 1997
(Unaudited).................. 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997
(Unaudited).................................. 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash
Provided by Operating Activities for the Nine Months Ended September
30, 1998
and 1997
(Unaudited).............................................................
................................... 6
Notes to Unaudited Consolidated Financial
Statements.................................................... 7
Management's Discussion and
Analysis................................................................
........... 11
Part II - Other Information
Item 6
Exhibits and Reports on Form 8-
K.......................................................................
...... 24
Signature
........................................................................
.............................................. 24
</TABLE>
- - 2 -
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(Unaudited)
ASSETS
<S>
<C> <C>
Investments:
Fixed maturities, at market (cost: $623,408 in 1998 and $566,784
in 1997)....................... $ 645,078 $ 590,597
Preferred stocks, at market (cost: $200,839 in 1998 and $148,135
in 1997)....................... 194,250 148,499
Common stocks, at market (cost: $245,699 in 1998 and $160,371 in
1997).......................... 269,311 178,089
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan
losses of $2,397 in 1998 and $2,812 in
1997)................................................... 74,782
82,839
Short-term
investments.............................................................
.............. 3,669 132,700
Cash and cash
equivalents.............................................................
........... 68,707 106,188
Other investments (cost: $7,177 in 1998 and $3,783 in
1997)..................................... 7,552 3,783
Total
investments.............................................................
............... 1,263,349 1,242,695
Accrued investment
income..................................................................
........ 13,998 12,237
Premiums receivable (less allowance for doubtful receivables of
$1,450 in 1998 and $1,451 in 1997). 198,817 169,469
Deferred policy acquisition
costs..................................................................
95,534 85,264
Property and equipment, net of accumulated
depreciation............................................ 36,354
36,280
Residual market receivable
Losses and loss adjustment
expenses..............................................................
113,658 129,137
Unearned
premiums................................................................
................ 46,701 51,662
Due from
reinsurers..............................................................
.................. 32,316 18,170
Other
assets..................................................................
..................... 8,708 9,839
Total
assets..................................................................
............... $1,809,435 $1,754,753
LIABILITIES AND
STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment
expenses..............................................................
$ 603,306 $ 649,473
Unearned
premiums................................................................
................ 436,291 379,599
Current income
taxes...................................................................
.......... 6,249 2,656
Deferred income
taxes...................................................................
......... 9,190 13,443
Deferred
income..................................................................
................ 7,252 7,271
Contingent commissions
accrued.................................................................
.. 21,504 13,861
Payable for securities
purchased...............................................................
.. 2,195 11,500
Other liabilities and accrued
expenses...........................................................
29,643 27,154
Total
liabilities.............................................................
............... 1,115,630 1,104,957
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 1998 and 1997.... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
issued and outstanding 38,000,000 shares in 1998 and
1997...................................... 19,000 19,000
Paid-in
capital.................................................................
................. 29,621 29,621
Net unrealized gains on fixed maturities, stocks, and other
investments net of income taxes of
$13,674 in 1998 and $14,663 in
1997............................................................
25,394 27,232
Retained
earnings................................................................
................ 658,477 612,630
732,492 688,483
Treasury stock 1,957,348 shares in 1998 and
1997................................................ (38,687)
(38,687)
Total stockholders'
equity..................................................................
. 693,805 649,796
Total liabilities and stockholders'
equity................................................... $1,809,435
$1,754,753
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 3 -
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three and Nine Months Ended September 30, 1998 and 1997
(Thousands of Dollars Except Share and Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
<S>
<C> <C> <C> <C>
Revenues
Direct premiums written.........................................
$ 189,488 $ 182,087 $ 633,622 $ 612,554
Assumed premiums................................................
19,424 17,801 64,355 58,421
Ceded premiums..................................................
(45,818) (27,495) (96,204) (78,827)
Net premiums written..........................................
163,094 172,393 601,773 592,148
(Increase) decrease in unearned premiums........................
17,942 10,087 (42,047) (49,540)
Earned premiums ................................................
181,036 182,480 559,726 542,608
Net investment income...........................................
21,324 19,827 63,428 59,013
Premium finance and service fees................................
3,910 1,857 9,815 5,253
Net realized investment gains (losses)..........................
(2) 20,995 5,081 22,915
Total revenues.........................................
206,268 225,159 638,050 629,789
Expenses
Losses and loss adjustment expenses.............................
121,775 124,647 388,303 396,443
Policy acquisition costs........................................
45,530 50,597 154,228 138,217
Total expenses.........................................
167,305 175,244 542,531 534,660
Earnings before income taxes...........................
38,963 49,915 95,519 95,129
Income taxes......................................................
9,102 14,903 20,838 23,508
NET EARNINGS...........................................
$ 29,861 $ 35,012 $ 74,681 $ 71,621
COMPREHENSIVE INCOME...................................
$ 32,417 $ 27,722 $ 72,843 $ 70,085
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE........
$ 0.83 $ 0.97 $ 2.07 $ 1.99
CASH DIVIDENDS PAID PER COMMON SHARE...................
$ 0.27 $ 0.26 $ 0.80 $ 0.77
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING...
36,042,652 36,042,652 36,042,652 36,045,363
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 4 -
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
<S>
<C> <C>
Cash flows from operating activities:
Premiums
collected...............................................................
. $578,490 $543,627
Net investment
income.............................................................
61,667 59,595
Premium finance and service
fees..................................................
9,815 5,253
Losses and loss adjustment expenses
paid.......................................... (419,070)
(377,694)
Policy acquisition costs
paid.....................................................
(150,581) (158,511)
Federal income tax
payments.......................................................
(20,508) (9,646)
Net cash provided by operating
activities................................ 59,813
62,624
Cash flows from investing activities:
Proceeds from maturity of fixed
maturities....................................... 49,806
91,783
Proceeds from sale of fixed
maturities............................................
25,840 118,032
Proceeds from sale of equity
securities...........................................
