UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to .
Commission file number 0-16882
The Commerce Group, Inc.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2599931
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
211 Main Street 01570
Webster, Massachusetts (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (508) 943-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of each Class on Which Registered Common
Stock, $.50 Par Value Per Share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-
affiliates of the registrant as of March 1, 1999, was approximately
$611,511,853.
As of March 1, 1999, the number of shares outstanding of the
registrant's common stock (exclusive of treasury shares) was 35,217,852.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II of this Form 10-K incorporate by reference
information from the registrant's annual report to stockholders for the
fiscal year ended December 31, 1998 (the "1998 Annual Report"). The
1998 Annual Report, except for portions thereof which have been
specifically incorporated by reference, shall not be deemed "filed" as
part of this Form 10-K.
Portions of the registrant's definitive Proxy Statement for its
annual meeting of stockholders which the Company intends to file within
120 days after the end of the registrant's fiscal year ended December
31, 1998 are incorporated by reference into Part III hereof as provided
therein.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Glossary of Selected Insurance
Terms................................................ 3
Part I
<S> <C> <C> <C>
Item 1.
Business..........................................................
...... 7
A.
General...........................................................
11
B. Commonwealth Automobile
Reinsurers................................ 13
C.
Marketing.........................................................
15
D.
Underwriting......................................................
17
E.
Reinsurance.......................................................
18
F. Settlement of
Claims.............................................. 20
G. Loss and Loss Adjustment Expense
Reserves......................... 21
H. Operating
Ratios.................................................. 24
I.
Investments.......................................................
25
J.
Regulation........................................................
27
K.
Competition.......................................................
32
L. Other
Matters..................................................... 32
Item 2.
Properties........................................................
...... 33
Item 3. Legal
Proceedings.......................................................
33
Item 4. Submission of Matters to a Vote of Security
Holders..................... 33
Item 4A. Executive Officers of the
Registrant.................................... 34
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters.... 36
Item 6. Selected Financial
Data................................................. 36
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of
Operations.................................................. 36
Item 7a. Qualitative and Quantitative Disclosures about Market
Risk.............. 36
Item 8. Financial Statements and Supplementary
Data............................. 37
Item 9. Changes in and Disagreements with Independent Auditors on
Accounting
and Financial
Disclosure............................................... 37
Part III
Item 10. Directors and Executive Officers of the
Registrant...................... 37
Item 11. Executive
Compensation.................................................. 37
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......... 37
Item 13. Certain Relationships and Related
Transactions.......................... 37
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......... 38
Signatures........................................................
...... 39
Index to Financial Statement
Schedules.................................. 41
Index to
Exhibits....................................................... 54
</TABLE>
2
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GLOSSARY OF SELECTED INSURANCE TERMS
Assumed premium.................... Premiums acquired or allocated to an
insurer other than
through its independent agencies.
Best's............................. A.M. Best Company, Inc. is a rating
agency reporting on
the financial condition of insurance
companies. A.M. Best's statistics
cited in this Form 10-K are based
upon information voluntarily
submitted to it by insurers. The
Company is aware of at least one
Massachusetts domestic insurer that
has not submitted data to Best's and
therefore may not be reflected in
Best's market share statistics.
Casualty insurance................. Insurance which is primarily
concerned with the losses
of the insured due to injuries to
other persons and to the property of
others, and the legal liability
imposed on the insured resulting
therefrom.
Catastrophe, catastrophic loss..... A severe loss, usually involving
many risks such as
conflagration, earthquake,
windstorm, explosion and other
similar events.
Combined ratio..................... A combination of the underwriting
expense ratio and the
loss and LAE ratio determined in
accordance with Statutory Accounting
Practices ("SAP"). The underwriting
expense ratio measures the ratio of
underwriting expenses to net
premiums written, determined in
accordance with SAP. The loss and
LAE ratio measures the ratio of
incurred losses and LAE to earned
premiums, determined in accordance
with SAP.
Commissioner....................... The Commissioner of the Division
of Insurance of the
Commonwealth of Massachusetts.
Commonwealth Automobile
Reinsurers ("C.A.R.").............. C.A.R. is a Massachusetts mandated
reinsurance mechanism,
under which all premiums, expenses
and losses on ceded business are
shared by all insurers. It is
similar to a joint underwriting
association because a number of
insurers (46 in 1998) act as
Servicing Carriers for the risks it
insures.
Direct............................. Refers to premiums, losses, LAE and
expenses on policies
which a company writes before
accounting for business ceded and
assumed through reinsurance.
Direct loss ratio.................. The ratio of direct incurred losses
and LAE to direct
earned premiums.
Direct premiums written............ Total premiums for insurance
sold to insureds, as
opposed to, and not including,
reinsurance premiums.
Domestic insurer................... An insurance company that operates
in the state in which it is
licensed.
Earned premiums.................... The portion of net premiums written
that is equal to the
expired portion of policies
recognized for accounting purposes
as income during a period. Also
known as premiums earned.
3
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Excess of loss reinsurance......... Reinsurance which indemnifies the
reinsured against all
or a specified portion of losses
under reinsured policies in excess
of a specific dollar amount or
"retention".
Exclusive representative
producer ("ERP")................... A Massachusetts automobile
insurance agency which does
not have a voluntary agency
automobile insurance relationship
with an insurer, and which is
assigned by C.A.R. to an insurer who
is a Servicing Carrier.
Exposure........................... An insurable unit defined as an
automobile.
Group marketing program............ A "group marketing program" is any
system, design or
plan whereby motor vehicle or
homeowner insurance is afforded to
employees of an employer or to
members of a trade union,
association or organization in
accordance with those provisions of
M.G.L. c. 175, s. 193R,
distinguishing such plans from a
"mass merchandising plan".
Specifically, a group marketing
program contemplates the issuance of
such insurance through other than
standard policies that preclude
individual underwriting, contains an
option to continue coverage by a
standard policy upon termination of
employment or membership, restricts
cancellation, requires the
continuance of certain
participation, in ways not
applicable to standard policies, and
provides for the modification of
rates based upon the experience of
the insured group.
Hard market........................ An insurance market in which the
demand for insurance
exceeds the readily available supply
and premiums are relatively high.
Incurred but not reported
("IBNR") reserves.................. Reserves for estimated losses which
have been incurred
by insureds but not yet reported to
the insurer.
Incurred losses.................... The total losses sustained by an
insurance company under
a policy or policies, whether paid
or unpaid. Incurred losses include a
provision for IBNR.
Inland marine insurance............ As used by the Company, insurance
that provides protec-
tion for specific types of personal
property, such as jewelry, coins and
fine arts, over the limits covered
in a standard homeowners insurance
policy.
Loss adjustment expenses ("LAE")... The expense of settling claims,
including legal and
other fees and the portion of
general expenses allocated to claim
settlement costs.
LAE ratio.......................... The ratio of LAE, net of
reinsurance recoveries, to
earned premiums.
Loss and LAE ratio................. The ratio of incurred losses and
loss adjustment ex-
penses, net of reinsurance
recoveries, to earned premiums.
4
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Loss reserves...................... Liabilities established by insurers
to reflect the esti-
mated cost of claims payments and
the related expenses that the
insurer will ultimately be required
to pay in respect of insurance it
has written. Reserves are
established for losses and for LAE.
Net premiums written............... Direct premiums written for a given
period less premiums
ceded to reinsurers during such
period plus premiums assumed during
such period.
Participation ratio................ A Massachusetts insurer's share of
the C.A.R. deficit
based upon the insurer's market
share of automobile risks not
reinsured through C.A.R., adjusted
for utilization of C.A.R. credits
for voluntarily writing less
desirable business and ceded
exclusions.
Premium-to-surplus ratio........... The ratio of net premiums written
to policyholders'
surplus.
Property insurance................. Insurance that indemnifies a
person with an insurable
interest in tangible property for
loss related to damage to or loss of
use of the subject property.
Pure loss ratio.................... The ratio of net incurred losses,
excluding LAE, to pre-
miums earned.
Quota share reinsurance............ Reinsurance in which the reinsured
shares a proportion
of the original premiums and losses
under the reinsured policy. Also
known as pro rata reinsurance.
Rate deviation..................... A specific state approved departure
from an otherwise
applicable state set rate level
provided to safe drivers.
Rate discount...................... A specific state approved discount
from an otherwise
applicable state set rate level
provided to members of group
marketing programs.
Reinsurance........................ The acceptance by one or more
insurers, called rein-
surers, of all or a portion of the
risk underwritten by another insurer
who has directly written the
coverage. However, the legal rights
of the insured generally are not
affected by the reinsurance
transaction and the insurance
company issuing the insurance policy
remains liable to the insured for
payment of policy benefits.
Safe Driver Insurance Plan ("SDIP") A program mandated by
Massachusetts state law that
encourages safe driving by rewarding
drivers who do not cause an
accident, or incur a traffic law
violation and by making sure that
high-risk drivers pay a greater
share of insurance costs. Under
SDIP, drivers incur surcharge points
for traffic violations and at-fault
accidents. Drivers also earn credit
points for each incident free year.
Drivers begin at a starting or
neutral SDIP Step 15. Drivers can
earn credits down to SDIP Step 9,
the lowest step, and incur surcharge
points up to SDIP Step 35, the
highest step.
Servicing Carrier.................. An automobile insurer writing
business in
Massachusetts which can reinsure
risks through C.A.R. while remaining
responsible for servicing the
related policies and which must
provide a market for ERPs assigned
to it by C.A.R.
5
<PAGE>
Soft market........................ An insurance market in which the
supply of insurance
exceeds the current demand and
premiums are relatively low.
Statutory accounting practices
("SAP").......................... Recording transactions and
preparing financial state-
ments in accordance with the rules
and procedures prescribed or
permitted by an insurer's state
insurance regulatory authority for
the purposes of financial reporting
to regulators, which in general
reflect a liquidating, rather than
going concern, concept of
accounting.
Statutory surplus.................. The excess of admitted assets
over total liabilities
(including loss reserves),
determined in accordance with SAP.
Take-all-comers.................... A phrase used to characterize the
Massachusetts auto-
mobile regulatory system under which
all insurers are required to
underwrite virtually all risks
submitted to them.
Underwriting....................... The insurer's process of reviewing
applications submit-
ted for insurance coverage, deciding
whether to accept all or part of the
coverage requested and determining
the applicable premiums.
Underwriting expenses.............. The aggregate of policy
acquisition costs, including
commissions, and the portion of
administrative, general and other
expenses attributable to
underwriting operations.
Underwriting expense ratio......... The ratio of underwriting expenses
to net premiums writ-
ten determined in accordance with
SAP.
Unearned premiums.................. The portion of a premium
representing the unexpired
amount of the contract term as of a
certain date.
6
<PAGE>
PART I
ITEM 1. BUSINESS
The Commerce Group, Inc. (the "Company"), was incorporated in
1976. The Company is engaged principally in providing personal and
commercial property and casualty insurance in Massachusetts primarily
through it's subsidiary, The Commerce Insurance Company ("Commerce"),
which was incorporated in 1971. The Company's principal insurance line
is motor vehicle insurance, primarily covering personal automobiles.
The Company also offers commercial automobile, homeowners, inland
marine, fire, general liability and commercial multi-peril insurance.
The Company also writes insurance in the state of California through
Commerce West Insurance Company ("Commerce West") formerly Western
Pioneer Insurance Company, a personal automobile insurer located in
Pleasanton, California, which was acquired on August 31, 1995. In
November 1998, Commerce formed a joint venture (ACIC Holding Co., Inc.),
with AAA Southern New England ("AAA SNE") to purchase Automobile Club
Insurance Company, located in Columbus, Ohio, a property and casualty
insurer with policies in twenty-eight states and licensed in several
others. In conjunction with this acquisition, which was completed on
January 29, 1999, the newly acquired company's name was changed to
American Commerce Insurance Company ("ACIC"). In addition to the
property and casualty insurance businesses, the Company originates
residential and commercial mortgages on a limited basis within
Massachusetts and Connecticut and operates an insurance agency dealing
in a full line of insurance products, including those of the Company.
The Company's business strategy is to focus its insurance
activities primarily on the personal automobile market. The Company has
over, 757,000 polices in force throughout the Commonwealth of
Massachusetts. The Company, through Commerce and Citation Insurance
Company ("Citation"), wholly-owned subsidiaries of Commerce Holdings,
Inc. ("CHI") which is a wholly-owned subsidiary of the Company, has been
the largest writer of personal property and casualty insurance in
Massachusetts in terms of market share of direct premiums written since
1990. At year end 1998 and 1997, the Company's Massachusetts private
passenger automobile market share was 21.6% and 21.8%, respectively.
The Company is also one of the leading writers of commercial automobile
insurance in the Commonwealth. During 1998, 98.3% of the Company's
$796,858,000 in direct premiums written were derived from personal
automobile, commercial automobile and homeowners insurance, its three
core lines of business. These lines represented $687,232,000,
$36,299,000 and $59,761,000, or 86.2%, 4.6% and 7.5%, respectively, of
the Company's direct premiums written.
The Company attributes its success primarily to its strong
relationships with professional independent agencies that provide
quality business for the Company. Other factors that have been
important to its success include an in-depth understanding of the
Massachusetts regulatory and underwriting environments, advanced
information systems, an extensive underwriting data base and beginning
in 1995, the ability to compete in an affinity group marketing
environment.
Because the Company offers its product lines only through
independent agencies, its relationships with those agencies are critical
to its continued success. The Company believes that it is the preferred
provider for most of its agencies and that, as a result of such
position, it has gained access to policyholders with average or above-
average underwriting profit characteristics in its personal and
commercial automobile insurance lines. The Company carefully selects
and retains agencies whose premium growth and loss ratio experience meet
the Company's agency criteria, and devotes substantial resources to
fostering and maintaining strong relationships with its existing
agencies. The Company pays its agencies significant compensation in the
form of profit sharing which is based in part on the underwriting
profits of the agency's business written with the Company. In addition,
the Company occasionally sponsors incentive award programs to encourage
agent profitability and growth. (Refer to Part I Item 1C - Marketing
for current program details.)
7
<PAGE>
Based upon agency surveys conducted several times a year, the Company
believes it is attentive to the needs and requirements of its agencies.
The Company emphasizes its commitment to the Massachusetts insurance
market, its responsiveness in servicing claims and its internal support
for agency operations, including direct billing of insureds, direct
claim reporting, on-line inquiry systems for its agents and by providing
competitively priced automobile insurance programs and products.
The Company's focus on automobile and homeowners insurance
primarily in Massachusetts has also been a factor in its success. The
terms, conditions and mandated rates of personal automobile insurance
are subject to extensive regulation. Because the Company has primarily
served the Massachusetts market, it has both an in-depth understanding
of this market and the ability to respond effectively to shifts in the
state's regulatory and underwriting environments. Currently, the
Company is required to accept virtually all automobile insurance
business submitted to it by its agencies. The Company's ability to
underwrite this business profitably, however, depends on its
understanding of the risks in the business as well as its management of
reinsurance through C.A.R.
Beginning in the latter part of 1995, the Company began to
actively pursue affinity group marketing programs. The primary purpose
of affinity group marketing programs is to provide participating groups
with a convenient means of purchasing private passenger automobile
insurance through associations and employee groups. Emphasis is placed
on writing larger affinity groups, although accounts with as few as 25
participants are considered. Affinity groups are eligible for rate
discounts which must be filed annually with the Division of Insurance.
In general, the Company looks for affinity groups with mature/stable
membership, favorable driving records and below average turnover ratios.
Participants who leave the sponsoring group during the term of the
policy are allowed to maintain the policy until expiration. At
expiration, a regular Commerce policy may be issued at the insured's
option.
During the latter part of 1995, Commerce signed affinity group
marketing agreements with the five American Automobile Association Clubs
of Massachusetts ("AAA clubs") offering a 10% discount on private
passenger automobile insurance to the clubs' members who reside in
Massachusetts. In 1997, two AAA clubs were consolidated, therefore
leaving only four clubs. In 1998, primarily as a result of four
consecutive private passenger rate reductions, the Company reduced the
AAA clubs discount from 10% to 6%. In 1999, the same 6% percent AAA
club discount was approved for policies effective as of January 1, 1999.
The AAA clubs discount can be combined with safe driver deviations for
up to a 13.5% reduction from the 1999 state mandated rates. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
43.2% increase in the number of personal automobile exposures written by
Commerce since year-end 1995. As expected, this increase leveled off in
1998 as evidenced by the 1.9% increase in personal automobile exposures
as compared to increases of 8.3% in 1997 and 29.8% in 1996. In 1998,
total direct premiums written attributable to the AAA group business
were $457,430,000 or 57.3% of the Company's total direct premiums
written (68.7% of the Company's total Massachusetts personal automobile
premium), an increase of 8.1% over 1997. Total exposures attributable
to the AAA clubs group business were 547,100 or 67.6% of total
Massachusetts personal automobile exposures in 1998, an increase of
25,002 or 4.8% over 1997. Of the total Massachusetts automobile
exposures written by the Company, approximately 11% were written through
insurance agencies owned by the AAA clubs. The remaining 89% were
written through the Company's network of independent agents.
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members must participate in a
group marketing program within one year. Accordingly, Commerce, in
coordination with the AAA clubs, aggressively pursued AAA members for
the AAA Affinity Group Marketing Program. At December 31, 1996,
Commerce had achieved the objective of writing more than 35% of the AAA
members within the first year, as over 300,000 AAA members joined the
program. The particular portion of the statute, dealing with achieving
the 35% penetration level in one year, was amended by the Massachusetts
Legislature in early 1997 to allow two years to reach the required
penetration level. This requirement has subsequently been waived by the
Massachusetts Legislature for 1998 and 1999. Waiving the penetration
requirements allows insurance companies to continue offering group
discounts without reaching the 35% level. The waiver of penetration
requirements cannot be predicted for years beyond 1999.
Commerce and the AAA clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
8
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Since 1996, the Company has been granted approval to offer its
Massachusetts customers safe driver deviations to drivers with Safe
Driver Insurance Plan ("SDIP") classifications of either Steps 9 or 10.
Safe driver deviations are rate discounts based on the customers driving
record and resulting SDIP classification. Steps 9 and 10 are the two
best driver SDIP classifications in Massachusetts, representing drivers
with no at fault accidents and not more than one minor moving vehicle
violation in the last six years. In January 1999, in response to the
average personal automobile rate decisions over the last several years,
the Company filed for and ultimately received approval to offer SDIP
deviations of 8% for Step 9 and 3% for Step 10 for the 1999 calendar
year. At December 31, 1998, 67.8% of the Company's exposures were
eligible for either Step 9 or Step 10 deviations. For drivers that
qualify, the Company's 1999 affinity group automobile discounts and SDIP
deviations can be combined for up to a 13.5% (Step 9) and 9.8% (Step 10)
reduction from the state mandated rates. This can be compared to the
SDIP deviations of 15% for Step 9 and 4% for Step 10 SDIP
classifications for the 1998 calendar year. For drivers that qualified,
the Company's 1998 group automobile discounts and SDIP deviations could
have been combined for up to a 20.1% (Step 9) and 9.8% (Step 10)
reduction from the state mandated rates.
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 all personal lines policies with effective dates of
January 1, 1998 and beyond. As a result of this change, premium finance
and service fees increased $6,366,000 or 90.0% in 1998. Previously, for
1997 and 1996, the Company had utilized a "late fee" system.
The Company's other than personal automobile products tend to be
derived from its other two core product lines and therefore have had
relatively predictable risk profiles. The Company offers a preferred
risk homeowners product through Citation, which has an alternative
pricing schedule for selected insureds meeting more restrictive
underwriting guidelines. Citation also provides a separate rating tier
for preferred commercial automobile business. Approximately 22.0% of
the voluntary commercial automobile premium produced by its voluntary
agents in 1998 was written by Citation. The Company expects that this
secondary rating tier will continue to assist the Company in retaining
its better commercial automobile accounts, while also further increasing
the percentage of commercial automobile business that can be retained
voluntarily by the Company in 1999 and beyond.
The Company's long-term commitment to providing consistent markets
for Massachusetts independent agencies, coupled with the withdrawal by
several national companies from the Massachusetts personal automobile
market, which occurred during the years 1987 through 1991, has been a
significant factor in enabling the Company to increase and maintain its
market share by contracting with agencies which meet its agency
criteria. The Company believes that Massachusetts agencies are more
likely to seek to develop and expand relationships with domestic
insurers, which, like the Company, have a long-term commitment to the
Massachusetts personal automobile market.
In the past, the Company has devoted substantial time and
resources to the development of its current information systems, which
enhanced both its underwriting and its agency support. Through the use
of several customized software programs, the Company has the ability to
analyze its internal historical underwriting data and use such
information in making, in the Company's belief, more informed
underwriting decisions. In particular, the Company believes that the
amount and extent of detail data accumulated as a result of its share of
the Massachusetts personal automobile market gives the Company a
competitive advantage in determining which automobile risks to reinsure
through C.A.R. The Company's information systems also enable it to
provide extensive support to its agencies. This support includes a
direct billing system, which covers over 97% of the Company's
policyholders, an on-line inquiry system, which allows agencies to
ascertain the status of pending claims and direct bill information and a
system which allows Company agencies to quote premiums for the Company's
three core product lines directly to policyholders.
9
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Internal Software Development Project with PMSC
The Company previously announced that it had entered into an
agreement with, and purchased software known as Series III from, Policy
Management Services Corporation ("PMSC") to allow for development of
internal operating systems to enable the Company to first process
policies in states outside of Massachusetts and eventually to replace
the Company's systems for Massachusetts business. Although the Company
began writing business in Rhode Island in early 1998 on the Series III
system, in early 1999 the Company stopped work on all development. The
Company is currently in the process of negotiating with PMSC as to the
future continuation of the Series III system. Costs to date for this
effort have been approximately $47.0 million, of which $18.4 million is
applicable to 1998. Funds expended to date included the purchase of a
main frame computer, license fees and the costs associated with
programming, implementation and training. The vast majority of these
costs were expensed as incurred.
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. The
Company subsequently initiated the Century Change project to address all
internal/external systems, software, agents, third parties and vendors
in dealing with year 2000 compliance.
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 four sub-categories: Data Exchange, 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 will primarily conclude at the end of the second quarter
1999.
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. This program includes
sending out questionnaires to our major business partners, including our
agents, regarding their year 2000 readiness. Based on the responses
received to date, the Company does not any anticipate any potential
impact on it's operations or financial condition. If there are
instances where the Company ascertains 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. The Company expects that the implementation of
the contingency plans, if necessary, will not have a material adverse
effect on the Company's ability to conduct its business or on its
operating results or financial condition.
The Company's Executive Committee, as well as all departments in
the Company, are 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 scenarios.
Contingency Plans will be discussed and developed, where deemed
appropriate, for all material systems and relationships during the first
half of 1999. At a minimum, contingency plans will be developed for the
continuation of policy and claim processing in the event that the
Company's computer systems are not available due to a year 2000 related
failure.
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The project to date has involved internal staff costs as well as
consulting expenses to prepare the systems for the year 2000. Total
costs to date for the Century Change project have been approximately
$4.9 million ($3.6 million of which relate to 1998). Costs to date
applicable to internal staff and external consulting have been
approximately $1.6 million and $3.3 million, respectively ($1.1 million
and $2.5 million, respectively, relate to 1998). Administration,
programming, testing and implementation of system applications relating
to the Century Change project are expected to cost an additional $1.9
million in 1999.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield
while maintaining investment quality. The Company's investment
objective is to maintain high quality diversified investments structured
to maximize after-tax investment income while minimizing risk. The
Company's funds are generally invested in securities with maturities
intended to provide adequate funds to pay claims and meet other
operating needs without the forced sale of investments. Periodically
sales have been made from the Company's fixed maturity portfolio to
actively manage portfolio risks, including credit-related concerns, to
optimize tax planning and to realize gains. This practice will continue
in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of
risk assumed by the Company is a function of the Company's overall
objectives, liquidity needs and market volatility.
The Company manages its overall market risk by focusing on higher
quality equity and fixed income investments, by continuously reviewing
the credit strength of all companies in which investments are made, by
limiting exposure in any one investment and by monitoring the quality of
the investment portfolio by taking into account credit ratings assigned
by recognized rating organizations.
As part of its investing activities, the Company assumes positions
in fixed maturity, equity, short-term and cash equivalents markets.
The Company is, therefore, exposed to the impacts of interest rate
changes in the market value of investments. For 1998, the Company's
exposure to interest rate changes and equity price risk has been
estimated using sensitivity analysis. The interest rate impact is
defined as the effect of a hypothetical interest rate change of plus-or-
minus 200 basis points on the market value of fixed maturities and
preferred stocks. The equity price risk is defined as a hypothetical
change of plus-or-minus 10% in the fair value of common stocks. Changes
in interest rates would result in unrealized gains or losses in the
market value of the fixed maturity and preferred stock portfolio due to
differences between current market rates and the stated rates for these
investments. Based on the results of the sensitivity analysis at
December 31, 1998, the Company's estimated market exposure for a 200
basis point increase (decrease) in interest rates was calculated. A 200
basis point increase results in a $42,665 decrease in the market value
of the fixed maturities and preferred stocks. A 200 basis point
decrease results in a $46,732 increase in the market value of the same
securities. The equity price risk at December 31, 1998, based upon a
10% increase in the fair value of common stocks would increase $28,396.
Based upon a 10% decrease, common stocks would decrease $28,396.
A. General
Insurance Lines
Commerce and Citation, the Company's Massachusetts property and
casualty insurance subsidiaries, currently have a combined Best's rating
of A (Excellent). Commerce West, the Company's California property and
casualty subsidiary, currently has a Best's rating of A- (Excellent).
The Company's new acquisition ACIC currently has a Best's rating of A
(Excellent). According to Best's, an insurer with an Excellent rating
has demonstrated, in Best's opinion, excellent overall performance when
compared to standards developed by Best's.
11
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Direct premiums written totalled approximately $796,858,000 in
1998, of which motor vehicle insurance accounted for approximately
$723,531,000, homeowners insurance accounted for approximately
$59,761,000 and commercial multi-peril insurance accounted for
approximately $8,216,000. During 1997, direct premiums written totalled
approximately $768,649,000, of which motor vehicle insurance accounted
for approximately $698,149,000, homeowners insurance accounted for
approximately $56,681,000 and commercial multi-peril insurance accounted
for approximately $8,726,000. Earned premiums are included in total
revenues of the Company and represent the net earned premiums remaining
after assumed and ceded reinsurance. In 1998 and 1997, total revenues
included insurance premiums earned of approximately $745,620,000 and
$730,497,000, respectively. Motor vehicle insurance accounted for
approximately 96.1% and 94.6%, homeowners insurance accounted for
approximately 3.1% and 4.2% and commercial multi-peril insurance
accounted for approximately 0.5% and 0.9% of total earned premiums, in
1998 and 1997, respectively.
The Company's principal insurance line is personal automobile
insurance. The Company offers automobile policyholders the following
types of coverage: bodily injury liability coverage, including
underinsured and uninsured motorist coverage, property damage liability
coverage and physical damage coverage, including fire, theft and other
hazards specified in the policy. Policies are usually written for one-
year terms. The Company's published liability limits are $500,000 per
person for bodily injury, $1,000,000 per accident and $100,000 for
property damage. Liability limits of $100,000 per person injured,
$300,000 per accident and $100,000 for property damage are the limits
most commonly purchased from the Company.
Personal automobile insurance is subject to extensive regulation.
Marketing and underwriting strategies for companies operating in
Massachusetts continue to be dominated by automobile premium rates and
commission levels which are mandated by the Massachusetts Division of
Insurance and by current and prospective legislation affecting the
industry. Automobile premium rates in Massachusetts are among the
highest in the nation as a direct result of high costs incurred by
companies which provide this type of protection. Claims, the costs
associated with the processing and settling of claims, assessments
required to subsidize the involuntary market mechanism, accident rates,
bodily injury claims and medical care costs remain among the highest in
the nation. Additionally, traffic density, as defined by vehicle miles
divided by highway miles, is among the highest in the nation.
During the three-year period from 1996 to 1998, Massachusetts
personal automobile insurance premium rates decreased an average of 4.9%
per year. The Commissioner approved an average 0.7% increase in
personal automobile premiums for 1999, the first increase since 1994.
Average mandated rates decreased by 4.0%, 6.2% and 4.5% in 1998, 1997
and 1996, respectively. Coinciding with the 1999 rate increase, the
Commissioner also approved a 1.0% increase in commission rates to agents
selling private passenger automobile insurance for 1999. The decision
slightly offsets the financial impact of the average 0.7% increase in
personal automobile premiums for 1999.
Although average mandated personal automobile premium rates
decreased 4.0% in 1998, the impact upon the Company resulted in a 2.6%
increase in the average personal automobile premium per exposure. The
2.6% increase for the Company was due to the facts that the rate
decision did not anticipate purchases of new automobiles in the year to
which the rate decision applied and, secondly, the Company's mix of
personal automobile business differs from that of the industry.
The 1997, 1998 and 1999 average rate decisions were partially
driven by corrections for an industry error that had impacted prior year
rate decisions. The industry error resulted from a miscalculation of
industry expense allowances that had the effect of overstating rates for
1991 through 1996. Mandated rates for 1997, 1998 and 1999 include an
adjustment to recoup $176 million from the industry. The adjustment
included in the rate decision to recoup the error was phased in at 40%,
40% and 20% in 1997, 1998 and 1999.
The estimated earned premium impact of the above item was
approximately $15.3 million for 1997, $23.9 million for 1998 and is
expected to be approximately $14.0 million for 1999. The earnings per
share after-tax impact resulting from lower earned premiums has been
estimated at $0.28 for 1997, $0.43 for 1998, and is estimated to be
$0.24 for 1999. If the Company's 1999 market share increases
(decreases), a larger (smaller) financial impact will result.
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<PAGE>
Also factored into the 1999 rate decision were two sanctions
levied by the Commissioner against the Massachusetts personal automobile
insurance industry. One fine, amounting to $6 million, was imposed as a
result of the industry's alleged failure to show that it adhered to
adequate cost containment efforts as identified by the Commissioner. A
second fine of $3 million was allegedly the result of what the
Commissioner termed "incomplete compliance" on the part of the
Automobile Insurers Bureau of Massachusetts ("AIB") with a discovery
order concerning disclosure of certain information as identified by the
Commissioner. The industry and several insurance carriers, including
Commerce, are appealing one or both of the sanctions.
In August 1998, then Acting Massachusetts Governor, Paul Cellucci
("Governor"), signed legislation granting Massachusetts-based insurers,
that choose to participate, $48 million a year in total tax relief in
exchange for a, total industry wide, $200 million investment commitment
to low income communities over a five-year period. The legislation
amounts to a gradual elimination of the 1.0% gross investment tax for
those insurers choosing to commit funds to these community investments.
The legislation effectively taxes Massachusetts based insurers at rates
levied equal with out-of-state insurers. Prior to the legislation,
Massachusetts was the only state in the nation to tax domestic insurers
at higher rates than charged to non-domestic insurers. If the overall
$200 million goal is attained, all domestic insurers will benefit from
the lower tax rate. The Company is currently analyzing the potential
benefits of participating in this program.
The Company also offers homeowners insurance in Massachusetts,
including a very limited amount of policies in designated coastal areas.
The Company's standard homeowners policy is an all risk, replacement
cost insurance policy covering a dwelling and the contents contained
therein. The Company's published limits of liability for property
damage to a dwelling are a minimum coverage of $60,000 and a maximum
coverage of $600,000, although some policies over this amount are
written on an exception basis. For personal liability, the minimum
coverage is $100,000 and the maximum coverage is $1,000,000. The
average dwelling coverage amount per policy is approximately $150,000,
and generally, the average amount of contents coverage is 70% of the
amount of coverage for the dwelling, with limitations on the amount of
coverage per item placed on securities, cash, jewelry, furs, silverware
and firearms. However, additional coverage for such items can be
purchased on a scheduled personal property basis. The Company also
offers $1,000,000, $2,000,000 and $3,000,000 personal liability umbrella
coverage for homeowners policies requiring certain specified
underwriting coverages which are reinsured through American Reinsurance
Corporation.
The Company offers a preferred homeowners product through Citation
which has higher policy limits and a lower premium structure and is
designed primarily for homes with above-average market values. The
Company also applies more stringent underwriting criteria by, among
other things, limiting the product to homes with modern electrical
systems.
The Company also offers inland marine, fire, general liability and
commercial multi-peril insurance.
Mortgage Operations
Insurance companies are authorized to invest in mortgages and the
Company formed Bay Finance Company, Inc. ("Bay Finance") to originate
and service residential and commercial mortgages in Massachusetts and
Connecticut. During fiscal 1998, 1997 and 1996 the mortgage operations
accounted for approximately $5,049,000, or 0.6%, $4,448,000, or 0.5% and
$4,249,000, or 0.6% of the Company's consolidated total revenues,
respectively.
Insurance Agency
Clark-Prout Insurance Agency, Inc. ("Clark-Prout") is a wholly-
owned insurance agency that writes both for the Company and for other
insurance companies. During fiscal 1998, 1997 and 1996, Clark-Prout's
revenues amounted to $785,000, or 0.1%, $840,000, or 0.1% and $930,000,
or 0.1% of the Company's consolidated total revenues, respectively. The
decrease in Clark-Prout's revenue is due to a change in how its
customers are billed.
Segment Information
The information in Note M in the Company's 1998 Annual Report is
incorporated herein by reference.
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B. Commonwealth Automobile Reinsurers
A significant aspect of the Company's automobile insurance
business relates to its interaction with C.A.R. C.A.R. is a state-
mandated reinsurance mechanism, which enables the Company and
approximately 45 other writers of automobile insurance in Massachusetts
("Servicing Carriers") to reinsure any undesirable automobile risk.
Servicing Carriers, which are responsible for over 99.0% of total
direct premiums written for personal automobile insurance in
Massachusetts, are required to offer automobile insurance coverage to
all eligible applicants pursuant to "take-all-comers" regulations, but
may reinsure undesirable business with C.A.R. In addition, Servicing
Carriers are obligated to accept involuntary agencies, known as ERPs,
from C.A.R. and to provide an automobile insurance market in
Massachusetts for those agencies.
C.A.R. maintains separate pools for liability and physical damage
coverage in personal and commercial automobile risks. All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines,
whether or not they are Servicing Carriers. Since its inception,
C.A.R. has annually generated multi-million dollar underwriting losses
in both the personal and commercial pools. Accordingly, each
automobile insurer attempts to develop and implement underwriting
strategies that will minimize its relative share of the C.A.R. deficit
while maintaining acceptable loss ratios on risks not reinsured through
C.A.R.
In general, the C.A.R. reinsurance mechanism operates as follows.
Within established time frames, a Servicing Carrier must identify which
policies it wishes to retain and which policies it wishes to cede to
C.A.R. A Servicing Carrier pays to C.A.R. all of the premiums
generated by the policies it has ceded and also reimburses C.A.R. for
the reduced premium resulting from affinity group marketing discounts.
C.A.R. reimburses Servicing Carriers for all losses incurred on account
of ceded policies, although, as with reinsurance generally, reinsurance
of a policy through C.A.R. does not legally discharge the Servicing
Carrier from its liability to the policyholder for the full amount of
the policy. In addition, Servicing Carriers also receive fees for
servicing ceded policies based upon the expense structure established
by C.A.R.
An insurer's proportionate share of the C.A.R. deficit is
allocated on the basis of a formula called a participation ratio, which
can vary significantly between the personal and commercial pools, and
between different policy years. Under current regulations, an
insurer's share of the C.A.R. deficit is based upon its market share
for retained automobile risks for the particular pool, adjusted by a
utilization formula, such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
reinsurance exceeds that of the Massachusetts industry and favorably
affected if its relative use of C.A.R. reinsurance is less than that of
the Massachusetts industry. At year end 1998 and 1997, the Company's
Massachusetts private passenger automobile market share was 21.6% and
21.8%, respectively. The current formula also contains a provision
whereby certain high risk business, if reinsured through C.A.R., is
excluded in determining an insurer's participation ratio. Finally, for
the personal automobile C.A.R. pool, an insurer's participation ratio
may be affected by credits received for not reinsuring through C.A.R.
automobile risks in selected underpriced classes and territories. An
insurer's participation ratio will be favorably affected if its
relative use of credits exceeds the Massachusetts industry's.
The Company's objective is to develop and implement underwriting
strategies to obtain the optimum balance between its C.A.R.
participation ratio and the loss ratios on automobile risks not
reinsured through C.A.R. For each automobile risk, the Company makes a
judgment as to whether the projected impact on the Company's
profitability from retaining the risk outweighs the incremental cost of
reinsuring the risk through C.A.R. In determining the incremental cost
of reinsuring a risk through C.A.R., the Company estimates its
participation ratio for a given period by modeling the anticipated
Massachusetts industry-wide C.A.R. trends. Once the Company estimates
its participation ratio, it is then able to compare the incremental
effect on the Company's share of the C.A.R. deficit of either
reinsuring or retaining the particular automobile risks. Finally, the
Company utilizes its internal underwriting database and internally-
developed actuarial reporting and analysis systems to develop for each
risk a projected underwriting loss ratio. It then compares the impact
of the automobile risk on the Company's participation ratio in order to
estimate whether, after taking all C.A.R. and other factors into
account, the Company's profitability will be enhanced by reinsuring or
retaining such risk. The Company believes that, because of its leading
share of the Massachusetts automobile insurance market, it can utilize
statistically credible data for a greater array of underwriting factors
than its competitors, which in turn gives it a competitive advantage in
deciding which automobile risks to reinsure through C.A.R.
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<PAGE>
The C.A.R. utilization-based participation ratio has been in place
since 1993, and individual companies in the marketplace make minor
yearly changes to find the optimum balance between voluntary and ceded
writings. In 1998, the Company ceded approximately $63,268,000 or
approximately 8.2% of the Company's Massachusetts personal automobile
direct premiums written, which was approximately the same as in 1997.
The Company's strategy has been to voluntarily retain more of the types
of personal automobile business that are factored as credits favorably
impacting the utilization formula. As a result of the credits impacting
the utilization formula, the Company estimates its personal automobile
participation ratio in C.A.R. to be approximately 16.7% at December 31,
1998. This ratio is several percentage points below the Company's
estimated 21.6% share of the Massachusetts personal automobile market.
Significant changes in the industry-wide private passenger cession
percentage are not expected for 1999.
Although commercial automobile insurance is a relatively smaller
portion of the Company's total insurance writings, the related
commercial automobile risk selection decisions remain an important
element in determining profitability. In 1998, the Company ceded
approximately $7,167,000 or 24.1% of the Company's Massachusetts
commercial automobile direct premiums written, a decrease of $1,348,000
or 15.8% from 1997.
C.A.R. rule changes occur, as C.A.R. adjusts the operations of the
personal and commercial reinsurance mechanisms to address the needs of
the Massachusetts automobile insurance market. Any material change to
the C.A.R. rules in the future will affect the Company. The Company is
not currently aware of any likely future rule changes that could have a
material impact on the Company, but there can be no assurance that such
rule changes will not occur.
C. Marketing
The Company markets its insurance products through a network of
licensed independent agencies, 534 throughout Massachusetts (of which
142 are ERPs), 219 in California and an additional 38 as a result of the
recent acquisition of ACIC. These independent agencies may also
represent other insurance companies, some of which may compete directly
with the Company. The independent insurance agencies are under contract
with the Company's subsidiaries and must conduct their business
according to the provisions of their contract. Contracts for
Massachusetts agencies may be terminated by the Company upon 180 days'
notice to the agency or at will by the agency.
The Company seeks to establish long-term relationships with
agencies that can generate a sizable volume of business with profitable
underwriting characteristics and for which the Company will be among the
top two or three preferred writers of its core products. The Company
also assesses whether the mix of a prospective agency's business will
expand the Company's presence in one or more of its core product lines.
In 1998, each agency representing the Company in Massachusetts produced
an average of approximately $1,422,000 of Company direct premiums
written or a 6.5% increase as compared to 1997. Also in Massachusetts
during 1998, 193 agencies produced in excess of $1.0 million of direct
premiums written, an additional 53 agencies produced over $2.0 million,
an additional 25 agencies produced over $3.0 million and lastly, an
additional 12 agencies produced over $4.0 million. The Company's three
largest agencies produced approximately $46.5, $13.9 and $9.4 million of
the Company's direct premiums written, respectively, or approximately
5.8%, 1.7% and 1.2% in 1998. Total direct premiums written attributable
to the AAA group business were $457,230,000 or 57.3% of the Company's
total direct premiums written. Total exposures attributable to the AAA
clubs group business were 547,100 or 67.6% of total personal automobile
exposures in 1998, an increase of 25,002 or 4.8% over 1997. Of this
amount, 11% was written through insurance agencies owned by the AAA
clubs and 89% was written by the Company's network of independent
agents.
Once appointed, each agency's performance is carefully monitored.
An Agency Evaluation Committee, comprised of representatives of the
Company's Marketing, Underwriting and Premium Accounting departments,
utilizes a host of pre-established criterion (loss ratio, premium
volume, etc.) to continuously evaluate agencies. Generally, the Company
will counsel an agency on how to improve its underwriting and
profitability before any agency will be terminated.
15
<PAGE>
Company agencies receive commissions on policies written for the
Company and are eligible to receive contingent commissions through a
profit sharing arrangement. The Commissioner annually establishes a
minimum average direct commission for personal automobile insurance,
which in 1998 was 12.9%. With respect to policies reinsured through
C.A.R., the maximum amount of commissions that C.A.R. will reimburse the
Company is fixed at that prescribed rate. Consequently, there is an
incentive for insurers not to permit their direct commission rate to
vary materially from the prescribed rate. The Company's contingent
commissions are tied to the underwriting profit on policies written by
an agency based upon a rolling three year experience methodology. The
Company generally pays up to 45% of the underwriting profit attributable
to the agency's business. The profit sharing plan is a three year
rolling plan, with one third of the current and two prior years profit
years profit or loss, summed to a single payment. This amount, if
positive, is multiplied by the profit sharing commission rate and paid
to the agent. To qualify for profit sharing, a three-year average loss
ratio of 50% to 55% or better is generally required. CAR credits for
voluntary business written in urban area or credits for writing youthful
operators on a voluntary basis increase the loss ratio eligibility for
profit sharing up to 55% from 50%. Books of business with no available
credits must achieve a lower loss ratio. In 1998, total commission
expensed by the Company to its agencies amounted to 16.8% of direct
premiums written, of which direct commissions and contingent commissions
constituted 14.3% and 2.5%, respectively versus total commission
expensed of 14.6%, of which 14.3% were direct and 0.3% were contingent
in 1997. Direct commissions are higher than the personal automobile
rates primarily due to higher commission rates on other lines of
business. In September 1996, the Company announced a reduction to 20%,
from a maximum of 25%, for the commission paid on homeowner insurance.
This reduction is for policies effective March 1, 1997 and subsequent.
In 1998, the Company's expense for contingent commissions was $20.0
million versus $2.2 million in 1997.
The Company also occasionally sponsors incentive award programs to
encourage and reward agency profitability and growth. The last such
program occurred during 1996 with trips taking place during the first
few months of 1997. This program resulted in 315 agents earning
incentives at a total cost of approximately $4.3 million. Much of the
success of these programs was attributable to group marketing programs.
In 1998, the Company initiated the T2000 Sales Incentive Contest. One
part of the contest will conclude on December 31, 1999, the other will
conclude on May 31, 2000 with agents earning incentive trips taking
place in 2000. The estimated total cost is approximately $1.8 million
of which approximately $678,000 was expensed in 1998.
The Company's information systems enable it to provide extensive
support to its agencies. This support includes a direct billing system,
which covers over 97% of the Company's policyholders, an on-line inquiry
system which allows agents to ascertain quickly the status of pending
claims or direct bill information and a system which allows Company
agents to quote many premiums directly to policyholders. The Company
also emphasizes its commitment to enhancing and expanding the role of
its information systems. The Company has provided agencies with the
ability to generate personal automobile policies from their own offices
and continuously explores new options on an ongoing basis.
The Company believes that because of its compensation arrangements
and by providing a consistent market with emphasis on service, an
increasing number of the Company's agencies will rely on it as their
principal supplier of insurance products. The Company believes that it
is the preferred provider for most of its agencies. Although the
Company believes, based on annual surveys of its agencies, that its
relationships with its independent agencies are excellent, any
disruption in these relationships could adversely affect the Company's
business.
During the latter part of 1995, Commerce signed affinity group
marketing agreements with the five American Automobile Association Clubs
of Massachusetts ("AAA clubs") offering a 10% discount on private
passenger automobile insurance to the clubs' members who reside in
Massachusetts. In 1997, two AAA clubs were consolidated, therefore
leaving only four clubs. In 1998, primarily as a result of four
consecutive private passenger rate reductions, the Company reduced the
AAA clubs discount from 10% to 6%. In 1999, the same 6% percent AAA
club discount was approved for policies effective as of January 1, 1999.
