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 March 31, 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 May 1, 1998, the number of shares outstanding of the
registrant's common stock (excluding Treasury Shares) was
36,042,652
Page 1 of 17
<PAGE>
The Commerce Group, Inc.
Table of Contents
<TABLE>
<CAPTION>
Page
No.
Part I - Financial Information
<S>
<C>
Consolidated Balance Sheets at
March 31, 1998 (Unaudited) and December 31,
1997................................................ 3
Consolidated Statements of Earnings for the
Three Months Ended March 31, 1998 and 1997
(Unaudited)....................................... 4
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1998 and 1997
(Unaudited)....................................... 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash
Provided by Operating Activities for the Three Months Ended March
31, 1998
and 1997
(Unaudited).............................................................
................................... 6
Notes to Unaudited Consolidated Financial
Statements.................................................... 7
Management's Discussion and
Analysis................................................................
........... 9
Part II - Other Information
Item 6
Exhibits and Reports on Form 8-
K.......................................................................
...... 17
Signature
........................................................................
.............................................. 17
</TABLE>
- - 2 -
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
(Unaudited)
ASSETS
<S> <C>
<C>
Investments:
Fixed maturities, at market (cost: $576,151 in 1998 and $566,784
in 1997)....................... $ 598,665 $ 590,597
Preferred stocks, at market (cost: $203,138 in 1998 and $148,135
in 1997)....................... 203,526 148,499
Common stocks, at market (cost: $180,415 in 1998 and $160,371 in
1997).......................... 197,436 178,089
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan
losses of $2,822 in 1998 and $2,812 in
1997)................................................... 84,359
82,839
Short-term
investments.............................................................
.............. 116,949 132,700
Cash and cash
equivalents.............................................................
........... 86,040 106,188
Other
investments.............................................................
................... 4,132 3,783
Total
investments.............................................................
............... 1,291,107 1,242,695
Accrued investment
income..................................................................
........ 12,485 12,237
Premiums receivable (less allowance for doubtful receivables of
$1,451 in 1998 and 1997)........... 209,425 169,469
Deferred policy acquisition
costs..................................................................
97,489 85,264
Property and equipment, net of accumulated
depreciation............................................ 36,559
36,280
Residual market receivable
Losses and loss adjustment
expenses..............................................................
128,228 129,137
Unearned
premiums................................................................
................ 43,781 51,662
Due from
reinsurers..............................................................
.................. 16,236 18,170
Other
assets..................................................................
..................... 11,070 9,839
Total
assets..................................................................
............... $1,846,380 $1,754,753
LIABILITIES AND
STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment
expenses..............................................................
$ 633,348 $ 649,473
Unearned
premiums................................................................
................ 441,705 379,599
Current income
taxes...................................................................
.......... 5,995 2,656
Deferred income
taxes...................................................................
......... 13,488 13,443
Deferred
income..................................................................
................ 7,058 7,271
Contingent commissions
accrued.................................................................
.. 19,785 13,861
Payable to securities
broker..................................................................
... 32,723 11,500
Other liabilities and accrued
expenses...........................................................
27,900 27,154
Total
liabilities.............................................................
............... 1,182,002 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 and stocks, net of income
taxes of $13,973 in 1998
and $14,663 in
1997....................................................................
........ 25,950 27,232
Retained
earnings................................................................
................ 628,494 612,630
703,065 688,483
Treasury stock 1,957,348 shares in 1998 and
1997................................................ (38,687)
(38,687)
Total stockholders'
equity..................................................................
. 664,378 649,796
Total liabilities and stockholders'
equity................................................... $1,846,380
$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 Months Ended March 31, 1998 and 1997
(Thousands of Dollars Except Share and Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
<S>
<C> <C>
Revenues
Earned premiums
..................................................... $
187,051 $ 178,003
Net investment
income................................................
20,830 19,694
Premium finance and service
fees..................................... 2,591
1,668
Net realized investment gains
(losses)............................... 3,801
(296)
Total
revenues..............................................
214,273 199,069
Expenses
Losses and loss adjustment
expenses.................................. 129,226
135,311
Policy acquisition
costs.............................................