58,096 191,029
Purchase of fixed
maturities......................................................
(134,540) (98,098)
Purchase of equity
securities.....................................................
(187,439) (193,154)
Purchase of other
investments.....................................................
(3,315) (410)
Net decrease in short-term
investments............................................
117,531 -
Payments received on mortgage loans and collateral notes
receivable............... 20,631 7,821
Mortgage loans and collateral notes
originated.................................... (11,659)
(5,021)
Purchase of property and
equipment................................................
(3,596) (6,307)
Other proceeds from investing
activities.......................................... 185
281
Net cash provided by (used in) investing
activities...................... (68,460) 105,956
Cash flows from financing activities:
Dividends paid to
stockholders....................................................
(28,834) (27,753)
Purchase of treasury
stock........................................................
- - (487)
Net cash used in financing
activities.................................... (28,834)
(28,240)
Increase (decrease) in cash and cash
equivalents.................................... (37,481)
140,340
Cash and cash equivalents at beginning of
period.................................... 106,188
140,535
Cash and cash equivalents at end of
period............................... $ 68,707
$280,875
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 5 -
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating
Activities
Nine Months Ended September 30, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
<S>
<C> <C>
Cash flows from operating activities:
Net
Earnings................................................................
.......... $ 74,681 $ 71,621
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums
receivable..............................................................
... (29,348) (45,372)
Deferred policy acquisition
costs...................................................
(10,270) (11,226)
Residual market
receivable..........................................................
20,440 9,231
Due to/from
reinsurers..............................................................
(14,146) 1,545
Losses and loss adjustment
expenses.................................................
(46,167) 149
Unearned
premiums................................................................
... 56,692 51,049
Current income
taxes................................................................
3,593 9,685
Deferred income
taxes...............................................................
(3,263) 4,177
Deferred
income..................................................................
... (19) (239)
Contingent
commissions.............................................................
. 7,643 (11,820)
Other assets, liabilities and accrued
expenses...................................... 3,620
2,424
Net realized investment
gains.......................................................
(5,081) (22,915)
Other -
net.....................................................................
.... 1,438 4,315
Net cash provided by operating
activities.................................... $ 59,813 $
62,624
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 6 -
<page
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
1. The financial information has been prepared on a basis consistent
with the accounting principles reflected in the audited
consolidated financial statements for the year ended December 31,
1997. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been omitted
pursuant to the Securities and Exchange Commission rules and
regulations, although the Company believes the disclosures which
have been made are adequate to make the information presented not
misleading.
2. The information furnished includes all adjustments and accruals
consisting only of normal recurring adjustments which are, in the
opinion of management, necessary for a fair presentation of
results for the interim periods. Certain 1997 account balances
have been reclassified to conform to the current year's
presentation.
3. This Form 10-Q contains some statements that are not historical
facts and are considered "forward-looking statements". Such
forward-looking statements involve opinions and predictions, and
no assurance can be given that the future results will be achieved
since events or results may differ as a result of risks facing the
Company. These include, but are not limited to, economic, market
or regulatory conditions as well as risks associated with the
Company's expansion into additional states, entry into new
markets, diversification, and catastrophic events.
4. The consolidated financial statements should be read in
conjunction with the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
5. Neither the results for the nine months ended September 30, 1998
nor comparison with the corresponding nine months ended September
30, 1997 should be considered indicative of the results which may
be expected for the year ending December 31, 1998.
6. In May 1995, the Board of Directors announced that it had approved
a stock buyback program of up to 3 million shares. As of
September 30, 1998, 1,957,348 shares of Treasury Stock were
purchased under the program. No shares have been purchased in
1998.
7. In May 1998 the Board of Directors voted to increase its quarterly
stockholder dividend from $0.26 per share to $0.27 per share.
8. Effective July 1, 1998, the Company transitioned to a new quota
share arrangement which expanded the Company's coverage to include
other than automobile casualty business (except umbrella) and
provide for a higher cession percentage of its other than
automobile property business.
- - 7 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
The new quota share contract covers 75% of the Company's other
than automobile property and casualty business. The former
contract provided for a 49% cession of other than automobile
property premium, a 45% cession of related losses and an excess
loss component providing 100% of reimbursement of property losses
in excess of $125,000 up to $1,000,000. Under the new contract,
the excess loss component was eliminated and the Company also
eliminated its pure catastrophe reinsurance coverage due to the
increase in the quota share coverage. The maximum per occurrence
dollar recovery under the new quota share contract is equal to
350% of the net premiums ceded to the quota share arrangement in a
contract year. The maximum aggregate per year dollar recovery
under the new quota share contract is equal to 450% of the net
premiums ceded to the quota share arrangement in a contract year.
The new contract is a five year contract written with the
following reinsurers: American Reinsurance Corporation; Employers
Reinsurance Corporation; Nationwide Insurance; and, Swiss Re
America.
9. Disclosure of Statement of Financial Accounting Standards No. 130
- - Reporting Comprehensive Income:
<TABLE>
<CAPTION>
Nine
Months Ended
September 30,
1998
1997
<S> <C>
<C>
Other comprehensive income, net of tax:
Change in unrealized gains (losses),
net of income taxes (benefits) of $1,161 in
1998 and $4,336 in 1997...................... $ 2,156
$ 8,052
Reclassification adjustment, net of
income tax benefits of ($2,151) in 1998
and ($5,163) in 1997.........................
(3,994) (9,588)
Other comprehensive income....................... $
(1,838) $ (1,536)
</TABLE>
<TABLE>
<CAPTION>
Three
Months Ended
September 30,
1998
1997
<S> <C>
<C>
Other comprehensive income, net of tax:
Change in unrealized gains (losses),
net of income taxes (benefits) of $1,588
in 1998 and $505 in 1997..................... $ 2,949
$ 938
Reclassification adjustment, net of
income tax benefits of ($212) in 1998
and ($4,430) in 1997.........................