The AAA clubs discount can be combined with safe driver deviations for
up to a 13.5% reduction of the state mandated rates. Membership in
these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
43.2% increase in the number of personal automobile exposures written by
Commerce since year-end 1995. As expected, this increase leveled off in
1998 as evidenced by the 1.9% increase in personal automobile exposures
as compared to increases of 8.3% in 1997 and 29.8% in 1996. In 1998,
total direct premiums written attributable to the AAA group business
were $457,430,000 or 57.3% of the Company's total direct premiums
written (68.7% of the Company's total Massachusetts personal automobile
premium), an increase of 8.1% over 1997.
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<PAGE>
Total exposures attributable to the AAA clubs group business were
547,100 or 67.6% of total Massachusetts personal automobile exposures in
1998, an increase of 25,002 or 4.8% over 1997. Of the total
Massachusetts automobile exposures written by the Company approximately
11% were written through insurance agencies owned by the AAA clubs. The
remaining 89% were written through the Company's network of independent
agents.
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members must participate in a
group marketing program within one year. Accordingly, Commerce, in
coordination with the AAA clubs, aggressively pursued AAA members for
the AAA Group Marketing Program. At December 31, 1996, Commerce had
achieved the objective of writing more than 35% of the AAA members
within the first year, as over 300,000 AAA members joined the program.
The particular portion of the statute, dealing with achieving the 35%
penetration level in one year, was amended by the Massachusetts
Legislature in early 1997 to allow two years to reach the required
penetration level. This requirement has subsequently been waived by the
Massachusetts Legislature for 1998 and 1999. Waiving the penetration
requirements allows insurance companies to continue offering group
discounts without reaching the 35% level. The waiver of penetration
requirement cannot be predicted for years beyond 1999.
Commerce and the AAA clubs have agreed that Commerce shall be its
exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
Since 1996, the Company has been granted approval to offer its
Massachusetts customers safe driver deviations to drivers with Safe
Driver Insurance Plan ("SDIP") classifications of either Steps 9 or 10.
Safe driver deviations are rate discounts based on the customers driving
record and resulting SDIP classification. Steps 9 and 10 are the two
best driver SDIP classifications in Massachusetts, representing drivers
with no at fault accidents and not more than one minor moving vehicle
violation in the last six years. In January 1999, in response to the
average personal automobile rate decisions over the last several years,
the Company filed for and ultimately received approval to offer SDIP
deviations of 8% for Step 9 and 3% for Step 10 for the 1999 calendar
year. At December 31, 1998, 68.7% of the Company's exposures were
eligible for either Step 9 or Step 10 deviations. For drivers that
qualify, the Company's 1999 affinity group automobile discounts and SDIP
deviations can be combined for up to a 13.5% (Step 9) and 9.8% (Step 10)
reduction from the state mandated rates. This can be compared to the
SDIP deviations of 15% for Step 9 and 4% for Step 10 SDIP
classifications for the 1998 calendar year. For drivers that qualified,
the Company's 1998 affinity group automobile discounts and SDIP
deviations could be combined for up to a 20.1% (Step 9) and 9.8% (Step
10) reduction from the state mandated rates.
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 all personal lines automobile policies with effective
dates of January 1, 1998 and beyond. As a result of this change,
premium finance and service fees increased $6,366,000 or 90.0% in 1998.
Previously, for 1997 and 1996, the Company had utilized a "late fee"
system.
D. Underwriting
The Company seeks to achieve an underwriting profit, as measured
by a statutory combined ratio of less than 100%, in each of its three
core product lines in both hard and soft markets. The strategy is
designed to achieve consistent profitability with substantial growth in
net premiums written during hard markets and more modest growth during
soft markets. All of the Company's policies have been written on a
"claims incurred basis," meaning that the Company covers claims based on
occurrences that take place during the policy period.
Agencies are authorized to bind the Company on risks as limited by
the Company's written underwriting rules and practices, which set forth
eligibility rules for various policies and coverages, unacceptable
risks, and maximum and minimum limits of liability. With respect to
non-automobile policies, other than umbrella policies, the Company's
agencies have the ability to bind the Company for a limited period,
typically 60 days, during which time the Company reviews all risks to
determine whether it will accept or reject the policy. During this
review period, the Company is obligated to pay any claim which would be
covered under the policy. Violation of the Company's underwriting rules
and practices is grounds for termination of the agency's contract with
the Company.
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The Company and each of the approximately 45 other Servicing
Carriers must write all automobile risks submitted to them.
Massachusetts personal automobile insurance rates are fixed annually by
the Commissioner. All companies writing personal automobile policies
are required to use such mandated rates, unless they have received prior
approval from the Commissioner to offer a lower rate. The actual
premium paid by a particular policyholder, however, is adjusted, either
up or down, based upon the SDIP record of the insured operator. Moving
violations and accidents for which the insured was at fault within the
most recent six year period are used to determine each operator's SDIP
surcharge or credit. The competitive nature of the Massachusetts
personal automobile insurance market which began in 1995 continued
through 1998 and into 1999.
Prices for Massachusetts commercial automobile insurance policies
that are not reinsured through C.A.R. are set competitively subject to
the Commissioner's authority to disapprove such prices. The rate for
commercial automobile risks reinsured through C.A.R. is mandated by the
Commissioner, except for private passenger type non-fleet business. The
Company's rates for other product lines, including homeowners and
commercial lines of general liability and property insurance, are based
in part on loss cost data from the Insurance Services Office ("ISO"),
which is an industry bureau providing policy forms and rate making data,
and in part, on the Company's own experience and industry price levels.
The Company is not obligated by statute to accept every homeowners
risk submitted to it. Accordingly, risks meeting the Company's
underwriting guidelines are accepted, and all other risks are declined
or not renewed. The Company has established an independent rate level
for its homeowners product line, based on its own loss experience and
recognizing the price levels available in the competitive marketplace.
The Company uses ISO policy forms and has added special coverage
features to meet its product needs. Rates and forms are filed with the
Commissioner.
Under Massachusetts law, residential property owners are strictly
liable for damages caused by lead poisoning in children under age six
residing in the premises, unless the property owner has a Letter of
Compliance or a Letter of Interim Control (i.e. has taken or is taking
specific measures to prevent lead poisoning). The Company has reduced
its exposure to lead poisoning by (i) excluding from coverage all intra-
familial claims for bodily injury or medical expenses brought by minors
living in an insured's household, (ii) revising its underwriting
standards for new and renewal business to avoid insuring properties with
lead poisoning hazards and (iii) excluding from homeowners and dwelling
fire liability coverage all lead poisoning perils to children under the
age of six on policies for properties built prior to 1978 that contain
rental units and where strict liability for lead poisoning would
otherwise apply. Effective on March 1, 1998 a similar exclusion was
added to the Business Owners Program. With regard to the exclusion
described in (iii), policy holders may buy a reinstatement of the
excluded coverage through a policy endorsement for an additional
premium, but very few such endorsements have been written. As a result
of these remedial steps and its historical claims experience, the
Company does not believe that its exposure to lead poisoning claims is
material.
The Company believes that its information systems give it a
competitive advantage in making underwriting decisions, particularly in
deciding which personal automobile risks should be reinsured through
C.A.R. Utilizing data the Company accumulates as a result of its major
market presence in the Massachusetts personal automobile line, the
Company believes that its information systems allow it to make informed
risk assessments and to respond effectively to shifts in the automobile
insurance markets and regulatory environment.
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. This objective
has been exemplified by the 1995 acquisition of Commerce West, a
personal automobile insurer, located in Pleasanton, California and, most
recently, in January 1999, by the acquisition of ACIC, located in
Columbus, Ohio.
18
<PAGE>
ACIC writes personal automobile and homeowners insurance solely
through 38 independent agents affiliated with AAA automobile clubs.
Commerce and AAA SNE intend that ACIC will retain its management team
and staff and continue to have its principle office in Columbus, Ohio.
Commerce, a subsidiary of the Company, invested $90.8 million in
the joint venture (ACIC Holding Co., Inc.) to fund the ACIC acquisition
and to capitalize the joint venture that is owned together with AAA SNE.
Of this $90.8 million, Commerce invested $90 million in the form of
preferred stock and an additional $800 representing its 80% common stock
ownership. The terms of the preferred stock call for quarterly cash
dividends at the rate of 10% per annum. AAA SNE invested $200
representing its 20% common stock ownership. Commerce intends to
consolidate ACIC Holdings Co., Inc. and its wholly-owned subsidiary ACIC
for financial reporting purposes. Since 1995, Commerce has maintained
an affinity group marketing relationship with AAA Insurance Agency,
Inc., a subsidiary of AAA SNE. AAA Insurance Agency, Inc. has been an
agent of Commerce since 1985.
E. Reinsurance
In addition to participating in C.A.R., the Company reinsures with
other insurance companies on a claims incurred basis, a portion of its
potential liability under the policies it has written, protecting itself
against severe loss under individual policies, or catastrophic
occurrences where a number of claims can produce an extraordinary
aggregate loss. Reinsurance does not legally discharge the Company from
its primary liability to the insured for the full amount of the
policies, but it does make the reinsurer liable to the Company to the
extent of the reinsured portion of any loss ultimately suffered. The
Company seeks to utilize reinsurers which it considers adequately
capitalized and financially able to meet their respective obligations
under reinsurance agreements with the Company. The Company utilizes a
variety of reinsurance mechanisms to protect itself against loss as
described below.
Property and Catastrophe Reinsurance
From September 30, 1995 through June 30, 1998, the Company had a
combined property quota share and excess loss reinsurance contract which
was written with six reinsurance companies. Under the quota share
portion of the arrangement, the reinsurers indemnified the Company for
45% of the loss and LAE, and paid a commission allowance based on the
ratio of losses incurred to premiums earned. In exchange, the Company
paid to the reinsurers 49% of the net premium pertaining to the related
business. The maximum per occurrence loss reimbursement was $50.0
million and the maximum annual aggregate occurrence loss reimbursement
was $75.0 million. Under the excess loss reinsurance portion of the
arrangement, the Company reinsured each risk, retaining $125,000 and
reinsuring 100% of the next $875,000.
Various catastrophe only reinsurance programs were utilized from
1996 through May, 1998 in conjunction with the quota share and excess
loss program noted above.
Effective July 1, 1998, the Company expanded the quota share
portion of the program. A 75% quota-share reinsurance program was
incepted, covering all non-automobile property and liability business,
except umbrella policies. The excess loss portion of the program was
reduced on July 1, 1998 and completely eliminated on September 30, 1998.
The expanded program is split between Employers Reinsurance Corporation,
American Re-Insurance Company, Nationwide Mutual Insurance Company and
Swiss Reinsurance America Corporation. The maximum per occurrence loss
reimbursement is the higher of 350% of premium ceded under the program
or $175.9 million. The maximum annual aggregate occurrence loss
reimbursement is the higher of 450% of premium ceded under the program
or $226.1 million. A sliding scale commission, based on loss ratio, is
utilized under this program. This program provides the Company with
sufficient protection for catastrophe coverage so as to enable the
Company to forego pure catastrophe reinsurance coverage, which was
previously tailored in conjunction with the former quota share
arrangement.
19
<PAGE>
The table below provides information depicting the approximate
recovery under the expanded quota share contract at various loss
scenarios, if a single catastrophe were to strike (in thousands):
<TABLE>
<CAPTION>
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
<S> <C> <C>
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 175,875 74,125
</TABLE>
Under the above scenario, the Company has no reinsurance
recoveries for a single event catastrophe in excess of a total loss of
approximately $234.5 million. The Company's estimated total loss on its
other than automobile business for 100 and 250 year storms is $108.6
million and $184.2 million, respectively. The Company estimates were
derived through the services of Swiss Reinsurance America Corporation
who utilized the CLASIC model provided by Applied Insurance Research.
Written premiums ceded in 1998, 1997 and 1996 under the above mentioned
programs were $54.0 million, $27.5 million and $26.6 million,
respectively. Ceding commission income is calculated on a ceded earned
premium basis.
Casualty Reinsurance
Through December 31, 1996, casualty reinsurance was on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$4.0 million over a net retention of $1.0 million. Effective January 1,
1997, casualty reinsurance is on an excess of loss basis for any one
event or occurrence with a maximum recovery of $9.0 million over a net
retention of $1.0 million. This coverage is placed with Swiss
Reinsurance America Corporation (rated A+ by A.M. Best).
Effective January 1, 1995, personal and commercial liability
umbrella policies are reinsured on a 95% quota share basis in regard to
limits up to $1.0 million and 100% quota share basis for limits in
excess of $1.0 million but not exceeding $5.0 million for policies with
underlying automobile coverage of $250,000/$500,000 or more. Effective
January 1, 1996, the Company added personal liability umbrella
reinsurance coverage for policies with underlying automobile coverage of
$100,000/$300,000 on a 65% quota share basis in regard to limits up to
$1.0 million and 100% quota share basis for limits in excess of $1.0
million but not exceeding $3.0 million. These coverages are placed with
American Re-Insurance Company (rated A+ by A.M. Best).
The Company believes that the terms of its reinsurance contracts
are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limits, retentions,
arbitration and occurrence. Based on its review of its reinsurers'
financial statements and their reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially
sound. The Company had no amount of reinsurance receivables more than
90 days past due at December 31, 1998.
F. Settlement of Claims
Claims under insurance policies written by the Company are
investigated and settled primarily by claims adjusters employed by the
Company. The Company employs a staff of 715 people at its claims
department, located in Webster, Massachusetts. In addition to these
individuals, the Company utilizes the services of approximately 31
independent appraisal firms and 9 independent property adjusting
companies who are strategically located throughout the state. The
Company also has a special unit which investigates suspected insurance
fraud and abuse. If a claim or loss cannot be settled and results in
litigation, the Company retains outside counsel to represent it.
20
<PAGE>
The Company believes that through its claims staff of experienced
adjusters, appraisers, managers, and administrative staff, it has higher
customer satisfaction than many of its competitors. All claims office
staff members work closely with agents, insureds and claimants with a
goal of settling claims fairly, rapidly and cost effectively.
Certain of the Company's Massachusetts agencies have settlement
authority for claims for other than automobile property losses which are
less than $2,500. The settlement authority of agencies under automobile
policies is limited to claims for towing.
The Massachusetts Unfair Claims Settlement Practices Act ("Chapter
176D") prohibits insurers from engaging in certain claim settlement
practices, including failing to acknowledge and act reasonably promptly
upon communications with respect to claims arising under insurance
policies, refusing to pay claims without conducting a reasonable
investigation based upon all available information, failing to
effectuate prompt, fair and equitable settlements of claims in which
liability has become reasonably clear, and compelling insureds to
institute litigation to recover amounts due under an insurance policy by
offering substantially less than the amounts ultimately recovered in
actions brought by such insureds. An insurer's violation of any of
these obligations expressly violates the Massachusetts Consumer
Protection Act ("Chapter 93A"). Any party, including claimants and
insureds, whose rights are affected by an insurer's violation of Chapter
176D, is entitled to bring a claim against the insurer under Chapter
93A.
The damages available under Chapter 93A may not necessarily be
related to the harm caused by the insurer's violation of Chapter 176D.
Chapter 93A provides in effect that the party bringing the Chapter 93A
claim will be entitled, at a minimum, to the amount of the judgment on
all claims arising out of the same underlying occurrence, regardless of
the limits of the policy issued by insurer. Moreover, Chapter 93A
permits the court to double or triple the party's damages if the
insurer's violation of Chapter 176D was willful or knowing. If the
underlying policy risk was ceded to C.A.R., the Company may seek
reimbursement from C.A.R. for the damages it will be obligated to pay if
it is found liable under Chapter 93A or amounts paid in settlement of
such claim. Such reimbursement is discretionary and C.A.R. may not
reimburse an insurer if C.A.R. determines that the insurer was negligent
in the handling of such claim and such negligence was the cause of
Chapter 93A liability. Additionally, certain time notification
restrictions apply to these judgments, which if not met, could preclude
an insurer from seeking reimbursement from C.A.R. Accordingly, there
can be no assurance that the Company will be reimbursed by C.A.R. in any
particular instance involving a Chapter 93A claim.
Since 1996, the Company has been expanding a twenty-four (24) hour
claim reporting service to third-party claimants and insureds of
interested agencies. This service allows customers to report their
first notice of a loss at anytime of the night or day; 365 days a year,
including weekends and holidays. This reporting methodology allows the
Company to improve customer satisfaction by making the initial claim
handling much faster and ultimately reducing indemnity payments such as
rental and storage. As of December 31, 1998, there were 230 agents who
have signed up for this claim reporting methodology; these agents
represent approximately 55% of total claim volume. The Company
anticipates growth in this program as it continues to discuss this
service with those agencies who have not yet been solicited to
participate.
G. Loss and Loss Adjustment Expense Reserves
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. The Company's reserving policy is intended to result in
a small redundancy. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to annually obtain a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
21
<PAGE>
When a claim is reported to the Company, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon an
evaluation of the type of claim involved, the circumstances surrounding
each claim and the policy provisions relating to the loss. The estimate
reflects informed judgment of such personnel based on general insurance
reserving practices and on the experience and knowledge of the claims
person. During the loss adjustment period, these estimates are revised
as deemed necessary by the Company's claims department based on
subsequent developments and periodic reviews of the cases.
In accordance with industry practice, the Company also maintains
reserves for estimated losses incurred but not yet reported ("IBNR").
IBNR reserves are determined on the basis of historical information and
the experience of the Company. Adjustments to IBNR are made
periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims
processing and other items that can be expected to affect the Company's
liability for losses and LAE over time.
When reviewing reserves, the Company analyzes historical data and
estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in general
economic conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for
predicting future events. There is no precise method, however, for
subsequently evaluating the impact of any specific factor on the
adequacy of reserves, because the eventual development of reserves is
affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company estimates
the ultimate net liability for losses and LAE. After taking into
account all relevant factors, management believes that the provision for
losses and LAE at December 31, 1998 is adequate to cover the ultimate
net cost of losses and claims incurred as of that date. The ultimate
liability may be greater or lower than reserves. Establishment of
appropriate reserves is an inherently uncertain process, and there can
be no certainty that currently established reserves will prove adequate
in light of subsequent actual experience. The Company does not discount
to present value that portion of its loss reserves expected to be paid
in future periods. The Company's loss and LAE reserves also include its
share of the aggregate loss and LAE reserves of all Servicing Carriers.
For a reconciliation of beginning and ending reserves for losses
and LAE, net of reinsurance, see Note E to the Company's 1997
Consolidated Financial Statements, which is incorporated herein by
reference from pages 38 through 41 of the Company's 1998 Annual Report.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known and
unknown losses. Because of the Company's limited exposure to these
types of claims, Management believes they will not have a material
impact on the consolidated financial position of the Company. Loss
reserves on environmental related claims amounted to $5,687,000 and
$6,924,000 in 1998 and 1997, respectively.
The following table represents the development of reserves, net of
reinsurance, for 1988 through 1998. The top line of the table shows the
reserves at the balance sheet date for each of the indicated years.
This represents the estimated amounts of losses and LAE for claims
arising in all years that were unpaid at the balance sheet date,
including losses that had been incurred but not yet reported to the
Company. The upper portion of the table shows the cumulative amounts
paid as of successive years with respect to that year's current reserve
liability expressed as a percentage. The lower portion of the table
shows the re-estimated amount as a percentage of the previously recorded
reserves based on experience as of the end of each succeeding year,
including cumulative payments made since the end of the respective year.
The estimate changes as more information becomes known about the
frequency and severity of claims for individual years. Favorable loss
development exists when the original reserve estimate is greater than
the re-estimated reserves at December 31, 1998.
22
<PAGE>
<TABLE>
<CAPTION>
In evaluating the cumulative information in the table, it should
be noted that each year's amount includes the effects of all changes in
amounts for prior periods. This table does not present accident or
policy year development data. Conditions and trends that have affected
development of the liability in the past may not necessarily occur in
the future. Accordingly, it is not appropriate to extrapolate future
development based on this table.
Year ended December 31,
1998 1997 1996 1995 1994
1993 1992 1991 1990 1989 1988
($ in thousands)
<S> <C> <C> <C> <C> <C>
<C> <C> <C> <C> <C> <C>
Reserves for
losses and loss
adjustment
expenses(1)..... $498,829 $530,077 $533,980 $493,911 $455,460
$422,224 $316,261 $228,657 $177,657 $138,456 $100,882
Paid (cumulative)
as a percentage
of current re-
serves as of:
One year later.. 48.6 48.9 47.4 47.0
52.4 51.0 46.3 46.2 46.8 41.5
Two years later. 70.2 68.7 67.3
71.5 76.7 71.3 68.5 69.3 67.5
Three years
later.......... 82.2 79.5
81.7 85.8 87.4 84.6 81.8 81.9
Four years
later.......... 88.1
87.9 90.9 91.4 95.8 90.3 88.8
Five years later
92.6 93.8 93.6 96.3 98.1 92.0
Six years later.
96.6 95.1 95.8 98.1 99.0
Seven years
later..........
97.1 96.7 97.0 99.3
Eight years
later..........
98.1 97.7 97.2
Nine years
later..........
98.4 97.7
Ten years later.
98.2
Reserves re-estimated
as a percentage of
initial reserves as of:
One year later.. 88.4 84.3 82.2 83.6
83.9 87.2 82.3 84.5 92.7 96.9
Two years later. 79.3 74.1 73.2
75.9 78.6 82.8 74.6 82.8 87.7
Three years
later.......... 71.5 68.9
69.4 73.0 77.1 75.1 76.7 80.5
Four years later 67.8
67.3 68.8 72.2 71.7 78.3 76.3
Five years later
66.4 67.0 68.7 68.2 75.6 80.2
Six years later.
66.7 67.8 65.5 74.0 78.0
Seven years
later.........
67.6 64.6 71.8 77.3
Eight years
later.........
64.6 71.3 75.4
Nine years later
71.2 75.5
Ten years later.
75.8
Redundancy expressed as a
percent of yearend
reserves......... 11.6 20.7 28.5 32.2
33.6 33.3 32.4 35.4 28.8 24.2
</TABLE>
(1) Prior to effect of ceded reinsurance recoverable.
<PAGE>
H. Operating Ratios
Loss and Underwriting Expense Ratios
Loss and underwriting expense ratios are used to interpret the
underwriting experience of property and casualty insurance companies.
Losses and LAE are stated as a percentage of premiums earned because
losses may occur over the life of a policy. Underwriting expenses on a
statutory basis are stated as a percentage of net premiums written
rather than premiums earned because most underwriting expenses are
incurred when policies are written and are not spread over the policy
period. Underwriting profit margins are reflected by the extent to
which the combined loss and underwriting expense ratios, the combined
ratio, is less than 100%. The combined ratio is considered the best
simple index of current underwriting performance of an insurer. The
Company's loss and LAE ratio, underwriting expense ratio and combined
ratio, and the industry combined ratio, on a statutory basis, are shown
in the following table. The Company's ratios include lines of insurance
other than automobile as do the industry combined ratios for all
writers. Data for the property and casualty industry generally may not
be directly comparable to Company data. This is due to the fact that
the Company conducts its business primarily in Massachusetts.
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
1995 1994
<S> <C> <C> <C>
<C> <C>
Company Statutory Ratios (unaudited):
Loss and LAE Ratio.............. 71.6% 71.4% 70.9%
62.0% 64.6%
Underwriting Expense Ratio...... 26.5 25.1 27.1
29.0 27.1
Combined Ratio................. 98.1% 96.5% 98.0%
91.0% 91.7%
Industry combined ratio
(all writers)(1)............... 101.2% 100.1% 102.9%
102.8% 103.0%
</TABLE>
(1) Source: Best's Review (January, 1999), as reported by A.M. Best for
all property and casualty insurance companies and weighted to reflect
the Company's product mix. The 1998 industry information is estimated by
A.M. Best.
Premiums to Surplus Ratio
The following table shows, for the periods indicated, the
Company's and the industry's statutory ratios of net premiums written to
policyholders' surplus. While there is no statutory requirement
applicable to the Company which establishes a permissible net premiums
to surplus ratio, guidelines established by the National Association of
Insurance Commissioners ("NAIC") provide that this ratio should be no
greater than 300%.
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
1995 1994
(dollars in
thousands)
<S> <C> <C> <C>
<C> <C>
Net premiums written by the
Company........................... $745,620 $741,501 $711,570
$603,421 $589,197
Policyholders' surplus of the
Company........................... 563,503 516,598 464,739
440,110 349,775
The Company's ratio................ 132.2% 143.3% 153.1%
137.1% 168.5%
Industry ratio(1).................. 80.0% 90.0% 110.0%
110.0% 130.0%
</TABLE>
__________________________________
(1) Source: Best's Review (January, 1999), for all property and
casualty insurance companies. The 1998 industry information is
estimated by A.M. Best.
24
<PAGE>
I. Investments
Investment income is an important source of revenue for the
Company and the return on its investment portfolio has a material effect
on its net earnings. The Company's investment objective is to maintain
high quality diversified fixed maturity and preferred stock investments
structured to maximize after-tax investment income while minimizing
risk. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" incorporated herein by reference from pages 4
through 22 of the Company's 1998 Annual Report.
The Company's investment portfolio carried at market value as of
December 31, 1998, was $1,257,900,000. Of that amount, 49.2% was
invested in fixed maturities, 15.7% was invested in preferred stocks,
22.6% was invested in common stocks, 0.3% was invested in short-term
investments and 6.5% was invested in mortgage loans and other
investments. Cash and cash equivalents accounted for the remaining
5.7%.
Investments in fixed maturities, which include taxable and non-
taxable bonds, preferred stocks, common stocks and preferred stock
mutual funds, are carried at fair market value. Unrealized investment
gains and losses on stocks and fixed maturities, to the extent that
there is no permanent impairment of value, are credited or charged
directly to stockholders' equity, net of any tax effect, through other
comprehensive income. When investment securities are sold, the realized
gain or loss is determined based on sales proceeds less book value.
The Company's bond portfolio is comprised of Government National
Mortgage Association ("GNMA") mortgage backed bonds (18.2%) and
municipal bonds (81.8%). Of the Company's bonds, 100.0% are rated in
the two highest quality categories provided by the NAIC.
The Company's investment policy, determined in accordance with
guidelines established by the Company's Board of Directors, emphasizes
investment yield while maintaining investment quality. The Board of
Directors reviews and ratifies management's investment decisions on a
quarterly basis. State insurance laws also impose restrictions on the
nature and extent of investments by the Company.
The table below sets forth investments (at cost) and the income
thereon for the five years ended December 31, 1998.
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
1995 1994
(dollars in
thousands)
<S> <C> <C> <C>
<C> <C>
Average net investments.......... $1,242,633 $1,181,181 $1,131,760
$1,033,439 $893,628
Net realized gains (losses) on
investments.................... 6,769 22,770 (7,574)
712 45,612
Net accumulated other
comprehensive income (loss):
on fixed maturities.......... 18,785 23,813 16,191
13,969 (56,366)
on preferred stocks.......... (2,845) 364 (801)
(377) (10,500)
on common stocks............. 22,601 17,718 20,116
11,799 1,613
Net investment income............ 86,501 80,794 77,402
71,313 62,901
Net investment income as a
percentage of total average
investments.................... 6.96% 6.84% 6.84%
6.90% 7.03%
Net investment income after-tax
as a percentage of total
average investments............ 5.72% 5.53% 5.61%
5.74% 5.27%
</TABLE>
25
<PAGE>
The following table sets forth an analysis of the fair market
value (except mortgages and collateral loans which are at cost) by the
type of investment at December 31, 1994 through 1998:
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
1995 1994
(dollars in
thousands)
<S> <C> <C> <C>
<C> <C>
Type of Investment
GNMA mortgage-backed bonds...... $ 112,588 $ 181,069 $ 225,552 $
221,373 $ 233,287
Tax exempt state and municipal
bonds.......................... 506,679 409,528 491,150
593,904 511,723
Total fixed maturities...... 619,267 590,597 716,702
815,277 745,010
Preferred stocks................ 197,425 148,499 147,680
111,220 85,574
Preferred stock mutual funds.... 172,455 119,439 29,087
- - -
Common stocks................... 111,506 58,650 56,954
40,359 9,656
Total common stocks......... 283,961 178,089 86,041
40,359 9,656
Short-term investments.......... 3,669 132,700 -
- - -
Mortgages and collateral loans
(net of allowance for possible
loan losses)................... 73,510 82,839 74,586
75,609 58,590
Cash and cash equivalents....... 72,243 106,188 140,535
52,665 5,485
Other investments............... 7,825 3,783 2,127
1,648 716
Total investments........... $1,257,900 $1,242,695 $1,167,671
$1,096,778 $ 905,031
</TABLE>
The table below sets forth as of December 31, 1998 the composition
of the Company's fixed maturity investments, excluding short-term
investments, by time to maturity at the dates indicated:
<TABLE>
<CAPTION>
Percent
of
Fixed
Maturity
Amount
Portfolio
(dollars in thousands)
<S> <C>
<C>
Period from December 31, 1998 to maturity:
One year or less................................. $ -
- - %
More than one year to five years.................
2,177 0.3
More than five years to ten years................
1,740 0.3
More than ten years..............................
615,350 99.4
$619,267 100.0%
</TABLE>
26
<PAGE>
At December 31, 1998, the Company's fixed income portfolio, which
represented 49.2% of the Company's total invested assets, had an
average stated maturity of approximately 22.2 years. The calculation
of average stated maturity utilizes the dollar weighted average of the
actual maturity date for a security. In contrast, the Company's
weighted average duration can be significantly less. At December 31,
1998, the Company's fixed income portfolio had a weighted average
duration of 4.2 years. The "duration" of a security is the time-
weighted present value of the security's expected cash flows and is
used to measure a security's price sensitivity to changes in interest
rates. The weighted average duration is short compared to the average
stated maturity because of the relatively large percentage of GNMA and
municipal housing bonds in the fixed maturity portfolio. The duration
reflects industry prepayment assumptions. The municipal housing bonds
are similar in nature to GNMAs in that they paydown principal during
the life of the bond. For these types of bonds, investors are
compensated primarily for reinvestment risk rather than credit quality
risk. During periods of significant interest rate volatility, the
underlying mortgages may prepay more quickly or more slowly than
anticipated. If the repayment of principal occurs earlier than
anticipated during periods of declining interest rates, investment
income may decline due to the reinvestment of these funds at the lower
current market rates. In regards to municipal bonds, the Bloomberg
Financial System, which was used to calculate the above maturity data,
utilizes optional call dates, sinking fund requirements and assumes a
non-static prepayment pattern in deriving these averages.
J. Regulation
General
The Company's primary business is subject to extensive
regulation. In Massachusetts the Commissioner who is appointed by the
Governor of Massachusetts, has broad authority to fix and establish
maximum policy rates and minimum agent commission levels on personal
automobile insurance. In addition, the Commissioner grants and revokes
licenses to write insurance, approves policy forms, sets reserve
requirements, determines the form and content of statutory financial
statements and establishes the type and character of portfolio
investments. The Commissioner also approves company submissions
regarding group insurance programs and corresponding discounts along
with SDIP deviations. Consequently, the policies and regulations set
by the Commissioner are an important element of writing insurance in
Massachusetts.
During the three-year period from 1996 to 1998 Massachusetts
personal automobile insurance premium rates decreased an average of
4.9% per year. The Commissioner approved an average 0.7% increase in
personal automobile premiums for 1999, the first increase since 1994.
Average mandated rates decreased 4.0%, 6.2% and 4.5% in 1998, 1997 and
1996, respectively. Coinciding with the 1999 rate increase, the
Commissioner also approved a 1.0% increase in commission rates to
agents selling private passenger automobile insurance for 1999. The
decision slightly offsets the financial benefit of the average 0.7%
increase in personal automobile premiums for 1999.
Although personal automobile premium rates decreased on average
by 4.9% in 1998, the impact upon the Company resulted in a 2.6%
increase in the average personal automobile premium per exposure (each
vehicle insured). The 2.6% increase for the Company was due to the
fact that the rate decision did not anticipate purchases of new
automobiles in the year to which the rate decision applies and,
secondly, the Company's mix of personal automobile business differed
from that of the industry.
The 1997, 1998 and 1999 average rate decisions were partially
driven by corrections for an industry error that had impacted prior
year rate decisions. The industry error resulted from a miscalculation
of industry expense allowances that had the effect of overstating rates
for 1991 through 1996. Mandated rates for 1997, 1998 and 1999 include
an adjustment to recoup $176 million from the industry. The adjustment
included in the rate decision to recoup the error was phased in at 40%,
40% and 20% in 1997, 1998 and 1999.
27
<PAGE>
The estimated earned premium impact of the above item, coupled
with the impact of a previous year imbalance in the SDIP, approximately
$15.3 million for 1997, $23.9 million for 1998 and $14.0 million for
1999. The earnings per share after-tax impact resulting from lower
earned premiums has been estimated at $0.28 for 1997, $0.43 for 1998,
and is estimated to be $0.24 for 1999. If the Company's future market
share increases (decreases), a larger (smaller) financial impact will
result.
Also factored into the 1999 rate decision were two sanctions
levied by the Commissioner against the Massachusetts personal
automobile insurance industry. One fine, amounting to $6 million, was
imposed as a result of the industry's alleged failure to show that it
adhered to adequate cost containment efforts as identified by the
Commissioner. A second fine of $3 million was allegedly the result of
what the Commissioner termed "incomplete compliance" on the part of the
Automobile Insurers Bureau of Massachusetts ("AIB") with a discovery
order concerning disclosure of certain information as identified by the
Commissioner. The industry and several insurance carriers, including
Commerce, are appealing one or both of the sanctions.
The State Divisions of Insurance are responsible for conducting
periodic examinations of insurance companies. Both Commerce and
Citation were last examined for the five year period ended December 31,
1993 and are scheduled for the five year period ended December 31, 1998
during 1999. Commerce West was last examined in 1997 by the California
Division of Insurance for the five year period ended December 31, 1996.
The concluded examinations produced no material findings.
Massachusetts Division of Insurance regulations provide that insurance
companies will be examined every five years or more frequently as
deemed prudent by the Commissioner. California Division of Insurance
regulations provide that insurance companies will be examined every
three years. ACIC was examined in 1999 by the Ohio Division of
Insurance for the three year period ending December 31, 1997. The
final impact has yet to be issued.
Automobile Insurance Regulation Overview
Massachusetts has required compulsory automobile insurance
coverage since 1925. Under current law, all motorists are required to
carry certain minimum coverages mandated by the state. The
Commissioner fixes and establishes, among other things, the maximum
rates insurers may charge for the compulsory personal automobile
coverages. With very limited exceptions, each insurer writing
automobile insurance in Massachusetts must accept all risks submitted
to it for the compulsory coverage, but is permitted to reinsure these
risks (including group insurance risks) through C.A.R.
Compulsory Coverage. Compulsory coverage includes no-fault
coverage, limited bodily injury coverage, property damage coverage and
coverage against uninsured or hit and run motorists. The Massachusetts
no-fault statute provides for personal injury protection ("PIP")
coverage, which entitles a party to be reimbursed directly by the
party's own insurer for certain medical expenses, lost wages and other
defined expenses arising from an automobile accident, up to a specific
amount, even if another party caused the accident.
Rates and Commissions. All Massachusetts personal automobile
insurance rates are fixed and established annually by the Commissioner.
Group insurance programs and rate deviations must be approved by the
Commissioner. For Massachusetts commercial automobile insurance, the
rates for the voluntary market are competitive, with insurers filing
rates for review by the Commissioner based on their own experience.
The rates for the Massachusetts commercial automobile risks reinsured
through C.A.R. are fixed and established by the Commissioner except for
non-fleet, private passenger-type automobiles.
In fixing classifications of risks and establishing rates, the
Commissioner must consider numerous factors including driver and
automobile characteristics and the claim rate in the state's designated
geographical territories. These factors are based upon data which are
two or more years old. The insurer adjusts the premiums it charges to
a policyholder based upon the SDIP record of the operator. Moving
violations and at-fault accidents affect each driver's SDIP record. In
addition, the Extra Risk Rating regulations permit insurers to deny or
charge surcharged rates for physical damage coverage to both high risk
vehicles and insureds with excessive prior loss or violation activity.
28
<PAGE>
The Commissioner sets an average minimum direct agency commission
rate for personal automobile insurance, which in 1998 was 12.9%. With
respect to risks reinsured through C.A.R., the maximum amount of
commissions that C.A.R. will reimburse is fixed at that prescribed
rate.
Mandatory Underwriting. Massachusetts law specifies that all
individuals holding a valid driver's license are entitled to purchase
the mandatory automobile insurance coverages regardless of their
driving experience or accident record. The Massachusetts Legislature
has also placed certain restraints on insurers' discretion to refuse to
renew automobile insurance policies. Policyholders are entitled to
renew except in cases of fraud, material misrepresentation, revocation
or suspension of an operator's license or nonpayment of premiums. With
very limited exceptions, Servicing Carriers writing automobile
insurance in Massachusetts must accept every automobile risk submitted
to them.
Under the Massachusetts system of rate regulation, it is intended
that some personal automobile insurance risks are underpriced at the
maximum rate permitted by the Commissioner, and therefore, absent
state-intervention, insurers would not ordinarily choose to write those
risks. The C.A.R. reinsurance program described below is intended to
mitigate the burden imposed by the Massachusetts take-all-comers system
by allowing insurers to transfer the exposure for undesirable risks to
an industry pool.
Commonwealth Automobile Reinsurers
General. C.A.R. is a state-mandated reinsurance mechanism, under
which all premiums, expenses and losses on ceded business are shared by
all insurers. It is similar to a joint underwriting association
because a number of insurers (46, including the Company) act as
Servicing Carriers for the risks it insures.
Agencies. In general, agencies licensed to issue automobile
insurance policies are entitled to be assigned to at least one
Servicing Carrier. There are two categories of agencies: those who
have voluntary agreements with one or more Servicing Carriers and those
who do not. The latter are assigned by C.A.R. to a single Servicing
Carrier and are known as ERPs.
C.A.R. Operations. All companies writing automobile insurance in
Massachusetts share in the underwriting results of the C.A.R. business
for their respective product line or lines, whether or not they are
Servicing Carriers. An insurer's share of the C.A.R. deficit is
allocated on the basis of a formula called a participation ratio, which
can vary significantly between the personal and commercial pools, and
between different policy years. See "Business-Commonwealth Automobile
Reinsurers" for a detailed discussion of the method of calculating the
participation ratio.
An insurer may terminate its participation in C.A.R. as of the
close of C.A.R.'s fiscal year by surrendering its license to write
automobile policies in Massachusetts. Termination does not discharge
or otherwise affect liability of an insurer incurred prior to
termination. A withdrawing insurer is assessed a share of C.A.R.'s
projected deficits for future years based on the insurer's prior years'
participation in C.A.R. The assessment paid by the withdrawing insurer
is redistributed to the remaining insurers based upon their
participation ratios.
An insurer can transfer its obligations for its personal
insurance policies to another insurer who formally agrees to assume
these obligations. The transferring insurer is thereby relieved of
future C.A.R. obligations which otherwise would have arisen as a
consequence of the business transferred. See "Business-Commonwealth
Automobile Reinsurers."
29
<PAGE>
Insurance Holding Company Structure
As an insurance holding company, the Company is subject to
regulation under the insurance holding company statutes of the states
in which any of its subsidiary insurance companies are domiciled.
Because the Company's subsidiaries are members of an insurance holding
company system, they are required to register with their respective
Divisions of Insurance and to submit reports describing the capital
structure, general financial condition, ownership and management of
each insurer and any person or entity controlling the insurer, the
identity of every member of the insurance holding company system and
the material outstanding transactions between the insurer and its
affiliates.
Each member of the insurance holding company system must keep
current the information required to be disclosed by reporting all
material changes or additions within 15 days of the end of the month in
which it learns of such change or addition.
Massachusetts law prohibits a party which is not a domestic
insurer from acquiring "control" of a domestic insurer or of a company
controlling a domestic insurer without prior approval of the
Commissioner. Control is presumed to exist if a party directly or
indirectly holds, owns or controls more than ten percent of the voting
stock of another party, but may be rebutted by a showing that control
does not exist.
In the event of the insolvency, liquidation or other
reorganization of any of the Company's insurance subsidiaries, the
creditors and stockholders of the Company will have no right to proceed
against the assets of those subsidiaries, or to cause the liquidation
or bankruptcy of any company under federal or state bankruptcy laws.
State laws govern such liquidation or rehabilitation proceedings and
the Division of Insurance would act as receiver for the particular
company. Creditors and policyholders of the insurance subsidiaries
would be entitled to payment in full from such assets before the
Company, as a stockholder, would be entitled to receive any
distribution therefrom.
Payment of Dividends
Under Massachusetts law, insurers may pay cash dividends only
from earnings and statutory surplus, and the insurer's remaining
surplus must be both reasonable in relation to its outstanding
liabilities and adequate to its financial needs.
The Company relies upon dividends from its subsidiaries for its
cash requirements. Every Massachusetts insurance company seeking to
make any dividend or other distributions to its stockholders may,
within certain limitations, pay such dividends and then file a report
with the Commissioner. Dividends in excess of these limitations are
called extraordinary dividends. An extraordinary dividend is any
dividend or other property, whose fair value together with other
dividends or distributions made within the preceding twelve months
exceeds the greater of ten percent of the insurer's surplus as regards
to policyholders as of the end of the preceding year, or the net income
of a non-life insurance company for the preceding year. No pro-rata
distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an
extraordinary dividend or other extraordinary distribution until thirty
days after the Commissioner has received notice of the intended
distribution and has not objected. No extraordinary dividends were
paid in 1998, 1997 and 1996.
30
<PAGE>
Protection Against Insurer Insolvency
All of the insurers writing the types of insurance covered by The
Massachusetts Insurers Insolvency Fund ("M.I.I.F.") are M.I.I.F.
members. M.I.I.F. is obligated to pay any unpaid claim, up to $300,000,
against an insolvent insurer if the claim existed prior to the
declaration of insolvency or arose within 60 days thereafter. M.I.I.F.
assesses members the amounts necessary to pay both its obligations and
the expenses of handling covered claims. Subject to certain
limitations, assessments are made in the proportion that each member's
net written premiums for the preceding calendar year for all property
and casualty lines of business bore to the corresponding net written
premiums for all members for the same period. The statute that
established M.I.I.F. also provides for the recoupment by insurers of
amounts paid to M.I.I.F. Historically, the Commissioner has allowed
insurers to recoup the amounts they paid M.I.I.F. through rate
increases.
Consistent with industry practice in Massachusetts, it has been
the Company's policy to expense all assessments when they are assessed.
M.I.I.F. refunded assessments to Commerce and Citation in the aggregate
amount of $271,000 in 1998 and $283,000 in 1997. M.I.I.F. assessed
Commerce and Citation an aggregate of $742,000 in 1996. The Company
anticipates that there will be additional assessments. By statute, no
insurer may be assessed in any year an amount greater than two percent
of that insurer's net direct written premiums for the calendar year
preceding the assessment. The Company believes that any such
additional assessments should not have a material adverse effect on the
consolidated financial position of the Company, although the timing and
amounts of any such assessments cannot be presently ascertained.
NAIC Guidelines
Insurance Regulatory Information System Ratios. The NAIC
Insurance Regulatory Information System ("IRIS") was developed by a
committee of state insurance regulators and is intended primarily to
assist state insurance regulators in executing their statutory mandates
to oversee the financial condition of insurance companies operating in
their respective states. IRIS identifies eleven industry ratios and
specifies "usual values" for each ratio. Departure from the usual
values on four or more of the ratios can lead to inquiries from
individual state insurance commissioners as to certain aspects of an
insurer's business. For the year ended December 31, 1998, the
Company's consolidated property and casualty operations had no ratios
outside the "normal" range.
Risk-Based Capital ("RBC"). In order to enhance the regulation of
insurer insolvency, the NAIC developed a formula and model law to
implement RBC requirements for property and casualty insurance
companies which are designed to assess capital adequacy and to raise
the level of protection that statutory surplus provides for
policyholder obligations. The RBC model for property and casualty
insurance companies measures three major areas of risk facing property
and casualty insurers: (i) underwriting, which encompasses the risk of
adverse loss development and inadequate pricing; (ii) declines in asset
values arising from credit risk; and (iii) other business risks from
investments. Insurers having less statutory surplus than required by
the RBC calculation will be subject to varying degrees of regulatory
action, depending on the level of capital inadequacy.
The Company's subsidiaries, Commerce, Citation, and Commerce West
have RBC amounts at December 31, 1998 of $71 million, $2 million, and
$3 million, respectively, and they have statutory surplus of
approximately $470 million, $93 million and $25 million, respectively.
The statutory surplus of Commerce, Citation and Commerce West at
December 31, 1998 exceeded the RBC Company Action Levels of $142
million, $4 million and $6 million, respectively, by approximately $328
million, $89 million and $19 million, respectively. The Company's new
acquisition, ACIC, has RBC amounts at December 31, 1998 of $15 million
and they have statutory surplus of approximately $90 million. The
statutory surplus of ACIC, at December 31, 1998, exceeded the RBC
company action levels of $30 million by approximately $60 million. The
RBC model formula proposes four levels of regulatory action. The
extent of regulatory intervention and action increases as the level of
surplus to RBC falls. The first level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the
regulator if surplus falls below 200% of the RBC amount.