52,204 43,350
Total
expenses..............................................
181,430 178,661
Earnings before income
taxes................................ 32,843
20,408
Income
taxes...........................................................
7,608 3,770
NET
EARNINGS................................................ $
25,235 $ 16,638
COMPREHENSIVE
INCOME........................................ $ 23,953
$ 12,335
BASIC AND DILUTED NET EARNINGS PER COMMON
SHARE............. $ .70 $ .46
CASH DIVIDENDS PAID PER COMMON
SHARE........................ $ .26 $ .25
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING........ 36,042,652 36,050,874
</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
Three Months Ended March 31, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
<S>
<C> <C>
Cash flows from operating activities:
Premiums
collected...............................................................
. $217,588 $191,744
Net investment
income.............................................................
20,582 19,181
Premium finance and service
fees..................................................
2,591 1,668
Losses and loss adjustment expenses
paid.......................................... (142,239)
(132,009)
Policy acquisition costs
paid.....................................................
(58,875) (60,047)
Federal income tax
payments.......................................................
(3,534) (6,565)
Net cash provided by operating
activities................................ 36,113
13,972
Cash flows from investing activities:
Proceeds from maturity of fixed
maturities....................................... 15,885
13,699
Proceeds from sale of fixed
maturities............................................
9,510 4,130
Proceeds from sale of equity
securities...........................................
21,324 14,386
Purchase of fixed
maturities......................................................
(7,105) (10,767)
Purchase of equity
securities.....................................................
(87,287) (26,084)
Purchase of other
investments.....................................................
(283) -
Net increase in short-term
investments............................................
4,251 -
Payments received on mortgage loans and collateral notes
receivable............... 3,034 1,893
Mortgage loans and collateral notes
originated.................................... (4,722)
(586)
Purchase of property and
equipment................................................
(1,469) (1,626)
Other proceeds from investing
activities..........................................
(28) 31
Net cash used in investing
activities.................................... (46,890)
(4,924)
Cash flows from financing activities:
Dividends paid to
stockholders....................................................
(9,371) (9,011)
Purchase of treasury
stock........................................................
- - (487)
Net cash used in financing
activities.................................... (9,371)
(9,498)
Decrease in cash and cash
equivalents...............................................
(20,148) (450)
Cash and cash equivalents at beginning of
period.................................... 106,188
140,535
Cash and cash equivalents at end of
period............................... $ 86,040
$140,085
</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
Three Months Ended March 31, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
<S>
<C> <C>
Cash flows from operating activities:
Net
Earnings................................................................
.......... $ 25,235 $ 16,638
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums
receivable..............................................................
... (39,956) (49,761)
Deferred policy acquisition
costs...................................................
(12,225) (16,923)
Residual market
receivable..........................................................
8,790 (9,463)
Due to/from
reinsurers..............................................................
1,934 2,689
Losses and loss adjustment
expenses.................................................
(16,125) 1,565
Unearned
premiums................................................................
... 62,106 71,909
Current income
taxes................................................................
3,339 (4,203)
Deferred income
taxes...............................................................
735 1,408
Deferred
income..................................................................
... (213) (361)
Contingent
commissions.............................................................
. 5,924 894
Other assets, liabilities and accrued
expenses...................................... (485)
(1,781)
Net realized investment (gains)
losses.............................................. (3,801)
296
Other -
net.....................................................................
.... 855 1,065
Net cash provided by operating
activities.................................... $ 36,113 $
13,972
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 6 -
<page
The Commerce Group, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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. Statements in this Form 10-Q concerning future premium writings
and profit levels look forward in time and involve risks and
uncertainties that may affect the Company's actual results of
operations. Actual results may differ materially from those set
forth in the forward looking statements.
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 three months ended March 31, 1998 nor
comparison with the corresponding three months ended March 31,
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 March
31, 1998, 1,957,348 shares of Treasury Stock were purchased under
the program.
7. Disclosure of Statement of Financial Accounting Standards No. 130
- - Reporting Comprehensive Income:
<TABLE>
<CAPTION>
1998
1997
<S> <C>
<C>
Other comprehensive income, net of tax:
Change in unrealized gains (losses),
net of income taxes of 856 in 1998 and
(2,048) in 1997.............................. $ 1,591
$ (3,803)
Reclassification adjustment, net of
income taxes of (1,546) in 1998 and (269)
in 1997......................................