(393) (8,228)
Other comprehensive income....................... $ 2,556
$ (7,290)
</TABLE>
- - 8 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
9. Disclosure of Statement of Financial Accounting Standards No. 131
- - Disclosures about Segments of an Enterprise and Related
Information:
<TABLE>
<CAPTION>
Earnings
Before Identifiable
Revenue Income
Taxes Assets
Nine Months Ended September 30, 1998
<S> <C> <C>
<C>
Property and casualty insurance............ $631,619 $ 90,891
$1,721,738
Real estate and commercial lending......... 3,805 3,805
75,407
Corporate and other........................ 2,626 823
12,290
Consolidated............................ $638,050 $ 95,519
$1,809,435
Nine Months Ended September 30, 1997
Property and casualty insurance............ $624,205 $ 97,014
$1,694,438
Real estate and commercial lending......... 3,057 3,057
71,491
Corporate and other........................ 2,527
(4,942) 9,611
Consolidated............................ $629,789 $ 95,129
$1,775,540
</TABLE>
<TABLE>
<CAPTION>
Earnings Before
Identifiable
Revenue Income Taxes
Assets
Three Months Ended September 30, 1998
<S> <C> <C>
<C>
Property and casualty insurance............ $204,131 $ 32,935
$1,721,738
Real estate and commercial lending......... 1,271 1,271
75,407
Corporate and other........................ 866 4,757
12,290
Consolidated............................ $206,268 $ 38,963
$1,809,435
Three Months Ended September 30, 1997
Property and casualty insurance............ $223,655 $ 52,998
$1,694,438
Real estate and commercial lending......... 656 656
71,491
Corporate and other........................ 848
(3,739) 9,611
Consolidated............................ $225,159 $ 49,915
$1,775,540
</TABLE>
This basis of measurement utilized with the adoption of Statement No.
131 does not differ from prior disclosures of segment information as
part of the Notes to Consolidated Financial Statements found in the
Company's Annual Report.
- - 9 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
10. Disclosure of Supplemental Information:
<TABLE>
<CAPTION>
September
30,
1998
1997
OTHER BALANCE SHEET INFORMATION:
<S> <C> <C>
Fixed maturities, at cost.......................... $ 623,408 $
590,713
Statutory surplus.................................. $ 531,668 $
478,384
OTHER INFORMATION:
Massachusetts policies in force
Private passenger automobile..................... 607,205
587,306
Homeowners....................................... 118,961
116,318
Commercial automobile............................ 14,677
14,447
Three Months
Ended
September
30,
1998
1997
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned
Private passenger automobile..................... $ 168,602 $
163,347
Homeowners....................................... $ 4,063 $
7,643
Commercial automobile............................ $ 7,391 $
9,363
Net investment income, after tax................... $ 18,321 $
15,787
Pure loss ratios
Private passenger automobile..................... 59.0%
59.3%
Homeowners....................................... 58.0%
5.3%
Commercial automobile............................ 54.4%
45.9%
Massachusetts private passenger automobile
exposures written................................. 183,687
178,578
Massachusetts private passenger automobile
premiums written................................. $ 154,337 $
146,405
Nine Months
Ended
September
30,
1998
1997
Premiums earned
Private passenger automobile..................... $ 507,408 $
483,404
Homeowners....................................... $ 20,213 $
22,922
Commercial automobile............................ $ 26,813 $
29,837
Net investment income, after tax................... $ 53,194 $
47,736
Pure loss ratios
Private passenger automobile..................... 61.0%
64.3%
Homeowners....................................... 37.2%
42.0%
Commercial automobile............................ 52.3%
50.6%
Massachusetts private passenger automobile
exposures written................................ 654,216
642,443
Massachusetts private passenger automobile
premiums written................................. $ 526,713 $
504,889
</TABLE>
- - 10 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30, 1998 compared to
three months ended September 30, 1997
Direct premiums written during the third quarter of 1998, increased
$7,401,000 or 4.1% to $189,488,000, as compared to the same period in
1997. The increase was primarily attributable to an $8,347,000, or 5.7%
increase in direct premiums written for Massachusetts personal
automobile insurance, a $932,000, or 5.7% increase to homeowners
insurance offset by a net decrease of $1,878,000 or 10.4% in all other
lines combined. The increase in Massachusetts personal automobile
direct premiums written resulted primarily from a 5.6% increase in the
number of physical damage exposures (Massachusetts automobile exposures
written with liability coverage increased 2.9%), coupled with average
rate increases in the physical damage side of the business. The impact
of this was partially offset by slight decreases in the average rates
for liability exposures. These changes were also impacted by changes to
the Company's safe driver deviations and group discounts which were
effective at the beginning of 1998. The combination of these factors
resulted in a 2.5% increase in the average personal automobile premium
per exposure (each vehicle insured). Despite the 1998 state mandated
average rate decrease of 4.0%, the increase in the average personal
automobile premium per exposure was primarily due to the fact that the
rate decision does not anticipate purchases of new automobiles in the
year in which the rate decision applies, the Company's mix of personal
automobile business differs from that of the industry and the factors
mentioned above. In February 1998, the Company was granted, for the
1998 calendar year, approval to offer its customers safe driver
deviations of 15% for Step 9 (10% in 1997) and 4% for Step 10 (10% in
1997). Companies must re-apply annually, after the state sets rates, to
offer safe driver deviations. The AAA group discount for 1998 policies
was established at 6% (10% for 1997 policies). For drivers who qualify,
both group discount and safe driver deviations can be combined for up to
a 20.1% reduction from state mandated rates.
Net premiums written during the third quarter of 1998 decreased
$9,299,000 or 5.4% as compared to the third quarter of 1997. The
decrease in net premiums written was primarily due to changes in direct
premiums written as described above offset by increased levels of
coverage provided through non-automobile reinsurance treaties resulting
in an increase of ceded premiums. Written premiums assumed from the
Commonwealth Automobile Reinsurers ("C.A.R.") increased $1,623,000 or
9.1% and written premiums ceded to C.A.R. decreased $237,000, or 1.3% as
compared to the third quarter of 1997, as a result of changes in the
industry's and the Company's utilization of C.A.R. reinsurance.