31
<PAGE>
The Regulatory Action Level (as defined by the NAIC) requires an
insurer to submit a plan containing corrective actions and permits the
Commissioner to perform an examination or other analysis and issue a
corrective order if surplus falls below 150% of the RBC amount. The
Authorized Control Level (as defined by the NAIC) allows the regulator
to rehabilitate or liquidate an insurer in addition to the
aforementioned actions if surplus falls below 100% of the RBC amount.
The fourth action level is the Mandatory Control Level (as defined by
the NAIC) which requires the regulator to rehabilitate or liquidate the
insurer if surplus falls below 70% of the RBC amount.
K. Competition
The property and casualty insurance industry is highly cyclical,
characterized by periods of increasing premium rates and limited
underwriting capacity, followed by periods of intensive price
competition and abundant underwriting capacity. This industry also is
highly competitive, with a large number of companies, many of which
operate in more than one state, offering automobile, homeowners,
commercial property and other lines of insurance. Some of the
Company's competitors have larger volumes of business and greater
financial resources. Some sell insurance directly to policyholders
rather than through independent agents.
In 1995, several insurers, including the Company, within the
Massachusetts Insurance Industry began pursuing group marketing as a
means of shifting market share. Arising from this pursuit, additional
programs such as safe driver deviations and the elimination of finance
fees have followed. In January 1999, in response to the average
personal automobile rate decisions over the last several years, the
Company received approval to offer SDIP deviations of 8% for Step 9 and
3% for Step 10 for the 1999 calendar year. For drivers that qualify,
the Company's 1999 affinity group automobile discounts and SDIP
deviations can be combined for up to 13.5% (Step 9) and 9.8% (Step 10)
reduction of the state mandated rates. This can be compared to the
SDIP deviations of 15% for Step 9 and 4% for Step 10 SDIP
classifications for the 1998 calendar year. For drivers that
qualified, the Company's 1998 affinity group automobile discounts and
SDIP deviations then could have been combined for up to a 20.1% (Step
9) and 9.8% (Step 10) reduction from the state mandated rates.
Because the Company's insurance products are marketed exclusively
through independent agencies, most of whom represent more than one
company, the Company faces competition within each agency. The Company
competes for business within independent agencies by offering a more
attractively priced product to the consumer and by paying agents
significant compensation in the form of commissions and profit sharing
which are based in part on the underwriting profits of the agency
business written with the Company. The Company also provides a
consistent market, the prompt servicing of policyholder claims and
agency support services. Although the Company believes, based upon
regular surveys of its agencies, its relationships with its independent
agencies are excellent, any disruption in these relationships could
adversely affect the Company's business.
The Company believes the Massachusetts regulatory environment,
which fixes maximum personal automobile insurance rates, apportions
losses incurred by C.A.R. and establishes minimum agency commissions,
has discouraged certain companies with more diverse geographic markets
and interests from establishing a presence or expanding their market
share in Massachusetts.
L. Other Matters
Human Resources
As of December 31, 1998, the Company and its subsidiaries
employed 1,533 people. The Company is not a party to any collective
bargaining agreements and believes its relationship with employees to
be good. ACIC, which was acquired in January 1999, employed another
209 people.
32
<PAGE>
The Company offers benefits, compensation and employee relations
programs to assure a productive and positive working environment. The
Company monitors job grades and salary scales of peer companies to
assure that its compensation levels and benefits are competitive both
within the property and casualty industry and geographically within
Central Massachusetts. The Company has been recognized for its
progressive programs designed to meet the needs of a modern-day
workforce. In addition to alternative work schedules and casual dress,
on-site child care has been offered to employees since 1986. Commerce
was one of the first businesses in the region to offer this benefit. A
newly constructed child care center can currently accommodate up to 200
children of our employees.
The Company maintains an Employee Stock Ownership Plan
("E.S.O.P."), for the benefit of all employees and former employees
still participating in the E.S.O.P. There were a total of 1,662
participants at December 31, 1998.
In September 1998, the Company implemented a 401(k) Plan enabling
eligible employees to contribute up to 15% of eligible compensation on
a pre-tax basis up to the annual maximum limits under federal tax law.
The Company incurs no expenses in the form of matching contributions
but does pay for administration of The Plan.
ITEM 2. PROPERTIES
The Company conducts its Massachusetts operations from
approximately 297,000 square feet of space in several buildings which
it owns in Webster, Massachusetts, which is located approximately 50
miles southwest of Boston. The Company's principal administrative
offices in Webster consist of recently rehabilitated and newly
constructed buildings. Its data processing and operational departments
are housed in modern office buildings on a separate nine acre site. In
1998, the Company completed the construction of a 20,000 square foot
child care center located on a separate seven acre site in Webster,
Massachusetts. The child care center enables the Company to care for
up to 200 children of employees. Commerce West currently leases
approximately 12,000 square feet of office space in Pleasanton,
California. The Company's new acquisition, ACIC, conducts its
operations from approximately 39,000 square feet of space in a building
located on a two acre site in Columbus, Ohio. The Company considers
that its properties are in good condition, are well maintained, and are
generally suitable to carry on the Company's business. For additional
information concerning property, see Note D to the Company's 1998
Consolidated Financial Statements, which is incorporated herein by
reference from page 38 of the Company's 1998 Annual Report.
ITEM 3. LEGAL PROCEEDINGS
As is common with property and casualty insurance companies, the
Company is a defendant in various legal actions arising from the normal
course of its business, including claims based on Chapter 176D and
Chapter 93A. See "Business - Settlement of Claims". These proceedings
are considered to be ordinary to operations or without foundation in
fact. Management is of the opinion that these actions will not have a
material adverse effect on the consolidated financial position of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders
during the fourth quarter of 1998.
33
<PAGE>
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's executive officers are as follows:
<TABLE>
<cation>
Name Age Position with
Company
<S> <C> <C>
Arthur J. Remillard, Jr. 68 Chief Executive
Officer, Director
Gerald Fels 56 Executive Vice
President,
Chief Financial
Officer, Director
Arthur J. Remillard, III 43 Senior Vice President--
Policyholder
Benefits, Assistant
Clerk, Director
Regan P. Remillard 35 Senior Vice President--
General Counsel,
President of Commerce
West, Chief Executive
Officer of ACIC,
Director
David H. Cochrane 45 Senior Vice President--
Underwriting
of Commerce and
Citation
Peter J. Dignan 47 Senior Vice President--
Marketing
of Commerce and
Citation
Mary M. Fontaine 42 Senior Vice President--
Human Resources
Joyce B. Virostek 56 Senior Vice President--
Management
Information Systems of
Commerce and Citation
</TABLE>
Arthur J. Remillard, Jr. has been the President, Chief Executive
Officer and Chairman of the Board of the Company since 1976 and
Commerce since 1972. Mr Remillard, Jr. has been in the insurance
business for more than 30 years. Mr. Remillard, Jr. is Chairman of the
Automobile Insurers Bureau of Massachusetts. Mr. Remillard, Jr. is
also a member of the Governing Committee, Chairman of the Actuarial
Committee, a member of the Governing Committee Review Panel, Chairman
of the Budget Committee and a member of the Personnel Committee of
C.A.R.
Gerald Fels, a certified public accountant, was appointed
Executive Vice President of the Company in 1989. From 1981 to 1989,
Mr. Fels had been Senior Vice President of the Company. Mr. Fels was
the Treasurer of the Company from 1976 to 1995 and Commerce from 1975
to 1995. Mr. Fels has also been Chief Financial Officer of the Company
since 1976 and Commerce since 1975. Mr. Fels also serves on the C.A.R.
Audit Committee.
Arthur J. Remillard, III was appointed Senior Vice President--
Policyholder Benefits in 1988 and has been Assistant Clerk of the
Company since 1982. From 1981 to 1988, Mr. Remillard, III had been Vice
President--Mortgage Operations. In addition, Mr. Remillard, III has
also served on the Board of Governors of the Insurance Fraud Bureau of
the A.I.B. since January, 1991, the C.A.R. Claims Advisory Committee
since June 1990 and the A.I.B. Claims Committee since April 1991.
Regan P. Remillard was appointed Chief Executive Officer of
American Commerce Insurance Company in 1999. Mr. Remillard has been
President of Commerce West Insurance Company since 1996. Mr. Remillard
has been Senior Vice President--General Counsel since 1995. From 1994
to 1995, Mr. Remillard was a practicing attorney at Hutchins, Wheeler &
Dittmar, a Massachusetts law firm specializing in corporate law and
litigation. From 1989 to 1993, Mr. Remillard was Government Affairs
Monitor of the Company. Mr. Remillard is a member of the Massachusetts
Bar.
34
<PAGE>
David H. Cochrane has been the Senior Vice President--
Underwriting of Commerce and Citation since 1988. For approximately
four years prior to that, Mr. Cochrane was the Vice President of
Financial Services of C.A.R. Mr. Cochrane has also served on the
C.A.R. Market Review Committee since 1988.
Peter J. Dignan was appointed the Senior Vice President--
Marketing of Commerce and Citation in 1997. From 1989 to 1997, Mr.
Dignan was Vice President--Financial Operations of Commerce and
Citation. From 1987 to 1989 Mr. Dignan was Assistant Vice President--
Financial Operations of Commerce and Citation. Mr. Dignan also serves
on the C.A.R. Defaulted Brokers Committee.
Mary M. Fontaine has been the Senior Vice President--Human
Resources of the Company since 1988. From 1982 to 1988, Ms. Fontaine
was Assistant Vice President--Human Resources of Commerce and Citation.
Joyce B. Virostek has been the Senior Vice President--Management
Information Systems of Commerce and Citation since 1988. From 1981 to
1988, Ms. Virostek had been Vice President of Commerce and Citation in
charge of data processing.
The only family relationship among the executive officers is that
Arthur J. Remillard, III and Regan P. Remillard are the sons of Arthur
J. Remillard, Jr.
35
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's common stock trades on the NYSE under the symbol
"CGI". The high, low and close prices for shares of the Company's
common stock for 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998
1997
High Low Close High
Low Close
<S> <C> <C> <C> <C>
<C> <C>
First Quarter........... $37-3/8 $31-3/4 $35-1/4 $29
$22-7/8 $23-1/4
Second Quarter.......... 39-5/8 34-3/8 38-3/4 24-
3/4 21-3/8 24-5/8
Third Quarter........... 39 24-7/8 27-5/8 33-
3/8 23-7/8 30-7/8
Fourth Quarter.......... 36-1/2 22-11/16 35-7/16 36
30 32-5/8
</TABLE>
As of March 1, 1999, there were 1,241 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name"
or held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.07 per share
and $1.03 per share in 1998 and 1997, respectively. On May 15, 1998,
the Board voted to increase the quarterly stockholder dividend from
$0.26 to $0.27 per share to stockholders of record as of June 5, 1998.
Prior to that declaration, the Company had paid quarterly dividends of
$0.26 per share dating back to May 30, 1997 when the Board voted to
increase the dividend from $0.25 to $0.26 per share.
The Company purchased no additional Treasury Stock under the
stock buyback program during 1998. The stock buyback program,
authorized by the Board on May 19, 1995, enables the Company to
purchase up to 3,000,000 shares of the Company's common stock. As of
December 31, 1998, 1,957,348 shares of Treasury Stock were purchased
under the program. Since December 31, 1998, the Company completed its
share purchases under that program. Additionally, under prior Board of
Director authorizations, the Company purchased 143,248 shares through
March 19, 1999.
A portion of the Company's cash flow consists of dividends
received from CHI, which receives dividends from Commerce and Citation.
The payment of any cash dividends to holders of common stock by the
Company therefore depends on the receipt of dividend payments from CHI.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends
to the Company. The payment of dividends by Commerce and Citation is
subject to limitations imposed by Massachusetts law, as discussed under
the caption "Payment of Dividends" in Item 1J of this report.
ITEM 6. SELECTED FINANCIAL DATA
The five-year financial information under the caption "Selected
Consolidated Financial Data" on page 50 of the Company's 1998 Annual
Report is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 4 through 22 of the Company's 1998
Annual Report is incorporated herein by reference.
ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The information on page 4 through page 22 of the Company's 1998
Annual Report is incorporated herein by reference.
36
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements for the years
ended December 31, 1998, 1997 and 1996 and the report of its
independent auditors on pages 24 through 49 of the Company's 1998
Annual Report are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item and not provided in Item
4A will be contained in the Company's Proxy Statement which the Company
intends to file within 120 days after the end of the Company's fiscal
year ended December 31, 1998 and such information is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1998
and such information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1998
and such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item will be contained in the
Company's Proxy Statement which the Company intends to file within 120
days after the end of the Company's fiscal year ended December 31, 1998
and such information is incorporated herein by reference.
37
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-
K
<TABLE>
<CAPTION>
<S><C> <C>
<C>
A. (1) The following financial statements have been incorporated
herein by reference
from the pages indicated below of the Company's 1998
Annual Report:
Page
Report of Independent
Auditors................................... 24
Consolidated Balance Sheets as of December 31, 1998 and
1997..... 25
Consolidated Statements of Earnings for the years ended
December 31, 1998, 1997 and
1996................................ 26
Consolidated Statements of Stockholders' Equity for the
years
ended December 31, 1998, 1997 and
1996.......................... 27
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and
1996................................ 28
Consolidated Statements of Cash Flows - Reconciliation of
Net
Earnings to Net Cash provided by Operating Activities
for the
years ended December 31, 1998, 1997 and
1996................... 29
Notes to Consolidated Financial
Statements....................... 30
(2) The financial statement schedules are listed in the Index
to Consolidated
Financial Statement Schedules.
(3) The exhibits are listed in the Index to Exhibits.
B. No reports on Form 8-K were filed during the quarter ended
December 31,
1998
</TABLE>
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated: February 19, 1999
THE COMMERCE GROUP,
INC.
By
ARTHUR J.
REMILLARD, JR.
(Arthur J.
Remillard, Jr.)
(President, Chief Executive
Officer and Director)
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title
<S> <C>
ARTHUR J. REMILLARD, JR. President, Chief
Executive Officer and
(Arthur J. Remillard, Jr.) Director
GERALD FELS Executive Vice
President, Chief Financial
(Gerald Fels) Officer and Director
ARTHUR J. REMILLARD, III Senior Vice President--
Policyholder
(Arthur J. Remillard, III) Benefits, Assistant
Clerk and Director
REGAN P. REMILLARD Senior Vice President--
General Counsel,
(Regan P. Remillard) President of Commerce
West, Chief Executive
Officer of American
Commerce Insurance
Company and Director
JOHN W. SPILLANE Clerk and Director
(John W. Spillane)
RANDALL V. BECKER Treasurer and Chief
Accounting Officer
(Randall V. Becker)
HERMAN F. BECKER Director
(Herman F. Becker)
JOSEPH A. BORSKI, JR. Director
(Joseph A. Borski, Jr.)
Director
(Eric G. Butler)
HENRY J. CAMOSSE Director
(Henry J. Camosse)
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
DAVID R. GRENON Director
(David R. Grenon)
ROBERT W. HARRIS Director
(Robert W. Harris)
ROBERT S. HOWLAND Director
(Robert W. Howland)
JOHN J. KUNKEL Director
(John J. Kunkel)
RAYMOND J. LAURING Director
(Raymond J. Lauring)
ROGER E. LAVOIE Director
(Roger E. Lavoie)
NORMAND R. MAROIS Director
(Normand R. Marois)
SURYAKANT M. PATEL Director
(Suryakant M. Patel)
Director
(Antranig A. Sahagian)
GURBACHAN SINGH Director
(Gurbachan Singh)
</TABLE>
40
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULES*
<TABLE>
<CAPTION>
Page
<S>
<C>
Ernst & Young LLP Consent of Independent
Auditors............................ 42
Coopers & Lybrand, L.L.P. Report of Independent Accountants on
Financial Statement
Schedules............................................... 43
Coopers & Lybrand, L.L.P. Consent of Independent
Accountants................. 44
</TABLE>
Schedules
<TABLE>
<CAPTION>
<S>
<C>
II Condensed Financial Information of the Registrant as of and
for the
years ended December 31, 1998, 1997 and
1996...................... 45
III Supplementary Insurance Information for the years ended
December 31, 1998, 1997 and 1996
................................. 50
IV Reinsurance for the years ended December 31, 1998, 1997 and
1996... 51
V Valuation and Qualifying Accounts for the years ended
December 31, 1998, 1997 and
1996.................................. 52
X Supplemental Information Concerning Property-Casualty
Insurance
Operations for the years ended December 31, 1998, 1997 and
1996... 53
</TABLE>
* Financial statement schedules other than those listed are omitted
because they are not required, not applicable or the required
information has been included elsewhere.
41
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We consent to the incorporation by reference in this Annual Report (Form
10-K) of The Commerce Group, Inc. of our report dated January 22, 1999,
included in the 1998 Annual Report to Stockholders of The Commerce
Group, Inc.
Our audits also included the 1998 and 1997 financial statement schedules
of The Commerce Group, Inc. listed in Item 14(a). The accompanying
financial statement schedules for the year ended December 31, 1996, were
audited by other auditors whose report dated January 24, 1997, expressed
an unqualified opinion on those schedules. These schedules are the
responsibility of the Company's management. Our responsibility is to
express an opinion based on our audits. In our opinion, the 1998 and
1997 financial statement schedules referred to above, when considered in
relation to the basic financial statements taken as a whole, present
fairly in all material respects the information set forth therein.
We also consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 333-62367) pertaining to The Commerce Group,
Inc. 401(k) Plan of our report dated January 22, 1999, with respect to
the consolidated financial statements incorporated herein by reference,
and our report included in the preceding paragraph with respect to the
financial statement schedules included in this Annual Report (Form 10-K)
of The Commerce Group, Inc.
ERNST & YOUNG LLP
Boston, Massachusetts
March 29, 1999
42
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Board of Directors and Stockholders of
The Commerce Group, Inc.:
Our report on the consolidated financial statements of The
Commerce Group, Inc. and Subsidiaries as of December 31, 1996, and for
the year then ended, has been incorporated by reference in this Form 10-
K from Page 18 of the 1996 Annual Report to Stockholders of The Commerce
Group, Inc. In connection with our audit of such financial statements,
we have also audited the related financial statement schedules as of
December 31, 1996 and for the year then ended, listed in the index on
Page 41 of this Form 10-K.
In our opinion, the financial statement schedules referred to
above, when considered in relation to the basic financial statements
taken as a whole, present fairly, in all material respects, the
information required to be included therein.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
January 24, 1997
43
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration
Statement of The Commerce Group, Inc. on Form S-8 (File No. 333-62367)
of our report dated January 24, on our audit of the consolidated
financial statements and consolidated financial statement schedules of
The Commerce Group, Inc., as of and for the year ended December 31,
1996, which report is incorporated by reference in this Annual Report on
Form 10-K.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
March 25, 1999
44
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
BALANCE SHEETS
December 31,
(Thousands of Dollars)
1998
1997 1996
ASSETS
<TABLE>
<CAPTION>
<S> <C>
<C> <C>
Investments:
Investment in Commerce Holdings, Inc................... $651,447
$610,854 $551,490
Investment in Bay Finance Company, Inc................. 25,558
23,750 33,061
Investment in the Clark-Prout Insurance Agency, Inc.... 313
566 1,282
Other investments...................................... -
- - 2,000
Total investments.................................. 677,318
635,170 587,833
Cash and cash equivalents................................ 2
2 2
Property and equipment, net of accumulated depreciation.. 1,219
1,368 1,345
Receivable from affiliates............................... 37,077
30,395 3,767
Current income taxes..................................... -
7,682 3,468
Deferred income taxes.................................... 1,706
- - -
Other assets............................................. 3,626
4,628 2,411
Total assets....................................... $720,948
$679,245 $598,826
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses.................. $ 9,609
$ 23,428 $ 9,506
Deferred income taxes.................................. -
4,691 1,831
Current income taxes................................... 5,519
- - -
Other liabilities...................................... 35
1,330 450
Total liabilities.................................. 15,163
29,449 11,787
Stockholders' equity:
Capital stock:
Common stock......................................... 19,000
19,000 19,000
Paid-in capital........................................ 29,621
29,621 29,621
Retained earnings...................................... 695,851
639,862 576,618
744,472
688,483 625,239
Treasury stock, 1,957,348, 1,957,348 and 1,937,348
shares in 1998, 1997 and 1996, at cost................. (38,687)
(38,687) (38,200)
Total stockholders' equity......................... 705,785
649,796 587,039
Total liabilities and stockholders' equity......... $720,948
$679,245 $598,826
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
45
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF EARNINGS
Years ended December 31,
(Thousands of Dollars)
1998
1997 1996
<TABLE>
<CAPTION>
<S> <C>
<C> <C>
Revenues
Dividends received from subsidiaries................... $ 51,745
$ 47,105 $ 43,470
Rent income............................................ 461
397 357
Investment income...................................... -
- - 8
Total revenues...................................... 52,206
47,502 43,835
Expenses
Depreciation........................................... 298
242 257
Administrative expenses................................ 492
11,933 5,698
Total expenses...................................... 790
12,175 5,955
Earnings before income tax benefits and equity in
net earnings of subsidiaries over amounts distributed... 51,416
35,327 37,880
Income tax benefits...................................... (991)
(5,063) (2,880)
Earnings before equity in net earnings of subsidiaries
over amounts distributed................................ 52,407
40,390 40,760
Equity in net earnings of subsidiaries over amounts
distributed............................................. 44,085
55,825 33,204
Net earnings........................................ $ 96,492
$ 96,215 $ 73,964
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
46
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
STATEMENTS OF CASH FLOWS
Years ended December 31,
(Thousands of Dollars)
1998
1997 1996
<TABLE>
<CAPTION>
<S> <C>
<C> <C>
Cash flows from operating activities:
Net earnings............................................ $ 96,492
$ 96,215 $ 73,964
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Dividends received from consolidated subsidiaries..... 51,745
47,105 43,470
Equity in earnings of consolidated subsidiaries....... (95,830)
(102,930) (76,674)
Depreciation and amortization......................... 298
242 257
Other liabilities and accrued expenses................ (14,112)
25,226 1,281
Balances with affiliates.............................. (6,682)
(26,628) 1,979
Income taxes (benefits)............................... 6,804
(1,354) (930)
Other--net............................................ 102
(49) (83)
Net cash provided by operating activities........... 38,613
37,827 43,264
Cash flows from investing activities:
Purchase of property and equipment for company use...... (196)
(344) (186)
Proceeds from sale of property and equipment............ 149
128 132
Net cash used in investing activities............... (47)
(216) (54)
Cash flows from financing activities:
Dividends paid to stockholders.......................... (38,566)
(37,124) (29,373)
Purchase of treasury stock.............................. -
(487) (13,841)
Net cash used in financing activities............... (38,566)
(37,611) (43,214)
Decrease in cash and cash equivalents..................... -
- - (4)
Cash and cash equivalents at beginning of year............ 2
2 6
Cash and cash equivalents at end of year.................. $ 2
$ 2 $ 2
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
47
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the
accompanying notes thereto in the Annual Report.
NOTE A--Dividends
The amounts of cash dividends paid to The Commerce Group, Inc.
(Parent only) were as follows:
1998
1997 1996
<TABLE>
<CAPTION>
<S> <C>
<C> <C>
Consolidated insurance subsidiaries................. $51,745
$47,105 $43,470
</TABLE>
See Note K to the Consolidated Financial Statements in the Annual
Report for a description of dividend restrictions applicable to the
Company's subsidiaries.
NOTE B--Federal Income Tax Allocation
As a member of a consolidated group for tax purposes, the Company
and its subsidiaries (said parties constituting an "Affiliated Group" as
defined in and for purposes of the Internal Revenue Code) are jointly
and severally liable for federal income taxes of the Affiliated Group
and have entered into an agreement establishing an allocation of tax
liability and for compensation of the respective members of the
Affiliated Group for use of their tax losses and credits.
The method of allocation calls for current taxes to be allocated
among all affiliated companies based on a written tax-sharing agreement.
Under this agreement, allocation is made primarily on a separate return
basis with current payment for losses and other tax items utilized in
the consolidated return. However, to the extent that a payor member of
the group has future net operating losses which it cannot absorb in the
year incurred, other members within the group will refund payments to
the payor.
48
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE II
(continued)
CONDENSED FINANCIAL INFORMATION
THE COMMERCE GROUP, INC.
(Parent Company Only)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Thousands of Dollars)
NOTE C--Consolidated Financial Statements
In preparing the consolidated financial statements of the Company
and its subsidiaries, the following amounts have been eliminated:
<TABLE>
<CAPTION>
At December 31,
Balance Sheet 1998 1997 1996
<S> <C> <C> <C>
Investment in subsidiaries......... $677,318 $635,170 $585,833
Receivable from affiliates......... 37,077 30,395 3,767
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
Statement of Earnings 1998 1997 1996
<S> <C> <C> <C>
Dividends from subsidiaries........ $ 51,745 $ 47,105 $ 43,470
Rent income........................ 461 397 357
</TABLE>
49
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
Years Ended December 31, 1998, 1997 and 1996
(Thousands of Dollars)
<TABLE>
<CAPTION>
Future
Policy Other Benefits,
Amortization
Deferred Benefits, Policy
Claims, of Deferred
Policy Claims and Claims and Net Losses
and Policy Other Net
Acquisition Loss Unearned Benefits Premium Investment
Settlement Acquisition Operating Premiums
Segment Costs Expenses Premiums Payable Revenue Income(1)
Expenses Costs Expenses Written
<S> <C> <C> <C> <C> <C> <C>
<C> <C> <C> <C>
1998
Property and casualty insurance.......... $ 88,759 $596,996 $391,424 None $745,620 $
77,969 $531,429 $196,434 None $745,048
Real estate and commercial lending....... - - - -
5,049 - - -
Corporate and other...................... - - - -
3,483 - - -
Total.............................. $ 88,759 $596,996 $391,424 $745,620 $
86,501 $531,429 $196,434 $745,048
1997
Property and casualty insurance.......... $ 85,264 $649,473 $379,599 None $730,497 $
73,141 $526,127 $187,491 None $741,501
Real estate and commercial lending....... - - - -
4,448 - - -
Corporate and other...................... - - - -
3,383 - - -
Total.............................. $ 85,264 $649,473 $379,599 $730,497 $
80,972 $526,127 $187,491 $741,501
1996
Property and casualty insurance.......... $ 82,968 $662,832 $367,991 None $668,716 $
69,852 $475,231 $181,013 None $711,570
Real estate and commercial lending....... - - - -
4,249 - - -
Corporate and other...................... - - - -
3,301 - - -
Total.............................. $ 82,968 $662,832 $367,991 $668,716 $
77,402 $475,231 $181,013 $711,570
</TABLE>
(1) The allocation of net investment income is based upon the specific
identification of activity within the various segments.
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV
REINSURANCE
Years Ended December 31, 1998, 1997 and 1996
(Thousands of Dollars)
<TABLE>
<CAPTION>
Assumed
Percentage
Ceded to From
of Amount
Gross Other
Other Net Assumed
Insurance Premiums Earned Amount Companies
Companies Amount to Net
<S> <C> <C> <C>
<C> <C>
1998
Property and casualty insurance.. $781,464 $111,901 $ 76,057
$745,620 10.2%
1997
Property and casualty insurance.. $753,184 $105,824 $ 83,137
$730,497 11.4%
1996
Property and casualty insurance.. $698,290 $122,238 $ 92,664
$668,716 13.9%
</TABLE>
51
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997 and 1996
(Thousands of Dollars)
<TABLE>
<CAPTION>
Net
addition
(reduction)
Balance charged to
Balance
beginning costs and
at end
of year expenses
Deductions(1) of year
<S> <C> <C> <C>
<C>
1998
Allowance for losses on mortgage loans
and collateral notes receivable........ $2,812 $ (511) $
- - $2,301
Allowance for doubtful premium
receivables............................ $1,451 $1,297
$(1,298) $1,450
1997
Allowance for losses on mortgage loans
and collateral notes receivable........ $2,760 $ 52 $
- - $2,812
Allowance for doubtful premium
receivables............................ $1,500 $1,645
$(1,694) $1,451
1996
Allowance for losses on mortgage loans
and collateral notes receivable........ $3,173 $ (413) $
- - $2,760
Allowance for doubtful premium
receivables............................ $1,103 $1,942
$(1,545) $1,500
</TABLE>
(1) Deductions represent net write-offs of amounts determined to be
uncollectible.
52
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
SCHEDULE X
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
Years Ended December 31, 1998, 1997 and 1996
(Thousands of Dollars)
<TABLE>
<CAPTION>
Claims and Claim
Paid
Adjustment Expenses
Claims
Affiliation Incurred Related to
and Claim
with Current Prior
Adjustment
Registrant Year Years
Expenses
<S> <C> <C>
<C>
1998
Consolidated property-casualty entities...... $592,796 $(61,367)
$562,677
1997
Consolidated property-casualty entities...... $609,930 $(83,803)
$530,030
1996
Consolidated property-casualty entities...... $562,997 $(87,766)
$435,162
</TABLE>
53
<PAGE>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
INDEX TO EXHIBITS(A)
<TABLE>
<CAPTION>
Exhibit
Number Title
<S> <C>
2 Share and Note Purchase Agreement dated November 2, 1998 by
an among ACIC
Holding Company, Inc., The American Automobile Association
(Incorporated),
California State Automobile Association Inter-Insurance
Bureau and Automobile
Club Insurance Company.
3.1 Articles of Organization, as amended(B)
3.2 By-Laws(B)
4 Stock Certificate(B)
10.6* Form of Stock-Appreciation Right Agreement(B)
10.7* Stock-Appreciation Right and Book Value Award Agreement as
amended. (C)
10.8* 1994 Management Incentive Plan as amended (D)
10.17 Multiple Line Quota Share Reinsurance Agreement No. TM666A
between Commerce
Insurance and Citation Insurance with Swiss Reinsurance
America Corporation
dated July 1, 1998.
13.1 Annual Report for the year ended December 31, 1998 to
Security Holders.
22.1 Subsidiaries of the Registrant filed herewith.
</TABLE>
(A) Exhibits other than those listed are omitted because they are not
required or are not
applicable. Copies of exhibits are available without charge by
writing to the Assistant
to the President at 211 Main Street, Webster, MA 01570.
(B) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Registration Statement on Form S-18
(No. 33-12533-B).
(C) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Form 10-K for the year ended December
31, 1994.
(D) Incorporated herein by reference to the exhibit with the same
exhibit number, filed as
an exhibit to the Registrant's Form 10-Q for the period ended
September 30, 1997.
* Denotes management contract or compensation plan or arrangement.
54
<PAGE>
SHARE AND NOTE PURCHASE AGREEMENT
AMONG
ACIC HOLDING CO., INC.,
CALIFORNIA STATE AUTOMOBILE ASSOCIATION
INTER-INSURANCE BUREAU,
AUTOMOBILE CLUB INSURANCE COMPANY
AND
THE AMERICAN AUTOMOBILE ASSOCIATION, (INCORPORATED)
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C> <C>
<C>
ARTICLE I - SALE AND
PURCHASE..........................................................
.........1
1.1 Transfer of the ACIC Shares and the ACIC
Note..............1
1.2 Purchase
Price.............................................2
ARTICLE II - REPRESENTATIONS AND WARRANTIES OF
BUYER.......................2
2.1 Corporate
Organization.....................................2
2.2
Authorization..............................................2
2.3 Consents and
Approvals.....................................2
2.4 Investment
Intent..........................................3
2.5
Litigation.................................................3
2.6 No
Conflicts...............................................3
2.7 Transaction
Financing......................................3
ARTICLE III - REPRESENTATIONS AND WARRANTIES
OF............................4
3.1 Corporate
Organization......................................4
3.2
Authorization...............................................
4
3.3 Share Ownership and
Authority...............................4
3.4 Note Ownership, Authority and
Validity......................4
3.5 No
Conflicts................................................5
3.6
Litigation..................................................
5
3.7 Representations and Warranties of
Company...................5
3.8 Close Corporation Agreement and Shareholder's
Agreement.....5
3.9 Full
Disclosure.............................................5
3.10 AAA
Marks....................................................6
ARTICLE IV - REPRESENTATIONS AND WARRANTIES OF
CSAAIIB.....................6
4.1 Corporate
Organization......................................6
4.2
Authorization...............................................
6
4.3 Share Ownership and
Authority...............................6
4.4
Litigation..................................................
6
4.5 Close Corporation Agreement and Shareholders'
Agreement.....7
4.6 No Further Representations and
Warranties...................7
<PAGE>
ARTICLE V - REPRESENTATIONS AND WARRANTIES OF THE
COMPANY..................7
5.1 Corporate Organization;
Subsidiaries........................7
5.2
Authorization...............................................
7
5.3 Capitalization and Security
Holders.........................8
5.4
Litigation..................................................
8
5.5 No
Conflicts................................................8
5.6
Taxes.......................................................
9
5.7 Financial
Statements........................................10
5.8
Reports.....................................................
10
5.9 Insurance;
Reinsurance......................................10
5.10 Regulatory
Agreements.......................................12
5.11 Absence of
Changes..........................................12
5.12 Absence of Undisclosed
Liabilities..........................12
5.13 Insurance Coverage
Reserves..................................12
5.14 Operating Permits/Compliance with
Law........................13
5.15 Personal and Real
Property...................................13
5.16 Intellectual
Property........................................13
5.17 Year
2000....................................................14
5.18 Labor
Relations.............................................14
5.19 Benefit Plans and
Agreements................................15
5.20 Environmental
Matters.......................................16
5.21 Full
Disclosure.............................................17
ARTICLE VI - CONDITIONS PRECEDENT TO
OBLIGATIONS...........................17
6.1 Conditions to Obligations of
Buyer..........................17
6.2 Conditions to Obligations of
Sellers........................17
ARTICLE VII -
CLOSING...........................................................
.........21
7.1 The
Closing.................................................21
7.2 Deliveries of AAA at
Closing................................21
7.3 Deliveries of CSAAIIB at
Closing............................21
7.4 Deliveries of the Company at
Closing........................21
7.5 Deliveries of Buyer at
Closing..............................21
<PAGE>
ARTICLE VIII -
COVENANTS.........................................................
.........23
8.1 Covenant Not to
Compete.....................................23
8.2 Conduct of Business of the Company Prior to the
Closing.....24
8.3 No
Negotiations.............................................25
8.4 Access to
Records...........................................26
8.5 Hart-Scott-Rodino Act
Filings...............................27
8.6 Insurance License
Filings...................................27
8.7 Insurance Holding Company
Filings...........................27
8.8 Additional Financial
Statements.............................27
8.9 Welfare Plans and Other Benefit
Plans.......................27
8.10 Severance
Pay...............................................28
8.11 Certain Tax
Matters.........................................28
8.12 Insurance
Coverage..........................................30
8.13 Sun Bank
Guaranty...........................................30
ARTICLE IX - INTELLECTUAL
PROPERTY..........................................................
..........30
9.1 Use of Certain Intellectual
Property........................30
9.2 Change of Company's
Name....................................31
9.3 Dividend of Name and
Mark...................................31
9.4 Specific
Performance........................................31
9.5
Enforcement.................................................
31
ARTICLE X -
TERMINATION.....................................................32
10.1 Termination of
Agreement.....................................32
10.2 Effect of
Termination........................................33
10.3 Right of First
Refusal.......................................33
ARTICLE XI -
INDEMNIFICATION...................................................
..........34
11.1 Survival of Representations, Warranties and
Agreements.......34
11.2
Indemnification.............................................
.34
11.3 Limitations on
Indemnification...............................36
11.4 Procedure for
Indemnification................................37
ARTICLE XII - MISCELLANEOUS
PROVISIONS........................................................
..........39
12.1
Notice......................................................
.39
<PAGE>
12.2 Entire
Agreement.............................................40
12.3 Binding Effect;
Assignment...................................41
12.4 No Third-Party
Beneficiaries.................................41
12.5
Counterparts................................................
.41
12.6
Captions....................................................
.41
12.7 Expenses and
Transactions....................................41
12.8 Waiver;
Consent..............................................41
12.9 Other and Further
Covenants..................................41
12.10
Construction................................................
..41
12.11 Governing
Law.................................................42
12.12 Public
Announcements..........................................42
12.13 Certain
Definitions...........................................42
SCHEDULES.........................................................
..........55
EXHIBITS..........................................................
..........56
</TABLE>
<page
SHARE AND NOTE PURCHASE AGREEMENT
THIS SHARE AND NOTE PURCHASE AGREEMENT (this "Agreement") is made
and entered into as of the 2nd day of November 1998, by and among ACIC
HOLDING CO., INC., a Rhode Island corporation ("Buyer"), THE AMERICAN
AUTOMOBILE ASSOCIATION, (INCORPORATED), a Connecticut non-stock
corporation ("AAA"), CALIFORNIA STATE AUTOMOBILE ASSOCIATION
INTER-INSURANCE BUREAU, a California reciprocal insurer ("CSAAIIB") (AAA
and CSAAIIB each a "Seller", together the "Sellers") and AUTOMOBILE CLUB
INSURANCE COMPANY, an Ohio corporation (the "Company").
W I T N E S S E T H:
WHEREAS, AAA is the record and beneficial owner of 98,769 of the
outstanding common shares (the "AAA Shares") of the Company and capital
surplus note of the Company with a principal balance of $24,500,000 (the
"ACIC Note");
WHEREAS, CSAAIIB is the record and beneficial owner of 8,769 of
the outstanding common shares of the Company (the "CSAAIIB Shares"; the
AAA Shares and the CSAAIIB Shares together the "ACIC Shares");
WHEREAS, the Company has the right to use (through agreements with
various agencies which are affiliated with AAA Affiliated Clubs) AAA's
service mark (e.g., the AAA oval) in marketing its insurance products
through certain of the agencies which are affiliated with AAA-affiliated
automobile clubs;
WHEREAS, Buyer desires to purchase from Sellers, and Sellers
desire to sell to Buyer, the ACIC Shares on the terms and subject to the
conditions hereinafter set forth; and
WHEREAS, Buyer desires to purchase from AAA, and AAA desires to
sell to Buyer, the ACIC Note on the terms and subject to the conditions
hereinafter set forth;
NOW, THEREFORE, in consideration of the premises and the mutual
promises herein contained, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto agree as follows:
ARTICLE I
SALE AND PURCHASE
1.1 Transfer of the ACIC Shares and the ACIC Note. Upon the
terms and subject to the conditions set forth in this Agreement, at the
Closing (as defined in Section 5.1), each Seller shall sell, assign,
transfer and deliver to Buyer its respective ACIC Shares and AAA shall
sell, assign, transfer and deliver to Buyer the ACIC Note.
<PAGE>
1.2 Purchase Price.
(a) In consideration of the delivery to Buyer in accordance with
this Agreement of certificates representing the ACIC Shares and the ACIC
Note, at the Closing, Buyer shall pay to Sellers an aggregate purchase
price (the "Purchase Price") of Seventy Eight Million Five Hundred
Thousand Dollars ($78,500,000), which Purchase Price shall be allocated
between AAA and CSAAIIB in accordance with Section 1.2(c).
(b) The Purchase Price shall be payable at the Closing by
delivery to Sellers by wire transfer of immediately available funds to a
bank account or accounts designated by Sellers prior to the Closing.
(c) The Purchase Price shall be allocated as follows: (i)
$24,500,000 shall be payable to AAA for the ACIC Note, (ii) $3,500,000
shall be payable to AAA for the Covenant Not to Compete (as defined in
Section 8.1), and (iii) the balance shall be allocated to the ACIC
Shares. The portion of the Purchase Price allocated to the ACIC Shares
shall be allocated between the AAA Shares and the CSAAIIB Shares in
accordance with Schedule 1.2(c).
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF BUYER
Buyer hereby represents and warrants to Seller as of the date of
this Agreement and as of the Closing that:
2.1 Corporate Organization. Buyer is a corporation duly
organized, validly existing and in good standing under the laws of the
State of Rhode Island, and has all requisite power and authority
(corporate and other) to enter into this Agreement, perform its
obligations hereunder and consummate the transactions contemplated
hereby.
2.2 Authorization. All necessary and appropriate corporate
action has been taken by Buyer with respect to the execution and
delivery of this Agreement and the performance of its obligations
hereunder, and this Agreement constitutes a valid and binding obligation
of Buyer enforceable against it in accordance with its terms, except as
such enforceability may be limited by: (i) bankruptcy, insolvency,
reorganization, moratorium or similar laws now or hereafter in effect
relating to creditor's rights generally, and (ii) the remedy of specific
performance and injunctive and other forms of equitable relief which may
be subject to equitable defenses and to the discretion of the court
before which any proceeding therefor may be instituted.
2.3 Consents and Approvals. No consent, approval, order or
authorization of, or registration, declaration or filing with, any
governmental authority is required in connection with Buyer's execution
and delivery of this Agreement or its performance of the terms hereof,
other than filings with and approvals of state insurance regulatory
authorities and the filing of a pre-merger notification report by Buyer
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended (the "HSR Act").
<PAGE>
2.4 Investment Intent. Buyer is acquiring the ACIC Shares and
the ACIC Note for the purpose of investment only and not with a view to,
or for sale in connection with, the distribution thereof within the
meaning of the Securities Act.
2.5 Litigation. There is no claim, litigation, action, suit,
proceeding, investigation or inquiry, administrative or judicial,
pending or, to the best knowledge of Buyer, threatened against Buyer, at
law or in equity, before any federal, state or local court or regulatory
agency, or other governmental authority, which, individually or in the
aggregate, is reasonably likely to have a Material Adverse Effect on
Buyer or materially affect its ability to consummate the transactions
contemplated hereby, or seeks to prohibit, enjoin or otherwise challenge
the consummation by Buyer of the transactions contemplated hereby.
2.6 No Conflicts. Neither the execution and delivery of this
Agreement by Buyer, nor the consummation by Buyer of the transactions
contemplated hereby will (i) conflict with or result in a breach of any
provision of the Articles of Incorporation or By-Laws of Buyer, (ii)
violate, conflict with or result in a breach of any provision of, or
constitute a default (or an event which, with the giving of notice, the
passage of time or otherwise, would constitute a default) under, or
entitle any party (with the giving of notice, the passage of time or
otherwise) to terminate, accelerate or cause a default under, or result
in the creation of any lien, security interest, charge or encumbrance
upon any of the properties or assets of Buyer under any of the terms,
conditions or provisions of any agreement, indenture, instrument, order,
judgment or decree binding on Buyer or its properties or assets, except
for such violations, conflicts, breaches, defaults, terminations,
accelerations, liens, security interests, charges or encumbrances which
would not have a Material Adverse Effect on Buyer, (iii) violate any
judgment, order, decree, stipulation, injunction or charge of any court,
administrative agency or commission or other governmental authority or
instrumentality by which Buyer is bound, except for such violations
which would not have a Material Adverse Effect on Buyer, or (iv) require
any consent, approval, declaration, order or authorization of, or
registration or filing with, any third party, court or governmental body
or other agency, instrumentality or authority by or with respect to
Buyer in connection with the execution and delivery of this Agreement or
the consummation of the transactions contemplated hereby, other than
filings with and approvals of state insurance regulatory Authorities,
and other than the filing of a pre-merger notification report by Buyer
under the HSR Act, except where the failure to obtain any such consent,
approval, declaration, order or authorization or to make any such
registration or filing would not have a Material Adverse Effect on Buyer
or materially affect its ability to consummate the transactions
contemplated hereby.
2.7 Transaction Financing. Buyer has binding investment
commitments from its Affiliates in an amount sufficient to enable it to
purchase the ACIC Shares and ACIC Note as provided in Section 1.2.
<PAGE>
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF AAA
AAA represents and warrants to Buyer, as of the date of this
Agreement and as of the Closing that:
3.1 Corporate Organization. AAA is a non-stock corporation duly
organized, validly existing and in good standing under the laws of the
State of Connecticut. AAA has all requisite power and authority
(corporate and other) and licenses necessary to own, lease and operate
its properties and conduct its business as presently conducted. AAA has
previously delivered to Buyer true, correct and complete copies of the
Articles of Incorporation of AAA and the AAA Bylaws.
3.2 Authorization. All necessary and appropriate corporate
action has been taken by AAA with respect to the execution and delivery
of this Agreement and the performance of AAA's obligations hereunder.
This Agreement has been duly and validly executed and delivered by AAA
and constitutes the legal, valid and binding obligations of AAA,
enforceable against AAA in accordance with its terms, except as such
enforceability may be limited by: (i) bankruptcy, insolvency,
reorganization, moratorium or similar laws now or hereafter in effect
relating to creditor's rights generally, and (ii) the remedy of specific
performance and injunctive and other forms of equitable relief which may
be subject to equitable defenses and to the discretion of the court
before which any proceeding therefor may be instituted.
3.3 Share Ownership and Authority. AAA is the sole beneficial
and record owner of the AAA Shares. To AAA's knowledge, together the
AAA Shares and the CSAAIIB Shares constitute all the issued and
outstanding shares of capital stock of the Company, and (except for the
Close Corporation Agreement and the Shareholders' Agreement as defined
in Section 3.8) AAA has the full and unrestricted power to sell, assign,
transfer and deliver the AAA Shares to Buyer in accordance with the
terms of this Agreement. At the Closing, AAA shall transfer and convey
to Buyer, and Buyer will acquire, good, valid and marketable title to
the AAA Shares, free and clear of any and all rights, title, interest
and claims of others, including without limitation liens, security
interests, encumbrances, pledges, charges, claims, voting trusts and
restrictions on transfer of any nature whatsoever and without the
consent of any third party other than the consent of CSAAIIB pursuant to
Section 4.5 and the consent of any state insurance regulatory
authorities, except as set forth on Schedule 3.3, and except for
restrictions on transfer imposed by or pursuant to the securities laws
of the United States.