(2,873) (500)
Other comprehensive income....................... $
(1,282) $ (4,303)
</TABLE>
- - 7 -
<PAGE>
The Commerce Group, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
8. 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
<S> <C> <C>
<C>
March 31, 1998
Property and casualty insurance............ $212,106 $ 33,244
$1,748,716
Real estate and commercial lending......... 1,287 1,287
84,920
Corporate and other........................ 880
(1,688) 12,744
Consolidated............................ $214,273 $ 32,843
$1,846,380
March 31, 1997
Property and casualty insurance............ $196,912 $ 20,525
$1,694,169
Real estate and commercial lending......... 1,311 1,311
73,244
Corporate and other........................ 846
(1,428) 11,826
Consolidated............................ $199,069 $ 20,408
$1,779,239
</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.
- - 8 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended March 31, 1998 compared to
three months ended March 31, 1997
Direct premiums written during the first quarter of 1998, increased
$4,175,000, or 1.7% to $248,303,000, as compared to the same period in
1997. The increase was primarily attributable to a $4,527,000, or 2.2%
increase in direct premiums written for Massachusetts personal
automobile insurance and a $478,000, or 4.7% increase to homeowners
insurance offset by a $735,000 or 5.8% decrease in direct premiums
written for commercial automobile insurance and by a net decrease of
$95,000, or 0.9% in all other lines combined. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from a 2.2% increase in the number of physical damage
exposures (Massachusetts automobile exposures written with liability
coverage remained the same), 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 2.1% 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 quarter of 1998 increased $614,000
or 0.2% as compared to 1997. The increase in net premiums written was
primarily due to changes in direct premiums written as described above,
as well as to the effects of reinsurance. Written premiums assumed from
the Commonwealth Automobile Reinsurers ("C.A.R.") decreased $3,630,000
or 12.1% and written premiums ceded to C.A.R. decreased $285,000, or
1.6% as compared to the first quarter of 1997, as a result of changes in
the industry's and the Company's utilization of C.A.R. reinsurance.
Earned premiums increased $9,048,000, or 5.1% during the first quarter
of 1998 as compared to the same period in 1997. Earned premiums assumed
from C.A.R. decreased $10,000 or 0.1% and earned premiums ceded to
C.A.R. decreased $1,276,000, or 7.2% as compared to the first quarter of
1997. Direct premiums earned for Massachusetts personal automobile
insurance increased $8,082,000, or 5.4% compared to the same period in
1997. Commercial automobile insurance direct premiums earned decreased
$670,000, or 6.9%, and homeowners direct premiums earned increased
$610,000, or 4.7%, as compared to the first quarter of 1997. Earned
premiums attributable to Western Pioneer decreased $166,000, or 2.4% to
$6,711,000 for the three months ended March 31, 1998, compared to
$6,877,000 for the same period in 1997.
- - 9 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net investment income increased $1,136,000 or 5.8%, compared to the
first quarter of 1997 principally as a result of a 6.4% increase in
average invested assets for the period. Net investment income as a
percentage of total average investments was 6.7% in the first quarter of
1998 as compared to 6.8% during the same period in 1997. Net investment
income after tax as a percentage of total average investments was 5.6%
in the first quarter of 1998 as compared to 5.5% 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 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 $203 million
in cash and short-term investments which yield lower returns than its
current long-term investment portfolio.