Earned premiums decreased $1,444,000, or 0.8% during the third quarter
of 1998 as compared to the same period in 1997. Earned premiums were
impacted by increased levels of coverage provided by non-automobile
reinsurance treaties which took effect during the third quarter of 1998.
Earned premiums assumed from C.A.R. decreased $4,163,000 or 22.4% and
earned premiums ceded to C.A.R. decreased $579,000, or 3.2% as compared
to the third quarter of 1997. Direct premiums earned for Massachusetts
personal automobile insurance increased $8,090,000, or 5.2% compared to
the same period in 1997.
- - 11 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Commercial automobile insurance direct premiums earned decreased
$413,000, or 4.3%, and homeowners premiums earned decreased $3,580,000,
or 46.8%, as compared to the third quarter of 1997. The decrease in
homeowners premiums earned is attributable to increased levels of
coverage provided through the other than automobile quota share
reinsurance treaty that resulted in increased ceded premiums.
Net investment income increased $1,497,000 or 7.6%, compared to the
third quarter of 1997 principally as a result of a 6.2% increase in
average invested assets for the period. Net investment income as a
percentage of total average investments was 6.8% in the third quarter of
1998 as compared to 6.7% during the same period in 1997. Net investment
income after tax as a percentage of total average investments was 5.6%
in the third quarter of 1998 as compared to 5.4% during the same period
in 1997. As previously announced the Company is seeking greater
flexibility to provide for enhanced potential future capital
appreciation. The Company's continuing strategy is to acquire equity
investments, including potential acquisitions, which forego current
investment yield in favor of potential higher yielding capital
appreciation in the future. As a result, the Company is carrying
approximately $72.4 million in cash and short-term investments which
yield lower returns than its current long-term investment portfolio. On
November 3, 1998 the Company, along with American Automobile Association
Club-Southern New England ("AAA-SNE"), announced that a joint venture
owned by them had entered into a definitive agreement to acquire
Automobile Club Insurance Company ("ACIC"), located in Columbus, Ohio,
from the American Automobile Association ("AAA") and the California
State Automobile Association Inter-Insurance Bureau ("CSAAI-IB") for a
total purchase price of $78.5 million. This acquisition is discussed
further in the liquidity and capital resources section found later in
this MD&A.
Premium finance and service fees increased $2,053,000 or 110.6% during
the third quarter of 1998 as compared to the same period in 1997. The
increase for the third quarter of 1998 versus 1997 was primarily
attributable to a change from a "late payment" fee based system to an
installment fee of $3.00 on each invoice following the down payment, for
personal lines policies with January 1, 1998 or subsequent effective
dates. Previously, for 1996 and 1997, the Company eliminated interest
based finance fees on personal automobile insurance policies.
Net realized investment losses totaled $2,000 during the third quarter
of 1998 as compared to net realized investment gains of $20,995,000 for
the same period in 1997. Net realized investment gains during the third
quarter of 1997 were the result of a merger of a major New England
financial corporation and it's property and casualty subsidiary. The
merger election and exchange of stock resulted in net realized
investment gains of $15,178,000. Subsequent post merger sales of this
corporation's common stock resulted in additional net realized
investment gains of $3,790,000.
- - 12 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Losses and loss adjustment expenses ("LAE") incurred (on a statutory
basis) as a percentage of insurance premiums earned ("loss ratio")
increased to 68.9% for the third quarter of 1998 as compared to 67.3%
for the same period in 1997. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on personal
automobile decreased to 59.0% compared to 59.3% in the third quarter of
1997. The improvement in the loss ratio was primarily due to better
underwriting results during the current period, offset by less favorable
loss development from the residual market. The commercial automobile
pure loss ratio increased to 54.4% compared to 45.9% during the third
quarter of 1997. For homeowners, the pure loss ratio increased to 58.0%
compared to 5.3% during the third quarter of 1997. The Company
experienced favorable development in the homeowners liability area
during the third quarter of 1997. Additionally, total expenses related
to the Company's management incentive compensation plan included in
losses and loss adjustment expenses were $7,571,000 lower in the third
quarter of 1998 as compared to the same period in 1997. Of this
decrease, approximately $2,337,000 benefited the insurance companies
with the remainder benefiting corporate expenses. The decrease was
primarily driven by decreases, during the quarter, in the market price
of the Company's common stock. The expenses related to the management
incentive compensation plan are directly impacted by the average market
price of the Company's common stock.
Policy acquisition costs decreased $5,067,000 or 10.0% during the third
quarter of 1998 compared to the same period in 1997. As a percentage of
net premiums written, underwriting expenses for the insurance companies
(on a statutory basis) were 26.8% during the third quarter of 1998 as
compared to 28.5% for the same period in 1997. This decrease in policy
acquisition costs was primarily impacted by lower expenses related to
the Company's management incentive plan (see below) which were offset by
higher contingent commission accruals due to the improved loss ratio
described earlier and higher computer services expenses related to
upgrading the Company's computer systems. Specifically, total expenses
related to the Company's management incentive compensation plan included
in policy acquisition costs were $6,575,000 lower in the third quarter
of 1998 as compared to the same period in 1997. Of this decrease,
approximately $2,292,000 benefited the insurance companies with the
remainder benefiting corporate expenses. The decrease was primarily
driven by decreases, during the quarter, in the market price of the
Company's common stock. The expenses related to the management
incentive compensation plan are directly impacted by the average market
price of the Company's common stock.
The Company's effective tax rate was 23.3% for the third quarter of 1998
as compared to 29.9% for the same period in 1997. In both years the
effective tax rate was lower than the statutory rate of 35.0% primarily
due to tax-exempt interest income and the corporate dividends deduction.