3.4 Note Ownership, Authority and Validity. AAA is the sole
beneficial and record owner of the ACIC Note which constitutes the only
capital surplus note issued by the Company, and AAA has the full and
unrestricted power to sell, assign, transfer and deliver the ACIC Note
to Buyer in accordance with the terms of this Agreement. At the
Closing, AAA shall transfer and convey to Buyer, and Buyer will acquire,
good, valid and marketable title to the ACIC Note, free and clear of any
and all rights, title, interest and claims of others, including without
limitation liens, security interests, encumbrances, pledges, charges,
claims, and restrictions on transfer of any nature whatsoever and
without the consent of any third party, except as set forth on Schedule
3.4
<PAGE>
and except for restrictions on transfer imposed by or pursuant to the
securities laws of the United States. The ACIC Note has been validly
issued by the Company and is the binding obligation of the Company,
enforceable against it in accordance with its terms, except as such
enforceability may be limited by: (i) bankruptcy, insolvency,
reorganization, moratorium or similar laws now or hereafter in effect
relating to creditor's rights generally, and (ii) the remedy of specific
performance and injunctive and other forms of equitable relief which may
be subject to equitable defenses and to the discretion of the court
before which any proceeding therefor may be instituted.
3.5 No Conflicts. Except as set forth on Schedule 3.5 and
except for the Close Corporation Agreement and the Shareholders'
Agreement, neither the execution and delivery of this Agreement by AAA,
nor the consummation by AAA of the transactions contemplated hereby will
(i) conflict with or result in a breach of any provision of the Articles
of Incorporation of AAA or the AAA bylaws (ii) require any consent,
approval, declaration, order or authorization of, or registration or
filing with, any third party, court or governmental body or other
agency, instrumentality or authority by or with respect to AAA in
connection with the execution and delivery of this Agreement or the
consummation of the transactions contemplated hereby, other than filings
with and approvals of any state insurance regulatory authorities and
other than the filing of a pre-merger notification report by AAA and
Buyer under the HSR Act, except where the failure to obtain any such
consent, approval, declaration, order or authorization or to make any
such registration or filing would not have a Material Adverse Effect on
AAA or materially affect AAA's ability to consummate the transactions
contemplated hereby.
3.6 Litigation. There is no claim, litigation, action, suit or
proceeding, pending or, to the best knowledge of AAA, threatened, that
questions the validity of this Agreement or seeks to prohibit, enjoin,
or otherwise challenge the consummation by AAA of the transactions
contemplated hereby.
3.7 Representations and Warranties of Company. To the best
knowledge of AAA, the representations and warranties of the Company set
forth in Article V are true and accurate.
3.8 Close Corporation Agreement and Shareholder's Agreement.
AAA acknowledges that it is a party to (a) the Close Corporation
Agreement effective December 21, 1988 among it, CSAAIIB, the Company and
each party who becomes a party to such Close Corporation Agreement
pursuant to Section 5.06 thereof (the "Close Corporation Agreement").
and to (b) the Amended Shareholders' Agreement dated July 1, 1990
between AAA and CSAAIIB (the "Shareholders' Agreement").
Notwithstanding the terms of the Close Corporation Agreement and the
Shareholders Agreement, AAA consents to the execution of this Agreement
by CSAAIIB and CSAIIB's performance of its obligations hereunder and
waives any claim that such execution or performance constitutes a
violation of either the Close Corporation Agreement or the Shareholders
Agreement. AAA further acknowledges and agrees that the Close
Corporation Agreement and the Shareholders Agreement shall terminate as
of the Closing, and neither Buyer nor the Company shall have any
liability thereunder.
<PAGE>
3.9 Full Disclosure. Each statement of fact set forth in any
Schedule referenced in this Article III is true and accurate and does
not omit to state any material fact necessary in order to make the
statements made or information disclosed, in light of the circumstances
under which they were made or disclosed, not misleading.
3.10 AAA Marks. AAA owns the AAA Marks. Each AAA Affiliated
Club that is a AAA Organization (as defined in the AAA Bylaws) member in
good standing has the right to use the AAA Marks in the Service Area of
such AAA Affiliated Club in accordance with the Emblem Regulations,
which Emblem Regulations may be amended, supplemented or superceded at
any time in the sole discretion of AAA.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF CSAAIIB
CSAIIB represents and warrants to Buyer, as of the date of this
Agreement and as of the Closing that:
4.1 Corporate Organization. CSAAIIB is a reciprocal insurer
duly organized, validly existing and in good standing under the laws of
the State of California. CSAAIIB has all requisite power and authority
and licenses necessary to own, lease and operate its properties and
conduct its business as presently conducted.
4.2 Authorization. All necessary and appropriate action has
been taken by CSAAIIB with respect to the execution and delivery of this
Agreement and the performance of CSAAIIB's obligations hereunder. This
Agreement has been duly and validly executed and delivered by CSAAIIB
and constitutes the legal, valid and binding obligations of CSAAIIB,
enforceable against CSAAIIB in accordance with its terms, except as such
enforceability may be limited by: (i) bankruptcy, insolvency,
reorganization, moratorium or similar laws now or hereafter in effect
relating to creditor's rights generally, and (ii) the remedy of specific
performance and injunctive and other forms of equitable relief which may
be subject to equitable defenses and to the discretion of the court
before which any proceeding therefor may be instituted. Neither the
execution and delivery of this Agreement by CSAAIIB nor the consummation
by CSAAIIB of the transactions contemplated hereby will conflict with or
result in a breach of any provision of CSAAIIB's rules and regulations.
4.3 Share Ownership and Authority. CSAAIIB is the sole
beneficial and record owner of the CSAAIIB Shares. To CSAAIIB's
knowledge, together the CSAAIIB Shares and the AAA Shares constitute all
the issued and outstanding shares of capital stock of the Company and,
except as provided in the Close Corporation Agreement and the
Shareholders' Agreement, CSAAIIB has the full and unrestricted power to
sell, assign, transfer and deliver the CSAAIIB
<PAGE>
Shares to Buyer in accordance with the terms of this Agreement. At the
Closing, CSAAIIB shall transfer and convey to Buyer, and Buyer will
acquire, good, valid and marketable title to the CSAAIIB Shares, free
and clear of any and all rights, title, interest and claims of others,
including without limitation liens, security interests, encumbrances,
pledges, charges, claims, voting trusts and restrictions on transfer of
any nature whatsoever and without the consent of any third party other
than the consent of AAA pursuant to Section 3.8 and the consent of any
state insurance regulatory authorities, except as set forth on Schedule
4.3, and except for restrictions on transfer imposed by or pursuant to
the securities laws of the United States.
4.4 Litigation. There is no claim, litigation, action, suit or
proceeding, pending or, to the best knowledge of CSAAIIB, threatened,
that questions the validity of this Agreement or seeks to prohibit,
enjoin, or otherwise challenge the consummation by CSAAIIB of the
transactions contemplated hereby.
4.5 Close Corporation Agreement and Shareholders' Agreement.
CSAAIIB acknowledges that it is a party to each of the Close Corporation
Agreement and the Shareholders' Agreement. Notwithstanding the terms of
the Close Corporation Agreement and the Shareholders Agreement, CSAAIIB
consents to the execution of this Agreement by AAA and AAA's performance
of its obligations hereunder and waives any claim that such execution or
performance constitutes a violation by AAA of either the Close
Corporation Agreement or the Shareholders' Agreement. CSAAIIB further
acknowledges and agrees that the Close Corporation Agreement and the
Shareholders Agreement shall terminate as of the Closing, and neither
Buyer nor the Company shall have any liability thereunder.
4.6 No Further Representations and Warranties. CSAAIIB
disclaims any and all other warranties, express or implied, including,
without limitation, those of the Company and AAA.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to Buyer that:
5.1 Corporate Organization; Subsidiaries.
(a) The Company is a corporation duly organized, validly
existing and in good standing under the laws of the State of Ohio. The
Company has previously delivered to Buyer true, correct and complete
copies of its Articles of Incorporation, By-Laws and Code of
Regulations. The Company has no Subsidiaries (defined as a corporation
or other entity controlled by the Company).
(b) The Company is duly qualified to do business and is in good
standing in each jurisdiction listed on Schedule 5.1, is not qualified
to do business in any other jurisdiction, and neither the nature of the
business conducted by it nor the property it owns, leases or operates
requires it to qualify to do business as a foreign corporation in any
other jurisdiction. The Company has all requisite power and authority
(corporate and other) and licenses necessary to own, lease and operate
its properties and conduct its business as presently conducted.
<PAGE>
5.2 Authorization. All necessary corporate action has been
taken by the Company with respect to the execution and delivery of this
Agreement and the performance of its obligations hereunder. This
Agreement has been duly and validly executed and delivered by the
Company and constitutes the legal, valid and binding obligations of the
Company, enforceable against the Company in accordance with its terms,
except as such enforceability may be limited by: (i) bankruptcy,
insolvency, reorganization, moratorium or similar laws now or hereafter
in effect relating to creditor's rights generally, and (ii) the remedy
of specific performance and injunctive and other forms of equitable
relief which may be subject to equitable defenses and to the discretion
of the court before which any proceeding therefor may be instituted.
5.3 Capitalization and Security Holders. The authorized capital
stock of the Company consists solely of one million (1,000,000) shares
of common stock, of which the 107,538 ACIC Shares are the only issued
and outstanding shares. All outstanding shares of common stock of the
Company have been validly issued and are fully paid and nonassessable.
Except as set forth on Schedule 5.3, (i) there are no outstanding
subscriptions, options, warrants, puts, calls, agreements,
understandings, or other commitments or rights of any type relating to
the issuance, sale or transfer by the Company of any securities of the
Company, (ii) there are no outstanding securities which are convertible
into or exchangeable for any shares of capital stock of the Company; and
(iii) the Company has no obligation of any kind to issue any additional
securities. None of the shares of Company capital stock outstanding was
issued in violation of the preemptive rights of any person.
5.4 Litigation. Except as set forth on Schedule 5.4, and except
for all reported, and all incurred but unreported, claims incurred in
the ordinary course under insurance policy obligations, there is no
claim, litigation, action, suit, proceeding, investigation or inquiry,
administrative or judicial, pending or, to the best knowledge of the
Company, threatened against the Company, at law or in equity, before any
federal, state or local court or regulatory agency, or other
governmental authority. Without limiting the scope of the immediately
preceding sentence, except as set forth on Schedule 5.4, there is no
claim, litigation, action, suit, proceeding, investigation or inquiry
pending or, to the best knowledge of the Company, threatened that
alleges that the Company has committed fraud or acted in bad faith in
contesting a claim under one or more insurance policies issued by the
Company. There is no claim, litigation, action, suit, proceeding,
investigation or inquiry pending or, to the best knowledge of the
Company, threatened, that questions the validity of this Agreement or
seeks to prohibit, enjoin or otherwise challenge the consummation of the
transactions contemplated hereby.
5.5 No Conflicts. Except as set forth on Schedule 5.5, neither
the execution and delivery of this Agreement by the Company, nor the
consummation by the Company of the transactions contemplated hereby will
(i) conflict with or result in a breach of any provision of the Articles
of Incorporation or Code of Regulations of the Company, (ii) violate,
conflict with or result in a breach of any provision of, or constitute a
default (or an event which, with the giving of notice, the passage of
time or otherwise, would constitute a default) under, or entitle any
party (with the giving of notice, the passage of time or otherwise) to
terminate, accelerate or cause a default under, or result in the
creation of any lien, security interest, charge or encumbrance upon any
of the properties or assets of the Company, under any of the terms,
conditions or provisions of any agreement, indenture, instrument, order,
judgment or decree binding on the Company or its
<PAGE>
properties or assets, (iii) violate any judgment, order, decree,
stipulation, injunction or charge of any court, administrative agency or
commission or other governmental authority or instrumentality by which
the Company or any of the Company's assets is bound, or (iv) require any
consent, approval, declaration, order or authorization of, or
registration or filing with, any third party, court or governmental body
or other agency, instrumentality or authority by or with respect to the
Company in connection with the execution and delivery of this Agreement
or the consummation of the transactions contemplated hereby, other than
filings with and approvals of any state insurance regulatory authority
and other than the filing of a pre-merger notification report under the
HSR Act. The Company has received a letter from International Business
Machines Corporation ("IBM"), the successor entity to Integrated Systems
Solutions Corporation ("ISSC"), to the effect that the purchase of the
ACIC Shares and the ACIC Note by Buyer in accordance with the terms
herein will not be deemed by IBM to constitute an assignment in
violation of Section 16.13 of that certain Agreement for Information
Technology Services dated as of January 10, 1996 by and between Buyer
and ISSC, a copy of which letter is included with Schedule 5.5.
5.6 Taxes.
(a) Except as set forth on Schedule 5.6, for all taxable years
ending on or after January 1, 1995, the Company and any affiliated,
combined or unitary group of which the Company is or was a member has
(i) correctly prepared and timely filed all returns, declarations,
estimates, reports, claims for refund, information returns and
statements, (collectively "Returns") required to be filed with respect
to all federal, state, local and foreign income (gross or net) taxes,
customs, premium tax (other than premium taxes not in excess of $1,000
in any instance), duties, fees, together with any interest, penalties or
other additions ("Taxes"), (ii) timely and properly paid all Taxes due
and payable, and (iii) established on its books and records reserves
that are adequate for the payment of all Taxes accrued but not yet due
and payable.
(b) Except as set forth on Schedule 5.6, there are no actual or
proposed Tax deficiencies, assessments, or adjustments for Taxes with
respect to the Company or any assets, property or operations of the
Company. Except as set forth in Schedule 5.6, (i) there are no liens
for Taxes upon the assets of the Company, (ii) there has been no
extension of time within which to file any Return which has not since
been filed, (iii) there are no waivers or consents regarding the
application of the statute of limitations with respect to any Taxes or
Returns and (iv) no federal, state, local or foreign audits or other
administrative proceedings or court proceedings are pending with regard
to any Taxes or Returns.
(c) The Company has not made any election under Section 341(f)
of the Code or any corresponding provision of state, local or foreign
Tax Law. The Company is not required to include in income any
adjustment pursuant to Section 481(a) of the Code by reason of a
voluntary change in accounting method nor does the Company have any
knowledge that the Internal Revenue Service has proposed any such
adjustment or change in accounting method. The Company, as a result of
any "closing agreement" as defined in Section 7121 of the Code (or any
corresponding provisions of any state, local or foreign Tax Law), is not
required to include any item of income in or exclude any item of
deduction from taxable income. The Company, as a result of any deferred
intercompany gain or any excess loss account, described in Section
1.1502
<PAGE>
of the Treasury Department Regulations concerning consolidated returns,
is not required to include any item of income in taxable income. The
Company has not been at any time during the past ten (10) years a member
of an affiliated group, as defined in Section 1504 of the Code, other
than one of which AAA was the common parent, or filed or been included
in a combined, consolidated or unitary income tax return other than one
filed by AAA.
(d) The Company has not made any payments and is not obligated
under any contract to make any payments that will be nondeductible, in
whole or in part, under Section 280G or 162(m) of the Code.
(e) There are no deficiencies, assessments or adjustments for
the Taxes of any Person other than the Company for which the Company
would have liability under Reg. 1.1502-6 (or any similar provision of
state, local or foreign law), whether as a transferee or successor, by
contract or otherwise.
(f) Attached as Schedule 5.6(f) is a copy of the Tax Sharing
Agreement (the "Tax Sharing Agreement") to which the Company currently
is a party. The Company has not been a party to any other tax sharing
agreement with AAA.
5.7 Financial Statements. The statutory financial statements
(including the notes thereto) of the Company as of and for the years
ended December 31, 1996 and December 31, 1997 (the "Annual Statement")
have been prepared in conformity with SAP applied on a consistent basis
and present fairly, in all material respects, the admitted assets,
liabilities and capital and surplus of the Company at the dates stated
therein on the basis of such accounting practices and the results of
operations for the periods then ended. The Quarterly Statement for the
quarter ended June 30, 1998 (the "Quarterly Statement") has been
prepared in conformity with SAP (except for lack of footnotes and normal
year-end adjustments as described on Schedule 5.7) and presents fairly,
in all material respects, the admitted assets, liabilities and capital
and surplus of the Company at the dates stated therein and the results
of its operations for their periods then ended on the basis of such
practices. The books and records of the Company have been and are being
maintained in conformity with SAP.
5.8 Reports. Since December 31, 1994, the Company has filed all
reports, registrations and statements, together with any amendments
required to be made with respect thereto, that were required to be filed
with: (i) the Ohio Superintendent of Insurance; and (ii) any applicable
state or foreign insurance or licensing authorities (all such reports
and statements are collectively referred to herein as the "Company
Reports"). As of their respective dates, the Company Reports complied
with the statutes, rules and regulations enforced or promulgated by the
regulatory authority with which they were filed.
5.9 Insurance; Reinsurance.
(a) [INTENTIONALLY OMITTED.]
<PAGE>
(b) Since December 31, 1994, all insurance policies issued,
reinsured or underwritten by the Company have been, to the extent
required by applicable law, in all material respects on forms approved
by the insurance regulatory authority of the jurisdiction where issued
or delivered or have been filed with and not objected to by such
authority within the period prescribed for such objection, and have
utilized premium rates which if required to be filed with or approved by
insurance regulatory authorities have been so filed or approved and the
premiums charged conform thereto.
(c) All reported claims under insurance policy obligations
incurred by the Company have either been paid (or provision for payment
has been made therefor) in accordance with the terms of the contracts
under which they arose, except for (i) such obligations for which the
Company reasonably believes there is a basis to contest payment, (ii)
such claims as the Company is currently investigating, and (iii) the
items listed on Schedule 5.9(c).
(d) No outstanding insurance contract has been issued or assumed
by the Company that would entitle the holder thereof or any other Person
to receive dividends, distributions or other benefits based on the
revenues or earnings of the Company.
(e) Except as set forth on Schedule 5.9(e), there are (A) no
claims asserted, (B) no actions, suits, investigations or proceedings by
or before any court or other governmental entity, and (C) no
investigations by or on behalf of the Company ((A), (B) and (C) being
collectively referred to as "Actions") pending or, to the best knowledge
of the Company threatened, against the Company that include allegations
that the Company was in violation of or failed to comply with any Law,
determination or award applicable to the Company in the respective
jurisdictions in which its products have been sold, and, to the best
knowledge of the Company, no facts exist which would reasonably be
expected to result in the filing or commencement of any such Action.
(f) Schedule 5.9(f) contains a complete and correct list as of
the date hereof of all reinsurance agreements to which the Company is a
party.
(g) Since December 31, 1994, all advertising, promotional, sales
and solicitation materials and product illustrations used by the
Company, or, to the best knowledge of the Company as of the date of this
Agreement, by any Agent of the Company, have complied, with all
applicable Laws.
(h) Since December 31, 1994, each Agent appointed by the
Company, at the time such Agent wrote, sold or produced business for the
Company, was duly appointed and, to the best knowledge of the Company,
duly licensed, as an insurance agent (for the type of business written,
sold or produced by such Agent) in the particular jurisdiction in which
such Agent wrote, sold or produced such business for the Company; and to
the best knowledge of the Company as of the date of this Agreement, no
such Agent has violated (or with or without notice or lapse of time or
both would have violated) any term or provision of any Law applicable to
the writing, sale or production of business for the Company.
<PAGE>
(i) As of the date of this Agreement, to the best knowledge of
the Company, except as disclosed on Schedule 5.9(i) the Company has not
received any written notification by any Agent or Agents threatening
litigation or termination of their agency agreements with the Company or
otherwise establishing a basis reasonably to believe that such Agents
are likely to cease to do business with the Company in the same manner
as such business has been conducted historically, whether as a result of
the transactions contemplated by this Agreement or otherwise. There are
no side agreements or other written agreements between the Company and
such Agents or former Agents, including, without limitation, agreements
with respect to the payment of compensation by the Company to such
Agents or former Agents in existence on the date hereof and on the
Closing Date.
(j) As of the date of this Agreement, all reinsurance treaties
and arrangements to which the Company is a party are in full force and
effect, and neither the Company nor, to the best knowledge of the
Company, any other party thereto, is in violation of or in default in
the performance, observance or fulfillment of any material obligation,
agreement, covenant or condition contained therein; the Company has not
received any notice from any of the other parties to such treaties,
contracts or agreements that such other party intends not to perform
such treaty, contract or agreement and, to the best knowledge of the
Company, the Company has no reason to believe that any of the other
parties to such treaties, contracts or arrangements will be unable to
perform such treaty, contract or arrangement.
5.10 Regulatory Agreements. Except as set forth on Schedule
5.10, as of the date of this Agreement, the Company is not subject to or
the recipient of any of the following (each a "Regulatory Agreement"):
a cease-and-desist or other order issued by, a written agreement,
consent agreement or memorandum of understanding with, a commitment
letter or similar undertaking to, an order or directive by (in each case
specifically addressed to the Company), or an extraordinary supervisory
letter from, or a board of director resolution adopted at the request
of, any Authority that restricts the conduct of the business of the
Company or of any direct or indirect beneficial owner of the capital
stock of the Company, or that, in any other manner, relates to the
Company's capital adequacy, its underwriting or investment policies, its
management, or its business. There are no disciplinary proceedings
pending before or, to the best knowledge of the Company, being actively
considered by any Authority.
5.11 Absence of Changes.
(a) Since December 31, 1997: (i) the business of the Company
has been conducted in the ordinary course and substantially consistent
with recent past practices; and (ii) there has not been, occurred or
arisen any adverse change in the business, affairs or financial
condition of the Company other such events which, individually or in the
aggregate, have not had a Material Adverse Effect on the Company.
(b) The Company has not been given notice from A.M. Best
Company, Inc. of any condition (financial or otherwise) on retaining the
currently held rating or any threatened or prospective downgrading in
such rating.
<PAGE>
5.12 Absence of Undisclosed Liabilities. Except as and to the
extent reflected in the Annual Statement, the Quarterly Statement, or on
Schedule 5.12, the Company does not have any liabilities, commitments or
obligations of any nature, whether absolute, accrued, contingent or
otherwise, and whether due or to become due which would be required by
SAP to be disclosed on the Annual Statement or the Quarterly Statement,
other than liabilities incurred since the Most Recent Balance Sheet Date
in the ordinary course of business, consistent with past practice.
5.13 Insurance Coverage Reserves.
(a) The aggregate reserves and other amounts of liabilities or
obligations of the Company (including, without limitation, reserves
established as an allowance for uncollectible amounts under any
reinsurance, coinsurance or similar contract) as established or
reflected in the Annual Statements and the Quarterly Statements were
determined in accordance with SAP consistently applied and meet the
requirements of the insurance Laws of the applicable jurisdiction.
(b) The Company has made no material change in its insurance
reserving practices since December 31, 1994.
5.14 Operating Permits/Compliance with Law.
(a) Except as set forth on Schedule 5.14, the Company has
received no notice from any Authority that it is lacking any approvals,
authorizations, consents, licenses, orders, governmental security
clearances, and registrations and permits of all governmental agencies,
whether federal, state or local, United States or foreign, required to
permit the operation of its business as presently conducted.
(b) The Company has complied and is in compliance with all
United States and foreign laws, rules, regulations, ordinances, decrees
and orders applicable to the operation of its business as presently
conducted and/or to its owned or leased properties.
5.15 Personal and Real Property. Schedule 5.15 sets forth (i) a
true and correct list of all real property owned by the Company, and
(ii) a true and correct list of all real property leased by the Company.
Except as disclosed on Schedule 5.15, the Company has good and
marketable title to, and owns outright or leases or holds licenses to
use, all of its properties and assets (including, but not limited to,
the assets reflected in the Quarterly Statement) except for those
disposed of in the ordinary course of business, and none of such assets
is encumbered by any mortgage, lien, claim or encumbrance except such
mortgages, liens, claims or encumbrances as (a) are reflected on the
Quarterly Statement or Schedule 5.15, (b) arise out of taxes not yet due
and payable, or (c) relate to immaterial properties or assets. All
leases pursuant to which the Company leases any real or material
personal property are valid and binding in accordance with their
respective terms, and there is not under any such lease any existing
default by the Company, event of default or event which, with notice
and/or lapse of time, would constitute a default.
<PAGE>
All items of real or personal property owned or used by the Company and
material to its business have been property maintained and, to the best
knowledge of the Company, are in good operating order and repair in
light of their age. As of the date of this Agreement, there are no
pending lawsuits or condemnation, expropriation, eminent domain or
similar proceedings affecting all or any portion of any property listed
on Schedule 5.15 or the value thereof, and, to the best knowledge of the
Company, no such lawsuits or proceedings are contemplated.
5.16 Intellectual Property. Schedule 5.16 hereto sets forth a
list of all trademarks, trade names, service marks and copyrights (or
pending registrations and applications therefor) owned or used under
license by the Company (collectively, the "Intellectual Property,"
provided, however, that the term "Intellectual Property" shall not
include the AAA Marks and the Automobile Insurance Marks and Phrases),
and except as set forth in Schedule 5.16, no royalties, honorariums or
fees are payable by the Company to any Person by reason of the ownership
or use of the Intellectual Property, the AAA Marks or the Automobile
Insurance Marks and Phrases. Schedule 5.16 indicates each item of
Intellectual Property which the Company licenses or sublicenses to
others. No claims have been asserted against the Company by any Person
in connection with the use by the Company of any Intellectual Property,
no Person is infringing upon any of the rights of the Company with
respect to the Intellectual Property; and the Company's use of the
Intellectual Property does not infringe upon the rights of any Person.
5.17 Year 2000.
(a) Schedule 5.17 summarizes, as of the date of this Agreement,
in all material respects (i) the Company's communications and actions to
endeavor to ensure that the Company's computer systems will maintain the
functionality existing as of the date hereof, taking into account any
processing, accepting, calculating, writing and outputting of
date-related data whether on, before, or after January 1, 2000 (failure
to maintain such functionality hereinafter referred to as a "Year 2000
Problem") and (ii) the status of the Company's dealings and
communications with the Company's Agents, insurance companies, vendors,
suppliers and service providers with respect to the preparedness of such
Persons with respect to the Year 2000 Problem. The Company has made
available to Buyer copies of all in-house correspondence and memoranda
and all correspondence between the Company and its Agents, insurance
companies, vendors, suppliers and service providers concerning Year 2000
Problem compliance.
(b) As of the date of this Agreement, to the best knowledge of
the Company, no Agent, insurance company, supplier, vendor or service
provider with which the Company transacts business will be unable to
timely remedy their own deficiencies in respect of the Year 2000
Problem.
<PAGE>
5.18 Labor Relations.
(a) Schedule 5.18(a) sets forth (i) the name and respective
salaries, or wages, dates of employment, and positions of each officer
and director of the Company and each other Employee whose total
compensation during the year ended December 31, 1997 exceeded $75,000,
(ii) all wage or salary increases or bonuses received by such persons
since December 31, 1997, and any accrual for such increases or bonuses
since December 31, 1997, and (iii) all commitments or agreements by the
Company to increase the wages or modify the conditions or terms of
employment of any of its Employees, other than, in the case of Employees
who are not officers or directors, year-end raises consistent with past
practice.
(b) Except as disclosed on Schedule 5.18(b), there are no
complaints, charges or claims against the Company pending or, to the
best knowledge of the Company, threatened to be brought or filed with
any governmental authority, arbitrator or court based on, arising out
of, in connection with, or otherwise relating to the employment or
termination of employment of any individual by the Company. True and
correct copies of all written personnel policies and manuals of the
Company as they relate to the Employees have been made available to
Buyer.
(c) The Company is not a party to any labor or collective
bargaining agreement, and no employees of the Company are represented by
any labor organization. Since December 31, 1994, (i) there have been no
representation or certification proceedings, or petitions seeking a
representation proceeding, pending or, to the best knowledge of the
Company, threatened to be brought or filed with the National Labor
Relations Board or any other labor relations tribunal or authority, and
(ii) to the best knowledge of the Company, there have been no organizing
activities involving the Company with respect to any group of employees
of the Company. No election or proceedings relating to the Company's
labor relations with the Employees is pending or, to the best knowledge
of the Company, contemplated.
(d) Except as set forth on Schedule 5.18(d), the Company has no
written policy or written agreement requiring the Company to make
severance payments to any Employee in connection with the termination of
their employment with the Company.
5.19 Benefit Plans and Agreements.
(a) A true and complete list of all Benefit Plans in effect that
the Company maintains or to which it contributes or since December 31,
1994 has maintained or contributed for the benefit of the Employees is
listed in Schedule 5.19(a).
(b) The Company has delivered to Buyer an accurate and complete
copy of each of (i) each Benefit Plan (including any amendments thereto)
listed on Schedule 5.19(b) (or, to the extent any Benefit Plan has not
been reduced to writing, an accurate description thereof), and, to the
extent applicable, an accurate and complete copy of each of any related
trust agreement, annuity contract or other funding instrument and any
other documents pursuant to which the Benefit Plan is or has been
maintained, funded or administered; (ii) the most recent determination
letter issued by the Internal Revenue Service with respect to each
Benefit Plan and all written
<PAGE>
communications with the Internal Revenue Service, the U. S. Department
of Labor and/or the Pension Benefit Guaranty Corporation made or
received since January 1, 1993 with respect to each plan and any summary
plan description and other written communication by the Company to the
Employees, plan participants and beneficiaries concerning such Benefit
Plan; (iii) with respect to each Benefit Plan Internal Revenue Service
Form 5500 and attached schedules, audited financial statements,
actuarial valuation reports and attorneys' responses to any auditor's
request for information filed or prepared since January 1, 1995; and
(iv) the most recent non-discrimination tests performed for each of the
tax-qualified Benefit Plans, including, without limitation, the average
deferral percentage and average contribution percentage tests for the
defined contribution pension benefit plans.
(c) Each Benefit Plan has been established and administered in
all respects in accordance with its terms, and in compliance with the
applicable provisions of the Code, ERISA and other applicable Laws.
Each Benefit Plan which is intended to be qualified within the meaning
of the Code is so qualified and has received a favorable determination
letter from the Internal Revenue Service as to its qualification and, to
the best knowledge of the Company, nothing has occurred which would
cause the loss of such qualification. With respect to each Benefit
Plan, no action, suit or claim (other than ordinary and usual claims for
benefits) is pending or, to the best knowledge of the Company,
threatened, and to the best knowledge of the Company no fact or
circumstance exists which could reasonably be expected to give rise to
any such action, suit or claim. No event has occurred and no condition
exists and the transactions contemplated by this Agreement shall not
constitute or cause any such event to occur or condition to exist that
would subject the Company to any tax, fine, penalty, cause of action or
damages imposed under the Code or ERISA with respect to any Controlled
Group Benefit Plan. Except as identified on Schedule 5.19(c), each
Benefit Plan may be amended or terminated, without obligation or
liability (other than (i) those obligations and liabilities for which
specific and sufficient assets have been set aside in a trust or other
funding vehicle or reserved for on the Most Recent Balance Sheet, and
(ii) those obligations and liabilities identified under Section 5.19
hereof that might arise upon termination of the Company's Employees'
Pension Plan), which currently is known as the Automobile Club Insurance
Company Employees' Pension Plan (the "Employees' Pension Plan"). No
Benefit Plan has incurred any "accumulated funding deficiency" as such
term is defined in Section 412 of the Code or Section 302 of ERISA
(whether or not waived). The Company has made all payments and
contributions identified by the actuary for the Employees' Pension Plan
as necessary to satisfy the funding requirements imposed by the Code and
under the terms of said pension plan for the period commencing January
1, 1998, and ending on the Closing Date, as computed by said pension
plan's actuary in the actuarial valuation prepared August 11, 1998 for
the 1998 calendar year as previously provided to Buyer pursuant to
Section 5.19(b) above. No Benefit Plan will be amended other than for
any amendment that is required by law to be adopted prior to or at the
Closing without Buyer's prior written consent.
(d) There exists no condition or set of circumstances which
present a risk of termination or partial termination of any Benefit Plan
which could result in any liability, increased funding obligation or
acceleration of vesting or benefit availability on the part of the
Company. The Company does not and has not contributed to a Multiemployer
Plan.
<PAGE>
(e) Except as disclosed on Schedule 5.19(e), there is no
unfunded obligation under any Benefit Plan providing benefits after
termination of employment to any Employee and the Company has made no
other commitment to Employees, former Employees or their beneficiaries
under which they are or would be obligated to provide any benefit or
payment which is not fully funded through a trust or other funding
arrangement or reserved for on the most recent Quarterly Statement.
Except as disclosed on Schedule 5.19(e), the Company has no "accumulated
post-retirement benefit obligation," as defined in FASB Statement No.
106 (or any successor statements), in respect of post-retirement
benefits for Employees. No Benefit Plan exists which could result in
the payment to any Employee as a result of any transaction explicitly
contemplated by this Agreement.
(f) The Company is not, nor at any time since January 1, 1992
has it been, a fiduciary, service provider or "party in interest," as
defined by Section 3(14) of ERISA and applicable regulations, or
"disqualified person," as defined by Section 4975(e)(2) of the Code and
applicable regulations, with respect to any employee benefit plan, other
than a Benefit Plan.
5.20 Environmental Matters.
(a) Company is not subject to any liability (and has not handled
or disposed of any substance, arranged for the disposal of any
substance, or owned or operated any property or facility in any manner
that could reasonably be expected to form the basis for any future
Environmental Claim against the Company giving rise to any liability)
for damage to the atmosphere or any site, location or body of water
(surface or subsurface) or for any other reason under any Environmental
Law.
(b) No notice, citation, summons or order has been received by
the Company and no complaint has been filed and no penalty has been
assessed or, to the best knowledge of the Company, threatened by any
Authority or third party with respect to (i) any alleged violation by
the Company of any Environmental Law, (ii) any alleged failure by the
Company to have any Environmental Permit required under any
Environmental Law in connection with its business or (iii) any other
Environmental Claim to which the Company or any of its assets is, or
reasonably could be expected to be, subject.
(c) Except as disclosed on Schedule 5.20, to the best knowledge
of the Company, no environmental inspection report (collectively,
"Environmental Reports") has been prepared by any Person concerning
compliance with, or actual or potential liability under, applicable
Environmental Law with respect to the Company's business, operations,
assets or properties or any property contiguous thereto.
5.21 Full Disclosure. Each statement of fact set forth in any
Schedule to Article V of this Agreement is true and accurate and does
not omit to state any material fact necessary in order to make the
statements made or information disclosed, in light of the circumstances
under which they were made or disclosed, not misleading.
<PAGE>
ARTICLE VI
CONDITIONS PRECEDENT TO OBLIGATIONS
6.1 Conditions to Obligations of Buyer. Each and every
obligation of Buyer to be performed under this Agreement shall be
subject to the satisfaction at or prior to the Closing of each of the
following conditions (unless waived in writing by Buyer):
(a) Representations and Warranties. The representations and
warranties set forth in Articles III and IV and Sections 5.1(a), 5.3,
5.18(d) and 5.19(a) of this Agreement shall have been true and correct
when made and shall be true and correct at and as of the Closing. The
representations and warranties set forth in Article V, other than
Sections 5.1(a), 5.3, 5.18(d), and 5.19(a) shall have been true and
correct in all material respects when made and shall be true and correct
in all material respects at and as of the Closing, including those
representations and warranties that, by their terms, are made only "as
of the date of this Agreement" or "as of the date hereof," disregarding
such qualification solely for purposes of this Section 6.1(a); provided,
however, that for purposes of this sentence, such representations and
warranties shall be deemed to be true and correct in all material
respects unless the failure or failures of such representations and
warranties to be so true and correct, in the aggregate, represents a
material adverse change to the properties, assets, liabilities
(contingent or other), business, results of operations or condition
(financial or otherwise) (including contingent liabilities) of the
Company as represented in this Agreement, and further provided that for
purposes of determining whether such a material adverse change occurred
from the date of execution of this Agreement to the Closing, there shall
be disregarded any adverse change that, is directly and proximately
related solely to (w) a decrease in the volume of the Company's direct
written premiums, or (x) a decision by one or more agents of the Company
to terminate doing business with the Company or to decrease the volume
of the policies that they write on behalf of the Company, or (y) a
decrease in the market value of the Company's investment securities, or
(z) an increase in either or both the volume or average severity of
claims made under insurance policies issued by the Company in the
ordinary course of business consistent with past practice, which claims
arise out of facts or circumstances occurring after the date of this
Agreement, including, without limitation, an increase in either or both
the volume or average severity of claims as a consequence of adverse
weather conditions occurring after the date of this Agreement; provided,
however, that the exclusion set forth in clause (z) shall not apply to
the extent such material adverse change arises out of the Company's
mismanagement of one or more such claims, including, without limitation,
acts or omissions constituting fraud or bad faith by the Company.
(b) Performance of Agreement. Each of AAA, CSAAIIB and the
Company shall have fully performed and complied in all material respects
with the covenants, conditions and other obligations under this
Agreement which are to be performed or complied with by it at or prior
to the Closing, including, without limitation, all deliveries to be made
pursuant to Sections 7.2, 7.3 and 7.4 of this Agreement and all
covenants to be performed prior to the Closing pursuant to Articles VIII
and IX of this Agreement.
<PAGE>
(c) Consents. All applicable governmental approvals, including
approval of the Superintendent of Insurance of the State of Ohio and any
other state and other Authorities whose approval is required to
consummate the transactions contemplated hereby shall have been
received, and no approval shall have imposed any condition or
requirement which would have a Material Adverse Effect on the Company or
on the economic benefits to Buyer of the transactions contemplated by
this Agreement. All conditions required to be satisfied prior to the
Closing imposed by the terms of such approvals shall have been
satisfied. All waiting periods relating to such approvals shall have
expired. All notifications to any Authority that are required shall
have been made. All pre-merger filing requirements and waiting periods,
including, without limitation, those under the HSR Act, shall have been
received or satisfied.
(d) No Adverse Change. There shall not have been any material
adverse change in the business operations, assets, or financial position
of the Company since the date of this Agreement provided, however, that
for purposes of determining whether this condition has been satisfied
there shall be disregarded any adverse change that is directly and
proximately related solely to (w) a decrease in the volume of the
Company's direct written premiums, or (x) a decision by one or more
agents of the Company to terminate doing business with the Company or to
decrease the volume of the policies that they write on behalf of the
Company, or (y) a decrease in the market value of the Company's
investment securities, or (z) an increase in either or both the volume
or average severity of claims made under insurance policies issued by
the Company in the ordinary course of business consistent with past
practice, which claims arise out of facts or circumstances occurring
after the date of this Agreement, including, without limitation, an
increase in either or both the volume or average severity of claims as a
consequence of adverse weather conditions occurring after the date of
this Agreement; further provided, however, that the exclusion set forth
in clause (z) shall not apply to any material adverse change arising out
of the Company's mismanagement of one or more such claims, including,
without limitation, a material adverse change arising out of allegations
that the Company committed acts or omissions constituting fraud or bad
faith. Since the date of this Agreement, the Company shall have
conducted its business, operations, activities and practices only in the
ordinary course of business substantially consistent with past practice.
(e) No Adverse Proceeding. There shall not be pending or
threatened any claim, action, litigation or proceeding (judicial or
administrative) or governmental investigation against Buyer, either
Seller or the Company for the purpose of enjoining or preventing the
consummation of this Agreement, or otherwise claiming that this
Agreement or the consummation of the transactions contemplated hereby is
illegal.
<PAGE>
(f) Certificates.
(i) AAA shall have delivered to Buyer at the Closing a
certificate signed on its behalf by its President or Vice
President and Secretary or Assistant Secretary, dated the date of
Closing, to the effect that AAA has fully performed and satisfied
all covenants and conditions required hereunder to be performed
and satisfied by it at or prior to the Closing, including, without
limitation, the condition set forth in Section 6.1(a) and all
deliveries to be made by it pursuant to Section 7.2 of this
Agreement and all covenants to be performed by it prior to the
Closing pursuant to Article VIII of this Agreement, (2) to the
best knowledge of AAA the Company has fully performed and
satisfied all covenants required hereunder to be performed and
satisfied by it at or prior to the Closing, including, without
limitation, all covenants to be performed by it prior to the
Closing pursuant to Article VIII of this Agreement, (3) the
condition set forth in subsection (e) of this Section 6.1 has been
satisfied insofar as it pertains to AAA, and (4) to the best
knowledge of AAA, the condition set forth in subsection (e) of
this Section 6.1 has been satisfied insofar as it pertains to the
Company.
(ii) CSAAIIB shall have delivered to Buyer at the Closing a
certificate signed on its behalf by its President, Senior Vice
President or Vice President and Secretary, dated the Closing Date,
to the effect that the representations and warranties set forth in
Article IV which apply to CSAAIIB were true and correct when made
and are true and correct at and as of the Closing and that it has
made the deliveries required of it by Section 7.3 of the
Agreement.
(iii) The Company shall have delivered to Buyer at the
Closing a certificate signed on its behalf by its President or
Vice President and Secretary or Assistant Secretary, dated the
Closing Date, to the effect that (1) the Company has fully
performed and satisfied all covenants and conditions required
hereunder to be performed and satisfied by it at or prior to the
Closing, including, without limitation, the condition set forth in
Section 6.1(a) and all deliveries to be made by it pursuant to
Section 7.4 of this Agreement and all covenants to be performed by
it prior to the Closing pursuant to Article VIII of this
Agreement, (2) the condition set forth in subsection (d) of this
Section 6.1 has been satisfied and (3) the condition set forth in
subsection (e) of this Section 6.1 has been satisfied insofar as
it pertains to the Company.
(g) ACIC Shares. There shall have been delivered to Buyer
certificates representing the ACIC Shares, which shall be registered in
the name of Buyer, or duly endorsed for transfer to Buyer or accompanied
by duly executed stock powers.
(h) ACIC Note. There shall have been delivered to Buyer the
ACIC Note which shall be duly endorsed for transfer to Buyer or
accompanied by a duly executed instrument effectuating its transfer to
Buyer.
(i) No Bankruptcy Issues. No proceeding in which the Company or
either Seller shall be a debtor, defendant or party seeking an order for
its own relief or reorganization shall have been brought or be pending
by or against such Person under any federal, state or foreign bankruptcy
or insolvency law.
<PAGE>
(j) Resignation of Directors. The directors of the Company on
the date of the Closing shall have resigned as directors of the Company.
6.2 Conditions to Obligations of Sellers. Each and every
obligation of each Seller to be performed under this Agreement shall be
subject to the satisfaction at or prior to the Closing of the following
conditions (unless waived in writing by each Seller affected by such
waiver):
(a) Representations and Warranties. The representations and
warranties of Buyer set forth in Article II of this Agreement shall have
been true and correct when made, and shall be true and correct at and as
of the Closing as though such representations and warranties were made
as of the Closing.
(b) Performance of Agreement. Buyer shall have fully performed
and complied with the covenants, conditions and other obligations under
this Agreement which are to be performed or complied with by it at or
prior to the Closing, including, without limitation, all deliveries to
be made pursuant to Section 7.5 of this Agreement.
(c) Consents. All applicable governmental approvals, including
approval of the Superintendent of Insurance of the State of Ohio and any
other state and other Authorities whose approval is required to
consummate the transactions contemplated hereby shall have been
received. All conditions required to be satisfied prior to the Closing
imposed by the terms of such approvals (other than those conditions
which could not reasonably be expected to have a Material Adverse Effect
on the economic benefits of the transaction to either Seller) shall have
been satisfied. All waiting periods relating to such approvals shall
have expired. All notifications to any Authority that are required
shall have been made. All pre-merger filing requirements and waiting
periods, including, without limitation, those under the HSR Act, shall
have been received or satisfied.
(d) No Adverse Proceeding. There shall not be pending or
threatened any claim, action, litigation, proceeding or order or decree
(judicial or administrative) or governmental investigation against
Buyer, the Sellers or the Company for the purpose of enjoining or
preventing the consummation of this Agreement, or otherwise claiming
that this Agreement or the consummation of the transactions contemplated
hereby is illegal.
(e) Certificates. Buyer shall have delivered to the Sellers at
the Closing a certificate signed on its behalf by its President or Vice
President and Secretary or Assistant Secretary, dated the date of
Closing, to the effect that Buyer has fully performed and satisfied all
covenants and conditions required hereunder to be performed and
satisfied by it at or prior to the Closing, including, without
limitation, all deliveries to be made by it pursuant to Section 7.5 of
this Agreement and all covenants to be performed by it prior to the
Closing pursuant to Article VIII of this Agreement.
(f) Purchase Price. Buyer shall have paid the Purchase Price at
the Closing in accordance with Section 1.2 hereof.
<PAGE>
(g) Sun Bank Guaranty. The Commerce Insurance Company ("CIC")
shall have delivered to AAA a guaranty in form and substance reasonably
acceptable to AAA pursuant to which CIC will agree to guarantee Buyer's
obligations under Section 8.13 of this Agreement.