Premium finance and service fees increased $923,000 or 55.3% during the
first quarter of 1998 as compared to the same period in 1997. The
increase for the first 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 gains totaled $3,801,000 during the first
quarter of 1998 as compared to net realized investment losses of
$296,000 for the same period in 1997. A significant portion of the net
realized investment gains were the result of a sale of 120,000 shares of
stock of a major international insurance company resulting in net
realized investment gain of $5,054,000. This realized investment gain
was partially offset by realized investment losses in the sales of non-
taxable bonds, preferred stocks and in the maturity 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 68.7% for the first quarter of 1998 as compared to 75.7%
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 62.0% compared to 67.8% in the first quarter of
1997. Approximately one-third of the improvement in the loss ratio for
the first quarter 1998 was due to better underwriting results from the
first accident quarter. The remaining improvement was the result of
increased loss redundancies from prior year reserves. The commercial
automobile pure loss ratio increased to 49.5% compared to 48.5% during
the first quarter of 1997. This increase was primarily due to adverse
loss experience on business assumed from C.A.R. For homeowners, the
pure loss ratio decreased to 14.7% compared to 60.2% during the first
quarter of 1997. This decrease was due to extremely favorable weather
conditions during the first quarter of 1998 as compared to normal
weather conditions experienced during the same period in 1997, coupled
with favorable development in the homeowners liability area.
- - 10 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy acquisition costs increased by 20.4% during the first 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 25.9% during the first quarter of 1998 as
compared to 24.1% for the same period in 1997. This increase in policy
acquisition costs was primarily impacted by more contingent commissions
due to the improved loss ratio described earlier and higher computer
services expense related to upgrading the Company's computer systems.
The Company's effective tax rate was 23.2% for the first quarter of 1998
as compared to 18.5% for the same period in 1997. The increase was
primarily attributable to better underwriting results and net realized
investment gains in 1998. 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
lesser percentage of net income before taxes and more realized gains
during the first quarter of 1998 as compared to 1997.
Net earnings increased $8,597,000 during the first quarter 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
$14,582,000 or 2.2%, during the first three months of 1998. This
increase was the result of net earnings of $25,235,000, offset by a
decrease in net unrealized gains, net of income taxes, on fixed
maturities and equity securities of $1,282,000 and dividends paid to
stockholders of $9,371,000. Total assets at March 31, 1998 increased by
$91,627,000 or 5.2%, to $1,846,380,000 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 $48,412,000 or 3.9%, of
$39,956,000 or 23.6% in premiums receivable, of $12,225,000, or 14.3% in
deferred policy acquisition costs, offset by a decrease in all other
assets of $8,966,000. The increase in premiums receivable was primarily
attributable to the seasonality of the policy effective dates of the
Company's business.
- - 11 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
As of March 31, 1998, the market value of the Company's fixed maturity
portfolio exceeded its book value by $22,514,000 ($14,634,000 after
taxes, or $0.41 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 market
value of the Company's preferred stocks exceeded cost by $388,000
($252,000 after taxes, or $0.01 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). The market value of the Company's
common stocks exceeded cost by $17,021,000 ($11,064,000 after taxes, or
$0.31 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). Unrealized gains remained relatively unchanged during the
first quarter of 1998.
Preferred stocks increased $55,027,000 or 37.1% and common stocks
(primarily composed of closed-end preferred stock mutual funds)
increased $19,347,000 or 10.9%, during the first three 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 $203
million in cash and short-term investments which yield lower returns
than its current long-term investment portfolio.
The Company's liabilities totalled $1,182,002,000, at March 31, 1998 as
compared to $1,104,957,000 at December 31, 1997. The $77,045,000 or
7.0% increase was comprised of a decrease of $16,125,000 or 2.5% in loss
and loss adjustment expenses, offset by an increase of $62,106,000 or
16.4% in unearned premiums, an increase of $5,924,000 or 42.7% in
contingent commissions accrued, an increase of $21,223,000 or 184.5% in
securities broker payables and a $3,917,000 or 7.8% increase in all
other liabilities. The decrease in loss and loss adjustment expenses is
attributed to higher loss redundancies from prior year reserves and the
mild winter experienced during the first three months of 1998. The
change in unearned premiums primarily resulted from 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 1996 and 1997, 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
first quarter of 1998 has resulted in a 55.3% increase in combined
premium finance and service fees as compared to the same period in 1997.