The lower effective tax rate for the third quarter of 1998 was the
result of the tax exempt interest and the dividends received deduction
comprising a greater portion of net earnings before taxes and less
realized capital gains during the third quarter of 1998 as compared to
the same period in 1997.
- - 13 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Nine months ended September 30, 1998 compared to
nine months ended September 30, 1997
Net earnings decreased $5,151,000 during the third quarter of 1998 as
compared to the same period in 1997. Operating earnings after income
taxes increased $8,497,000 which was offset by a decrease in after tax
realized investment gains of $13,648,000 during the third quarter of
1998 as compared to the same period of 1997.
Direct premiums written during the first nine months of 1998, increased
$21,068,000, or 3.4% to $633,622,000, as compared to the same period in
1997. The increase was primarily attributable to a $22,797,000, or 4.5%
increase in direct premiums written for Massachusetts personal
automobile insurance and a $2,370,000, or 5.7% increase to homeowners
insurance offset by a net decrease of $4,099,000, or 6.8% in all other
lines combined. The increase in Massachusetts personal automobile
direct premiums written resulted primarily from a 4.4% increase in the
number of physical damage exposures (Massachusetts automobile exposures
written with liability coverage increased 1.8%), coupled with average
rate increases in the physical damage side of the business. The impact
of this was partially offset by slight decreases in the average rates
for liability exposures. These changes were also impacted by changes to
the Company's safe driver deviations and group discounts. The
combination of these factors resulted in a 2.4% increase in the average
personal automobile premium per exposure (each vehicle insured).
Despite the 1998 state mandated average rate decrease of 4.0%, the
increase in the average personal automobile premium per exposure was
primarily due to the fact that the rate decision does not anticipate
purchases of new automobiles in the year in which the rate decision
applies, the Company's mix of personal automobile business differs from
that of the industry and the factors mentioned above. In February 1998,
the Company was granted, for the 1998 calendar year, approval to offer
its customers safe driver deviations of 15% for Step 9 (10% in 1997) and
4% for Step 10 (10% in 1997). Companies must re-apply annually, after
the state sets rates, to offer safe driver deviations. The AAA group
discount for 1998 policies was established at 6% (10% for 1997
policies). For drivers who qualify, both group discount and safe driver
deviations can be combined for up to a 20.1% reduction from state
mandated rates.
Net premiums written during the first nine months of 1998 increased
$9,625,000 or 1.6% as compared to 1997. The increase in net premiums
written was primarily due to changes in direct premiums written as
described above offset by increased levels of coverage provided by non-
automobile reinsurance treaties resulting in an increase of ceded
premiums. Written premiums assumed from the Commonwealth Automobile
Reinsurers ("C.A.R.") increased $5,934,000 or 10.2% and written premiums
ceded to C.A.R. decreased $1,337,000, or 2.4% as compared to the first
nine months of 1997, as a result of changes in the industry's and the
Company's utilization of C.A.R. reinsurance.
- - 14 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Earned premiums increased $17,118,000, or 3.2% during the first nine
months of 1998 as compared to the same period in 1997. Earned premiums
were impacted by increased levels of coverage provided by non-automobile
reinsurance treaties which took effect during the third quarter of 1998.
Earned premiums assumed from C.A.R. decreased $3,702,000 or 6.0% and
earned premiums ceded to C.A.R. decreased $2,961,000, or 5.5% as
compared to the same period in 1997. Direct premiums earned for
Massachusetts personal automobile insurance increased $24,520,000, or
5.4% compared to the same period in 1997. Commercial automobile
insurance direct premiums earned decreased $1,531,000, or 5.3%,
homeowners premiums earned decreased $2,710,000, or 11.8%, and as
compared to the same period in 1997. The decrease in homeowners
premiums earned is attributable to increased levels of coverage provided
through the other than automobile quota share reinsurance treaty that
resulted in increased ceded premiums.
Net investment income increased $4,415,000 or 7.5%, compared to the
first nine months of 1997 principally as a result of a 6.2% increase in
average invested assets for the period. Net investment income as a
percentage of total average investments was 6.8% in the first nine
months of 1998 as compared to 6.7% during the same period in 1997. Net
investment income after tax as a percentage of total average investments
was 5.6% in the first nine months of 1998 as compared to 5.5% during the
same period in 1997. On November 3, 1998 the Company along with AAA-SNE
announced that a joint venture owned by them has entered into a
definitive agreement to acquire ACIC, located in Columbus, Ohio, from
AAA and CSAAI-IB for a total purchase price of $78.5 million. This
acquisition is discussed further in the liquidity and capital resources
section found later in this MD&A.
Premium finance and service fees increased $4,562,000 or 86.8% during
the first nine months of 1998 as compared to the same period in 1997.
The increase for the first nine months of 1998 versus 1997 was primarily
attributable to a change from a "late payment" fee based system to an
installment fee of $3.00 on each invoice following the down payment, for
personal lines policies with January 1, 1998 or subsequent effective
dates. Previously, for 1996 and 1997, the Company eliminated interest
based finance fees on personal automobile insurance policies.
Net realized investment gains totaled $5,081,000 during the first nine
months of 1998 as compared to net realized investment gains of
$22,915,000 for the same period in 1997. A significant portion of the
net realized investment gains during the first nine months of 1998 were
the result of sales of common stocks resulting in net realized
investment gains of $7,002,000. These realized investment gains were
partially offset by realized investment losses in the sales of non-
taxable bonds, preferred stocks and in the maturity of GNMA's. A
significant portion of the net realized investment gains during the
first nine months of 1997 were the result of a merger of a major New
England financial corporation and it's property and casualty subsidiary
during the third quarter of 1997.