ARTICLE VII
CLOSING
7.1 The Closing. The transactions contemplated by this
Agreement shall be closed (the "Closing"), and all deliveries to be made
at such time in connection therewith shall take place at the offices of
Baker & Hostetler, L.L.P., 2300 Sun Trust Center, 200 South Orange
Avenue, Orlando, Florida, or at such other place as the parties mutually
agree, commencing at 10:00 a.m., Orlando, Florida time, on that date
(the "Closing Date") which is the third Business Day following the date
on which the last to occur of (i) the receipt of all required
governmental authorizations, approvals, and consents that are conditions
to the consummation of the transactions contemplated hereby have been
obtained, and (ii) the expiration of all required waiting periods.
7.2 Deliveries of AAA at Closing. At the Closing, AAA will
deliver or cause to be delivered to Buyer the following:
(a) Certificates representing the AAA Shares, which shall be
registered in the name of Buyer, or duly endorsed for transfer to Buyer
or accompanied by duly executed stock powers as set forth in Section
6.1(g);
(b) The ACIC Note which shall be duly endorsed for transfer to
Buyer or accompanied by a duly executed instrument effectuating their
transfer to Buyer as set forth in Section 6.1(h);
(c) The certificates of officers of AAA referred to in Section
6.1(f)(i) of this Agreement;
(d) Certificate issued by the Secretary of State of Connecticut,
as of a date reasonably acceptable to Buyer, as to the legal existence
and good standing of AAA, together with a copy of its Articles of
Incorporation, as certified by the Secretary of State of Connecticut, as
of a date reasonably acceptable to Buyer.
(e) A certificate of the Secretary or an Assistant Secretary of
AAA and certifying as to (i) the requisite corporate or other action
authorizing the transactions contemplated by the Agreement and (ii) the
incumbency and signatures of the Officers of AAA executing this
Agreement and the other agreements contemplated hereby;
(f) All minute books, stock transfer books, stock certificate
books, and corporate certificates, and all corporate seals of the
Company in AAA's possession; and
<PAGE>
(g) An opinion letter of Baker & Hostetler LLP, counsel to AAA,
dated as of the Closing Date, addressed to Buyer in substantially the
form attached hereto as Exhibit 7.2(g).
7.3 Deliveries of CSAAIIB at Closing. At the Closing, CSAAIIB
shall deliver or cause to be delivered to Buyer the following:
(a) Certificates representing the CSAAIIB Shares, which shall be
registered in the name of Buyer, or duly endorsed for transfer to Buyer
or accompanied by duly executed stock powers as set forth in Section
6.1(g);
(b) The certificate of officers of CSAAIIB referred to in
Section 6.1(f)(ii) of this Agreement;
(c) A certificate of the President, Senior Vice President or
Secretary, or an Assistant Secretary of CSAIIB and certifying as to:
(i) the requisite action authorizing the transactions contemplated by
this Agreement; and (ii) the incumbency and signatures of the CSAAIIB
officers executing this Agreement and the other instruments contemplated
hereby.
7.4 Deliveries of the Company at Closing. At the Closing, the
Company will deliver or cause to be delivered the following:
(a) To Buyer:
(i) The certificate of officers of the Company referred to
in Section 6.1(f)(iii);
(ii) A Certificate of the Secretary of State of Ohio as to
the legal existence and good standing of the Company, together
with a copy of the Company's Articles of Incorporation, certified
by the Secretary of State of Ohio; and
(iii) A certificate issued by the Ohio Department of
Insurance, as of a date reasonably acceptable to Buyer, that the
Company is duly licensed to conduct the business presently
conducted by the Company; and
(b) To Sellers:
(i) A certificate of the individuals listed on Schedule
7.4(b) to AAA that the representations and warranties of the
Company set forth in Article V are true and correct, except as set
forth on the Disclosure Schedule attached to that certificate, to
the best knowledge of each such individual, after reasonable
inquiry of appropriate management personnel.
7.5 Deliveries of Buyer at Closing. At the Closing, Buyer will
deliver or cause to be delivered to Sellers the following:
(a) The Purchase Price in the form specified in Section 1.2 of
this Agreement, against an appropriate receipt therefor;
<PAGE>
(b) The certificate referred to in Section 6.2(e) of this
Agreement; and
(c) A Certificate of the Secretary of State of Rhode Island as
to the legal existence and good standing of Buyer, together with a copy
of Buyer's Articles of Incorporation, certified by the Secretary of
State of Rhode Island.
ARTICLE VIII
COVENANTS
8.1 Covenant Not to Compete. AAA covenants and agrees that it
shall not, for a period of ten (10) years following the Closing Date
engage whether on its own account or as a shareholder, partner, joint
venturer or agent of any Person, in any business which competes with the
personal lines property and casualty insurance business of the Company
anywhere in the United States; provided, however, the foregoing covenant
shall not be deemed to have been violated by the ownership of shares of
any class of capital stock of any publicly held corporation so long as
the aggregate holdings of AAA represent less than five percent (5%) of
the outstanding shares of such class of capital stock and that class of
capital stock is registered under Section 12(b) or 12(g) of the Exchange
Act and is listed or admitted for trading on any United States national
securities exchange or is quoted on the National Association of
Securities Dealers, Inc. Automated Quotations System. Notwithstanding
the foregoing, this Section 8.1 shall not in any way limit AAA from
conducting any activities (other than activities directly related to the
underwriting and issuance of personal line property and casualty
insurance policies directly by AAA or indirectly by AAA as a
shareholder, partner, joint venturer or agent of any Person) that AAA
reasonably determines are necessary for, or incident to, the performance
of its functions as a national association of entities that perform
automobile club services, including but not limited to: (a) granting to
any AAA-Affiliated Club or any Related Underwriter the right to use
(including, without limitation, such use in connection with the sale of
any insurance products whether personal line property and casualty
insurance policies or otherwise) the AAA Marks and the Automobile
Insurance Marks and Phrases (excluding the ACIC Name), (b) the
performance of any functions, actions or activities (other than
activities directly related to the underwriting and issuance of personal
line property and casualty insurance policies directly by AAA or
indirectly by AAA as a shareholder, partner, joint venturer or agent of
any Person) contemplated by, or referenced in, AAA's By-laws or other
governing documents, as the same shall be amended from time to time, (c)
or any activities (other than activities directly related to the
underwriting and issuance of personal line property and casualty
insurance policies directly by AAA, or indirectly by AAA as a
shareholder, partner, joint venturer, or agent of any Person) presently
conducted directly or indirectly by AAA. Buyer acknowledges that AAA-
Affiliated Clubs and their Related Underwriters shall not be bound by
the covenants set forth in this Agreement, including, without
limitation, this Section 8.1, and nothing in this Section 8.1 shall in
any way limit the activity of any entity other than AAA, including but
not limited to any AAA-Affiliated Club or any Related Underwriter,
including but not limited to those Related Underwriters listed on
Schedule 8.1. This Section 8.1 is the "Covenant Not to Compete."
<PAGE>
8.2 Conduct of Business of the Company Prior to the Closing.
AAA covenants and agrees that on and after the date hereof and prior to
the Closing, and except as otherwise consented to or approved by Buyer
in writing, AAA shall take all commercially reasonable efforts
(excluding the payment of money) to cause the Company to comply with the
following, and the Company covenants and agrees that on and after the
date hereof and prior to the Closing, and except as otherwise consented
to or approved by Buyer, the Company shall comply with the following:
(a) The business, operations, activities and practices of the
Company shall be conducted only in the ordinary course of business and
consistent with past practice including making contributions required to
be made to any Benefit Plan, except as otherwise expressly provided in
this Agreement;
(b) The Company shall not sell, transfer, pledge, mortgage,
encumber or otherwise dispose of any of its material amount of property
or assets other than the sale of insurance policies issued in the
ordinary course of business;
(c) The Company shall not merge or consolidate with any other
person or entity or acquire a material amount of assets of any other
person or entity;
(d) No change shall be made in the Articles of Incorporation or
Code of Regulations of the Company, except as otherwise expressly
provided in this Agreement;
(e) No change shall be made in the number of shares of
authorized or issued capital stock of the Company; nor shall any option,
warrant, call, right, commitment or agreement of any character be
granted or made by the Company relating to its authorized or issued
capital stock; nor shall the Company issue, grant or sell any securities
or obligations convertible into or exchangeable for shares of capital
stock of the Company;
(f) Except as provided in Section 9.3, no dividend shall be
declared or paid or other distribution (whether in cash, stock, property
or any combination thereof) or payment declared or made in respect of
the capital stock of the Company, nor shall the Company purchase,
acquire or redeem or split, combine or reclassify any shares of its
capital stock;
(g) The Company shall not (i) except in the ordinary course of
business and consistent with past practice, incur any indebtedness for
borrowed money in addition to any such indebtedness outstanding on the
date of this Agreement, including any renewals or extensions thereof;
(ii) assume, guarantee, endorse, or otherwise become liable or
responsible (whether directly, contingently or otherwise) for the
obligations of any other individual, firm or corporation except in the
ordinary course of the conduct of its insurance business consistent with
past practice; or (iii) make any loans, advances or capital
contributions to, or investments in, any other individual, firm or
corporation, except for investments in the ordinary course of its
insurance business consistent with past practice;
(h) The Company shall not materially change any method or
principle of accounting in a manner that is inconsistent with past
practice except as a result of changes to SAP and after prior notice to
Buyer;
<PAGE>
(i) Except as set forth in Section 8.11 and the Tax Sharing
Agreement, the Company shall not make any payment to AAA or CSAAIIB or
any of their respective Affiliates (other than for expenditures made on
behalf of the Company in the ordinary course of business consistent with
past practice made after ten (10) Business Days notice to Buyer) or
forgive any indebtedness due or owing from AAA or CSAAIIB or any of
their respective Affiliates; or
(j) The Company shall not (i) enter into any agreement with any
labor union or association representing any Employee, (ii) institute,
amend or terminate any Benefit Plan, (iii) pay any pension or retirement
allowance to any Person not required by an existing plan or agreement,
(iv) except as set forth on Schedule 8.2, increase in any manner the
compensation or fringe benefits of, or pay any bonus to, any officer or
employee other than customary annual (or less frequent) increases in the
wages or salaries of non-officer employees consistent with past
practice, which increases on an annualized basis do not increase the
salary or wage of any individual employee by more than 5% and in the
aggregate do not increase personnel costs for all non-officer employees
by more than 2% over the levels in effect as of December 31, 1997, or
(v) increase any other direct or indirect compensation or employee
benefit for or to any of its officers, directors or employees; or
(k) The Company shall not enter into, amend, terminate or fail
to renew any Material Contract except in the ordinary course of business
consistent with past practices; or
(l) The Company shall not amend, terminate or renew any
reinsurance contract set forth on Schedule 5.9(f) without Buyer's
consent, which consent shall not be unreasonably withheld or delayed.
(m) The Company shall not make any capital expenditures, capital
additions or capital improvements in excess of $50,000 in the aggregate;
or
(n) The Company shall not enter into any agreement or commitment
to do any of the foregoing.
8.3 No Negotiations.
(a) After the date of this Agreement and prior to the Closing,
AAA and the Company shall not, and shall instruct and cause each of
their respective Representatives not to, solicit or encourage, directly
or indirectly, inquiries or proposals from any Person (including any of
their respective Representatives) with respect to any recapitalization,
merger, consolidation or other business combination involving the
Company, any sale of all or a substantial portion of the assets of the
Company, or the sale of the ACIC Shares or ACIC Note or any material
equity interest in the Company (any of the foregoing, a "Competing
Transaction"). Except as expressly permitted by Section 8.3(b), AAA and
the Company shall not, and shall instruct and cause each of their
respective Representatives not to, furnish any non-public information
relating to or participate in any negotiations, discussions or other
activities concerning any Competing Transaction with any Person other
than Buyer.
<PAGE>
(b) If any bona fide written proposal for a Competing
Transaction (a "Competing Transaction Proposal") is received by, or any
negotiations or discussions regarding a Competing Transaction Proposal
are sought to be initiated with, directly or indirectly, AAA or the
Company or any of their Representatives, AAA or the Company, as the case
may be, shall promptly notify Buyer and shall disclose to Buyer the
identity of the Person making or seeking to make such Competing
Transaction Proposal, the terms and conditions thereof and such other
information as Buyer may reasonably request.
(c) Notwithstanding Section 8.3(a), following receipt of a
"Qualifying Competing Transaction Proposal" (as defined below), neither
AAA nor any of its Representatives shall be prohibited from (x) engaging
in discussions or negotiations with the Person that has made the
Qualifying Competing Transaction Proposal and thereafter providing to
such Person information previously provided or contemporaneously made
available to Buyer, provided such Person shall have entered into a
confidentiality agreement substantially in the form attached hereto as
Exhibit 8.3(c), or (y) subject to the terms of Section 10.1(f) of this
Agreement, terminating this Agreement. A "Qualifying Competing
Transaction Proposal" shall mean a Competing Transaction Proposal with
respect to which the following condition is satisfied: the AAA Board of
Directors, or a duly constituted committee thereof, shall have
determined that the financial terms of such Competing Transaction
Proposal are, from AAA's perspective, financially superior to the value
to be received by AAA pursuant to this Agreement as of the date
referenced in Section 1.2(b)(i).
(d) In the event that AAA determines that a Competing
Transaction Proposal is a Qualifying Competing Transaction Proposal, it
shall, within twenty (20) Business Days of the date of the determination
referenced in Section 8.3(c), give notice to Buyer either (i)
reaffirming AAA's intent to proceed under this Agreement and to
consummate the purchase and sale of the ACIC Shares and the ACIC Note,
or (ii) seeking to terminate this Agreement pursuant to Section 10.1(g).
If AAA does not, within such twenty (20) Business Day-period, either
expressly reaffirm its intent to proceed under this Agreement or
terminate this Agreement pursuant to Section 10.1(g), Buyer may at any
time thereafter terminate this Agreement pursuant to Section 10.1(f).
8.4 Access to Records. From the date of this Agreement until
the Closing, AAA and the Company, upon reasonable notice, shall make or
cause to be made fully available to Buyer and its representatives,
attorneys, accountants and agents, for examination the assets and
property of the Company and all books, contracts, agreements,
commitments, records and documents relating to the Company's business,
and shall permit Buyer and its representatives, attorneys, accountants
and agents to have full access to the same at all reasonable times after
reasonable notice. Buyer shall hold in confidence all information so
obtained and shall use such information only for the purpose of
implementing the transactions contemplated hereby.
<PAGE>
Buyer further covenants and agrees that, prior to the consummation of
the transactions contemplated herein, it shall not at any time, and
shall cause its agents, affiliates and representatives not to at any
time, without the prior written consent of AAA and CSAAIIB (as to such
information as relates to CSAAIIB), disclose any confidential
information regarding the operations of the Company, AAA or CSAAIIB to
third parties. If the transactions contemplated hereby are not
consummated, Buyer shall return all data and other information to AAA or
the Company and continue to honor the foregoing confidentiality and
nondisclosure covenants. Such obligation of confidentiality and nonuse
shall not extend to any (i) information which is shown to be or to have
been generally known to others engaged in the same trade or business as
the Company; (ii) information that is or shall be public knowledge
through no act or omission by Buyer or any of its directors, officers,
employees, professional advisors, or other representatives; (iii)
information which is rightfully obtained by Buyer from a third party
that is under no contractual or other obligation of confidentiality with
respect to such information; or (iv) information which is required to be
disclosed pursuant to judicial or governmental requirements.
8.5 Hart-Scott-Rodino Act Filings. AAA, CSAAIIB and Buyer shall
reasonably cooperate in the preparation of, and promptly file, all
notices and other filings required of it under the HSR Act as a result
of the transactions contemplated by this Agreement.
8.6 Insurance License Filings. Buyer, with the cooperation of
AAA and the Company, shall prepare and file within (15) fifteen Business
Days of the date hereof (unless such delay is due to AAA or the Company)
with the Ohio Department of Insurance and any other applicable
jurisdictions, such applications or notifications as may be required in
order to obtain any approvals necessary for the consummation of the
transactions contemplated hereby and such other pre-acquisition
notifications as may be required to be made by Buyer prior to Closing in
order for the Company to maintain, after the Closing Date, the insurance
licenses of the Company in effect on the date hereof. In connection
with such approvals, Buyer shall accept, and use all reasonable efforts
to satisfy, all conditions to the consummation of the transactions
contemplated hereby imposed by such regulatory authorities which would
not have a material adverse effect on the financial condition or
business of the Company.
8.7 Insurance Holding Company Filings. Prior to the Closing,
Buyer, with the cooperation of AAA and the Company shall prepare and
file within fifteen (15) Business Days of the date hereof (unless such
delay is due to the Company or AAA) with all applicable state insurance
authorities such registrations or other information as may be required
to comply with all applicable state insurance holding company statutes,
including, without limitation, the filing of a Form A with the Ohio
Department of Insurance.
8.8 Additional Financial Statements. For the periods ending
subsequent to June 30, 1998 and prior to the Closing, the Company shall
promptly furnish to Buyer (i) copies of monthly unaudited financial
statements of the Company, and (ii) copies of quarterly unaudited
financial statements of the Company, and (iii) copies of Quarterly
Statements of the Company. Such financial statements will be complete
and correct in all material respects and will be consistent in form with
those previously prepared by the Company for such interim periods.
<PAGE>
8.9 Welfare Plans and Other Benefit Plans.
(a) Employees of the Company shall continue to participate in
the Employee Welfare Benefit Plans (as defined in Section 3(1) of ERISA)
available through AAA and its affiliates (the "Welfare Plan") through
11:59 p.m. the day before the Closing Date, at which time coverage under
the Welfare Plan shall cease for such employees of the Company and their
eligible beneficiaries and dependents.
(b) Effective as of 12:01 a.m. on the day of the Closing the
Company shall establish such new employee welfare benefits plans (as
defined in section 3(1) of ERISA) as it may desire; provided, however,
that the Company (or Purchaser for employees of the Company) shall,
effective as of 12:01 a.m. on the Closing Date: (i) establish a group
health plan (as defined in section 607(1) of ERISA) for active employees
of the Company which plan shall waive any pre-existing conditions and
evidence of insurability requirements with respect to employees of the
Company (and, if applicable, count total service with the Company both
before and after the Closing for eligibility purposes), except for such
pre-existing conditions and evidence of insurability requirements as are
contained in the Welfare Plan on the Closing Date which could have been
imposed had coverage under the Welfare Plan continued; and (ii) shall
also provide to any then retired employees and their eligible
beneficiaries and dependents ongoing retiree healthcare and other
related benefits under such terms and conditions as are then applicable
to such retirees and their eligible beneficiaries and dependents.
Effective as of 12:01 a.m. on the day of the Closing, the Company and
the Buyer shall be solely responsible and liable for such employee
welfare benefit plans, and Seller shall have no liability whatsoever
with respect to such plans; and Buyer shall, and shall cause the Company
to, indemnify Seller against, and hold them harmless from, any liability
related to any such employee welfare benefit plans established or
maintained by the Company or Buyer.
(c) AAA shall, at no cost to AAA, provide such cooperation at
any time and from time to time after the Closing as the Company or Buyer
may reasonably request in connection with any termination of a Defined
Benefit Pension Plan.
8.10 Severance Pay. If, during the one year period from and
after the Closing, the Company terminates the employment of any Employee
other than for cause or as a result of unsatisfactory job performance,
the Company shall give such Employee two weeks' prior notice of such
termination for each year the Employee was employed by the Company, up
to a maximum of twenty-six (26) weeks of notice.
<PAGE>
8.11 Certain Tax Matters.
(a) AAA will include the income of the Company (including any
deferred income triggered into income by Treasury Regulations 1.1502-13
and 1.502-14 and any excess loss accounts taken into income under
Treasury Regulation 1.1502-19) on AAA's consolidated federal income Tax
Returns for all periods through the Closing Date and pay all federal
income Taxes attributable to such income; provided, however, that for
all periods ending on or prior to the Closing the Company shall continue
to be liable to reimburse AAA, in accordance with the terms of the Tax
Sharing Agreement in effect as of the date of this Agreement, for the
Company's share of such income Taxes. The Company will furnish to AAA
upon AAA's request, no later than ten Business Days after such request,
Tax information for inclusion in AAA's federal consolidated income Tax
Return for any period ending on or prior to the Closing Date in
accordance with the Company's past custom and practice. AAA will take
no position with respect to any item on its Tax Returns that relate to
the Company that is inconsistent with respect to the treatment of such
item by the Company on prior Tax Returns and that is reasonably likely
to have a Material Adverse Effect on the Company's Tax liability after
the Closing Date. AAA will allow the Company a period of not more than
twenty (20) Business Days to review and comment upon such Tax Return
(including any amended returns) to the extent they relate to the Company
provided, however, that the Company will not object to any return
position taken by AAA with respect to the Company unless such position
is reasonably likely to have a Material Adverse Effect on the Company's
Tax liability after the Closing Date. The income of the Company will be
apportioned to the period up to and including the Closing Date and the
period after the Closing Date by closing the books of the Company as of
the end of the Closing Date. The Company and AAA shall terminate, not
later than the Closing Date, the Tax Sharing Agreement, which
termination shall provide that the Tax Sharing Agreement shall have no
further effect after the Closing for any taxable year (whether the
current year, a future year or a past year).
(b) If AAA is assessed additional federal income tax
attributable to an increase in the taxable income of the Company for any
period (a "Pre-Closing Period") ending on or prior to the Closing during
which the Company joined with AAA in the filing of a consolidated
federal income tax return, then, provided that AAA has complied in all
material respects with the procedures set forth under Section 8.11(c),
the Company shall reimburse AAA within twenty (20) Business Days after
receipt of a written request therefor from AAA, which request shall be
accompanied by evidence that AAA has paid such assessment.
Notwithstanding the immediately preceding sentence, the Company will
have no obligation to reimburse AAA for any such assessment to the
extent that the aggregate amount of "Damages" under "Buyer Indemnifiable
Claims" for which the Buyer has given notice is equal to or in excess of
the "Deductible" (as such term is defined in Article XI of this
Agreement).
<page
(c) AAA shall provide the Company with prompt notice of any
actual or proposed IRS audit of a Pre-Closing Period to the extent that
such audit will relate to the Company, and the Company and its counsel
shall e entitled to participate at the Company's expense in any such
audit to the extent that it relates to the Company. Without the
Company's prior written consent, which consent may not be unreasonably
withheld, AAA may not settle any issue arising in such audit in a manner
that would obligate the Company to reimburse AAA pursuant to Section
8.11(b) or otherwise adversely affect, in any material respect, the
Company's Taxes after the Closing. AAA also shall promptly notify the
Company of any actions taken, inquiries made (whether written or oral),
or written determinations received by the IRS relating to the Company
for any Pre-Closing Period.
(d) Any refund of Taxes received by the Company and attributable
to a period prior to the Closing shall be applied and offset against any
Buyer's Indemnifiable Claims described in Section 11.2(b)(iv) asserted
at the time such refund is received, and the resulting amount shall be
paid to AAA (if a refund results) or treated as a Buyer Indemnifiable
Claim (if a Buyer Indemnifiable Claim results). The netting of amounts
described in the previous sentence shall be done without regard to the
Deductible.
8.12 Insurance Coverage. Buyer shall cause the Company to
maintain in full force and effect the directors' and officers'/errors
and omissions/fiduciary/employment practices and liability insurance in
effect immediately prior to the Closing for such time as is necessary to
provide coverage for acts of directors and officers on or prior to the
Closing; provided, however, that Buyer shall not be obligated to cause
the Company to expend more than Twenty-Five Thousand Dollars
($25,000)(the "Premium Cap") to maintain or procure such coverage; and
provided further that if the Company is unable to maintain or procure
the insurance coverage called for by this Section 8.12 for an amount
equal to or less than the Premium Cap, Buyer shall cause the Company to
obtain as much comparable insurance as may be obtained for an amount
equal to the Premium Cap; and provided further that AAA may, at its sole
discretion, request the Company to procure additional coverage in excess
of the amount purchased for $25,000, but only if and to the extent AAA
pays the incremental cost of such coverage over $25,000. The Company
will upon request make available to Buyer for inspection and copying at
the Company's headquarters complete and correct copies of all forms of
insurance policies of the Company together with all forms of riders
thereto.
8.13 Sun Bank Guaranty. Buyer shall indemnify and hold AAA
harmless from any and all liability that AAA may have under that certain
Corporate Guaranty Agreement given to Sun Bank National Association
dated April 1993, a copy of which is set forth as Schedule 8.13.
<PAGE>
ARTICLE IX
INTELLECTUAL PROPERTY
9.1 Use of Certain Intellectual Property.
(a) Buyer acknowledges that the Company presently has the right
to use the AAA Marks for the purpose of selling personal lines property
and casualty insurance products in the Service Areas of AAA Affiliated
Clubs that have granted such rights to the Company (the "Granting AAA
Club"). The Service Areas where the Company has obtained, and
subsequent to the Closing obtains, the right to use the AAA Marks from
the Granting AAA Club operating in such Service Area and such right has
not been revoked or terminated are collectively referred to herein as
the "Approved Territories" and separately as an "Approved Territory."
The Company may, from and after the Closing, use the AAA Marks in
accordance with the Emblem Regulations in the Approved Territories until
such right is revoked or terminated in whole or in part by the Granting
AAA Club. The Company shall have no right to use (and AAA shall have
the right to prevent the Company from using) any AAA Marks outside of
the Approved Territories. All other uses by the Company of any AAA Marks
will be terminated prior to the Closing. AAA shall not grant any
Person, including the Company, the right to use the ACIC Name, provided,
however, that AAA may grant to any AAA Affiliated Club or Related
Underwriter the right to use (i) the Automobile Insurance Marks and
Phrases; and (ii) the phrase "Automobile Club Insurance Company" as part
of a larger name or phrase. Example of the types of usage allowed by
(i) and (ii) of the preceding sentence are set forth on Schedule 9.1.
The Company shall use all commercially reasonable efforts not to (and
Buyer shall use all commercially reasonable efforts to cause the Company
not to) by any means, including, without limitation, any display or
transmission via radio broadcast, television broadcast, cable
transmission or internet transmission use, display or transmit any AAA
Marks or Automobile Insurance Marks and Phrases or any component or
derivation thereof outside of the Approved Territories; provided,
however, that the Company shall not be deemed to be in breach of this
sentence if the radio, television, cable or print medium is disseminated
from, and the message is solely directed to customers or potential
customers who reside in, an Approved Territory. The Company shall not
(and Buyer shall cause the Company not to) make any reference to its
affiliation with AAA or any AAA Affiliated Club in connection with any
activities conducted in, or with respect to, any geographic area other
than an Approved Territory, and then reference may be made only to AAA
and the Granting AAA Club to the extent permitted by the Granting AAA
Club operating in such Approved Territory.
<PAGE>
9.2 Change of Company's Name. As soon as practical after the
date of this Agreement, Sellers and the Company shall cause the
Company's Articles of Incorporation to be amended to change the name of
the Company to Members Property & Casualty Company. AAA, the Company,
and Buyer shall cooperate and use all commercially reasonable efforts to
prepare, execute, file and deliver all documentation necessary to
effect, evidence or notify third parties (including without limitation,
Authorities) of such name change. The Company shall have the right to
use the name "Automobile Club Insurance Company" but only in an Approved
Territory and only until completion of the change of name, provided that
Buyer and the Company are cooperating and, after the Closing, Buyer and
the Company are diligently pursuing, such name change. Buyer
acknowledges that nothing in this Agreement shall be construed as
granting to Buyer any rights to use the Automobile Insurance Marks and
Phrases except and to the extent expressly provided in the immediately
preceding sentence. Provided that the Closing occurs, the reasonable
fees and expenses relating to such name change (including filing fees
and attorney fees) shall be shared equally by AAA and Buyer. Each party
shall, to the extent practicable, give the other party notice of such
expense prior to incurring the expense. The covenant set forth in this
Section 9.2 shall survive the Closing.
9.3 Dividend of Name and Mark. The parties acknowledge and
agree that, prior to the Closing, the Company shall distribute as a
dividend to Sellers all of the Company's rights to the service mark
"Automobile Club Insurance," the ACIC Name and all trademarks and
service marks and other intellectual property related to the name or the
service mark. AAA, the Buyer and the Company shall cooperate and use
all commercially reasonable efforts to prepare, execute, file and
deliver all documentation necessary to effect, evidence or notify third
parties (including, without limitation, Authorities) of such transfer.
The covenant set forth in this Section 9.3 shall survive Closing.
9.4 Specific Performance. Sellers and Buyer acknowledge and
agree that a party's remedy for a breach of any provision of this
Article IX shall be specific performance, in addition to any other
remedies available to it under this Agreement.
9.5 Enforcement. AAA and the Company agree to notify each other
in writing (an "Infringement Notice") of any material infringing use of
the precise name "Automobile Club Insurance Company" (the "ACIC Name"),
other than as part of a larger name or phrase. AAA in its sole and
absolute discretion may commence or prosecute claims or suits with
respect to any infringing use of, or challenge to any and all rights
Sellers may presently have or may acquire in the future to the ACIC
Name, in its own name or in the name of the Company, or join the Company
as a party in any such claim or suit, provided, however, that AAA shall
provide the Company with written notice (a "Commencement Notice") of the
commencement of any such suit or proceeding no later than thirty (30)
Business Days after the commencement thereof. If, within sixty (60)
Business Days after the Company delivers an Infringement Notice to
Sellers, AAA does not provide the Company with a Commencement Notice
with respect to the subject matter of the Infringement Notice, the
Company shall be free to pursue the infringement action described in the
Infringement Notice at the Company's cost and expense provided, however,
that the Company
<PAGE>
may not agree to any settlement terms other than the payment of money
without the prior written consent of AAA, which shall not be
unreasonably withheld. AAA shall not be compelled to commence litigation
in order to protect the Company's rights to the ACIC Name nor be
required to bear the costs incurred in any litigation commenced by the
Company. In the event AAA elects to commence litigation to protect its
rights in the ACIC Name against third parties, AAA shall bear all fees,
costs and expenses incurred in connection therewith. The covenant set
forth in this Section 9.5 shall survive the closing.
ARTICLE X
TERMINATION
10.1 Termination of Agreement. This Agreement may be terminated
at any time prior to the Closing:
(a) by the mutual written consent of Buyer and the Sellers;
(b) by either Buyer or AAA if any of the representations or
warranties of the other party contained herein shall be inaccurate or
untrue in any material respect;
(c) by either Buyer or AAA if any obligation, term or condition
to be performed, kept or observed by such other party hereunder has not
been performed, kept or observed in any material respect at or prior to
the time specified in this Agreement;
(d) by Buyer or either Seller if any permanent injunction or
other order of a court or other competent authority preventing the
consummation of the transactions contemplated by this Agreement shall
have become final and nonappealable;
(e) by either Buyer or AAA, if not then in material breach of
any of its obligations hereunder, if the Closing has not occurred by May
31, 1999;
(f) by Buyer if AAA has not reaffirmed, pursuant to Section
8.3(d), its intent to proceed with the transactions contemplated by this
Agreement following its receipt of a Qualifying Competing Transaction
Proposal; provided, however, that in the case of a termination under
this Section 10.1(f), Buyer shall be entitled to receive from AAA the
Reimbursement Fee (as defined below) pursuant to Section 10.2; or
(g) by AAA following notice to Buyer if AAA elects to accept a
Qualifying Competing Transaction Proposal, subject to termination of
this Agreement and Buyer's first refusal right specified below, which
notice shall specify the final terms and conditions of such Qualifying
Competing Transaction Proposal, including, without limitation, the form
and amount of consideration to be received by AAA and CSAAIIB in
exchange for the ACIC Shares and the ACIC Note; provided, however, that
the effectiveness of a termination pursuant to this Section 10.1(g) is
subject to the satisfaction of each of the following conditions: (i)
Buyer shall not have exercised its right of first refusal pursuant to
Section 10.3 and (ii) AAA shall have paid the Termination Fee to Buyer
pursuant to Section 10.2.
<PAGE>
10.2 Effect of Termination.
(a) A termination under this Article X shall not prejudice any
claims which any party may have under this Agreement, in law or in
equity, as a consequence of any failure or default under this Agreement
by another party hereto provided, however, that in no event shall a
termination of this Agreement entitle any party to a claim for
consequential, special or punitive damages.
(b) If this Agreement is terminated pursuant to Section 10.1(f)
or 10.1(g), AAA shall pay to Buyer the Termination Fee not more than ten
(10) days after the later of (X) AAA's receipt of notice of Buyer's
termination of this Agreement pursuant to Section 10.1(f) or (Y) the
expiration of Buyer's right of first refusal pursuant to Section 10.3.
The "Termination Fee" means the greater of (i) Five Million Dollars
($5,000,000) or (ii) fifty percent (50.0%) of the amount by which the
aggregate value to be received by AAA and CSAAIIB pursuant to the
Qualifying Competing Transaction Proposal exceeds the Purchase Price.
If Buyer terminates this Agreement pursuant to Section 10.2(f) and
within one (1) year after such termination AAA enters into a definitive
agreement for a different Competing Transaction pursuant to which the
aggregate value to be received by AAA and CSAAIIB would be greater than
the value of the Qualifying Competing Transaction Proposal used
initially in calculating the Termination Fee, then the Termination Fee
shall be recalculated using such higher value and AAA shall pay the
increase, if any, in the Termination Fee not more than five (5) days
after closing such subsequent Competing Transaction.
10.3 Right of First Refusal. By notice from Buyer to AAA given
not later than twenty (20) Business Days after delivery to Buyer of
notice from AAA of its intention to seek termination of this Agreement
as provided by Section 8.3(d)(ii) and Section 10.1(g), Buyer shall have
the right to enter into a definitive agreement with AAA and, if
applicable, CSAAIIB on the same terms and conditions as the Qualifying
Competing Transaction Proposal that AAA identified in its notice
pursuant to Section 10.1(g), except that the purchase price payable
thereunder shall be reduced by the amount of the Termination Fee that
would have otherwise been payable to Buyer pursuant to Section 10.2.
Notwithstanding any provision of this Agreement to the contrary, any
proposed sale by AAA of the AAA Shares other than the sale contemplated
by this Agreement, including, without limitation, a sale pursuant to
this Section 10.3 shall remain subject to CSAAIIB's rights of first
refusal as set forth in the Shareholders' Agreement.
<PAGE>
ARTICLE XI
INDEMNIFICATION
11.1 Survival of Representations, Warranties and Agreements.
Subject to the limitations set forth in Section 11.3 of this Agreement
and notwithstanding any investigation conducted at any time with regard
thereto by or on behalf of either party hereto, all representations and
warranties of Buyer, Seller and the Company in this Agreement shall
survive execution, delivery and performance of this Agreement. All
representations and warranties of Buyer, Seller and the Company set
forth in this Agreement shall be deemed to have been made again by
Buyer, Seller or the Company, as the case may be, at and as of the
Closing except to the extent any representation and warranty (or part
thereof) is limited in time by its specific terms. All statements
contained in any Schedule or Exhibit hereto shall be deemed
representations and warranties of Buyer, Seller or the Company, as the
case may be, set forth in this Agreement within the meaning of this
Article.
11.2 Indemnification.
(a) As used in this Article, any reference to a representation,
warranty or covenant contained in any Section of this Agreement shall
include the Schedule relating to such Section.
(b) AAA shall indemnify and hold harmless Buyer, its directors,
officers, employees and agents, from and against any and all losses,
liabilities, damages, demands, claims, suits, actions, judgments or
causes of action, assessments, costs and expenses, and any and all
amounts paid in settlement of any claim or litigation (collectively,
"Damages"), asserted against, resulting to, imposed upon, or incurred or
suffered by Buyer, directly as a result of or arising from any of the
following (collectively with the CSAAIIB Claims as defined in Section
11.2(c), "Buyer's Indemnifiable Claims"): (i) any inaccuracy in or
breach or nonfulfillment of any of the representations, warranties,
covenants or agreements made by AAA in this Agreement, provided,
however, that any failure to deliver the certificate to be delivered
with regard to Section 6.1(a) shall not give rise to any liability on
the part of AAA; (ii) any inaccuracy in or any breach of any
representation or warranty of the Company; (iii) any facts or
circumstances constituting such an inaccuracy, breach or nonfulfillment;
(iv) any liability of the Company for Taxes incurred by the Company
prior to the Closing. For purposes of this Agreement, Damages for
claims other than third party claims shall not include any
consequential, special or punitive damages. Notwithstanding anything
else in this Agreement, Buyer shall not be entitled to indemnification
pursuant to this Section 11.2 on account of the failure of any of the
representations set forth in this Agreement, including but not limited
to Section 5.11(a)(ii), to be accurate from the date of this Agreement
up to and including the Closing Date to the extent that the failure of
such representation to be accurate as of the Closing Date is directly
and proximately related solely to (w) a decrease in the volume of the
Company's direct written premiums, or (x) a decision by one or more
agents of the Company to terminate doing business with the Company or to
decrease the volume of the policies that they write on behalf of the
Company, or (y) a decrease in the market value of the Company's
investment securities, or (z) an increase in either or both the volume
or average severity of claims made under insurance policies issued by
the Company in the ordinary course of business consistent with past
practice, which claims arise out of facts or circumstances occurring
after the date of this Agreement, including, without limitation, an
increase in either or
<PAGE>
both the volume or average severity of claims as a consequence of
adverse weather conditions occurring after the date of this Agreement
shall be disregarded; provided, however, that the exclusion set forth in
clause (z) shall not apply to any Damages arising out of the Company's
mismanagement of one or more of such claims, including without
limitations Damages arising out of allegations that the Company
committed acts or omissions constituting fraud or bad faith; and
provided further, the exclusion shall not affect in any way AAA's
obligation under this Section 11.2 to indemnify Buyer for a breach of
the Company's representation set forth in Section 5.13(a).
(c) CSAAIIB shall indemnify and hold harmless Buyer, AAA and
their respective directors, officers, employees and agents, from and
against any and all Damages asserted against, resulting to, imposed
upon, or incurred or suffered by Buyer or AAA, directly as a result of
or arising from any inaccuracy in or breach or nonfulfillment of any of
the representations, warranties covenants or agreements made by CSAAIIB
in Article IV and Section 7.3 of this Agreement (collectively, "CSAAIIB
Claims").
(d) Buyer shall indemnify and hold harmless each Seller and
their respective, directors, officers, employees and agents, from and
against any and all Damages asserted against, resulting to, imposed
upon, or incurred or suffered by Seller, directly as a result of or
arising from any inaccuracy in or breach or nonfulfillment of any of the
representations, warranties, covenants or agreements made by Buyer in
this Agreement or any facts or circumstances constituting such an
inaccuracy, breach or nonfulfillment (collectively, "Sellers
Indemnifiable Claims").
(e) Any payment made by either Seller pursuant to either
Seller's indemnification obligations under this Section 11.2 shall
constitute a reduction in the Purchase Price hereunder. Any payment
made by Buyer pursuant to Buyer's indemnification obligations under this
Section 11.2 shall constitute an addition to the Purchase Price
hereunder.
(f) If the event that has caused the Damages for the purposes of
this Section 11.2 gives rise to a current deduction against taxable
income of the Indemnified Party, the Damages shall be reduced by the tax
benefit attributable thereto. If such event will give rise to a future
tax deduction to the Indemnified Party, the Damages shall be reduced by
the tax benefit attributable thereto discounted at the prime rate of
interest reported in the Wall Street Journal at the time of payment.
(g) The amount of any indemnification claim by Buyer against
either Seller under this Section 11.2 shall be reduced by any insurance
payment received by Buyer, pursuant to an insurance policy of the
Company in effect as of the date of this Agreement, on account of the
Damages that give rise to such indemnification claim; provided, however,
that this Section 11.2(g) shall not obligate Buyer or the Company to
obtain any insurance coverage or, if already obtained, to maintain the
effectiveness of such insurance or to make any claim thereunder.
(h) Buyer shall be deemed to have suffered Damages arising out
of or resulting from the matters referred to in subsection (b) or (c) of
this Section 11.2 if the same shall be suffered by any parent,
subsidiary or affiliate of Buyer, including, without limitation, the
Company.
<PAGE>
(i) Either Seller shall be deemed to have suffered Damages
arising out of or resulting from the matters referred to in subsection
(d) of this Section 11.2 if the same shall be suffered by any parent,
subsidiary or affiliate of either Seller.
(j) In the event and to the extent Buyer asserts a Buyer's
Indemnifiable Claim against CSAAIIB, other than pursuant to a CSAAIIB
Claim, AAA shall indemnify and hold harmless CSAAIIB its directors,
officers, employees and agents from and against any and all Damages.
11.3 Limitations on Indemnification. Rights to indemnification
hereunder are subject to the following limitations:
(a) The obligation of indemnity provided herein with respect to
the representations and warranties set forth in Section 5.6 shall
terminate on the expiration of the periods of limitations applicable to
assessment and collection of federal, state and local taxes with respect
to the representations as to the absence of unpaid or undisclosed taxes
(including any interest, penalties or expenses) of any Person;
(b) The obligation of indemnity provided herein with respect to
the representations and warranties set forth in Article III, Article IV
and Sections 5.1(a) and 5.3 shall never terminate. The obligation of
indemnity provided herein with respect to the representation and
warranty set forth in Section 5.2 shall terminate on the Closing Date.
(c) The obligation of indemnity provided herein, other than with
respect to Article III, Article IV and Sections 5.1(a), 5.2, 5.3 and 5.6
of this Agreement, shall apply only to Indemnifiable Claims with respect
to which the Indemnifying Party has received notice as provided in this
Article XI on or before on March 31, 2000.
(d) Notwithstanding subsections (a), (b) and (c) of this Section
11.3, Buyer shall not be entitled to indemnification hereunder with
respect to Buyer's Indemnifiable Claim (as defined in Section 11.2) (or,
if more than one Indemnifiable Claim is asserted, with respect to all of
Buyer's Indemnifiable Claims) unless the aggregate amount of Damages
with respect to Buyer's Indemnifiable Claim or Claims exceeds $3,925,000
(the "Deductible"), in which event the indemnity provided for in Section
11.2 hereof shall be effective with respect to only such amount of such
Damages as exceeds the Deductible. The Deductible shall not apply to or
be reduced by: (i) claims asserted for breaches of the representations
and warranties set forth in Article III, Article IV and Sections 5.1(a),
5.3, 5.18(d) and 5.19(a); (ii) claims asserted for a breach or breaches
of the representations and warranties set forth in Section 5.6(e); and
(iii) claims asserted for Damages incurred by the Company with respect
to any Controlled Group Benefit Plan other than a Benefit Plan. With
respect to those Buyer Indemnifiable Claims that are subject to the
limitation set forth in this subsection (d), Buyer shall not be entitled
to indemnification for any Buyer Indemnifiable Claim unless the total
amount of Damages attributable to such Buyer Indemnifiable Claim
(measured on a claim by claim basis, with no aggregation of claims
provided that all claims made with respect to a financial statement
described in Section 5.7 shall be treated as a single claim) exceeds
$25,000, and any Buyer Indemnifiable Claim for which the Damages are
below that threshold shall not be taken into account for purposes of
calculating the aggregate amount of Damage in excess of the Deductible.
<PAGE>
(e) Notwithstanding anything contained in this Agreement to the
contrary, the maximum liability of a Seller for Buyer's Indemnifiable
Claims shall be the Purchase Price received by such Seller.
(f) Any claim for indemnification hereunder which is not
asserted by notice given as herein provided which specifically
identifies a particular breach and the underlying facts and Damages
relating thereto in the periods of survival specified in this Section
11.3 may not be pursued and is hereby irrevocably waived after such
time.
11.4 Procedure for Indemnification.
If any party hereto determines to seek indemnification (for
purposes of this Section 11.4, the "Indemnified Party") under this
Article with respect to an Indemnifiable Claim, it shall give notice to
the other party hereto (for purposes of this Section 11.4, the
"Indemnifying Party") in accordance with the following procedures.
(a) Procedure with Respect to All Claims.
(i) Notice of Claim. An Indemnified Party shall give
written notice to the Indemnifying Party specifying the nature and
amount of the alleged Indemnifiable Claim and setting forth a
reasonably detailed statement of the facts giving rise to the
claim.
(ii) Acceptance of Claim. If the Indemnifying Party,
within thirty (30) Business Days after the receipt of notice from
the Indemnified Party, shall not give written notice to the
Indemnified Party announcing its intent to contest such assertion
of the Indemnified Party, such assertion shall be deemed accepted
and the amount of the claim shall be deemed a valid Indemnifiable
Claim.
(iii) Contesting Assertion of Claim. The Indemnifying Party
may contest the assertion of a claim by giving such written notice
to the Indemnified Party within such thirty (30) Business Day
period.
(A) Negotiations. The parties, acting in good
faith, shall endeavor to reach agreement with respect to
such claim within thirty (30) Business Days after the
Indemnified Party's receipt of such notice contesting the
assertion of an Indemnifiable Claim.
<PAGE>
(B) Arbitration. If the parties cannot reach
agreement with respect to such claim within the thirty (30)
Business Day period, the contested assertion of a claim
shall be resolved by binding arbitration administered by the
American Arbitration Association in accordance with the
American Arbitration Association's Commercial Arbitration
Rules. Any such arbitration proceeding shall be conducted
in Columbus, Ohio before a panel of three neutral
arbitrators, all of whom shall be professionals with at
least five (5) years of experience in the applicable field.