- - 12 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's operating activities provided cash of $36,113,000 in the
first three months of 1998 as compared to $13,972,000 in 1997. These
cash flows were primarily impacted by the fact that while premiums
collected increased 13.5% during the first three months of 1998, losses
and LAE paid increased only 7.7% and policy acquisition costs paid
decreased 1.9%. 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. Net losses and LAE paid, which includes the change
in the losses and LAE liability, increased $10,230, primarily due to
increased redundancies in the first quarter of 1998. Additionally, net
loss payments in the direct personal automobile lines of business
increased approximately 3.8% or $3,900,000. Broken down by coverage,
net payments on personal automobile liability increased approximately
13.6% in 1998 and net payments on personal automobile physical damage
decreased 9.6% in 1998, both versus 1997. Offsetting this, payments for
other than automobile lines of business decreased approximately 40.3% or
$3,708,000, compared to 1997. The decrease in physical damage and other
than automobile loss payments were primarily the result of extremely
favorable weather conditions experienced during the first three months
of 1998 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. Bodily injury 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 of bodily injury claims in the long run, as well
as to reduce the overall number of open bodily injury claims.
The net cash flows used in investing activities were primarily the
result of purchases of equity securities offset by a net increase 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 $9,371,000 during the
first three months of 1998 compared to $9,498,000 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 $9,011,000 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 March 31, 1998, the Company held cash and cash
equivalents of approximately $86,040,000. These funds, coupled with
short-term investments of $116,949,000, 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.
- - 13 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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 1.55 to 1.00 and 1.73 to 1.00
for the twelve months ended March 31, 1998 and 1997, respectively.
The Company's long-term growth objective is 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 purchased software which allows for the development of
internal operating systems which will enable the Company to process
policies in states outside of Massachusetts. To facilitate this
development and, at the same time, address the year 2000 processing
issue facing computer system users, the Company established the Team
2000 and Century Change projects which are corporate-wide efforts to
prepare the Company's systems for the next millennium. These projects
involve 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 $2.4 million ($1.1 of which relate to
1998). Administration, programming, testing and implementation of
system applications related to Century Change are expected to cost an
additional $6.0 million over the next 21 months. Approximately $4.4
million is expected to be expensed during 1998 with the remainder
through the end of 1999.
The Company is utilizing both internal and external resources on the
Century Change Project. The Company has a formal plan to address the
Century Change issue and is progressing in accordance with that plan.
Programming changes dealing with policy issuance and maintenance of
same are expected to be completed by year-end 1998. Other internal
changes are scheduled to be completed in accordance with specified
delivery dates as outlined in the plan. The Company's plan has been
designed to, and is proceeding so as to, avoid any adverse business
production issues.
The Company has reviewed the Century Change status of vendors who
perform outside processing for the Company or whose software the
Company uses for internal processing. This review has determined that
the related software used by or provided by these vendors either is
currently century ready or will be ready without any adverse impact on
the Company.
- - 14 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Upon completion of the Century Change project, the Company expects to
focus its efforts on the Team 2000 project which will eventually
replace the Company's existing internal computer systems for
Massachusetts business utilizing software purchased from PMSC. Costs
to date for the Team 2000 effort have been approximately $34.5 million.
Costs applicable to 1998 have been approximately $5.9 million, of which
$5.8 million have been expensed during the year. Total Team 2000
project costs over the next 5 to 7 years have been estimated at
approximately $60.0 million. Funds expended 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 Rhode Island have been in
place since January 1998. Since that time, the Company has begun
writing insurance in Rhode Island on a limited basis. Other states
will be brought on-line in the future.
The Company continues to monitor acquisition opportunities consistent
with a long term growth strategy to expand outside Massachusetts
through acquisitions 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.
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 March 31,
1998, the Company has purchased 1,957,348 shares of Treasury Stock,
none of which were purchased during the first three 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 90,000 shares were purchased during the
first three months of 1998 for $3,017,000.
On March 20, 1998, the Company paid a quarterly dividend of $0.26 to
stockholders of record as of March 6, 1998. The Company increased its
quarterly dividend to stockholders from $0.25 to $0.26 during the
second quarter of 1997.
- - 15 -
<PAGE>
The Commerce Group, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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.
- - 16 -
<PAGE>
The Commerce Group, Inc.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the first 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
- - 17 -
<PAGE>
The Commerce Group, Inc.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the first 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
- - 17 -
<PAGE>
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<DEBT-CARRYING-VALUE> 576,151 566,784
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