- - 15 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The merger election and exchange of stock resulted in a net realized
gains of $15,178,000. Subsequent post merger sales of this
corporation's common stock resulted in additional net realized
investment gains of $3,790,000. The remainder of the net realized gains
for the first nine months of 1997 were primarily the result of sales of
non-taxable bonds, common and preferred stocks offset by minimal
realized investment losses in the sale of GNMA's.
Losses and loss adjustment expenses ("LAE") incurred (on a statutory
basis) as a percentage of insurance premiums earned ("loss ratio")
decreased to 69.6% for the first nine months of 1998 as compared to
72.7% for the same period in 1997. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on personal
automobile decreased to 61.0% compared to 64.3% in the first nine months
of 1997. The improvement in the loss ratio for the first nine months of
1998 was due to better current accident year underwriting results and
similar favorable loss development for prior accident years. The
commercial automobile pure loss ratio increased to 52.3% compared to
50.6% during the first nine months of 1997. For homeowners, the pure
loss ratio decreased to 37.2% compared to 42.0% during the first nine
months of 1997. This decrease was due to favorable weather conditions
during the first nine months of 1998 as compared to normal weather
conditions experienced during the same period in 1997, coupled with
favorable development in the homeowners liability area. Additionally,
total expenses related to the Company's management incentive plan
included in losses and loss adjustment expenses were $4,892,000 lower in
the third quarter of 1998 as opposed to the same period in 1997. Of
this decrease approximately $1,593,000 benefited the insurance companies
with the remainder benefiting corporate expenses. The decrease was
primarily driven by decreases, in the third quarter, in the market price
of the Company's common stock. The expenses related to the management
incentive compensation plan are directly impacted by the average market
price of the Company's common stock.
Policy acquisition costs increased by $16,011,000, or 11.6% during the
first nine months of 1998 compared to the same period in 1997. As a
percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) were 26.7% during the first
nine months of 1998 as compared to 25.0% for the same period in 1997.
The increase in policy acquisition costs was primarily impacted by
higher contingent commission accruals due to the improved loss ratio
described earlier and higher computer services expenses related to
upgrading the Company's computer systems offset by lower expenses
relating to the Company's management incentive plan. Specifically,
total expenses related to the Company's management incentive plan
included in policy acquisition costs were $4,261,000 lower in the third
quarter of 1998 as opposed to the same period in 1997. Of this decrease
approximately $1,562,000 benefited the insurance companies with the
remainder benefiting corporate expenses. The decrease was primarily
driven by decreases, in the third quarter, in the market price of the
Company's common stock. The expenses related to the management
incentive compensation plan are directly impacted by the average market
price of the Company's common stock.
- - 16 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's effective tax rate was 21.8% for the first nine months of
1998 as compared to 24.7% for the same period in 1997. The decrease was
primarily attributable to higher dividends on preferred and common stock
coupled with less realized capital gains during 1998 as compared to the
same period in 1997. In both years the effective tax rate was lower
than the statutory rate of 35.0% primarily due to tax-exempt interest
income and the corporate dividends deduction comprising a greater
portion of net earnings before taxes.
Net earnings increased $3,060,000 during the first nine months of 1998
as compared to the same period in 1997, as a result of the factors
mentioned above.
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on the
Consolidated Balance Sheets on page 3 and the Consolidated Statements of
Cash Flows on pages 5 and 6. Stockholders' equity increased by
$44,009,000 or 6.8%, during the first nine months of 1998. This
increase was the result of net earnings of $74,681,000, offset by a
decrease in net unrealized gains, net of income taxes, on fixed
maturities, equity securities and other investments of $1,838,000 and
dividends paid to stockholders of $28,834,000. Total assets at
September 30, 1998 increased by $54,682,000 or 3.1%, to $1,809,435,000
as compared to total assets of $1,754,753,000 at December 31, 1997. The
majority of this growth was reflected in an increase in invested assets
of $20,654,000 or 1.7%, of $29,348,000 or 17.3% in premiums receivable,
of $10,270,000, or 12.0% in deferred policy acquisition costs, offset by
a decrease in all other assets of $5,590,000 or 2.2%. The increase in
premiums receivable was primarily attributable to the seasonality of the
policy effective dates of the Company's business.
As of September 30, 1998, the market value of the Company's fixed
maturity portfolio exceeded its book value by $21,670,000 ($14,085,000
after taxes, or $0.39 per share). At December 31, 1997 the market value
of the Company's fixed maturity portfolio exceeded its book value by
$23,813,000 ($15,478,000 after taxes, or $0.43 per share). The cost of
the Company's preferred stocks exceeded market value by $6,589,000
($4,283,000 after taxes, or $0.12 per share). At December 31, 1997 the
market value of preferred stocks exceeded cost by $364,000 ($237,000
after taxes, or $0.01 per share). At September 30, 1998 the market
value of the Company's common stocks exceeded cost by $23,612,000
($15,347,000 after taxes, or $0.43 per share). At December 31, 1997 the
market value of common stocks exceeded cost by $17,718,000 ($11,517,000
after taxes, or $0.32 per share).
Preferred stocks increased $45,751,000 or 30.8% and common stocks
(primarily composed of closed-end preferred stock mutual funds)
increased $91,222,000 or 51.2%, during the first nine months of 1998
primarily as a result of the Company's previously announced change in
investment strategy. The Company's strategy is to acquire equity
investments, including potential acquisitions, which forego current
investment yield in favor of future potentially higher yielding capital
appreciation. As a result, the Company is carrying approximately $72.4
million in cash and short-term investments which yield lower returns
than its current long-term investment portfolio.