The arbitrators shall be appointed as provided in the
American Arbitration Association's Commercial Arbitration
Rules. In rendering the award, the arbitrators shall
determine whether there is an Indemnifiable Claim, and if
so, the value of the Indemnifiable Claim. The arbitration
shall be governed by the Federal Arbitration Act, 9 U.S.C.
201 et seq., and judgment upon the award rendered by the
arbitrators may be entered by any court having jurisdiction
thereof.
(C) Costs. Each party shall pay its own legal,
auditing and other fees in connection with such a contest;
provided, however, that the fees of the arbitrators and the
expenses incurred by the arbitrators shall be shared equally
by the parties.
(b) Procedures with Respect to Third Party Claims. With respect
to Indemnifiable Claims resulting from the assertion of liability by
third parties, the following procedures shall also apply.
Notwithstanding this Section 11.4(b), however, any difference(s) between
the parties concerning the existence of value of an Indemnifiable Claim
resulting from the assertion of liability by third parties shall be
resolved in accordance with the procedures detailed in Section 11.4(a).
(i) Time to Give Notice. The Indemnified Party shall
provide notice within sixty (60) days of becoming aware of an
Indemnifiable Claim. The notice shall set forth such information
with respect thereto as is then reasonably available to the
Indemnified Party. For purposes of this clause (i), the
Indemnified Party shall not be deemed to be "aware" of any
Indemnifiable Claim unless one or more executive officers of the
Indemnified Party has actual knowledge of the fact that the
Indemnified Party has a reasonable basis upon which to assert an
Indemnifiable Claim.
(ii) Assumption of Defense. The Indemnifying Party will be
entitled, if it so elects by written notice delivered to the
Indemnified Party within thirty (30) days after receiving the
Indemnified Party's notice, to assume the defense thereof with
counsel satisfactory to the Indemnified Party. Notwithstanding
the foregoing, the Indemnified Party shall also have the right to
employ its own counsel in any such case, but the fees and expenses
of such counsel shall be at the expense of the Indemnified Party.
(iii) Failure to Assume Defense. In the event that the
Indemnifying Party, within thirty (30) days after receipt of the
aforesaid notice of an Indemnifiable Claim, fails to provide any
written notice to the Indemnified Party, the Indemnifying Party
shall be deemed to have accepted the Indemnifiable Claim, and the
Indemnified Party shall have the right to undertake the defense,
compromise or settlement of such action on behalf of and for the
account and risk of the Indemnifying Party.
<PAGE>
ARTICLE XII
MISCELLANEOUS PROVISIONS
12.1 Notice.
All notices, requests, demands and other communications required
or permitted under this Agreement, including, without limitation, all
notices required pursuant to Article VIII of this Agreement, shall be
deemed to have been duly given and made if in writing and served either
by personal delivery (which shall include delivery by Federal Express or
similar services) to the party for whom it is intended, or by being
deposited postage prepaid, certified or registered mail, return receipt
requested (or such form of mail as may be substituted therefor by postal
authorities), in the United States mail, bearing the address shown in
this Agreement for, or such other address as may be designated in
writing hereafter by, such party, or by being sent by a telecopy with a
hard copy sent simultaneously via overnight courier:
If to Seller: The American Automobile Association
(Incorporated)
1000 AAA Drive
Heathrow, Florida 32746-5063
Attention: Richard D. Rinner
Telecopy (407) 444-7997
With a copy to: Edward G. Ptaszek, Jr.
Baker & Hostetler
3200 National City Center
1900 East 9th Street
Cleveland, Ohio 44114-3485
Telecopy (216) 696-0740
If to Buyer: AAA Southern New England
501 Centerville Road
Warwick, RI 02886-4390
Attention: H. Thomas Rowles, President
Telecopy (401) 732-5022
and
The Commerce Group, Inc.
211 Main Street
Webster, MA 01570
Attention: Gerald Fels,
Executive Vice President and CFO
Tel: (508) 949-4113
Fax: (508) 949-4111
<PAGE>
With a copy to: Regan P. Remillard, Senior Vice President
and General Counsel
The Commerce Group, Inc.
c/o Commerce West Insurance Company
500 Hopyard Road, Suite 2000 (94568)
Pleasanton, CA 94556
Tel: (925) 734-1701
Fax: (925) 734-6120
and
Partridge, Snow & Hahn
180 South Main Street
Providence, RI 02903-9120
Telecopy: (401) 861-8210
Attention: John J. Partridge, Esq.
Nutter, McClennen & Fish, LLP
One International Place
Boston, MA 92110-2699
Tel: (617) 439-2000
Fax: (617) 973-9748
Attention: Constantine Alexander, Esq.
and
Michael K. Krebs, Esq.
If to CSAAIIB: California State Automobile Association
Inter-Insurance Bureau
P.O. Box 429186
San Francisco, California 94142-9186
Telecopy: (415) 552-5261
Attention: Paul Drewitz
If to the Company: Automobile Club Insurance Company
3590 Twin Creeks Drive
P.O. Box 182580
Columbus, Ohio 43218-2580
Telecopy: (614) 272-2676
Attention: Thomas E. Berridge
<PAGE>
12.2 Entire Agreement. This Agreement and the Schedules and
Exhibits hereto embody the entire agreement and understanding of the
parties hereto with respect to the subject matter hereof, and supersede
all prior and contemporaneous agreements and understanding relative to
said subject matter. Each reference in this Agreement to an Exhibit or
Schedule shall mean an Exhibit or Schedule attached to this Agreement.
Each such Exhibit or Schedule is deemed to be incorporated into this
Agreement by such reference. Any item disclosed in this Agreement or
any Schedule hereto is deemed to be disclosed on any other Schedule, or
be treated as an exception to any other representation and warranty to
which the item reasonably relates.
12.3 Binding Effect; Assignment. This Agreement and the various
rights and obligations arising hereunder shall inure to the benefit of
and be binding upon Buyer, its representatives, successors and assigns,
and each Seller, their respective representatives, successors and
assigns. Neither this Agreement nor any of the rights, interests or
obligations hereunder shall be transferred or assigned (by operation of
law or otherwise) by any party hereto without the prior written consent
of the other parties (which consent shall not be unreasonably withheld),
except that Buyer shall have the right to assign any or all of its
rights hereunder to a wholly owned subsidiary of Buyer and to transfer
and assign ownership of the Company or its assets and properties to an
Affiliate of Buyer. No such transfer by Buyer shall operate in any way
to modify or discharge any of the obligations of Buyer contemplated by
this Agreement.
12.4 No Third-Party Beneficiaries. Subject to Section 12.3
hereof, nothing herein, expressed or implied, is intended or shall be
construed to confer upon or give to any person, firm, corporation or
legal entity, other than the parties hereto, any rights, remedies or
other benefits under or by reason of this Agreement.
12.5 Counterparts. This Agreement may be executed simultaneously
in multiple counterparts, each of which shall be deemed an original, but
all of which taken together shall constitute one and the same
instrument.
12.6 Captions. The article and section headings of this
Agreement are inserted for convenience only and shall not constitute a
part of this Agreement in construing or interpreting any provision
hereof.
12.7 Expenses and Transactions. Except as provided in Section
10.2 with respect to the Termination Fee, each of the parties hereto
will bear its own costs and expenses (including legal fees and expenses)
incurred in connection with this Agreement and the transactions
contemplated hereby.
12.8 Waiver; Consent. This Agreement may not be changed,
amended, terminated, augmented, rescinded or discharged (other than in
accordance with its terms), in whole or in part, except by a writing
executed by the parties hereto, and no waiver of any of the provisions
or conditions of this Agreement or any of the rights of a party hereto
shall be effective or binding unless such waiver shall be in writing and
signed by the party claimed to have given or consented thereto.
<PAGE>
12.9 Other and Further Covenants. The parties shall, in good
faith, execute such other and further instruments, assignments or
documents as may be necessary for the consummation of the transactions
and performance of the covenants contemplated by this Agreement, and
shall assist and cooperate with each other in connection with these
activities.
12.10 Construction. Whenever the context requires, words used in
the singular shall be construed to mean or include the plural and vice
versa, and pronouns of any gender shall be deemed to include and
designate the masculine, feminine or neuter gender. Whenever used in
this Agreement, the word "including" shall be non-exclusive and shall
mean "including without limitation." All references to Sections,
Articles, Schedules and Exhibits shall, unless another agreement is
expressly referenced, mean the applicable Sections or Articles of, or
the Schedules or Exhibits to, this Agreement. The terms "herein,"
"hereunder," and terms of similar import refer to this Agreement as a
whole and not to the specific Section or Article in which they are used.
This Agreement is the joint product of the parties, and each provision
hereof has been subject to the mutual consultation, negotiation and
agreement of such parties, and shall not be construed for or against any
party.
12.11 Governing Law. This Agreement shall in all respects be
construed in accordance with and governed by the laws of the State of
Ohio, without regard to any such laws relating to choice or conflict of
laws.
12.12 Public Announcements. Neither Buyer, the Company nor either
Seller shall, without the prior written consent of the others, make any
public announcement or any release to trade publications or to the press
or make any statement to any competitor, customer or any other third
party with respect to the transactions contemplated herein, except such
announcement, release or statement necessary in the opinion of its
counsel to comply with applicable requirements of federal or state law,
the content of which is reasonably acceptable to the parties.
12.13 Certain Definitions. In the context of this Agreement, the
following terms, when utilized in this Agreement and unless the context
otherwise requires, shall have the meanings indicated, which meaning
shall be equally applicable to both the singular and plural forms of
such terms:
"AAA Affiliated Club" means any corporation, association or
organization including parent or subsidiary corporations, and affiliated
business entities, operated primarily to accomplish objectives and
purposes similar to those of AAA, and who agrees to comply with, or
where the context is appropriate, agrees to cause member subsidiary
corporations to comply with, AAA Bylaws, and AAA Accreditation and
Quality Standards, including but not limited to a AAA Organization
Member as defined in the AAA Bylaws.
"AAA Bylaws" mean the Bylaws of AAA.
"AAA Marks" means the AAA emblem (the letters AAA in block form,
enclosed within an oval or without an oval and as otherwise described in
the Emblem Regulations.
<PAGE>
"ACIC Name" means the precise name "Automobile Club Insurance
Company."
"Affiliate" with respect to any Person means any person (a
"Controlling Person") which, directly or indirectly, through one or more
intermediaries, controls the subject Person or any person which is
controlled by or is under common control with a Controlling Person. For
the purposes of this definition, "control" (including the correlative
terms "controlling," "controlled by" and "under common control with"),
with respect to any Person, means possession, directly or indirectly, of
the power to direct or cause the direction of the management and
policies of such Person, whether through the ownership of voting
securities or by contract or otherwise.
"Agent" means any insurance broker or insurance agent used by the
Company.
"Amended Shareholders' Agreement" shall have the meaning set forth
in section 3.3.
"Approved Territory" shall have the meaning set forth in Section
9.1.
"Authority" means any federal, state or local governmental
regulatory agency, commission, bureau or authority.
"Automobile Insurance Marks and Phrases " means: (i) the ACIC
Name; (ii) the phrases contained within, and any component parts of or
derivation of the ACIC Name such as (A) "Auto Club Insurance," (B)
"Automobile Club Insurance" and (C) "Automobile Club Insurance Company"
but only when used in any combination or order in conjunction with other
words to form a larger name; and (iii) the name "Otto Klub."
"Benefit Plan" means each "employee benefit plan" as set forth in
Section 3(3) of ERISA, and includes, without limitation, Multiemployer
Plans, and each employment, compensation, deferred compensation, stock
purchase, stock option, consulting, severance, change-in-control, fringe
benefit, welfare, insurance, bonus, incentive and other employee or
service provider benefit plan, agreement, contract, program, policy or
arrangement, whether or not subject to ERISA (including any funding
mechanism therefor now in effect or required in the future), whether
formal or informal, oral or written, legally binding or not, under which
any employee or former employee of, or other provider or former provider
of services to, the Company has, had or may have any present or future
right to benefits or under which the Company has, had or may have any
liability to fund a present or future benefit, or which the Company
maintains or contributes to (including any such plan, agreement,
contract, program, policy or arrangement to which the Company or any
such entity is obligated to contribute) at any time during the five (5)
year period preceding the Closing Date.
"Best knowledge of Buyer " or as knowledge relates to Buyer, means
the actual knowledge of any officer or director of Buyer, without any
obligation to make any investigation or inquiry.
"Best knowledge of Company " or as knowledge relates to the
Company, means the actual knowledge of any of the individuals listed on
Schedule 7.4(d) after such individuals make reasonable inquiry of
appropriate management personnel.
<PAGE>
"Best knowledge of CSAAIIB" means the actual knowledge of CSAIIB's
chief executive officer, chief financial officer or general counsel
without any obligation to make any investigation or inquiry.
"Best knowledge of Seller" , "Best of Knowledge of AAA" or as
knowledge relates to Seller or AAA, means the actual knowledge of AAA's
chief executive officer, chief financial officer or general counsel
without any obligation to make any investigation or inquiry.
"Business Day" means each Monday, Tuesday, Wednesday, Thursday or
Friday that banks in Orlando, Florida or Boston, Massachusetts are not
required or permitted by Law to be closed.
"Buyer's Indemnifiable Claims" shall have the meaning set forth in
Section 11.2(b).
"CSAAIIB" shall have the meaning set forth in the preamble to this
Agreement.
"Closing Date" shall have the meaning set forth in Section 7.1.
"Code" means the Internal Revenue Code of 1986, as amended.
"Competing Transaction" shall have the meaning set forth in
Section 8.3.
"Controlled Group" means the group of organizations or entities
that may be treated as a single employer with the Company pursuant to
Section 414(b), (c), (m) or (o) of the Code or Section 4001(b) of ERISA.
"Controlled Group Benefit Plan" each "employee benefit plan" as
set forth in Section 3(3) of ERISA, and includes, without limitation,
Multiemployer Plans, and each employment, compensation, deferred
compensation, stock purchase, stock option, consulting, severance,
change-in-control, fringe benefit, welfare, insurance, bonus, incentive
and other employee or service provider benefit plan, agreement,
contract, program, policy or arrangement, whether or not subject to
ERISA (including any funding mechanism therefor now in effect or
required in the future), whether formal or informal, oral or written,
legally binding or not, under which any employee or former employee of,
or other provider or former provider of services to, the Company or any
other entity that may be deemed to be a single employer with the Company
for one or more employee benefit purposes, including, without
limitation, any other organization which is a member of the Controlled
Group has, had or may have any present or future right to benefits or
under which the Company or any such entity has, had or may have any
liability to fund a present or future benefit, or which the Company or
any such entity maintains or contributes to (including any such plan,
agreement, contract, program, policy or arrangement to which the Company
or any such entity is obligated to contribute) at any time during the
five (5) year period preceding the Closing Date.
"Damages" shall have the meaning set forth in Section 11.2.
"Deductible" shall have the meaning set forth in Section 11.3.
<PAGE>
"Emblem Regulations" means the Regulations Governing the Use of
the Emblem and Other Trademarks of the American Automobile Association
adopted by the AAA Board of Directors on July 8, 1992, attached hereto
as Exhibit 9.1, as the same may be amended, supplemented or superceded
from time to time.
"Employees" means all of the Company's officers and employees.
"Environmental Claim" means any civil, criminal or investigative
action, suit, litigation, demand, claim, citation, notice or notice of
violation, warning, consent decree, judgment or order by any Person
alleging, claiming, concerning or finding liability or potential
liability (including, without limitation, liability or potential
liability for investigatory costs, clean-up costs, governmental response
or oversight costs, natural resources damages, property damages,
penalties, personal injuries, death or any other damages or costs,
including, without limitation, litigation and settlement costs and
consultants' and attorneys' fees) arising out of, based on or resulting
from, in whole or in part, (1) the actual or alleged presence,
threatened release, release, emission, disposal, storage, treatment,
transportation, generation, manufacture or use of any Hazardous
Substance at or from any location or (2) circumstances forming the basis
of any violation, or alleged violation, of any Environmental Laws or (3)
under any Environmental Law.
"Environmental Law" means the Federal Water Pollution Control Act,
the Federal Resource Conservation and Recovery Act of 1976, the
Comprehensive Environmental Response, Compensation and Liability Act of
1980, each as amended, and any other Law concerning pollution or
protection of the environment, or natural resources, including any Law
relating to emissions, discharges, releases or threatened releases of
any Hazardous Substance into ambient air, surface water, groundwater, or
lands or otherwise relating to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling
of any Hazardous Substance. "Laws" for purposes of the foregoing
definition should be deemed to include, without limitation, nuisance,
trespass or "toxic tort," so called.
"Environmental Permit" means any authorization, approval,
registration or license or permit relating to the environmental Laws.
"ERISA" means the Employee Retirement Income Security Act of 1974,
as amended, and the regulations promulgated thereunder.
"GAAP" shall mean generally accepted accounting principles.
"Granting AAA Club" shall have the meaning set forth in Section
9.1.
"HSR Act" shall have the meaning set forth in Section 2.3.
"Law" means any law, statute, rule or regulation, and any
judgment, writ, decree, injunction, order or requirement of any court or
Authority.
<PAGE>
"Material Adverse Effect" means (i) with respect to the Company, a
material adverse effect on the properties, assets, liabilities
(contingent or other), business, results of operations or condition
(financial or otherwise) of the Company, and (ii) with respect to Buyer
or Seller, a material adverse effect on the ability of Buyer or Seller,
as applicable, to consummate the transactions contemplated hereby or to
perform its obligations set forth herein.
"Material Contract" means any (i) agreement, contract or
commitment, whether written or oral, which involves or may involve
payments or receipts of more than $50,000 in any single year or $250,000
in the aggregate or which cannot be terminated without liability to the
Company upon less than thirty (30) days' written notice; (ii) agreement,
understanding and arrangement of any kind between the Company and any
officer, director, employee, or stock holder; (iii) contract, agreement,
commitment, arrangement or understanding limiting the freedom of the
Company from competing in any line of business or with any Person, from
selling any products or services, from competing with or obtaining
products or services from any Person, or from soliciting any Person to
become an Employee; (iv) partnership or joint venture agreement between
the Company and any Person; (v) agreement, instrument, arrangement or
understanding which otherwise reasonably could be expected to have a
Material Adverse Effect on the Company's assets, financial condition,
properties or business; and (vi) commitment or understanding to enter
into any of the foregoing.
"Most Recent Balance Sheet" means the Company's balance sheet at
June 30, 1998.
"Most Recent Balance Sheet Date" is June 30, 1998.
"Multiemployer Plan" has the meaning set forth in ERISA Section
3(37) or Section 4001(a)(3).
"Operating Permits" means all licenses, permits, orders,
approvals, registrations, authorizations, qualification filings with all
Authorities and all industry or non-governmental self-regulatory
organizations required in connection with the operation of the business
of the Company as presently conducted, and includes, without limitation,
those licenses of the Company to transact insurance and reinsurance.
"PBGC" means the Pension Benefit Guaranty Corporation or any
entity succeeding to any or all of its functions under ERISA.
"Person" means any natural person, corporation, limited liability
company, unincorporated organization, partnership, limited partnership,
limited liability partnership, association, joint-stock company, joint
venture, trust or government, or any agency or political subdivision of
any government.
"Quarterly Statements" means the Company's quarterly financial
statements, including the notes thereto, filed with the Superintendent
of Insurance of the State of Ohio for the quarterly periods ended after
January 1, 1998.
<PAGE>
"Related Underwriter" shall mean any AAA Affiliated Club,
insurance affiliate of an AAA Affiliated Club or associated insurance
company granted rights to use the Automobile Insurance Marks and Phrases
by a Granting AAA Club, including any insurance company and any
subsidiary of any such AAA Affiliated Club, insurance affiliate of an
AAA Affiliated Club or associated insurance company, including but not
limited to any entity listed on Schedule 9.1.
"Representatives" means each of the applicable Person's directors,
officers, employees, agents, representatives, attorney, accountants, and
other advisors.
"SAP" means the statutory accounting practices prescribed or
permitted by the insurance regulatory Authority of Ohio.
"Seller's Indemnifiable Claims" shall have the meaning set forth
in Section 11.2(d).
"Service Area" shall have the meaning set forth in the AAA Bylaws.
"Taxes" shall have the meaning set forth in Section 5.6.
"Termination Fee" shall have the meaning set forth in Section
10.2(b).
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement
to be executed as of the date first set forth above.
BUYER:
ACIC HOLDING CO., INC.
By: H. Thomas Rowles
Title Chairman of the Board
And
By: Regan P. Remillard
Title President
SELLER:
THE AMERICAN AUTOMOBILE ASSOCIATION,
(INCORPORATED)
By: Richard D. Rinner
Title President & CEO
CALIFORNIA STATE AUTOMOBILE
ASSOCIATION INTER-INSURANCE BUREAU
By: James P. Molinelli
Title President
COMPANY
AUTOMOBILE CLUB INSURANCE COMPANY
By: Gerald P. Hogan
Title President / C.E.O.
722333.1
<PAGE>
GUARANTY AND UNDERTAKING
In consideration of the execution of the foregoing Share and Note
Purchase Agreement (the "Agreement"), and in order to induce Seller to
execute the Agreement with Buyer, each of The Commerce Insurance
Company, a Massachusetts corporation ("CIC") and AAA Southern New
England, a Rhode Island corporation ("AAA SNE") hereby:
(a) Jointly and severally absolutely and unconditionally
guaranty the full and timely performance by Buyer under the Agreement,
and any agreement, certificate or other document required by the
Agreement, of all of Buyer's obligations and duties thereunder to be
performed before or at the Closing Date; and
(b) Each of CIC and AAA SNE agree with AAA to exercise all
commercially reasonable efforts to cause Buyer to perform all of Buyer's
obligations and duties thereunder to be performed after the Closing Date
except Buyer's obligations set forth in Section 11.2 relating to
indemnification.
Neither Seller shall be obligated to pursue any remedies it may
have against Buyer under the Agreement prior to enforcing its rights
against either CIC or AAA SNE under this Guaranty and Undertaking.
All capitalized terms used herein and not otherwise defined shall
have the meaning ascribed to them in the Agreement.
THE COMMERCE INSURANCE AAA SOUTHERN NEW ENGLAND
COMPANY
By: Gerald Fels By: H.Thomas Rowles
Title: E.V.P. Title: President and CEO
<PAGE>
SCHEDULES
<TABLE>
<CAPTION>
<S> <C>
Schedule 1.2(c) Purchase Price Allocation
Schedule 3.3 AAA Share Ownership and Authority
Schedule 3.4 Note Ownership, Authority and Validity
Schedule 3.5 No Conflicts (AAA)
Schedule 4.3 CSAAIIB Share Ownership and Authority
Schedule 5.1 Jurisdictions Where Qualified to do Business
Schedule 5.3 Capitalization and Security Holders
Schedule 5.4 Litigation
Schedule 5.5 No Conflicts (Company)
Schedule 5.6 Taxes
Schedule 5.7 Financial Statements
Schedule 5.9(c) Reported Claims
Schedule 5.9(e) Asserted Claims
Schedule 5.9(f) Reinsurance Agreements
Schedule 5.9(i) Notifications from Agents
Schedule 5.10 Regulatory Agreements
Schedule 5.12 Undisclosed Liabilities
Schedule 5.14 Compliance with Law
Schedule 5.15 Real and Personal Property
Schedule 5.16 Intellectual Property
Schedule 5.17 Y2K
Schedule 5.18(a) Certain Employees
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Schedule 5.18(b) Employment Claims
Schedule 5.18(d) Severance Agreements
Schedule 5.19(a) Benefit Plans and Agreements
Schedule 5.19(b) Certain Benefit Plans
Schedule 5.19(c) Ability to Amend or Terminate Plans
Schedule 5.19(e) Unfunded Plan Obligations
Schedule 5.20 Environmental Matters
Schedule 7.4(d) Best Knowledge of Company
Schedule 8.1 Related Underwriters
Schedule 8.2 Increase in Compensation
Schedule 9.1 Permitted Use of ACIC Name
EXHIBITS
Exhibit 7.2(g) Opinion of Baker & Hostetler
Exhibit 8.3(c) Confidentiality Agreement
Exhibit 9.1 Emblem Regulations
</TABLE>
722333.1
<page
MULTIPLE LINE QUOTA SHARE
REINSURANCE AGREEMENT
NO. TM666A
EFFECTIVE JULY 1, 1998
between
COMMERCE INSURANCE COMPANY
CITATION INSURANCE COMPANY
both of Webster, Massachusetts
and
The reinsurers subscribing to the respective
Interests and Liabilities Contracts attached to
and forming part of this Agreement
<PAGE>
MULTIPLE LINE QUOTA SHARE REINSURANCE AGREEMENT NO. TM666A
<TABLE>
<CAPTION>
ARTICLE CONTENTS PAGE
<S> <C>
<C>
PREAMBLE
1
I BUSINESS COVERED
1
II EFFECTIVE DATE AND TERMINATION
2
III TERRITORY
3
IV DEFINITION OF ULTIMATE NET
LIABILITY 4
V RETENTION
4
VI CATASTROPHE REINSURANCE
4
VII LOSS IN EXCESS OF POLICY LIMITS
4
VIII EXTRA CONTRACTUAL OBLIGATIONS
4
IX DEFINITION OF RISK
5
X EXCLUSIONS
5
XI LOSS OCCURRENCE
11
XII REINSURANCE PREMIUM
13
XIII SLIDING SCALE COMMISSION
14
XIV LOSSES, LOSS ADJUSTMENT EXPENSES
AND
SALVAGES
16
XV REPORTS AND REMITTANCES
16
XVI ACCESS TO RECORDS
18
XVII TAXES
18
XVIII CURRENCY
18
XIX OFFSET
19
XX ERRORS OR OMISSIONS
19
XXI DISPUTE RESOLUTION
19
XXII INSOLVENCY
21
XXIII SPECIAL TERMINATION
22
XXIV AMENDMENTS
23
</TABLE>
ATTACHMENTS: INSOLVENCY FUNDS EXCLUSION CLAUSE
POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE
TOTAL INSURED VALUE EXCLUSION CLAUSE
POLLUTION AND SEEPAGE EXCLUSION CLAUSE
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE -
REINSURANCE - U.S.A.
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE -
REINSURANCE - CANADA
NUCLEAR INCIDENT EXCLUSION CLAUSE - REINSURANCE - NO. 4
POLLUTION LIABILITY EXCLUSION CLAUSE - REINSURANCE
NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY -
REINSURANCE - U.S.A.
NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY -
REINSURANCE - CANADA
<PAGE>
MULTIPLE LINE QUOTA SHARE
REINSURANCE AGREEMENT
NO. TM666A
(hereinafter referred to as the "Agreement")
between
COMMERCE INSURANCE COMPANY
CITATION INSURANCE COMPANY
both of Webster, Massachusetts
(hereinafter collectively referred to as the "Company")
and
The reinsurers subscribing to the respective
Interests and Liabilities Contracts attached to
and forming part of this Agreement
(hereinafter referred to as the "Reinsurer")
ARTICLE I - BUSINESS COVERED
A. By this Agreement the Company obligates itself to cede to the
Reinsurer and the Reinsurer obligates itself to accept from the
Company a 75% Quota Share participation of the Company's Ultimate
Net Liability for Policies in force as of July 1, 1998, and new and
renewal Policies becoming effective on or after said date as
respects losses occurring on or after July 1, 1998.
B. This Quota Share is subject to a maximum cession limit of
$750,000 each Policy (75% share of the Company's Ultimate Net
Liability of $1,000,000). Further, the liability of the Reinsurer
under this Agreement shall never exceed:
1. The greater of an amount equal to 350% of the Net
Premiums Written in any Agreement Year ceded hereunder or
$175,875,000 as respects any one Loss Occurrence, never to exceed
2. The greater of 450% of the Net Premiums Written in any
Agreement Year ceded hereunder or $226,125,000 as respects all
Loss Occurrences taking place during any Agreement Year.
The term "Agreement Year" shall mean each consecutive twelve
month period commencing July 1.
C. Any loss arising under this Agreement with respect to 100% of
Extra Contractual Obligations, as defined in Article VIII - Extra
Contractual Obligations shall be recovered in the same proportion
as the contractual loss recoverable hereunder provided such
contractual loss plus Extra Contractual Obligations shall never
exceed the
1. No. TM666A
<PAGE>
maximum cession, Loss Occurrence and Agreement Year limits set
forth under Paragraph B. above.
D. This Agreement is solely between the Company and the Reinsurer,
and nothing contained in this
Agreement shall create any obligations or establish any rights
against the Reinsurer in favor of any person or entity not a party
hereto.
E. The performance of obligations by both parties under this
Agreement shall be in accordance with a fiduciary standard of good
faith and fair dealing.
F. The term "Policies" shall mean each of the Company's binders,
policies and contracts of insurance or reinsurance on the business
covered hereunder.
G. Under this Agreement, the indemnity for reinsured loss applies
only to the following Property and Casualty Business except as
excluded under Article X - Exclusions of this Agreement.
PROPERTY BUSINESS
NAIC
CODE: LINES OF BUSINESS:
01 Fire
02 Allied Lines
09 Inland Marine
04 Homeowners (Section I only)
05 Commercial Multiple Peril (Section I only)
12 Earthquake
CASUALTY BUSINESS
CLASSES OF INSURANCE
1. Liability Other Than Automobile:
Bodily Injury Liability, Property Damage Liability, Personal
and Advertising Injury Liability, and Medical Payments Coverage
when written as part of a Commercial or Personal Package Policy
or on a monoline basis. However, Advertising Injury Liability
shall only apply to this Agreement when written as part of a
Commercial Package Policy or a Commercial General Liability
Coverage Form.
2. Umbrella Liability (for the Company's net retention.)
ARTICLE II - EFFECTIVE DATE AND TERMINATION
A. This Agreement shall become effective 12:01 a.m., Eastern
Standard Time, July 1, 1998, and shall remain in full force until
terminated.
2. No. TM666A
<PAGE>
This Agreement may be terminated at the close of any Agreement Year
by either party giving to the other 90 days prior written notice by
certified mail of its intention to do so.
B. During the running of such notice as stipulated in Paragraph A.
above, the Reinsurer shall
participate in business coming within the terms of this Agreement
until the date of termination of this Agreement.
C. In the event of termination of this Agreement, the Company
shall have the option of continuing or terminating the liability in
force at the date of termination as set forth below. The Company
may exercise such option provided written notice of the Company's
election is given by certified mail to the Reinsurer prior to the
date of termination.
1. All Policies covered hereunder and in force at the date of
termination of this Agreement shall continue until their natural
expiry, cancellation or next anniversary of such business,
whichever first occurs; but in no case shall this reinsurance be
extended for longer than one year, plus odd time, after the
termination date. At such time, the Reinsurer shall return to
the Company the unearned premiums, less commissions applicable,
for the unexpired periods.
2. All reinsurance hereunder shall be automatically cancelled as
of the date of termination and the Reinsurer shall be released of
all liability as respects losses occurring subsequent to the date
of termination. The Reinsurer shall return to the Company the
unearned premiums on the business in force hereunder at the date
of termination, less the commission allowed thereon.
ARTICLE III - TERRITORY
A. As respects Property Business this Agreement applies to risks
located in the United States of
America, its territories and possessions, and Canada, except that
with respect to Inland Marine and Multiple Peril Policies covered
hereunder, the territorial limits of this Agreement shall be those
of the original Policies when such Policies are written to cover
risks primarily located in the United States of America, its
territories and possessions, and Canada.
B. As respects Casualty Business this Agreement applies to Policies
issued by the Company within the United States of America, its
territories and possessions, and Canada and shall apply to losses
covered hereunder wherever occurring.
3. No. TM666A
<PAGE>
ARTICLE IV - DEFINITION OF ULTIMATE NET LIABILITY
The term "Ultimate Net Liability" shall mean the remaining portion of
the Company's gross liability on each risk reinsured under this
Agreement after deducting recoveries from all other reinsurance, whether
specific or general and whether collectible or not, other than the
reinsurance provided in Article VI - Catastrophe Reinsurance.
ARTICLE V - RETENTION
The Company warrants that it shall retain net for its own account and
not reinsure in any way subject to Catastrophe Reinsurance provided in
Article VI - Catastrophe Reinsurance, 25% of its Ultimate Net Liability.
ARTICLE VI - CATASTROPHE REINSURANCE
The Company has the right to maintain catastrophe reinsurance on that
portion of its Ultimate Net Liability which it retains net for its own
account and recoveries under such catastrophe reinsurance shall inure
solely to the benefit of the Company.
ARTICLE VII - LOSS IN EXCESS OF POLICY LIMITS
A. In the event the Company is liable to a policyholder as the result
of a settlement or judgment
rendered against the policyholder which is in excess of the Policy
limit, 100% of that portion of the award made to the third party
claimant which is in excess of the Company's Policy limit shall be
added to the amount of the Company's Policy limit and the sum
thereof shall be considered one loss, subject to the provision in
Paragraph B. below and all other provisions set forth in this
Agreement.
B. With respect to coverage provided under this Article, recoveries
from any insurance or reinsurance other than this Agreement, shall
inure to the benefit of the Reinsurer and shall be deducted to
arrive at the amount of the Company's Ultimate Net Liability.
ARTICLE VIII - EXTRA CONTRACTUAL OBLIGATIONS
A. "Extra Contractual Obligations" are defined as those liabilities not
covered under any other
provision of this Agreement and which arise from the handling of any
claim on business covered hereunder, such liabilities arising
because of, but not limited to, the following: failure by the
Company to settle within the Policy limit, or by reason of alleged
or actual negligence, fraud or bad faith in rejecting an offer of
settlement or in the preparation of the defense or in the trial of
4. No. TM666A
<PAGE>
any action against its insured or reinsured or in the preparation or
prosecution of an appeal consequent upon such action.
B. The date on which an Extra Contractual Obligation is incurred by
the Company shall be deemed, in all circumstances, to be the date of
the original accident, casualty, disaster or loss occurrence.
C. However, coverage hereunder as respects Extra Contractual
Obligations shall not apply where the loss has been incurred due to
the fraud of a member of the Board of Directors or a corporate
officer of the Company acting individually or collectively or in
collusion with any individual or corporation or any other
organization or party involved in the presentation, defense or
settlement of any claim covered hereunder.
D. Extra Contractual Obligations shall not include loss arising out
of engineering or other services or any other non-claims related
activity provided to the insured by the Company.
E. Recoveries, collectibles or retention from any other form of
insurance or reinsurance including
deductibles or self-insured retention which protect the Company
against Extra Contractual Obligations shall inure to the benefit of
the Reinsurer and shall be deducted from the total amount of Extra
Contractual Obligations for purposes of determining the loss
hereunder.
ARTICLE IX - DEFINITION OF RISK
The Company shall be the sole judge of what constitutes one risk
provided, however, that:
A. A risk shall never be less than all insurable values within
exterior walls and under one roof
regardless of fire divisions, the number of Policies involved, and
whether there is a single, multiple or unrelated named insureds
involved in such risk.
B. When two or more buildings are situated at the same general
location, the Company shall identify on its records at the time of
acceptance by the Company, those individual buildings and all
insurable values contained therein that are considered to constitute
each risk. If such identification is not made, each building and
all insurable values contained therein shall be considered to be a
separate risk.
ARTICLE X - EXCLUSIONS
I. AS RESPECTS PROPERTY BUSINESS COVERED UNDER THIS AGREEMENT THIS
AGREEMENT DOES NOT COVER:
A. THE FOLLOWING GENERAL CATEGORIES
5. No. TM666A
<PAGE>
1. All Lines of Business not specifically listed in Article I -
Business Covered.
2. Policies issued with a deductible of $100,000 or more; provided
this exclusion shall not apply to Policies which customarily
provide a percentage deductible on the perils of earthquake or
windstorm.
3. Reinsurance assumed, except pro rata local agency reinsurance
on specific risks.
4. Ex-gratia Payments.
5. Loss or damage occasioned by war, invasion, revolution,
bombardment, hostilities, acts
of foreign enemies, civil war, rebellion, insurrection, military
or usurped power, martial law, or confiscation by order of any
government or public authority, but not excluding loss or damage
which would be covered under a standard form of Policy containing
a standard war exclusion clause.
6. Insolvency Funds as per the attached Insolvency Funds
Exclusion Clause, which is made part of this Agreement.
7. Pool, Syndicate and Association business as per the attached
Pools, Associations and Syndicates Exclusion Clause, which is
made part of this Agreement.
8. Risks where the Total Insured Value, per risk, exceeds the
figure specified as per the attached Total Insured Value
Exclusion Clause, which is made part of this Agreement.
B. THE FOLLOWING CLASSES OF BUSINESS AND TYPES OF RISKS
1. Mortgage Impairment.
2. Growing and/or standing crops.
3. Mortality and Health covering birds, animals or fish.
4. All onshore and offshore gas and oil drilling rigs.
5. Petrochemical operations engaged in the production, refining
or upgrading of petroleum
or petroleum derivatives or natural gas
6. Satellites.
7. All railroad business.
8. As respects Inland Marine business:
a. Registered Mail and Armored Car Policies.
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b. Jeweler's Block Policies.
c. Furrier's Customers Policies.
d. Rolling Stock.
e. Parcel Post when written to cover banks and financial
institutions.
f. Commercial Negative Film Insurance.
g. Garment Contractors Policies.
h. Mining Equipment while underground.
i. Radio and Television Broadcasting Towers.
j. Motor Truck Cargo Insurance written for common carriers
operating beyond a radius of
200 miles.
C. THE FOLLOWING PERILS
1. Flood and/or Earthquake when written as such.
2. Difference in Conditions, however styled.
3. Pollution and Seepage as per the attached Pollution and Seepage
Exclusion Clause which is made
part of this Agreement.
4. Nuclear Incident Exclusion Clauses which are attached and made
part of this Agreement:
a. Nuclear Incident Exclusion Clause - Physical Damage -
Reinsurance - U.S.A.
b. Nuclear Incident Exclusion Clause - Physical Damage -
Reinsurance - Canada.
c. Nuclear Incident Exclusion Clause - Reinsurance - No. 4.
D. In the event the Company is inadvertently bound on any risk which is
xcluded under this Agreement and identified below, the reinsurance
provided under this Agreement shall apply to such risk until
discovery by the Company within its Home Office of the existence of
such risk and for 30 days thereafter, and shall then cease unless
within the 30 day period, the Company has received from the Reinsurer
written notice of its approval of such risk.
As respects Classes of Business and Types of Risks:
Items 1. through 8. of Section B. of this Part I.
II. AS RESPECTS CASUALTY BUSINESS COVERED UNDER THIS AGREEMENT THIS
AGREEMENT DOES NOT COVER:
A. THE FOLLOWING GENERAL CATEGORIES
1. Ex-gratia payments.
2. Risks subject to a deductible or a self-insured retention
excess of $25,000.
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3. Loss or damage caused directly or indirectly by: (a) enemy
attack by armed forces including action taken by military, naval
or air forces in resisting an actual or an immediately impending
enemy attack; (b) invasion; (c) insurrection; (d) rebellion; (e)
revolution; (f) intervention; (g) civil war; and (h) usurped
power.
4. Reinsurance assumed by the Company.
5. Business derived from any Pool, Association, including Joint
Underwriting Association, Syndicate, Exchange, Plan, Fund or other
facility directly as a member, subscriber or participant, or
indirectly by way of reinsurance or assessments.
6. Pollution Liability as per the attached Pollution Liability
Exclusion Clause - Reinsurance.
7. Insolvency Funds as per the attached Insolvency Funds Exclusion
Clause.
8. Nuclear Incident Exclusion Clauses which are attached and made
part of this Agreement:
a. Nuclear Incident Exclusion Clause - Liability - Reinsurance
- - U.S.A.
b. Nuclear Incident Exclusion Clause - Liability - Reinsurance
- - Canada.
c. Nuclear Incident Exclusion Clause - Reinsurance - No. 4.
B. THE FOLLOWING INSURANCE COVERAGES
1. Fiduciary Liability.
2. Fidelity and Surety.
3. Credit and Financial Guarantee.
4. Securities and Exchange Liability.
5. Retroactive coverage.
6. Personal and Commercial Excess Liability.
7. Malpractice or Professional Liability except incidental
Malpractice Liability and Professional Liability when written for
Beauticians, Morticians, Opticians and Pharmacists.
8. Errors and Omissions Liability.
9. Directors' and Officers' Liability except Condominium
Directors' and Officers' Liability.
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10. Advertisers', Broadcasters' and Telecasters' Liability as
respects Personal Injury Liability except as provided under
Commercial Package Policies or Commercial General Liability
Coverage Forms.
11. Liquor Law Liability except Host Liquor Law Liability.
12. Kidnap, Extortion and Ransom Liability.
13. Boiler and Machinery Insurance.
14. Protection and Indemnity (Ocean Marine).
15. Automobile Liability.
16. Automobile Collision.
17. Workers Compensation and Employers Liability.
C. THE FOLLOWING AS RESPECTS LIABILITY OTHER THAN AUTOMOBILE
1. The manufacturing, mining, refining, processing, distribution,
installation, removal or encapsulment of asbestos.
2. Risks involving known exposure to the following substances:
a. dioxin.
b. polychlorinated biphenols.
c. asbestos.
3. Liability as respects Products and Completed Operations:
a. The manufacture, labeling or re-labeling, importation or
wholesale distribution of:
(i) Drugs or pharmaceuticals.
(ii) Cosmetics.
(iii) Herbicides, insecticides or pesticides.
(iv) Petrochemical or electrical equipment used for
heating, lighting or cooking.
(v) Industrial or toxic chemicals.
(vi) Valves, gaskets or seals of a hydraulic,
petrochemical or high pressure nature.
(vii) Medical supplies.
(viii) Heavy machinery and equipment.
(ix) Power tools.
(x) Medical equipment used for diagnostic or life
sustaining purposes.
b. The manufacture or importing of motorized or self-
propelled vehicles and equipment.
c. The manufacturing, importing, packing, canning, bottling
or processing of foodstuffs.
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<PAGE>
d. The blending, mixing, processing or importing of animal
feed.
e. The manufacture, sale, distribution, handling, servicing or
maintenance of aircraft, aerospacecraft, missiles, satellites
or any component or components thereof.
4. Ownership, operation or use of vessels exceeding 50 feet in
length.
5. All railway operations except sidetrack agreements.
6. Amusement parks, carnivals or circuses.
7. Public assembly exposure in excess of 5,000.
8. Gas, electric and water utility companies.
9. Subaqueous operations.
10. Mining.
11. Blasting operations.
12. Demolition of buildings or structures in excess of two stories.
13. Shoring, underpinning or moving of buildings or structures.
14. Manufacture, sale, rental, lease, erection or repair of
scaffolds.
15. Construction of bridges, tunnels or dams.
16. a. Manufacturers or importers of fireworks, fuses, or any
substance, as defined and noted below, intended for use as an
explosive.
B. Loading of fireworks, fuses, or any explosive substance
defined below into containers for
use as explosive objects, propellant charges or detonation
devices and the storage thereof.
c. Manufacturers or importers of any product in which
fireworks, fuses, or any explosive substance defined below is
an ingredient.
d. Handling, storage, transportation or use of fireworks,
fuses, or any explosive substance defined below.
NOTE: An explosive substance is defined as any substance
manufactured for the express purpose of exploding as
differentiated from commodities used industrially and which are
only incidentally explosive.
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<PAGE>
17. Manufacture, production, refining, storage, wholesale
distribution or transportation of natural or artificial fuel gas,
butane, propane or liquefied petroleum gases or gasoline.
18. Onshore and offshore gas and oil drilling operations.
19. Ownership, maintenance or use of any airport or aircraft,
including fueling, or any device or machine intended for and/or
aiding in the achievement of atmospheric flight, projection or
orbit.
20. Municipalities.
D. Those exclusions set forth under Items 6. and 17. of Section C. of
this Part II. shall not apply if the exposure is incidental to the
regular operations of the insured covered hereunder.
E. In the event the Company is inadvertently bound on any risk which is
excluded under Items 3.
through 20. of Section C. of this Part II, the reinsurance provided
under this Agreement shall apply to such risk until discovery by the
Company within its Home Office of the existence of such risk and for
30 days thereafter, and shall then cease unless within the 30 day
period, the Company has received from the Reinsurer written notice of
its approval of such risk.
ARTICLE Xi - LOSS OCCURRENCE
As respects Property Business covered under this Agreement:
A. The term "Loss Occurrence" shall mean the sum of all individual
losses directly occasioned by any
one disaster, accident or loss or series of disasters, accidents or
losses arising out of one event which occurs within the area of one
state of the United States or province of Canada and states or
provinces contiguous thereto and to one another. However, the
duration and extent of any one Loss Occurrence shall be limited to
all individual losses sustained by the Company occurring during any
period of 168 consecutive hours arising out of and directly
occasioned by the same event except that the term "Loss Occurrence"
shall be further defined as follows:
1. As regards windstorm, hail, tornado, hurricane, cyclone,
including ensuing collapse and water damage, all individual losses
sustained by the Company occurring during any period of 72
consecutive hours arising out of and directly occasioned by the
same event. However, the event need not be limited to one state
or province or states or provinces contiguous thereto.