- - 17 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's liabilities totalled $1,115,630,000, at September 30, 1998
as compared to $1,104,957,000 at December 31, 1997. The $10,673,000 or
1.0% increase was comprised of a decrease of $46,167,000 or 7.1% in loss
and loss adjustment expenses, a decrease of $9,305,000 or 80.9% in
payables for securities purchased, offset by an increase of $56,692,000
or 14.9% in unearned premiums, an increase of $7,643,000 or 55.1% in
contingent commissions accrued and a $1,810,000 or 1.1% net increase in
all other liabilities. The decrease in the liability for loss and loss
adjustment expenses is attributed primarily to better underwriting
results coupled with increased net loss payments, as described below,
during the first nine months of 1998. However, $15,479,000 of the
$46,167,000 decrease in the liability for loss and loss adjustment
expenses relates to the decrease in losses and loss adjustment expense
receivable form the residual market. The change in unearned premiums
primarily resulted from the increase in Massachusetts personal
automobile direct premiums written and the expected seasonality impact
of policy effective dates previously mentioned.
The primary sources of the Company's liquidity are funds generated from
insurance premiums, net investment income, premium finance and service
fees and the maturing and sales of investments as reflected in the
Consolidated Statements of Cash Flows on pages 5 and 6. In November
1997, the Company received state regulatory approval to implement an
installment fee of $3.00 on each invoice following the down payment, for
personal lines policies with January 1, 1998 effective dates.
Previously, for 1997 and 1998, the Company eliminated interest based
finance fees on personal automobile insurance policies, utilizing
instead a "late fee" system. The impact of this change through the
third quarter of 1998 has resulted in a 86.8% increase in combined
premium finance and service fees as compared to the same period in 1997.
The Company's operating activities provided cash of $59,813,000 in the
first nine months of 1998 as compared to $62,624,000 in 1997. These
cash flows were primarily impacted by premiums collected which increased
6.4% during the first nine months of 1998, net losses and LAE paid which
increased 11.0% and policy acquisition costs paid which decreased 5.0%.
The increase in premiums was primarily the result of higher physical
damage exposures written, coupled with average rate increases in the
physical damage side of the business. The impact of this was partially
offset by slight decreases in the average rates for liability exposures.
(However, this impact was reduced with the slight increases of liability
exposures written.)
Net losses and LAE paid, which includes the change in the losses and LAE
liability, increased $41,376,000. This amount resulted primarily from a
decrease in the loss and loss adjustment expense liability.
Additionally, direct payments on automobile liability claims increased
$22,827,000 or 12.5%. The remaining amount is primarily the result of
increased payments for the management incentive compensation plan and
computer services expenses associated with claims coupled with increased
payments assumed from C.A.R. Offsetting this, claim payments for other
than automobile lines of business, after reinsurance, decreased in the
first half of 1998
- - 18 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
versus 1997. The increase in automobile liability loss payments was
primarily attributable to two factors: increased payments for bodily
injury claims and increased payments for property damage liability
claims. The liability payments were higher primarily due to increased
business writings coupled with continued efforts in the claims
department to accelerate the claims settlement process in an effort to
reduce the overall cost and potential build-up of bodily injury claims
in the long run, as well as to reduce the overall number of open
liability claims.
The net cash flows used in investing activities were primarily the
result of purchases of fixed maturities and equity securities offset by
a net decrease in short-term investments and by proceeds from the sale
and maturity of fixed maturities and equity securities. Investing
activities were funded by accumulated cash and cash provided by
operating activities during 1998 and 1997.
Cash flows used in financing activities totaled $28,834,000 during the
first nine months of 1998 compared to $28,240,000 during the same period
in 1997. The 1998 cash flows used in financing activities consisted
exclusively of dividends paid to stockholders. The 1997 cash flows used
in financing activities consisted of $27,753,000 in dividends paid to
stockholders and $487,000 used to purchase 20,000 shares of Treasury
Stock under the Company's stock buyback program. There have been no
Treasury Stock purchases in 1998.
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. At September 30, 1998, the Company held cash and cash
equivalents of approximately $68,707,000. These funds, coupled with
short-term investments of $3,669,000, provide sufficient liquidity for
the payment of claims and other short-term cash needs. The Company also
relies upon dividends from its subsidiaries for its cash requirements.
Periodically, sales have been made from the Company's fixed maturity
investment portfolio to actively manage portfolio risks, including
credit-related concerns and matching of asset and liability cash flows,
to optimize tax planning and to realize gains. This practice will
continue in the future.
Industry and regulatory guidelines suggest that the ratio of a property
and casualty insurer's annual net written premiums to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.41 to 1.00 and 1.54 to 1.00
for the twelve months ended September 30, 1998 and 1997, respectively.
- - 19 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's long-term growth objective has been to expand its writings
outside of Massachusetts. In continued pursuit of this objective the
Company became licensed in the states of Connecticut and Rhode Island
during 1996 and in the states of Vermont and New Hampshire in 1997.
License approval in the state of Maine was received in February 1998.
Concurrent with the filings submitted for these licenses, the Company
entered into an agreement with Policy Management Services Corporation
("PMSC") and licensed software which allows for the development of
internal operating systems which will enable the Company to process
policies in states outside of Massachusetts.
In keeping with the Company's long-term growth objective to expand
outside Massachusetts, the Company has also monitored potential
acquisition opportunities of 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 November 3,
1998 the Company along with AAA-SNE announced that a joint venture owned
by them had entered into a definitive agreement to acquire ACIC, located
in Columbus, Ohio, from AAA and CSAAI-IB for a total purchase price of
$78.5 million.
ACIC writes automobile and homeowners insurance solely through 930
independent agents affiliated with AAA automobile clubs. For the nine
months ended September 30, 1998, ACIC reported $73 million in direct
written premium, with policies written in 23 states. ACIC had total
assets of $174 million as of September 30, 1998. Commerce and AAA-SNE
intend that ACIC will retain its management team and staff and continue
to have its principle office in Columbus, Ohio. Completion of the
acquisition is expected in the first quarter of 1999 and is subject to
receipt of regulatory approvals and other customary closing conditions.