2. As regards riot, riot attending a strike, civil commotion,
vandalism and malicious mischief, all individual losses sustained
by the Company, occurring during any period of 72 consecutive
hours within the area of one municipality or county
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<PAGE>
and the municipalities or counties contiguous thereto arising out
of and directly occasioned by the same event. The maximum
duration of 72 consecutive hours may be extended in respect of
individual losses which occur beyond such 72 consecutive hours
during the continued occupation of an assured's premises by
strikers, provided such occupation commenced during the aforesaid
period.
3. As regards earthquake (the epicentre of which need not
necessarily be within the territorial confines referred to in the
opening paragraph of this Article) and fire following directly
occasioned by the earthquake, only those individual fire losses
which commence during the period of 168 consecutive hours may be
included in the Company's Loss Occurrence.
4. As regards Freeze, only individual losses directly occasioned
by collapse, breakage of glass and water damage (caused by
bursting of frozen pipes and tanks) may be included in the
Company's Loss Occurrence.
B. For all Loss Occurrences the Company may choose the date and time
when any such period of consecutive hours commences provided that it
is not earlier than the date and time of the occurrence of the first
recorded individual loss sustained by the Company arising out of that
disaster, accident or loss and provided that only one such period of
168 consecutive hours shall apply with respect to one event except
for those Loss Occurrences referred to in 1. and 2. above, where only
one such period of 72 consecutive hours shall apply with respect to
one event, regardless of the duration of the event.
C. No individual losses occasioned by an event that would be covered by
72 hours clauses may be included in any Loss Occurrence claimed under
the 168 hours provision.
As respects Casualty Business covered under this Agreement:
The term "Loss Occurrence" shall mean any accident or occurrence or
series of accidents or occurrences arising out of any one event and
happening within the term and scope of this Agreement. Without limiting
the generality of the foregoing, the term "Loss Occurrence" shall be
held to include:
A. As respects Products Bodily Injury and Products Property Damage
Liability, injuries to all persons and all damage to property of
others occurring during a Policy Period and proceeding from or
traceable to the same causative agency shall be deemed to arise out
of one Loss Occurrence, and the date of such Loss Occurrence shall be
deemed to be the commencing date of the Policy Period. For the
purpose of this provision, each annual period of a Policy which
continues in force for more than one year shall be deemed to be a
separate Policy Period.
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<PAGE>
B As respects Bodily Injury Liability (other than Automobile and
Products), said term shall also be understood to mean, as regards
each original assured, injuries to one or more than one person
resulting from infection, contagion, poisoning, or contamination
proceeding from or traceable to the same causative agency.
C. As respects Property Damage Liability (other than Automobile and
Products), said term shall also, subject to Provisions 1. and 2.
below, be understood to mean loss or losses caused by a series of
operations, events, or occurrences arising out of operations at one
specific site and which cannot be attributed to any single one of
such operations, events or occurrences, but rather to the cumulative
effect of the same. In assessing each and every Loss Occurrence
within the foregoing definition, it is understood and agreed that:
1. the series of operations, events or occurrences shall not extend
over a period longer than 12 consecutive months; and
2. the Company may elect the date on which the period of not
exceeding 12 consecutive months shall be deemed to have commenced.
In the event that the series of operations, events or occurrences
extend over a period longer than 12 consecutive months, then each
consecutive period of 12 months, the first of which commences on the
date elected under 2. above, shall form the basis of claim under this
Agreement.
D. As respects those Policies of the Company which provide aggregate
limits of liability, the total of all individual losses occurring
during any one Policy year which proceed from or are traceable to the
same causative agency.
ARTICLE XII - REINSURANCE PREMIUM
A. The Company shall cede to the Reinsurer 75% of the Company's
unearned premiums on its Ultimate Net Liability in force as of July
1, 1998 on the business covered hereunder.
B. The Company shall cede to the Reinsurer 75% of the Company's Net
Premiums Written applicable to new and renewal Policies becoming
effective on or after July 1, 1998, with respect to its Ultimate Net
Liability on the business covered hereunder.
C. The term "Net Premiums Written" shall mean gross and additional
premiums less return premiums and less premiums ceded on all other
reinsurance, other than premiums ceded for Catastrophe Reinsurance
provided in Article VI - Catastrophe Reinsurance.
13. No. TM666A
<PAGE>
D. The following percentages of the Company's premium shall be
allocated to the business covered
under this Agreement:
Homeowners: Section I - 90% Section II - 10%
Businessowners: Section I - 60% Section II - 40%
ARTICLE XIII - SLIDING SCALE COMMISSION
A. The Reinsurer shall make to the Company a provisional commission
allowance of 37.50% of the Net Premiums Written, ceded hereunder. The
Company shall debit the Reinsurer with the provisional commission
allowance; such provisional commission shall be adjusted as provided
hereafter. On all return premiums the Company shall return to the
Reinsurer the provisional commission allowance of 37.50%. Such
commission allowance includes provision for all brokerage and
commission, premium taxes of all kinds, all board, bureau and
exchange assessments and any other expenses whatsoever except Loss
Adjustment Expenses.
B. The adjusted commission allowance which the Reinsurer shall make to
the Company shall be in
accordance with the following formula and computed and paid on Earned
Premiums. All
intermediate and final calculations shall be rounded to two decimal
places.
<TABLE>
<CAPTION>
<S>
<C>
If the actual ratio of Incurred
The adjusted commission
Losses to Earned Premiums is:
shall be:
42.50% or less
43.50% Maximum
Higher than 42.50% but
43.50% less 60.00% of
not exceeding 52.50%
the difference between
the actual loss ratio
and 42.50%
Higher than 52.50% but
37.50% less 83.33% of
not exceeding 67.50%
the difference between
the actual loss ratio
and 67.50%
67.50% or higher
25.00% Minimum
</TABLE>
C. The term "Incurred Losses" means all losses and Loss Adjustment
Expenses paid less recoveries,
including salvage and subrogation, during the current Period for
which computation is being made
plus all losses and Loss Adjustment Expenses outstanding at the end
of the current Period less all
losses and Loss Adjustment Expenses outstanding at the close of the
preceding Period.
D. The term "Earned Premiums" means the total of the Net Premiums
Written, ceded during the current
Period plus the unearned premiums
14. No. TM666A
<PAGE>
at the close of the preceding Period less the unearned premiums at
the close of the current Period, said unearned premiums to be
calculated on a monthly pro rata basis.
E. The term "Period" means the actual time covered by each
adjustment of commission.
F. The adjustment of commission shall be made as soon as
practicable after the close of each Period.
The first adjustment shall be made as of June 30, 1999, for the
Period from July 1, 1998, through June 30, 1999, and thereafter
adjustments shall be made annually for each Period commencing July 1
and ending the following June 30.
G. As soon as practicable after the close of each Period, the Company
shall calculate the commission
adjustment on the Earned Premiums during the Period. If the
adjusted commission on the Earned Premiums during the Period exceeds
the provisional commission already allowed on the Earned Premiums,
the Reinsurer shall pay the difference to the Company. If the
provisional commission already allowed on the Earned Premiums
exceeds the adjusted commission on the Earned Premiums, the
difference shall be refunded by the Company to the Reinsurer. In
addition, the difference in commission adjustment shall be paid by
the debtor party within 30 days after the Reinsurer's verification
of the Company's calculations.
H. If the ratio of Incurred Losses to Earned Premiums for any Period,
including any debits or credits
carried forward, is more than 67.50%, the difference in percentage
between the actual ratio and 67.50% shall be multiplied by the
Earned Premiums for the Period, and the product shall be carried
forward to the next Period's commission adjustment calculations as a
debit to Incurred Losses.
I. If the ratio of Incurred Losses to Earned Premiums for any
Period, including any debits or credits
carried forward, is less than 42.50%, the difference in percentage
between the actual ratio and 42.50% shall be multiplied by the
Earned Premiums for the Period and the product shall be carried
forward to the next Period's commission adjustment calculations as a
credit to Incurred Losses.
J. In case notice of termination has been given, no further
adjustments of commission shall be made until the expiration of all
liability and the settlement of all losses covered under this
Agreement.
K. In the event this Agreement is terminated by the Company prior to
July 1, 2003 or at any subsequent date other than the end of an
adjustment Period, the ultimate commission allowance shall be
calculated in accordance with the following scale:
If the ratio of "Incurred Losses" to "Earned Premiums" is:
1. 92.50% or greater, the commission shall be 0;
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<PAGE>
2. Less than 92.50% but not less than 67.50%, the commission
shall be 100% of the difference between such ratio and 92.50%,
but such commission shall not be greater than 25.00%;
3. Less than 67.50%, the commission shall be 25.00% plus 83.33%
of the difference between such ratio and 67.50%, but such
commission shall not be greater than 43.50%.
ARTICLE XIV - LOSSES, LOSS ADJUSTMENT EXPENSES AND SALVAGES
A. The Reinsurer shall pay its pro rata share of losses paid by the
Company arising under Policies
covered under this Agreement, and the Reinsurer shall benefit
proportionately in all recoveries, including salvage and
subrogation.
B. The Reinsurer shall pay its pro rata share of Loss Adjustment
Expenses paid by the Company in connection with the investigation,
settlement, defense or litigation of any claim or loss which is the
subject matter of Policies covered under this Agreement. The term
"Loss Adjustment Expenses" shall mean all claim or loss expenses
and shall include Claim-Specific Declaratory Judgment Expenses.
However, the term "Loss Adjustment Expenses" shall not include the
salaries and expenses of Company employees, office expenses and
other overhead expenses.
C. "Claim-Specific Declaratory Judgment Expenses" shall mean
expenses incurred in actions brought to determine the Company's
defense and/or indemnification obligations for individual claims
presented against Policies covered under this Agreement. Any Claim-
Specific Declaratory Judgment Expense shall be deemed to have been
fully incurred on the same date as the insured's original loss (if
any) giving rise to the action, unless otherwise provided for within
this Agreement.
D. The Company shall have the responsibility to investigate, defend or
negotiate settlements of all
claims and lawsuits related to Policies written by the Company and
reinsured under this Agreement. The Reinsurer, at its own expense,
may associate with the Company in the defense or control of any
claim, suit or other proceeding which involves or is likely to
involve the reinsurance provided under this Agreement, and the
Company shall cooperate in every respect in the defense of any such
claim, suit or proceeding.
ARTICLE XV- REPORTS AND REMITTANCES
A. The Company shall provide the Reinsurer with a quarterly account
as well as quarterly and annual reports in accordance with the
provisions set forth in Paragraphs C., D. and E. below.
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<PAGE>
B. Portfolio Assumption - Within 30 days after July 1, 1998, the
Company shall pay to the Reinsurer the Reinsurer's pro rata share of
the Company's unearned premium reserve on the business in force as
of said date.
C. Quarterly Account - Within 45 days after the close of each quarter
the Company shall forward a
quarterly account summarizing the following transactions under this
Agreement during such quarter:
1. Net Premiums Written ceded segregated by Line of Business;
2. Commissions;
3. Loss and Loss Adjustment Expenses paid less recoveries,
including salvage and subrogation, segregated by Line of
Business, by year of loss.
The balance due either party shall be paid within 60 days after the
close of each quarter for the transactions during such quarter.
D. Quarterly Report - The Company shall furnish the Reinsurer within
45 days after the close of each
quarter the following information as respects the business ceded
hereunder:
1. Unearned premium reserves segregated by Line of Business at the
end of the quarter and calculated on the monthly pro rata basis;
2. Estimated loss and Loss Adjustment Expense reserves outstanding at
the end of the quarter
segregated by Line of Business, by year of loss.
E. Annual Report - The Company shall furnish the Reinsurer within
60 days after the close of each
calendar year a summary of the business ceded hereunder:
1. Net Premiums Written ceded during the year segregated by Line
of Business;
2. Unearned premium reserves segregated by Line of Business;
3. Losses and Loss Adjustment Expenses paid, less recoveries,
including salvage and subrogation,
during the year segregated by Line of Business, by year of loss;
4. Losses and Loss Adjustment Expenses outstanding at the end of
the year segregated by Line of
Business, by year of loss.
F. As respects Property Business covered under this Agreement, the
Company shall furnish the
following to the Reinsurer with respect to occurrences designated
as catastrophes by the Property Claim Services:
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<PAGE>
1. Prompt preliminary estimate of amount recoverable from the
Reinsurer;
2. Within 30 days after the close of each quarter the amount of
losses and Loss Adjustment
Expenses paid, less all recoveries, including salvage and
subrogation, at the end of each quarter segregated by Line of
Business;
3. Within 30 days after the close of each quarter the amount of
losses and Loss Adjustment
Expenses outstanding at the end of each quarter segregated by
Line of Business.
ARTICLE XVI - ACCESS TO RECORDS
The Reinsurer or its duly authorized representatives shall have the
right to examine, at the offices of the Company at a reasonable time,
during the currency of this Agreement or anytime thereafter, all books
and records of the Company relating to business which is the subject of
this Agreement.
ARTICLE XVII - TAXES
The Company shall be liable for all taxes on premiums paid to the
Reinsurer under this Agreement, except income or profit taxes of the
Reinsurer, and shall indemnify and hold the Reinsurer harmless for any
such taxes which the Reinsurer may become obligated to pay to any local,
state or federal taxing authority.
ARTICLE XVIII - CURRENCY
Wherever the word "dollars" or the "$" symbol is used in this Agreement,
it shall mean dollars of the United States of America, excepting in
those cases where the Policy is issued by the Company in Canadian
dollars, in which case it shall mean dollars of Canada. In the event
the Company is involved in a loss requiring payment in United States and
Canadian currency, the Company's retention and the limit of liability of
the Reinsurer shall be apportioned between the two currencies in the
same proportion as the amount of net loss in each currency bears to the
total amount of net loss paid by the Company. For the purposes of this
Agreement, where the Company receives premiums or pays losses in
currencies other than United States or Canadian currency, such premiums
and losses shall be converted into United States dollars at the actual
rates of exchange at which the premiums and losses are entered in the
Company's books.
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<PAGE>
ARTICLE XIX - OFFSET
Each party to this Agreement together with their successors or assigns
shall have and may exercise, at any time, the right to offset any
balance or balances due the other (or, if more than one, any other).
Such offset may include balances due under this Agreement and any other
agreements heretofore or hereafter entered into between the parties
regardless of whether such balances arise from premiums, losses or
otherwise, and regardless of capacity of any party, whether as assuming
insurer and/or ceding insurer, under the various agreements involved,
provided however, that in the event of insolvency of a party hereto,
offsets shall only be allowed in accordance with the provisions of
Section 7427 of the Insurance Law of the State of New York to the extent
such statute or any other applicable law, statute or regulation
governing such offset shall apply.
ARTICLE XX - ERRORS OR OMISSIONS
Errors or omissions of a clerical nature on the part of the Company
shall not invalidate the reinsurance under this Agreement, provided such
errors or omissions are corrected promptly after discovery thereof; but
the liability of the Reinsurer under this Agreement or any exhibits,
addenda, or endorsements attached hereto shall in no event exceed the
limits specified herein nor be extended to cover any risks, perils,
lines of business or classes of insurance generally or specifically
excluded herein.
ARTICLE XXI - DISPUTE RESOLUTION
Part I - Choice Of Law And Forum
Any dispute arising under this Agreement shall be resolved in the State
of Massachusetts, and the laws of the State of Massachusetts shall
govern the interpretation and application of this Agreement.
Part II - Mediation
If a dispute between the Company and the Reinsurer, arising out of the
provisions of this Agreement or concerning its interpretation or
validity and whether arising before or after termination of this
Agreement has not been settled through negotiation, both parties agree
to try in good faith to settle such dispute by nonbinding mediation,
before resorting to arbitration.
Part III - Arbitration
A. Resolution of Disputes - As a condition precedent to any right
arising hereunder, any dispute not resolved by mediation between
the Company and the Reinsurer arising out of the provisions of this
Agreement or concerning its interpretation or validity, whether
arising before or after termination of this Agreement, shall be
submitted to arbitration in the manner hereinafter set forth.
19. No. TM666A
<PAGE>
B. Composition of Panel - Unless the parties agree upon a single
arbitrator within 15 days after the
receipt of a notice of intention to arbitrate, all disputes shall
be submitted to an arbitration panel composed of two arbitrators
and an umpire chosen in accordance with Paragraph C hereof.
C. Appointment of Arbitrators - The members of the arbitration panel
shall be chosen from persons
knowledgeable in the insurance and reinsurance business. Unless a
single arbitrator is agreed upon, the party requesting arbitration
(hereinafter referred to as the "claimant") shall appoint an
arbitrator and give written notice thereof by certified mail, to
the other party (hereinafter referred to as the "respondent")
together with its notice of intention to arbitrate. Within 30 days
after receiving such notice, the respondent shall also appoint an
arbitrator and notify the claimant thereof by certified mail.
Before instituting a hearing, the two arbitrators so appointed
shall choose an umpire. If, within 20 days after the appointment
of the arbitrator chosen by the respondent, the two arbitrators
fail to agree upon the appointment of an umpire, each of them shall
nominate three individuals to serve as umpire, of whom the other
shall decline two and the umpire shall be chosen from the remaining
two by drawing lots. The name of the individual first drawn shall
be the umpire.
D. Failure of Party to Appoint an Arbitrator - If the respondent
fails to appoint an arbitrator within 30
days after receiving a notice of intention to arbitrate, the
claimant's arbitrator shall appoint an arbitrator on behalf of the
respondent, such arbitrator shall then, together with the
claimant's arbitrator, choose an umpire as provided in Paragraph C.
of Part III of this Article.
E. Involvement of Other Reinsurers - If more than one reinsurer is
involved in the same dispute, all
such reinsurers shall constitute and act as one party for purposes
of this Article and communications shall be made by the Company to
each of the reinsurers constituting the one party; provided,
however, nothing herein shall impair the right of such reinsurers
to assert several, rather than joint, defenses or claims, nor be
construed as changing the liability of the reinsurers under the
terms of this Agreement from several to joint.
F. If the Company is involved in a dispute under the terms of this
Agreement and in one or more
separate disputes with one or more other reinsurers in which common
questions of law or fact are in issue, the Company or the
Reinsurer, at its option, may join with such other reinsurers in a
common arbitration proceeding under the terms of this Article. If
the Company and such other reinsurers have commenced arbitration,
the Reinsurer may at its option join such proceeding for the
determination of the dispute between the Company and the Reinsurer.
20. No. TM666A
<PAGE>
G. Submission of Dispute to Panel - Unless otherwise extended by
the arbitration panel or agreed to by
the parties, each party shall submit its case to the panel within
30 days after the selection of the umpire.
H. Procedure Governing Arbitration - All proceedings before the
panel shall be informal and the panel
shall not be bound by the formal rules of evidence. The panel
shall have the power to fix all procedural rules relating to the
arbitration proceeding. In reaching any decision, the panel shall
give due consideration to the customs and usages of the insurance
and reinsurance business.
I. Arbitration Award - The arbitration panel shall render its
decision within 60 days after termination
of the proceeding, which decision shall be in writing, stating the
reasons therefor. The decision of the majority of the panel shall
be final and binding on the parties to the proceeding.
J. Cost of Arbitration - Unless otherwise allocated by the panel,
each party shall bear the expense of
its own arbitrator and shall jointly and equally bear with the
other parties the expense of the umpire and the arbitration.
ARTICLE XXII - INSOLVENCY
A. In the event of insolvency of the Company, the reinsurance
provided by this Agreement shall be
payable by the Reinsurer on the basis of the liability of the
Company as respects Policies covered hereunder, without diminution
because of such insolvency, directly to the Company or its
liquidator, receiver, conservator or statutory successor except as
provided in Sections 4118(a)(1)(A) and 1114(c) of the New York
Insurance Law.
B. The Reinsurer shall be given written notice of the pendency of
each claim or loss which may
involve the reinsurance provided by this Agreement within a
reasonable time after such claim or loss is filed in the insolvency
proceedings. The Reinsurer shall have the right to investigate
each such claim or loss and interpose, at its own expense, in the
proceedings where the claim or loss is to be adjudicated, any
defense which it may deem available to the Company, its liquidator,
receiver, conservator or statutory successor. The expense thus
incurred by the Reinsurer shall be chargeable, subject to court
approval, against the insolvent Company as part of the expense of
liquidation to the extent of a proportionate share of the benefit
which may accrue to the Company solely as a result of the defense
undertaken by the Reinsurer.
21. No. TM666A
<PAGE>
C. In addition to the offset provisions set forth in Article XIX -
Offset, any debts or credits, liquidated
or unliquidated, in favor of or against either party on the date of
the receivership or liquidation order (except where the obligation
was purchased by or transferred to be used as an offset) are deemed
mutual debts or credits and shall be set off with the balance only
to be allowed or paid. Although such claim on the part of either
party against the other may be unliquidated or undetermined in
amount on the date of the entry of the receivership or liquidation
order, such claim will be regarded as being in existence as of such
date and any claims then in existence and held by the other party
may be offset against it.
D. Nothing contained in this Article is intended to change the
relationship or status of the parties to this Agreement or to
enlarge upon the rights or obligations of either party hereunder
except as provided herein.
ARTICLE XXIII - SPECIAL TERMINATION
A. Notwithstanding the termination provisions set forth in Article
II - Effective Date and Termination,
this Agreement shall be:
1. Terminated automatically and simultaneously upon the happening
of any of the following
events:
a. Entry of an order of liquidation, rehabilitation,
receivership or conservatorship with respect
to the Company or the Reinsurer by any court or regulatory
authority;
b. General reinsurance of any portion of the Company's
business it retains net for its own
account, as determined under the provisions of this Agreement
without prior consent of the
Reinsurer.
2. Terminated simultaneously, at the option of either party, upon
the happening of any of the
following events:
a. Assignment of this Agreement by either party;
b. Any transfer of control of either party by change in
ownership or otherwise.
3. Terminated in accordance with the provisions set forth in
this Paragraph, upon the discovery of the following event:
A reduction of 50% or more of the Company's policyholders
surplus during any calendar year. Such reduction shall be
determined by calculating the difference between the
Company's prior year annual statement and each subsequent
22. No. TM666A
<PAGE>
quarterly statutory statement within such current calendar
year.
As respects the event set forth in this Paragraph A.3., the Company
shall be obligated to notify the Reinsurer in writing within 30 days
after the filing of its quarterly statement. Upon receipt of such
notification the Reinsurer shall have the right to terminate this
Agreement, by giving not less than 30 days notice of its intention to do
so.
B. Any notice of termination pursuant to provisions set forth in
Paragraphs A.2. and A.3. above shall be sent by certified mail,
return receipt requested. The notice period under Paragraph A.3.
above shall commence upon the other party's receipt of the notice
of termination.
C. In the event of termination, the Reinsurer shall not be liable
for losses occurring subsequent to the date of termination.
ARTICLE XXIV - AMENDMENTS
This Agreement may be amended by mutual consent of the parties expressed
in an addendum; and such addendum, when executed by both parties, shall
be deemed to be an integral part of this Agreement and binding on the
parties hereto.
KS:sb
COM666A-98
23. No. TM666A
<PAGE>
SUPPLEMENT TO THE ATTACHMENTS
DEFINITION OF IDENTIFICATION TERMS USED WITHIN THE ATTACHMENTS
A. Wherever the term "Company" or "Reinsured" or "Reassured" or
whatever other term is used to designate the reinsured company or
companies within the various attachments to the reinsurance
agreement, the term shall be understood to mean Company or
Reinsured or Reassured or whatever other term is used in the
attached reinsurance agreement to designate the reinsured company
or companies.
B. Wherever the term "Agreement" or "Contract" or "Policy" or
whatever other term is used to designate the attached reinsurance
agreement within the various attachments to the reinsurance
agreement, the term shall be understood to mean Agreement or
Contract or Policy or whatever other term is used to designate the
attached reinsurance agreement.
C. Wherever the term "Reinsurer" or "Reinsurers" or
"Underwriters" or whatever other term is used to designate the
reinsurer or reinsurers in the various attachments to the
reinsurance agreement, the term shall be understood to mean
Reinsurer or Reinsurers or Underwriters or whatever other term is
used to designate the reinsuring company or companies.
INSOLVENCY FUNDS EXCLUSION CLAUSE
This Agreement excludes all liability of the Company arising by
contract, operation of law, or otherwise from its participation or
membership, whether voluntary or involuntary, in any insolvency fund or
from reimbursement of any person for any such liability. "Insolvency
fund" includes any guaranty fund, insolvency fund, plan, pool,
association, fund or other arrangement, howsoever denominated,
established or governed, which provides for any assessment of or payment
or assumption by any person of part or all of any claim, debt, charge,
fee, or other obligation of an insurer, or its successors or assigns,
which has been declared by any competent authority to be insolvent or
which is otherwise deemed unable to meet any claim, debt, charge, fee or
other obligation in whole or in part.
<PAGE>
POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE
SECTION A
Excluding:
(a) All Business derived directly or indirectly from any Pool,
Association or Syndicate which maintains its own reinsurance
facilities.
(B) Any Pool or Scheme (whether voluntary or mandatory) formed after
March 1, 1968, for the purpose
of insuring Property whether on a country-wide basis or in respect
of designated areas. This Exclusion shall not apply to so-called
Automobile Insurance Plans or other Pools formed to provide
coverage for Automobile Physical Damage.
SECTION B
It is agreed that business, written by the Company for the same perils,
which is known at the time to be insure d by or in excess of underlying
amounts placed in the following Pools, Associations or Syndicates,
whether by way of insurance or reinsurance is excluded hereunder:
Industrial Risk Insurers (successor to Factory Insurance
Association and Oil Insurance Association); Associated Factory
Mutuals; Improved Risk Mutuals.
Any Pool, Association or Syndicate formed for the purpose of
writing Oil, Gas or Petro-Chemical Plants and/or Oil or Gas
Drilling Rigs.
United States Aircraft Insurance Group, Canadian Aircraft Insurance
Group, Associated Aviation Underwriters, American Aviation
Underwriters.
SECTION B does not apply:
(a) Where the Total Insured Value over all interests of the risk in
question is less than $250,000,000.
(b) To interests traditionally underwritten as Inland Marine or Stock
and/or Contents written on a
Blanket basis.
(c) To Contingent Business Interruption, except when the Company is
aware that the key location is
known at the time to be insured in any Pool, Association or
Syndicate named above.
(d) To risks as follows: Offices, Hotels, Apartments, Hospitals,
Educational Establishments, Public
Utilities (other than Railroad Schedules) and Builders Risks on the
classes of risks specified in this subsection (d) only.
<PAGE>
TOTAL INSURED VALUE EXCLUSION CLAUSE
It is the mutual intention of the parties to exclude risks, other than
Offices, Hotels, Apartments, Hospitals, Educational Establishments,
Public Utilities (except Railroad schedules) and Builders Risk on the
above classes where, at the time of the cession, the Total Insured Value
over all interests exceeds $250,000,000. However, the Company shall be
protected hereunder, subject to the other terms and conditions of this
Agreement, if subsequently to cession being made the Company becomes
acquainted with the true facts of the case and discovers that the mutual
intention has been inadvertently breached, the Company shall at the
first opportunity, and certainly by next anniversary of the original
policy, exclude the risk in question.
It is agreed that this mutual intention does not apply to Contingent
Business Interruption or to interest traditionally underwritten as
Inland Marine or to Stock and/or Contents written on a blanket basis
except where the Company is aware that the Total Insured Value of
$250,000,000 is already exceeded for buildings, machinery, equipment and
direct use and occupancy at the key location.
It is understood and agreed that this Clause shall not apply hereunder
where the Company writes 100% of the risk.
Notwithstanding anything contained herein to the contrary, it is the
mutual intention of the parties in respect of bridges and tunnels to
exclude such risks where the Total Insured Value over all interests
exceeds $250,000,000.
<PAGE>
POLLUTION AND SEEPAGE EXCLUSION CLAUSE
This Reinsurance does not apply to:
1. Pollution, seepage, contamination or environmental impairment
insurances (hereinafter collectively referred to as "pollution"),
however styled;
2. Loss or damage caused directly or indirectly by pollution,
unless said loss or damage follows as a result of a loss caused
directly by a peril covered hereunder;
3. Expenses resulting from any governmental direction or request
that material present in or part of or utilized on an insured's
property be removed or modified, except as provided in 5. Below;
4. Expenses incurred in testing for and/or monitoring pollutants;
5. Expenses incurred in removing debris, unless (A) the debris
results from a loss caused directly by a
peril covered hereunder, and (B) the debris to be removed is itself
covered hereunder, and (C) the debris is on the insured's premises,
subject, however, to a limit of $5,000 plus 25% of (i) the property
damage loss, any risk, any one location, any one original insured,
and (ii) any deductible applicable to the loss;
6. Expenses incurred to extract pollutants from land or water at
the insured's premises unless (A) the release, discharge, or
dispersal of pollutants results from a loss caused directly by a
peril covered hereunder, and (B) such expenses shall not exceed
$10,000;
7. Loss of income due to any increased period of time required to
resume operations resulting from enforcement of any law regulating
the prevention, control, repair, clean-up or restoration of
environmental damage;
8. Claims under 5. and/or 6. above, unless notice thereof is given
to the Company within 180 days
after the date of the loss occurrence to which such claims relate.
"Pollutants" means any solid, liquid, gaseous or thermal irritant or
contaminant, including smoke, vapor, soot, fumes, acids, alkalis,
chemicals and waste. Waste includes materials to be recycled,
reconditioned or reclaimed.
<PAGE>
Where no pollution exclusion has been accepted or approved by an
insurance regulatory authority for use in a policy that is subject to
this Agreement or where a pollution exclusion that has been used in a
policy is overturned, either in whole or in part, by a court having
jurisdiction, there shall be no recovery for pollution under this
Agreement unless said pollution loss or damage follows as a result of a
loss caused directly by a peril covered hereunder.
Nothing herein shall be deemed to extend the coverage afforded by this
reinsurance to property or perils specifically excluded or not covered
under the terms and conditions of the original policy involved.
<PAGE>
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE -
U.S.A.
N.M.A. 1119
1. This Reinsurance does not cover any loss or liability accruing to
the Reassured, directly or
indirectly, and whether as Insurer or Reinsurer, from any Pool of
Insurers or Reinsurers formed for the purpose of covering Atomic or
Nuclear Energy risks.
2. Without in any way restricting the operation of paragraph 1. of
this Clause, this Reinsurance does not cover any loss or liability
accruing to the Reassured, directly or indirectly, and whether as
Insurer or Reinsurer, from any insurance against Physical Damage
(including business interruption or consequential loss arising out
of such Physical Damage) to:
I. Nuclear reactor power plants including all auxiliary property
on the site, or
II. Any other nuclear reactor installation, including
laboratories handling radioactive materials in
connection with reactor installations, and critical
facilities as such, or
III. Installations for fabricating complete fuel elements or for
processing substantial quantities of
"special nuclear material," and for reprocessing, salvaging,
chemically separating, storing or
disposing of spent nuclear fuel or waste materials, or
IV. Installations other than those listed in paragraph 2. III.
above using substantial quantities of
radioactive isotopes or other products of nuclear fission.
3. Without in any way restricting the operation of paragraphs 1.
and 2. of this Clause, this Reinsurance
does not cover any loss or liability by radioactive contamination
accruing to the Reassured, directly or indirectly, and whether as
Insurer or Reinsurer, from any insurance on property which is on the
same site as a nuclear reactor power plant or other nuclear
installation and which normally would be insured therewith, except
that this paragraph 3. shall not operate:
(a) where the Reassured does not have knowledge of such
nuclear reactor power plant or nuclear installation, or
(b) where the said insurance contains a provision excluding
coverage for damage to property caused by or resulting from
radioactive contamination, however caused. However, on and
after 1st January, 1960, this sub-paragraph (b) shall only
apply provided the said radioactive contamination exclusion
provision has been approved by the Governmental Authority
having jurisdiction thereof.
- - 1 -
<PAGE>
4. Without in any way restricting the operation of paragraphs 1., 2.
and 3. of this Clause, this Reinsurance does not cover any loss or
liability by radioactive contamination accruing to the Reassured,
directly or indirectly, and whether as Insurer or Reinsurer, when
such radioactive contamination is a named hazard specifically
insured against.
5. It is understood and agreed this Clause shall not extend to
risks using radioactive isotopes in any form where the nuclear
exposure is not considered by the Reassured to be the primary
hazard.
6. The term "special nuclear material" shall have the meaning
given to it by the Atomic Energy Act of 1954 or by any law
amendatory thereof.
7. Reassured to be sole judge of what constitutes:
(a) substantial quantities, and
(b) the extent of installation, plant or site.
NOTE: - Without in any way restricting the operation of paragraph 1.
hereof, it is understood and agreed that
(a) all policies issued by the Reassured on or before 31st
December, 1957 shall be free from the
application of the other provisions of this Clause until expiry
date or 31st December, 1960 whichever first occurs whereupon
all the provisions of this Clause shall apply,
(b) with respect to any risk located in Canada policies issued
by the Reassured on or before 31st
December, 1958 shall be free from the application of the other
provisions of this Clause until expiry date or 31st December,
1960 whichever first occurs whereupon all the provisions of
this Clause shall apply.
N.M.A. 1119
- - 2 -
<PAGE>
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE -
CANADA
N.M.A. 1980
1. This Agreement does not cover any loss or liability accruing to
the Company directly or indirectly, and whether as Insurer or
Reinsurer, from any Pool of Insurers or Reinsurers formed for the
purpose of covering Atomic or Nuclear Energy risks.
2. Without in any way restricting the operation of paragraph 1. of
this clause, this Agreement does
not cover any loss or liability accruing to the Company, directly
or indirectly, and whether as Insurer or Reinsurer, from any
insurance against Physical Damage (including business interruption
or consequential loss arising out of such Physical Damage) to:
a. Nuclear reactor power plants including all auxiliary
property on the site, or
b. Any other nuclear reactor installation, including
laboratories handling radioactive materials in
connection with reactor installations, and critical facilities
as such, or
c. Installations for fabricating complete fuel elements or for
processing substantial quantities of
prescribed substances, and for reprocessing, salvaging,
chemically separating, storing or disposing of spent nuclear
fuel or waste materials, or
d. Installations other than those listed in c. above using
substantial quantities of radioactive
isotopes or other products of nuclear fission.
3. Without in any way restricting the operation of paragraphs 1.
and 2. of this clause, this Agreement does not cover any loss or
liability by radioactive contamination accruing to the Company,
directly or indirectly, and whether as Insurer or Reinsurer, from
any insurance on property which is on the same site as a nuclear
reactor power plant or other nuclear installation and which
normally would be insured therewith, except that this paragraph 3.
shall not operate:
a. where the Company does not have knowledge of such nuclear
reactor power plant or nuclear
|installation, or
b. where the said insurance contains a provision excluding
coverage for damage to property
caused by or resulting from radioactive contamination, however
caused.
- - 1 -
<PAGE>
4. Without in any way restricting the operation of paragraphs 1., 2.
and 3. of this clause, this
Agreement does not cover any loss or liability by radioactive
contamination accruing to the Company, directly or indirectly, and
whether as Insurer or Reinsurer, when such radioactive
contamination is a named hazard specifically insured against.
5. This clause shall not extend to risks using radioactive isotopes
in any form where the nuclear
exposure is not considered by the Company to be the primary
hazard.
6. The term "prescribed substances" shall have the meaning given to
it by the Atomic Energy
Control Act R.S.C. 1974 or by any law amendatory thereof.
7. Company to be sole judge of what constitutes:
a. substantial quantities, and
b. the extent of installation, plant or site.
8. Without in any way restricting the operation of paragraphs 1.,
2., 3. and 4. of this clause, this
Agreement does not cover any loss or liability accruing to the
Company, directly or indirectly, and whether as Insurer or
Reinsurer, caused by any nuclear incident as defined in The
Nuclear Liability Act, nuclear explosion or contamination by
radioactive material.
NOTE: Without in any way restricting the operation of paragraphs 1.,
2., 3. and 4. of this clause,
paragraph 8. of this clause shall apply to all original
contracts of the Company whether new, renewal or replacement
which become effective on or after December 31, 1984.
N.M.A. 1980
- - 2 -
<PAGE>
NUCLEAR INCIDENT EXCLUSION CLAUSE - REINSURANCE - NO. 4
1. This Reinsurance does not cover any loss or liability
accruing to the Reassured as a member of, or subscriber to, any
association of insurers or reinsurers formed for the purpose of
covering nuclear energy risks or as a direct or indirect reinsurer
of any such member, subscriber or association.
2. Without in any way restricting the operations of Nuclear
Incident Exclusion Clauses, - Liability, - Physical Damage, -
Boiler and Machinery and paragraph 1. of this Clause, it is
understood and agreed that for all purposes of the reinsurance
assumed by the Reinsurer from the Reinsured, all original
insurance policies or contracts of the Reinsured (new, renewal and
replacement) shall be deemed to include the applicable existing
Nuclear Clause and/or Nuclear Exclusion Clause(s) in effect at the
time and any subsequent revisions thereto as agreed upon and
approved by the Insurance Industry and/or a qualified Advisory or
Rating Bureau.
<PAGE>
POLLUTION LIABILITY EXCLUSION CLAUSE - REINSURANCE
This Reinsurance excludes:
(1) Any loss occurrence arising out of the actual, alleged or
threatened discharge, dispersal, release or |escape of pollutants:
a) At or from premises owned, rented or occupied by an original
assured; or
b) At or from any site or location used for the handling, storage,
disposal, processing or treatment of waste; or
c) Which are at any time transported, handled, stored, treated,
disposed of, or processed as waste; or
d) At or from any site or location on which any original assured
is performing operations:
(i) If the pollutants are brought on or to the site or location
in connection with such operations; or
(ii) If the operations are to test for, monitor, clean up, remove,
contain, treat, detoxify or
neutralize the pollutants.
(2) Any liability, loss, cost or expense arising out of any
governmental direction or request to test for, monitor, clean up,
remove, contain, treat, detoxify or neutralize pollutants.
"Pollutants" means any solid, liquid, gaseous or thermal irritant or
contaminant, including smoke, vapor, soot, fumes, acids, alkalis,
chemicals and waste. Waste includes materials to be recycled,
reconditioned or reclaimed.
Subparagraphs a) and d) (i) of paragraph (1) of this exclusion do not
apply to loss occurrences caused by heat, smoke or fumes from a hostile
fire. As used herein, "hostile fire" means one which becomes
uncontrollable or breaks out from where it was intended to be.
"Original assured" as used herein means all insureds as defined in the
policy issued by the Company.
<PAGE>
NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - U.S.A.
N.M.A. 1590
1. This reinsurance does not cover any loss or liability accruing
to the Reassured as a member of, or
subscriber to, any association of insurers or reinsurers formed for
the purpose of covering nuclear energy risks or as a direct or
indirect reinsurer of any such member, subscriber or association.
2. Without in any way restricting the operation of paragraph 1. of
this Clause it is understood and
agreed that for all purposes of this reinsurance all the original
policies of the Reassured (new, renewal and replacement) of the
classes specified in Clause II. in this paragraph 2. from the time
specified in Clause III. in this paragraph 2. shall be deemed to
include the following provision (specified as the Limited Exclusion
Provision):
LIMITED EXCLUSION PROVISION*
I. It is agreed that the policy does not apply under any
liability coverage, to injury,
sickness, disease, death or destruction, bodily injury or
property damage with respect to
which an insured under the policy is also an insured under a
nuclear energy liability
policy issued by Nuclear Energy Liability Insurance
Association, Mutual Atomic Energy
Liability Underwriters or Nuclear Insurance Association of
Canada, or would be an
insured under any such policy but for its termination upon
exhaustion of its limit of
liability.
II. Family Automobile Policies (liability only), Special
Automobile Policies (private passenger
automobiles, liability only), Farmers Comprehensive Personal
Liabilities Policies (liability only), Comprehensive Personal
Liability Policies (liability only) or policies of a similar
nature; and the liability portion of combination forms
related to the four classes of policies stated above, such
as the Comprehensive Dwelling Policy and the applicable types
of Homeowners Policies.
III. The inception dates and thereafter of all original
policies as described in II. above, whether
new, renewal or replacement, being policies which either
- - 1 -
<PAGE>
(a) become effective on or after 1st May, 1960, or
(b) become effective before that date and contain the Limited
Exclusion Provision set out above; provided this paragraph
2. shall not be applicable to Family Automobile Policies,
Special Automobile Policies, or policies or combination
policies of a similar nature, issued by the Reassured on New
York risks, until 90 days following approval of the Limited
Exclusion Provision by the Governmental Authority having
jurisdiction thereof.
3. Except for those classes of policies specified in Clause II. of
paragraph 2. and without in any way restricting the operation of
paragraph 1. of this Clause, it is understood and agreed that for
all purposes of this reinsurance the original liability policies of
the Reassured (new, renewal and replacement) affording the following
coverages:
Owners, Landlords and Tenants Liability, Contractual Liability, Elevator
Liability, Owners or Contractors (including railroad) Protective
Liability, Manufacturers and Contractors Liability, Product Liability,
Professional and Malpractice Liability, Storekeepers Liability, Garage
Liability, Automobile Liability (including Massachusetts Motor Vehicle
or Garage Liability)
shall be deemed to include with respect to such coverages, from the time
specified in Clause V. of this paragraph 3., the following provision
(specified as the Broad Exclusion Provision):
BROAD EXCLUSION PROVISION*
It is agreed that the policy does not apply:
I. Under any Liability Coverage to injury, sickness, disease,
death or destruction, bodily injury or
property damage
(a) with respect to which an insured under the policy is also an
insured under nuclear energy liability policy issued by Nuclear
Energy Liability Insurance Association, Mutual Atomic Energy
Liability Underwriters or Nuclear Insurance Association of
Canada, or would be an insured under any such policy but for
its termination upon exhaustion of its limit of liability; or
N.M.A. 1590
- - 2 -
<PAGE>
(b) resulting from the hazardous properties of nuclear material
and with respect to which (1) any person or organization is
required to maintain financial protection pursuant to the
Atomic Energy Act of 1954, or any law amendatory thereof, or
(2) the insured is, or had this policy not been issued would
be, entitled to indemnity from the United States of America, or
any agency thereof, under any agreement entered into by the
United States of America, or any agency thereof, with any
person or organization.
II. Under any Medical Payments Coverage, or under any Supplementary
Payments Provision relating
to immediate medical or surgical relief, first aid, to expenses
incurred with respect to bodily injury, sickness, disease or death,
bodily injury resulting from the hazardous properties of nuclear
material and arising out of the operation of a nuclear facility by
any person or organization.
III. Under any Liability Coverage, to injury, sickness, disease,
death or destruction, bodily injury or
property damage resulting from the hazardous properties of nuclear
material, if
(a) the nuclear material (1) is at any nuclear facility owned
by, or operated by or on behalf of, an insured or (2) has been
discharged or dispersed therefrom;
(b) the nuclear material is contained in spent fuel or waste at
any time possessed, handled, used, processed, stored,
transported or disposed of by or on behalf of an insured; or
(c) the injury, sickness, disease, death or destruction, bodily
injury or property damage arises out of the furnishing by an
insured of services, materials, parts or equipment in
connection with the planning, construction, maintenance,
operation or use of any nuclear facility, but if such facility
is located within the United States of America, its
territories, or possessions or Canada, this exclusion (c)
applies only to injury to or destruction of property at such
nuclear facility, property damage to such nuclear facility and
any property thereat.
N.M.A. 1590
- - 3-
<PAGE>
IV. As used in this endorsement:
"hazardous properties" include radioactive, toxic or explosive
properties; "nuclear material" means source material, special
nuclear material or byproduct material; "source material,"
"special nuclear material," and "byproduct material" have the
meanings given them in the Atomic Energy Act of 1954 or in any law
amendatory thereof; "spent fuel" means any fuel element or fuel
component, solid or liquid, which has been used or exposed to
radiation in a nuclear reactor; "waste" means any waste material
(1) containing byproduct material other than the tailings or
wastes produced by the extraction or concentration of uranium or
thorium from any ore processed for its source material content and
(2) resulting from the operation by any person or organization of
any nuclear facility included within the definition of nuclear
facility under paragraph (a) or (b) thereof; "nuclear facility"
means
(a) any nuclear reactor,
(b) any equipment or device designed or used for (1) separating
the isotopes of uranium or
plutonium, (2) processing or utilizing spent fuel, or (3)
handling, processing or packaging waste,
(c) any equipment or device used for the processing,
fabricating or alloying of special nuclear
material if at any time the total amount of such material in
the custody of the insured at the premises where such
equipment or device is located consists of or contains more
than 25 grams of plutonium or uranium 233 or any combination
thereof, or more than 250 grams of uranium 235,
(d) any structure, basin, excavation, premises or place prepared
or used for the storage or
disposal of waste
and includes the site on which any of the foregoing is located,
all operations conducted on such site and all premises used for
such operations; "nuclear reactor" means any apparatus designed or
used to sustain nuclear fission in a self-supporting chain
reaction or to contain a critical mass of fissionable material;
with respect to injury to or destruction of property, the word
"injury" or "destruction" includes all forms of radioactive
contamination of property; "property damage" includes all forms of
radioactive contamination of property.