The Commerce Insurance Company ("Commerce"), a subsidiary of the
Company, will invest approximately $91 million in the joint venture to
fund the ACIC acquisition and to capitalize the joint venture that will
be owned together with AAA-SNE. Of this $91 million, Commerce will
invest $90 million in the form of preferred stock and an additional
$800,000, representing its 80% common stock ownership. AAA-SNE will
invest the remaining $200,000, representing its 20% common stock
ownership. Commerce intends to consolidate ACIC for financial reporting
and tax purposes. Commerce has maintained an affinity group marketing
relationship with AAA-SNE since 1995. AAA-SNE has been an agent of
Commerce since 1995.
- - 20 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Information System Initiatives and Year 2000 Compliance
The year 2000 issue exists primarily because most computer programs were
originally coded to recognize only the last two digits in the date
field. If not addressed and corrected, many systems could fail and
produce erroneous results. The impact of this could lead to a material
adverse impact upon the Company's business including policy and claims
processing. As a result, considerable effort has taken place to assess
the impact and determine whether to replace and/or reprogram the systems
in order for the systems to distinguish the intended year. In response
to this problem and to correspond with the Company's long term growth
objective mentioned above, the Company first established the Team 2000
project in 1996 and then the Century Change project in 1997. Both
projects are presently concurrent corporate-wide efforts aimed at
preparing the Company's systems for the next millennium. The Company
expects, upon completion of the Century Change Project, mentioned in
detail below, to continue focusing its efforts primarily on the Team
2000 Project.
Team 2000 Project
The Team 2000 project is aimed at providing the Company with century
ready systems to write insurance in other states and, in the future,
eventually replace the Company's existing internal computer systems for
Massachusetts business. To achieve this objective, the Company has
entered into an agreement with and is utilizing software licensed from
PMSC, as mentioned above. Costs to date for the Team 2000 effort have
been approximately $43.3 million of which, $14.7 million is applicable
to 1998. Total additional Team 2000 project costs over the next 5 to 7
years have been estimated at approximately $60.0 million. Funds
expensed to date include the purchase of a main frame computer, license
fees and the costs associated with programming, implementation and
training. Systems enabling the Company to process policies in the state
of Rhode Island have been in place since January 1998. Since that time,
the Company has begun writing in Rhode Island on a limited basis.
Through the third quarter ending September 30, 1998, the Company
produced premiums written of $341,000 in the state of Rhode Island. It
is anticipated that other states will be brought on line in the future.
Century Change Project
The Company initiated the Century Change project to address all other
internal/external systems, software, agents, third parties and vendors
in dealing with year 2000 compliance.
- - 21 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
State of Readiness: The Century Change project, enlisting both a
redeployment of internal resources and additional external consultant
resources, involved the development of a formal plan to address the Year
2000 problem and has progressed in accordance with that plan. The
Company's plan, which was designed to, and is proceeding so as to, avoid
any material adverse business production issues, organized corporate
systems into five sub-categories: Data Exchange, Main Frame
Systems/Programs, AS400 Systems/Programs, PC Applications and PC Based
Vendor Purchased Application Software. Different sub-plans were
established for each category with the same Year 2000 objective in mind.
As a result of this effort, the majority of the programming changes
dealing with policy issuance, claims processing and maintenance have
been completed as of October 1998. Other internal changes are expected
to be completed in accordance with specified delivery dates as outlined
in the plan. Looking forward, the project has and will continue to move
into the testing phases of the plan which are expected to conclude
primarily in 1999.
Costs: The project to date has involved internal staff costs as well as
consulting expenses to prepare the systems for the year 2000. Costs to
date for the Century Change project have been approximately $4.1 million
($2.9 million of which relate to 1998). Administration, programming,
testing and implementation of system applications relating to the
Century Change project are expected to cost an additional $2.5 million
over the next 12 months. Approximately $3.7 million, including costs to
date in 1998, is expected to be expensed during 1998 with the remaining
$1.7 million through the end of 1999.
Risks of Non-Compliance: The Company has reviewed the Century Change
status of vendors who perform outside processing, those whose software
the Company uses for internal processing and those third parties with
whom the Company does significant business. Accordingly, the Company
has recognized that year 2000 non-compliance could materially adversely
affect the financial position, results of operations and cash flows of
the Company. As a result, the Company has contacted all significant
related third parties in an effort to determine year 2000 compliance.
In those instances where the Company has ascertained a potential non-
compliance, the Company will seek alternative year 2000 compliant third
parties. This process is on-going and the Company has started to
conduct system testing, as needed, with such third parties, which will
conclude in 1999. While the Company is taking what it believes are the
appropriate safeguards, there can be no assurances that the failure of
such third parties to be year 2000 compliant will not have a material
adverse impact on the Company.
Contingency Planning: The Company's Executive Committee is currently
reviewing issues dealing with identifying possible year 2000 worst case
scenarios and the development of contingency plans to respond to the
likelihood of these situations. The Company anticipates that
Contingency Plans will be discussed, and completed for all material
systems and relationships during the first quarter of 1999.
- - 22 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Stock Buyback and Dividends
The Company began a stock buyback program during the second quarter of
1995. The program, which was approved by the Board of Directors on May
19, 1995, authorizes the Company to purchase up to 3 million shares of
Treasury Stock. Since the inception of the program through September
30, 1998, the Company has purchased 1,957,348 shares of Treasury Stock,
none of which were purchased during the first nine months of 1998.
Additionally, the Company's Employee Stock Ownership Plan has purchased
more than 699,000 shares in open market transactions since the buyback
program was announced, of which 89,000 shares were purchased during the
first nine months of 1998 for $3,017,000.
On September 18, 1998, the Company paid a quarterly dividend of $0.27 to
stockholders of record as of September 4, 1998. The Company increased
its quarterly dividend to stockholders from $0.26 to $0.27 during the
second quarter of 1998.
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 Massachusetts personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in
Massachusetts 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.
- - 23 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the third quarter of 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
RANDALL V. BECKER
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 24 -
<PAGE>
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the third quarter of 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 24 -
<PAGE>
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