V. The inception dates and thereafter of all original policies
affording coverages specified in this
paragraph 3., whether new, renewal or replacement, being policies
which become effective on or after 1st May, 1960, provided this
paragraph 3. shall not be applicable to
N.M.A. 1590
- - 4 -
<PAGE>
(i) Garage and Automobile Policies issued by the Reassured
on New York risks, or
(ii) Statutory liability insurance required under Chapter 90,
General Laws of Massachusetts,
until 90 days following approval of the Broad Exclusion Provision
by the Governmental Authority having jurisdiction thereof.
4. Without in any way restricting the operations of paragraph 1. of
this Clause, it is understood and agreed that paragraphs 2. and 3.
above are not applicable to original liability policies of the
Reassured in Canada, and that with respect to such policies, this
Clause shall be deemed to include the Nuclear Energy Liability
Exclusion Provisions adopted by the Canadian Underwriters'
Association or the Independent Insurance Conference of Canada.
*NOTE: The words printed in BOLD TYPE in the Limited Exclusion
Provision and in the Broad Exclusion Provision shall apply only
in relation to original liability policies which include a
Limited Exclusion Provision or a Broad Exclusion Provision
containing those words.
N.M.A. 1590
- - 5 -
<PAGE>
NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - CANADA
N.M.A. 1979
1. This Agreement does not cover any loss or liability accruing to the
Company as a member of, or subscriber to, any association of insurers
or reinsurers formed for the purpose of covering nuclear energy risks
or as a direct or indirect reinsurer of any such member, subscriber
or association.
2. Without in any way restricting the operation of Paragraph 1. of
this Clause, it is agreed that for all
purposes of this Agreement all the original liability contracts of
the Company, whether new, renewal or replacement, of the following
classes, namely,
Personal Liability
Farmers' Liability
Storekeepers' Liability
which become effective on or after 31st December 1984, shall be
deemed to include, from their inception dates and thereafter, the
following provision:
Limited Exclusion Provision -
This Policy does not apply to bodily injury or property damage with
respect to which the Insured is also insured under a contract of
nuclear energy liability insurance (whether the Insured is unnamed in
such contract and whether or not it is legally enforceable by the
Insured) issued by the Nuclear Insurance Association of Canada or any
other group or pool of insurers or would be an Insured under any such
policy but for its termination upon exhaustion of its limits of
liability.
With respect to property, loss of use of such property shall be
deemed to be property damage.
3. Without in any way restricting the operation of Paragraph 1. of
this Clause, it is agreed that for all
purposes of this Agreement all the original liability contracts of
the Company, whether new, renewal or replacement, of any class
whatsoever (other than Personal Liability, Farmers' Liability,
Storekeepers' Liability or Automobile Liability contracts), which
become effective on or after 31st December 1984, shall be deemed to
include, from their inception dates and thereafter, the following
provision:
<PAGE>
Broad Exclusion Provision -
It is agreed that this Policy does not apply:
(a) to liability imposed by or arising under the Nuclear Liability
Act; nor
(b) to bodily injury or property damage with respect to which an
Insured under this Policy is also
insured under a contract of nuclear energy liability insurance
(whether the Insured is unnamed in such contract and whether or
not it is legally enforceable by the Insured) issued by the
Nuclear Association of Canada or any other insurer or group or
pool of insurers or would be an Insured under any such policy but
for its termination upon exhaustion of its limit of liability; nor
(c) to bodily injury or property damage resulting directly or
indirectly from the nuclear energy hazard arising from:
(i) the ownership, maintenance, operation or use of a
nuclear facility by or on behalf of an Insured;
(ii) the furnishing of an Insured of services, materials,
parts or equipment in connection with the planning,
construction, maintenance, operation or use of any
nuclear facility; and
(iii) the possession, consumption, use, handling, disposal
or transportation of fissionable substances, or of
other radioactive material (except radioactive
isotopes, away from a nuclear facility, which have
reached the final stage of fabrication so as to
be usable for any scientific, medical, agricultural,
commercial or industrial purpose) used, distributed,
handled or sold by an Insured.
As used in this Policy:
(1) The term "nuclear energy hazard" means the radioactive, toxic,
explosive, or other hazardous properties of radioactive material;
(2) The term "radioactive material" means uranium, thorium, plutonium,
neptunium, their respective derivatives and compounds, radioactive
isotopes of other elements and any other substances that the Atomic
Energy Control Board may, by regulation, designate as being
prescribed substances capable of releasing atomic energy, or as
being requisite for the production, use or application of atomic
energy;
N.M.A. 1979
- - 2 -
<PAGE>
(3) The term "nuclear facility" means:
(a) any apparatus designed or used to sustain nuclear fission in a
self-supporting chain reaction or to contain a critical mass of
plutonium, thorium and uranium or any one or more of them;
(b) any equipment or device designed or used for (i) separating the
isotopes of plutonium, thorium
and uranium or any one or more of them, (ii) processing or
utilizing spent fuel, or (iii) handling, processing or packaging
waste;
(c) any equipment or device used for the processing, fabricating or
alloying of plutonium, thorium
or uranium enriched in the isotope uranium 233 or in the isotope
uranium 235, or any one or more of them if at any time the total
amount of such material in the custody of the Insured at the
premises where such equipment or device is located consists of or
contains more than 25 grams of plutonium or uranium 233 or any
combination thereof, or more than 250 grams of uranium 235;
(d) any structure, basin, excavation, premises or place prepared or
used for the storage or disposal of waste radioactive material;
and includes the site on which any of the foregoing is located,
together with all operations conducted thereon and all premises used
for such operations.
(4) The term "fissionable substance" means any prescribed substance
that is, or from which can be obtained, a substance capable of
releasing atomic energy by nuclear fission.
(5) With respect to property, loss of use of such property shall be
deemed to be property damage.
N.M.A. 1979
- - 3 -
<page
1998
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
<page
<TABLE>
<CAPTION>
INDEX TO 1998 ANNUAL REPORT
Page
<S> <C>
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 4
Common Stock Price and Dividend Information..................... 22
Report of Management............................................ 23
Report of Independent Auditors.................................. 24
Consolidated Balance Sheets at December 31, 1998 and 1997....... 25
Consolidated Statements of Earnings for the Years Ended
December 31, 1998, 1997 and 1996............................... 26
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1998, 1997 and 1996......................... 27
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996............................... 28
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash Provided by Operating Activities for the
years ended December 31, 1998, 1997 and 1996................... 29
Notes to Consolidated Financial Statements...................... 30
Selected Consolidated Financial Data............................ 50
Management's Discussion of the Supplemental Information on
Insurance Operations........................................... 51
Directors....................................................... 56
Officers........................................................ 59
Stockholder Information......................................... 61
<PAGE>
FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share and Share Amounts)
</TABLE>
<TABLE>
<CAPTION>
1998 1997
1996
<S> <C> <C>
<C>
Net premiums written............................ $ 745,048 $
741,501 $ 711,570
Earned premiums................................. $ 745,620 $
730,497 $ 668,716
Net investment income........................... 86,501
80,972 77,402
Premium finance and service fees................ 13,440
7,074 9,713
Net realized investment gains (losses).......... 6,769
22,770 (7,574)
Total revenues............................ $ 852,330 $
841,313 $ 748,257
Earnings before income taxes.................... $ 124,467 $
127,695 $ 92,013
Income taxes.................................... 27,975
31,480 18,049
Net earnings.............................. $ 96,492 $
96,215 $ 73,964
Comprehensive income............................ $ 94,555 $
100,368 $ 80,539
Basic and diluted net earnings per common share. $ 2.68 $
2.67 $ 2.04
Net earnings excluding the after-tax impact of
net realized investment gains (losses)(1)...... $ 92,092 $
81,415 $ 78,887
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (losses)(1).......... $ 2.56 $
2.26 $ 2.18
Cash dividends paid per share................... $ 1.07 $
1.03 $ 0.81
Weighted average number of common shares
outstanding................................... 36,042,652
36,044,679 36,311,887
Total investments at market value............... $1,257,900
$1,242,695 $1,167,671
Total assets.................................... 1,755,983
1,754,753 1,676,799
Total liabilities............................... 1,050,198
1,104,957 1,089,760
Total stockholders' equity...................... 705,785
649,796 587,039
Total stockholders' equity per share............ 19.58
18.03 16.28
Certain statutory financial ratios (unaudited):
Loss and LAE ratio............................ 71.6%
71.4% 70.9%
Underwriting expense ratio.................... 26.5
25.1 27.1
Combined ratio............................ 98.1%
96.5% 98.0%
Net premiums written to policyholders'
surplus..................................... 132.2%
143.3% 153.1%
</TABLE>
(1) The above figures are presented to provide information to the reader
due to the amount
of, and fluctuations in, net realized gains and losses. The amounts
noted, commonly
known as Operating Income, are important measures of corporate
performance.
1
<page
THE COMMERCE GROUP, INC.
March 26, 1999
To Our Stockholders:
In 1998, your Company experienced satisfactory financial results
for the 23rd consecutive year. From the very first day the funding of
The Commerce Insurance Company was accomplished (April 3, 1972) through
December 31, 1998, we have achieved underwriting profit of $243.5
million on total premiums written of $6.8 billion. This underwriting
profit represents 3.6% of total premiums written.
In January, the 1999 personal automobile insurance rates were
announced by the Massachusetts Insurance Commissioner. Despite the
industry's request for a 15.5% increase, 1999 rates increased only 0.7%.
This slight increase follows four consecutive years of rate decreases.
Although a number of companies modified safe driver deviations and
affinity group discount programs in response to the 1999 rates, the
Massachusetts marketplace continues to be highly competitive. Through
these ongoing competitive conditions, your Company's share of the
Massachusetts personal automobile market has remained stable, and at
year-end, our market share was 21.6%.
Your Company made a significant acquisition in 1999, which will
provide us with a vehicle to grow and expand our business beyond
Massachusetts. In a joint venture with AAA Southern New England, we
purchased the Automobile Club Insurance Company of Columbus, Ohio. This
company writes personal automobile and homeowners insurance in 28 states
through AAA affiliated insurance agencies. Their annual direct written
premium is approximately $100 million. Following the acquisition, the
Company's name was changed to American Commerce Insurance Company
("ACIC"). Together with our California company, Commerce West Insurance
Company, we are poised to grow and expand geographically well beyond the
borders of Massachusetts.
Through it all, your Company has continued to grow and prosper.
The Commerce Insurance Company continues to be the largest writer of
Massachusetts private passenger automobile insurance, as well as the
second largest writer of Massachusetts homeowners insurance. Written
premiums, earned premiums, investment income, total assets, total
stockholders' equity and total stockholders' equity per share, as
illustrated in the bar graph on the facing page, are all at new highs.
For those of you who are interested in the details, I draw your
attention to the pages in this report labeled "Management's Discussion
and Analysis of Financial Condition and Results of Operations". Behind
these numbers, including the newest member of our corporate family -
ACIC, are an extremely dedicated group of people: Our Policyholders
(represented by over 894,000 policies in force); Agents (791); Employees
(1,692); Officers (47); Directors (19); and of course, our Stockholders
(over 4,300, not including our Employee Stock Ownership Plan
participants who now number 1,662).
Property-liability insurance remains a good business to be in--and
The Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to
believe that owners' interests are its primary constituency.
Our sincere thanks to those who have helped in this building
process--especially our Agents, Employees, Officers and Board of
Directors. This diverse force of committed, ethical and hard working
people will continue to build on our past successes and look to the
future with excitement and opportunity. Their individual creativity,
energy and professionalism will continue to serve our stockholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J. Remillard, Jr.
President
Caring in everything we do.
2
<page
The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders'
equity per share value including cumulative cash dividends paid per
share on December 31, over the most recent fifteen year period. The X
axis lists the years beginning with 1984 through 1998. The Y axis lists
the dollar values starting at $0.00 and increasing in one dollar
increments to $24.00. The graph depicts a total stockholders' equity
per share value in 1984 of $0.67; 1985 of $0.81, 1986 of $0.95, 1987 of
$1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991 of $4.80, 1992
of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of $14.96, 1996 of
$16.28, 1997 of $18.03 and 1998 of $19.58. The graph also depicts the
total stockholders' equity per share value adjusted for cumulative
dividends paid per share in 1984 of $0.67, 1985 of $0.81, 1986 of $0.95,
1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991 of
$4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $11.03, 1995 of $15.34,
1996 of $17.47, 1997 of $20.25 and 1998 of $22.87.
3
<page
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty industry has been and remains highly
cyclical in nature. The financial results of property and casualty
insurance companies are impacted by many forces unique to the market.
Market forces include competition, frequency and severity of losses
resulting from weather conditions, the state of the economy and the
general regulatory environment in those states in which the insurer
operates. During 1998, the industry as a whole, experienced slightly
weaker underwriting results and slower premium growth as compared to
1997. Slightly weaker industry underwriting results were primarily
attributable to competitive markets. Within the property and casualty
industry, personal automobile insurance remains profitable, however
trends have indicated increased claims costs. The frequency of loss
occurrences continue to improve, which reflects the absence of severe
weather, safer cars and highways, enforcement of speeding laws and
continued drunk driver awareness. The severity, or cost per accident,
however, is increasing due to higher medical and automobile repair
costs. Industry results have further intensified competition among
insurers, which when coupled with lower insurance rates, emphasizes the
advantages to companies of operating efficiently. The Commerce Group,
Inc. ("Company") is well positioned to both lead in this environment and
to respond to the prevailing conditions in the market.
The Company, incorporated in 1976, is a holding company for
several property and casualty insurers which, through its subsidiaries,
offers predominantly motor vehicle insurance, covering personal
automobiles, in addition to a broad range of other property and casualty
insurance products. These products are marketed to affinity groups,
individuals, families and businesses through the Company's strong
relationships with professional independent insurance agencies. The
Company writes insurance primarily in the state of Massachusetts through
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation"), both wholly-owned subsidiaries of Commerce
Holdings, Inc. ("CHI"). The Company also writes insurance in the state
of California through Commerce West Insurance Company ("Commerce West"),
formerly Western Pioneer Insurance Company, a wholly-owned subsidiary of
Commerce. Commerce formed a joint venture (ACIC Holding Co., Inc.), in
November 1998, with AAA Southern New England to purchase Automobile Club
Insurance Company, located in Columbus, Ohio, a property and casualty
insurer with policies written in 28 states and licensed in several
others. In conjunction with the acquisition, which was completed on
January 29, 1999, the newly acquired company's name was changed to
American Commerce Insurance Company ("ACIC").
The Company's business strategy remains focused on activities
primarily related to personal automobile insurance. The Company has
been the largest writer of personal property and casualty insurance in
the state of Massachusetts in terms of market share of direct premiums
written since 1990. The Company's share of the Massachusetts personal
automobile market remained fairly stable in 1998 at approximately 21.6%,
a slight decrease from the 21.8% in 1997.
During 1998, direct premiums written totalled $796,858, a 3.7%
increase over 1997. Direct premiums written through Commerce and
Citation amounted to $773,463. Direct premiums written in California,
through Commerce West amounted to $23,395. Of the total direct premiums
written, direct personal automobile premiums written during 1998
totalled $687,232, an increase of 4.0% over 1997, and direct homeowners
insurance premiums written totalled $59,761, an increase of 5.4% over
1997. The Company is also the fourth largest writer of commercial
automobile insurance in Massachusetts based on direct premiums written.
During 1998, direct commercial automobile premiums written totalled
$36,299, a 2.1% decrease compared to 1997.
4
<page
Personal automobile insurance is subject to extensive regulation.
Owners of registered automobiles are generally required to maintain
certain minimum automobile insurance coverages. In Massachusetts, with
very limited exceptions, automobile insurers are required by law to
issue a policy to any applicant seeking to obtain such coverages.
Companies in Massachusetts are also assigned agents, known as Exclusive
Representative Producers ("ERP's") based on market share, that have been
unable to get a voluntary contract with an insurance carrier. Marketing
and underwriting strategies for companies operating in Massachusetts are
limited by maximum premium rates and minimum agency commission levels
for personal automobile insurance which are mandated by the
Massachusetts Commissioner of Insurance ("Commissioner"). In
Massachusetts, accident rates, bodily injury claims, and medical care
costs continue to be among the highest in the nation.
During the three-year period from 1996 to 1998, Massachusetts
personal automobile insurance premium rates decreased an average of 4.9%
per year. The Commissioner approved an average 0.7% increase in
personal automobile premiums for 1999, the first increase since 1994.
Average mandated rates decreased 4.0%, 6.2% and 4.5% in 1998, 1997 and
1996, respectively. Coinciding with the 1999 rate increase, the
Commissioner also approved a 1.0% increase in the commissions agents
receive from selling private passenger automobile insurance for 1999.
The decision slightly offsets the financial benefit of the average 0.7%
increase in personal automobile premiums for 1999.
Although average mandated personal automobile premium rates
decreased 4.0% in 1998, the impact upon the Company resulted in a 2.6%
increase in the average personal automobile premium per exposure (each
vehicle insured). The 2.6% increase for the Company was due to the
facts that the rate decision did not anticipate purchases of new
automobiles in the year to which the rate decision applied and,
secondly, the Company's mix of personal automobile business differs from
that of the industry.
The 1997, 1998 and 1999 average rate decisions were partially
driven by corrections for an industry error that had impacted prior year
rate decisions. The industry error resulted from a miscalculation of
industry expense allowances that had the effect of overstating rates for
1991 through 1996. Mandated rates for 1997, 1998 and 1999 include an
adjustment to recoup $176 million from the industry. The adjustment
included in the rate decision to recoup the error was phased in at 40%,
40% and 20% in 1997, 1998 and 1999.
The estimated earned premium impact of the above item, coupled
with the impact of a previous year imbalance in the SDIP, was
approximately $15.3 million for 1997, $23.9 million for 1998 and is
expected to be approximately $14.0 million for 1999. The earnings per
share after-tax impact resulting from lower earned premiums has been
estimated at $0.28 for 1997, $0.43 for 1998, and is estimated to be
$0.24 for 1999. If the Company's 1999 market share increases
(decreases), a larger (smaller) financial impact will result.
Also factored into the 1999 rate decision were two sanctions
levied by the Commissioner against the Massachusetts personal automobile
insurance industry. One fine, amounting to $6 million, was imposed as a
result of the industry's alleged failure to show that it adhered to
adequate cost containment efforts as identified by the Commissioner. A
second fine of $3 million was allegedly the result of what the
Commissioner termed "incomplete compliance" on the part of the
Automobile Insurers Bureau of Massachusetts ("AIB") with a discovery
order concerning disclosure of certain information as identified by the
Commissioner. The industry and several insurance carriers, including
Commerce, are appealing one or both of the sanctions.
5
<page
In August 1998, then Acting Massachusetts Governor, Paul Cellucci
("Governor"), signed legislation granting Massachusetts-based insurers,
that choose to participate, $48 million a year in total tax relief in
exchange for a, total industry-wide, $200 million investment commitment
to low income communities over a five-year period. The legislation
amounts to a gradual elimination of the 1.0% gross investment tax for
those insurers choosing to commit funds to these community investments.
The legislation effectively taxes Massachusetts based insurers at rates
levied equal with out-of-state insurers. Prior to the legislation,
Massachusetts was the only state in the nation to tax domestic insurers
at higher rates than charged to non-domestic insurers. If the overall
$200 million goal is attained, all domestic insurers will benefit from
the lower tax rate. The Company is currently analyzing the potential
benefits of participating in this program.
The Company's performance in its personal and commercial
automobile insurance lines is integrally tied to its participation in
the Commonwealth Automobile Reinsurers ("C.A.R."). All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines.
Since its inception, C.A.R. has annually generated multi-million dollar
underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or
commercial deficit (its participation ratio) is based upon its market
share of the automobile risks for the particular pool, adjusted by a
utilization formula such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
exceeds that of the industry, and favorably affected if its relative use
of C.A.R. is less than that of the industry. Automobile insurers
attempt to develop and implement underwriting strategies that will
minimize their relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not insured through C.A.R.
Significant changes in the utilization of the C.A.R. private
passenger pooling mechanism are not expected for 1999. Various C.A.R.
participation formula changes have been fully implemented since 1993
with only minor changes since then. The Company's strategy has been to
voluntarily retain more of the types of private passenger automobile
business that are factored as credits favorably impacting the
utilization formula. As a result of increased voluntary retention, the
credits impacting the utilization formula have favorably affected the
Company's participation ratio. The Company estimates its private
passenger automobile participation ratio in C.A.R. to be approximately
16.7% at December 31, 1998. This ratio is several percentage points
below the Company's estimated 21.6% share of the Massachusetts personal
automobile market. The Company continues to expect the marketplace to
make minor yearly adjustments to find the optimum balance between
voluntary and ceded writings.
The percentage of commercial automobile premiums ceded to C.A.R.
by the industry has decreased to a Company estimate of 21% in 1998. The
percentage of commercial automobile business ceded to C.A.R. by the
Company, is approximately 19%. C.A.R. depopulation, coupled with C.A.R.
rate increases for ceded commercial business, have led to a reduction in
the size of the annual commercial automobile deficits. The Company
intends to continue to respond to the incentives and disincentives
provided by C.A.R. rules as deemed necessary and appropriate.
The Company provides a separate rating tier for preferred
commercial automobile business through Citation. Approximately 22% of
the commercial automobile premiums produced by its voluntary agents in
1998 were written by Citation. The Company expects that this secondary
rating tier will continue to assist the Company in retaining its better
commercial automobile accounts, while also further increasing the
percentage of commercial automobile business that can be retained
voluntarily by the Company in 1999 and beyond.
6
<page
Beginning in the latter part of 1995, the Company began to
actively pursue affinity group marketing programs. The primary purpose
of affinity group marketing programs is to provide participating groups
with a convenient means of purchasing private passenger automobile
insurance through associations and employee groups. Emphasis is placed
on writing larger affinity groups, although accounts with as few as 25
participants are considered. Affinity groups are eligible for rate
discounts which must be filed annually with the Division of Insurance.
In general, the Company looks for affinity groups with mature/stable
membership, favorable driving records and below average turnover ratios.
Participants who leave the sponsoring group during the term of the
policy are allowed to maintain the policy until expiration. At
expiration, a regular Commerce policy may be issued at the insured's
option.
During the latter part of 1995, Commerce signed affinity group
marketing agreements with the five American Automobile Association Clubs
of Massachusetts ("AAA clubs") offering a 10% discount on private
passenger automobile insurance to the clubs' members who reside in
Massachusetts. In 1997, two AAA clubs were consolidated, therefore
leaving only four clubs. In 1998, primarily as a result of four
consecutive private passenger rate reductions, the Company reduced the
AAA clubs discount from 10% to 6%. In 1999, the same 6% percent AAA
club discount was approved for policies effective as of January 1, 1999.
The AAA clubs discount can be combined with safe driver deviations for
up to a 13.5% reduction from the 1999 state mandated rates. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
43.2% increase in the number of personal automobile exposures written by
Commerce since year-end 1995. As expected, this increase leveled off in
1998 as evidenced by the 1.9% increase in personal automobile exposures
as compared to increases of 8.3% in 1997 and 29.8% in 1996. In 1998,
total direct premiums written attributable to the AAA group business
were $457,430 or 57.3% of the Company's total direct premiums written
(68.7% of the Company's total Massachusetts personal automobile
premium), an increase of 8.1% over 1997. Total exposures attributable
to the AAA clubs group business were 547,100 or 67.6% of total
Massachusetts personal automobile exposures in 1998, an increase of
25,002 or 4.8% over 1997. Of the total Massachusetts automobile
exposures written by the Company, approximately 11% were written through
insurance agencies owned by the AAA clubs. The remaining 89% were
written through the Company's network of independent agents.
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members must participate in a
group marketing program within one year. Accordingly, Commerce, in
coordination with the AAA clubs, aggressively pursued AAA members for
the AAA Affinity Group Marketing Program. At December 31, 1996,
Commerce had achieved the objective of writing more than 35% of the AAA
members within the first year, as over 300,000 AAA members joined the
program. The particular portion of the statute, dealing with achieving
the 35% penetration level in one year, was amended by the Massachusetts
Legislature in early 1997 to allow two years to reach the required
penetration level. This requirement has subsequently been waived by the
Massachusetts Legislature for 1998 and 1999. Waiving the penetration
requirements allows insurance companies to continue offering group
discounts without reaching the 35% level. The waiver of penetration
requirements cannot be predicted for years beyond 1999.
Commerce and the AAA clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
7
<page
The Company previously announced that it had entered into an
agreement with, and purchased software known as Series III, from Policy
Management Services Corporation ("PMSC") to allow for development of
internal operating systems to enable the Company to first process
policies in states outside of Massachusetts and eventually to replace
the Company's systems for Massachusetts business. Although the Company
began writing business in Rhode Island in early 1998 on the Series III
system, in early 1999 the Company stopped work on all development. The
Company is currently in the process of negotiating with PMSC as to the
future continuation of the Series III system. Costs to date for this
effort have been approximately $47.0 million, of which $18.4 million is
applicable to 1998. Funds expended to date included the purchase of a
main frame computer, license fees and the costs associated with
programming, implementation and training. The vast majority of these
costs were expensed as incurred.
Underwriting profit margins are reflected by the extent to which
the combined ratio is less than 100%. This ratio is considered the best
simple index of current underwriting performance of an insurer. During
the five-year period ended December 31, 1998, the property and casualty
industry's combined ratio, as reported by A.M. Best and weighted to
reflect the Company's product mix ("weighted industry average"), has
ranged from a low of 100.1% in 1997 to a high of 103.0% in 1994 on a
statutory accounting principles basis. During this same period of time,
the Company's combined ratio has consistently remained below the
weighted industry average, ranging from as low as 91.0% in 1995 to a
high of 98.1% in 1998. On an average basis, the Company's combined
ratio was 95.1% for the five year period ended December 31, 1998
compared to a weighted industry average of 102.0%.
The Company's total revenues were supplemented in fiscal 1998,
1997 and 1996 by net investment income of $86,501, $80,972 and $77,402
respectively. Additionally, the Company had realized investment gains
(losses) of $6,769, $22,770 and ($7,574) in 1998, 1997 and 1996,
respectively.
Regulatory Matters
General
Although the U.S. federal government does not directly regulate
the insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies continue to investigate
the current condition of the insurance industry (encompassing both life
and health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Congress conducts hearings
relating, in general, to the solvency of insurers and has proposed
federal legislation from time to time on this and other subjects. The
Company is unable to predict whether or in what form initiatives will be
implemented and what the possible effects on the Company would be.
In May 1996, state legislation was passed offering insurers
incentives to write more inner city and coastal homeowners insurance.
The legislation, which arose over concerns of availability and
allegations of redlining, expands coverages and provides various credits
under the Massachusetts Property Insurance Underwriting Association
("Massachusetts FAIR Plan").
In December 1996, a United States District Court, acting on a suit
filed in October 1996, ordered the Massachusetts Division of Insurance
to disregard the existing ban on bank sales of life, health and accident
insurance. The decision cited U.S. Supreme Court decisions in the
Barnett and VALIC cases that essentially preempt the State of
Massachusetts ban on the licensing of bank-owned insurance agencies.
Also, in December 1996, a bill was filed in the Massachusetts
Legislature that would allow certain banks to become licensed agents of
an insurance company or brokers of insurance, permitting such things as
the sale of insurance products in distinctly designated bank branch
areas separate and apart from retail deposit areas. The Company is
unable to predict the possible impacts of these issues at this time.
8
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Various forms of automobile insurance reform are continuously
debated in the Massachusetts Legislature. New regulations and
legislation are often proposed with the goal of reducing the need for
premium increases. For further details, please refer to the general
discussion on insurance regulation and premium rates beginning on page
4.
Personal Automobile Insurance
As previously mentioned, beginning in 1995, the Company received
approval for affinity group discounts to members of the AAA clubs.
Membership in these clubs is estimated to represent approximately one-
third of the Massachusetts motoring public. The Company increased its
Massachusetts private passenger automobile insurance exposures by 1.9%
in 1998 primarily as a result of this program, ending the year with
approximately 21.6% of the Massachusetts private passenger automobile
market.
Since 1996, the Company has been granted approval to offer its
Massachusetts customers safe driver deviations to drivers with Safe
Driver Insurance Plan ("SDIP") classifications of either Steps 9 or 10.
Safe driver deviations are rate discounts based on the customers driving
record and resulting SDIP classification. Steps 9 and 10 are the two
best driver SDIP classifications in Massachusetts, representing drivers
with no at fault accidents and not more than one minor moving vehicle
violation in the last six years. In January 1999, in response to the
average personal automobile rate decisions over the last several years,
the Company filed for and ultimately received approval to offer SDIP
deviations of 8% for Step 9 and 3% for Step 10 for the 1999 calendar
year. At December 31, 1998, 68.7% of the Company's exposures were
eligible for either Step 9 or Step 10 deviations. For drivers that
qualify, the Company's 1999 affinity group automobile discounts and SDIP
deviations can be combined for up to a 13.5% (Step 9) and 9.8% (Step 10)
reduction from the state mandated rates. This can be compared to the
SDIP deviations of 15% for Step 9 and 4% for Step 10 SDIP
classifications for the 1998 calendar year. For drivers that qualified,
the Company's 1998 affinity group automobile discounts and SDIP
deviations could be combined for up to a 20.1% (Step 9) and 9.8% (Step
10) reduction from the state mandated rates.
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 all personal lines policies with effective dates of
January 1, 1998 and beyond. As a result of this change, premium finance
and service fees increased $6,366 or 90.0% in 1998. Previously, for
1997 and 1996, the Company had utilized a "late fee" system.
Risk-Based Capital
In order to enhance the regulation of insurer insolvency, the
National Association of Insurance Commissioners ("NAIC") developed a
formula and model law to implement Risk-Based Capital ("RBC")
requirements for property and casualty insurance companies which are
designed to assess capital adequacy and to raise the level of protection
that statutory surplus provides for policyholder obligations. The RBC
model for property and casualty insurance companies measures three major
areas of risk facing property and casualty insurers: (i) underwriting,
which encompasses the risk of adverse loss development and inadequate
pricing; (ii) declines in asset values arising from credit risk; and,
(iii) other business risks from investments. Insurers having less
statutory surplus than required by the RBC calculation will be subject
to varying degrees of regulatory action, depending on the level of
capital inadequacy.
9
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The RBC model formula proposes four levels of regulatory action.
The extent of regulatory intervention and action increases as the level
of surplus to RBC falls. The first level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the
regulator if surplus falls below 200% of the RBC amount. The Regulatory
Action Level (as defined by the NAIC) requires an insurer to submit a
plan containing corrective actions and permits the Commissioner to
perform an examination or other analysis and issue a corrective order if
surplus falls below 150% of the RBC amount. The Authorized Control
Level (as defined by the NAIC) allows the regulator to rehabilitate or
liquidate an insurer in addition to the aforementioned actions if
surplus falls below 100% of the RBC amount. The fourth action level is
the Mandatory Control Level (as defined by the NAIC) which requires the
regulator to rehabilitate or liquidate the insurer if surplus falls
below 70% of the RBC amount. The Company's subsidiaries, Commerce,
Citation and Commerce West, have RBC amounts at December 31, 1998 of $71
million, $2 million and $3 million, respectively, and they have
statutory surplus of approximately $470 million, $93 million and $25
million, respectively. The statutory surplus of Commerce, Citation and
Commerce West at December 31, 1998 exceeded the RBC Company Action
Levels of $142 million, $4 million and $6 million, respectively, by
approximately $328 million, $89 million and $19 million, respectively.
The Company's new acquisition, ACIC, has RBC amounts at December 31,
1998 of $15 million and they have statutory surplus of approximately $90
million. The statutory surplus of ACIC at December 31, 1998, exceeded
the RBC company action levels of $30 million by approximately $60
million.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Direct premiums written during 1998 increased $28,209, or 3.7% to
$796,858 as compared to 1997. The increase was primarily attributable
to a $26,157, or 4.0% increase in direct premiums written for personal
automobile insurance to $687,232. This increase was the result of a
$30,239 or 4.8% increase in direct premiums written for Massachusetts
personal automobile insurance offset by a $4,082 or 14.9% decrease in
California personal automobile written premiums. The decrease in
California personal automobile direct premiums written resulted
primarily from the increasingly competitive personal automobile market
that has witnessed several new entrants since 1997. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from an increase of 4.5% in the number of personal automobile
physical damage exposures written (Massachusetts personal automobile
exposures written with liability coverage increased 1.9%), coupled with
a 13.3% increase in average rates for personal automobile physical
damage exposures. The impact of this was partially offset by a 3.2%
decrease in the average rates for liability exposures. These results
were primarily the result of the changes to the Company's affinity group
marketing programs, safe driver rate deviations and the effect of the
1998 state mandated average rate decrease of 4.0%. The combination of
these factors resulted in a 2.6% increase in the average personal
automobile premium (each vehicle insured). Despite the 1998 state
mandated average rate decrease of 4.0%, the Company's 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 previously. In 1998, the Company
offered its customers safe driver deviations of 15% to drivers with SDIP
classifications of Step 9 and 4.0% for Step 10 (10% for both Steps 9 and
10 in 1997).
The AAA affinity group discount for 1998 was established at 6.0%
(10% in 1997). In 1998, for drivers who qualified, the Company's group
discount and safe driver deviations could be combined for up to a 20.1%
reduction from state mandated rates.
Direct premiums written for commercial automobile insurance
decreased by $772 or 2.1%, due primarily to a decrease of approximately
0.2% in the number of policies written, and a 1.9% decrease in the
average commercial automobile premium per policy. Direct premiums
written for homeowners insurance (excluding the Massachusetts FAIR Plan)
increased by $2,862, or 5.2% due primarily to a 1.6% increase in the
number of policies written and a 3.6% increase in the average premium
per policy.
10
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Net premiums written during 1998 increased $3,547, or 0.5% as
compared to 1997. The increase in net premiums written was due to the
growth 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 C.A.R. decreased $1,887, or 2.5% and written premiums ceded
to C.A.R. decreased $1,381 or 1.9% as compared to 1997, both as a result
of changes in the industry's and the Company's utilization of C.A.R.
reinsurance. Premiums ceded to reinsurers other than C.A.R. increased
$24,151 or 75.0% as compared to 1997 as a result of the changes to
reinsurance mentioned previously.
Earned premiums increased $15,123 or 2.1% during 1998 as compared
to 1997. The increase was primarily attributable to a $32,407 or 5.2%
increase in earned premiums for Massachusetts personal automobile
insurance offset by a $7,115 decrease in earned premiums for homeowners
insurance, a $3,803 or 9.3% decrease in earned premiums for commercial
automobile insurance, a $3,481 or 12.3% decrease in earned premiums for
California personal automobile insurance and a $2,885 or 29.4% decrease
in earned premiums for all other than automobile lines. Earned premiums
were impacted by increased levels of coverage provided by non-automobile
reinsurance treaties which took effect during the 2nd half of 1998.
Earned premiums assumed from C.A.R. decreased $7,149 or 8.6% during 1998
compared to 1997. Earned premiums ceded to C.A.R. decreased $3,594 or
5.0% during 1998 compared to 1997.
Net investment income increased $5,529 or 6.8%, compared to 1997,
principally as a result of an increase in average invested assets (at
cost). Net investment income as a percentage of total average
investments was 7.0% in 1998 compared to 6.8% in 1997. Net investment
income after tax as a percentage of total average investments was 5.7%
in 1998 compared to 5.5% in 1997. The increase was primarily the result
of increased dividends received on common and preferred stocks.
Premium finance and service fees increased $6,366 or 90.0% during
1998. The increase was primarily attributable to the Company receiving
state regulatory approval to charge a $3.00 installment on each invoice
following the down payment for all personal lines policies with
effective dates of January 1, 1998 and beyond. Previously, in 1996 and
1997, the Company had utilized a "late fee" system.
The market value of the Company's investment portfolio totaled
$1,257,900, at December 31, 1998 compared to $1,242,695 at December 31,
1997. Management's investment philosophy is to emphasize investment
yield while maintaining investment quality. Fixed maturities comprised
49.2% of the portfolio at December 31, 1998 compared to 47.5% at
December 31, 1997. Equity investments comprised 38.3% at December 31,
1998 compared to 26.3% at December 31, 1997. Cash and short-term
investments comprised 6.0% at December 31, 1998 compared to 19.2% at
December 31, 1997. The decrease in cash and short-term investments and
increase in equity investments was partially driven by the Company's
previously announced change in investment strategy. 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 forgo current
investment yield in favor of potential higher yielding capital
appreciation in the future.
The market value of fixed maturities, which totaled $619,267 at
December 31, 1998, is comprised of 81.8% tax-exempt and 18.2% taxable
investments as compared to total fixed maturities of $590,597, comprised
of 69.3% tax-exempt and 30.7% taxable investments at December 31, 1997.
The market value of equity investments, which totaled $481,386 at
December 31, 1998, is comprised of 41.0% preferred stocks and 59.0%
common stocks as compared to total equity investments of $326,588,
comprised of 45.5% preferred stocks and 54.5% common stocks at December
31, 1997. The increase in equity investments was primarily attributable
to a change in the mix of investments resulting primarily from the
maturity of Government National Mortgage Association ("GNMA") mortgage-
backed bonds and the redeployment of cash and short-term investments to
higher yielding preferred stock mutual funds which are classified as
common stocks. Of the common stock portfolio $172,455 or 60.7% of the
balance, is comprised of preferred stock mutual funds and $111,506 or
39.3% of pure common stocks.
11
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Gross realized gains and losses on fixed maturity investments
totaled $99 and $2,903, respectively, for the year ended December 31,
1998 compared to gross realized gains and losses on fixed maturity
investments of $4,306 and $2,887, respectively, for the year ended
December 31, 1997. Gross realized gains and losses on preferred stocks
totaled $369 and $1,096, respectively, for the year ended December 31,
1998 compared to gross realized gains and losses on preferred stocks of
$2,688 and $2,682, respectively, for the year ended December 31, 1997.
Gross realized gains on common stocks amounted to $9,313 for the year
ended December 31, 1998 compared to gross realized gains on common
stocks of $21,440 for the year ended December 31, 1997.
Net realized investment gains totalled $6,769 during 1998 as
compared to net realized investment gains of $22,770 for 1997. A
significant portion of the net realized gains in 1998 were the result of
sales of common stocks partially offset by net realized losses in the
sales of non-taxable bonds, preferred stocks and in the maturity of
GNMA's, all as detailed in the preceding paragraph. A significant
portion of the realized gains in 1997 were primarily the result of a
merger of a major New England financial corporation and its property and
casualty subsidiary. The merger election and exchange of stock coupled
with subsequent post merger sales of this corporation's common stock
resulted in realized investment gains of $18,968. Also included were
realized gains on mortgage activity of $321 in 1998 compared to realized
losses of $95 in 1997 and realized investment gains in the Conning
Insurance Limited Partnership of $666 in 1998 compared with none in
1997.
Gross unrealized gains and losses on fixed maturity investments
totaled $21,381 and $2,596, respectively, at December 31, 1998 compared
to $24,190 and $377, respectively, at December 31, 1997. The unrealized
gains on fixed maturities decreased despite increased fixed maturity
holdings and declining interest rates in 1998. Gross unrealized gains
and losses on preferred stocks totaled $2,706 and $5,551, respectively,
at December 31, 1998 compared to $1,599 and $1,235, respectively at
December 31, 1997. Gross unrealized gains and losses on common stocks
totaled $24,721 and $2,120, respectively, at December 31, 1998 compared
to $17,888 and $170, respectively, at December 31, 1997. The Company
also recognized gross unrealized gains in the Conning Insurance Limited
Partnership of $375 in 1998 compared with none in 1997.
Losses and loss adjustment expenses ("LAE") incurred (on a
statutory basis) as a percentage of insurance premiums earned ("loss
ratio") was 71.6% in 1998 as compared to 71.4% in 1997. The ratio of
net incurred losses, excluding LAE, to premiums earned ("pure loss
ratio") on personal automobile was 61.4% in 1998 compared to 61.3% in
1997. Although the personal automobile pure loss ratio remained stable,
various components impacted the ratio, primarily in the bodily injury
area. Redundancies from prior year losses realized in the current year,
relating to bodily injury claims, were approximately $18.0 million less
in 1998, as compared to 1997. Approximately $11.0 million of this
amount was attributable to voluntary personal automobile bodily injury
loss reserves and $7.0 million to fewer redundancies from C.A.R. assumed
reserves. The decreased redundancies, however, were offset by better
current year experience, also primarily in the personal automobile
bodily injury area. This improvement was primarily the result of
improved severity of bodily injury claims coupled with slightly improved
claim frequency. The commercial automobile pure loss ratio increased to
52.3% in 1998 compared to 45.4% in 1997. For homeowners, the pure loss
ratio was 31.0% in 1998 compared to 48.2% in 1997. This decrease was
due to favorable weather conditions during 1998 as compared to normal
weather conditions experienced during 1997, coupled with favorable
development in the homeowners liability area. The LAE component of the
loss ratio was primarily impacted by an increase of approximately $3.2
million in computer service expenses, relating to the Year 2000 and PMSC
projects, offset by a decrease of management incentive plan expenses.
On a consolidated financial statement basis, total expenses related to
the Company's management incentive plan included in losses and loss
adjustment expenses were $10,093 lower in 1998 as compared to 1997. Of
this decrease, $3,112 benefited the insurance companies with the
remainder benefiting corporate expenses. Corporate expenses are not
included in the calculation of the Company's statutory loss ratio. The
decrease in the Company's management incentive plan expenses was
primarily driven by the average decrease in the market price of the
Company's common stock which directly impacts plan expenses.
12
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Policy acquisition costs expensed increased by $8,943 or 4.8% in
1998, compared to an increase of $6,478 or 3.6% in 1997. The increase
in policy acquisition costs was primarily due to higher contingent
commission accruals, and higher computer service expenses relating to
the Year 2000 and PMSC projects, both 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 $8,764 lower in 1998 as compared to 1997.
Of this decrease, $3,052 benefited the insurance companies with the
remainder benefiting corporate expenses. Corporate expenses are not
included in the calculation of the statutory underwriting expense ratio.
The decrease in the Company's management incentive plan expenses was
primarily driven by the average decrease in the market price of the
Company's common stock which directly impacts plan expenses. As a
percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) were 26.5% during 1998 as
compared to 25.1% for 1997.
The Company's effective tax rate was 22.5% and 24.7% for the years
ended December 31, 1998 and 1997, respectively. The decrease was
primarily attributable to higher dividends on preferred and common stock
coupled with less realized capital gains during 1998 as compared to
1997. In both years the effective rate was lower than the statutory
rate of 35% primarily due to tax-exempt interest income and the
corporate dividends deduction comprising a greater portion of net
earnings before taxes.
Net earnings increased to $96,492, during 1998 as compared to
$96,215 in 1997 and operating earnings, which exclude the after-tax
impact of net realized investment gains, increased $10,677 or 13.1% to
$92,092 during 1998 as compared to $81,415 in 1997, both as a result of
the factors previously mentioned.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Direct premiums written during 1997 increased $36,826, or 5.0% to
$768,649 as compared to 1996. The increase was primarily attributable
to a $38,223, or 6.1% increase in direct premiums written for personal
automobile insurance to $661,077. This increase was the result of a
$38,109 increase in direct premiums written for Massachusetts personal
automobile insurance and an increase of $114 which was derived from the
Company's California subsidiary, Commerce West. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from an increase of 8.3% in the number of personal automobile
exposures written, offset by a 1.8% decrease in the average personal
automobile premiums written per exposure (each vehicle insured). This
was primarily the result of the Company's affinity group marketing
programs, safe driver rate deviations and the effect of the 1997 state
mandated average rate decrease of 6.2%. In 1997, the Company offered
its customers safe driver deviations of 10% to drivers with SDIP
classifications of either Step 9 or 10. For drivers who qualify, the
Company's group discount and safe driver deviations could be combined
for up to a 19.0% reduction from state mandated rates. Direct premiums
written for commercial automobile insurance decreased by $3,363 or 8.3%,
due primarily to a decrease of approximately 6.7% in the number of
policies written, with the remainder due to a decrease in the average
commercial automobile premium per policy. Direct premiums written for
homeowners insurance (excluding the Massachusetts FAIR Plan) increased
by $2,329, or 4.4% due primarily to an increase in the number of
policies written.
Net premiums written during 1997 increased $29,931, or 4.2% as
compared to 1996. The increase in net premiums written was due to the
growth in direct premiums written as described above, offset by the
effects of reinsurance. Written premiums assumed from C.A.R. decreased
$17,172, or 18.3% and written premiums ceded to C.A.R. decreased $11,045
or 13.3% as compared to 1996, both as a result of changes in the
industry's and the Company's utilization of C.A.R. reinsurance.
Premiums ceded to reinsurers other than C.A.R. increased $901 or 2.9% as
compared to 1996.
13
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Earned premiums increased $61,781 or 9.2% during 1997 as compared
to 1996. The increase in earned premiums was primarily due to changes
in 1997 and 1996 direct and net premiums written including the increase
in direct premiums written attributable to group marketing programs
during the latter part of 1996 and in 1997, as previously mentioned.
Earned premiums assumed from C.A.R. decreased $9,602 or 10.4% during
1997 compared to 1996. Earned premiums ceded to C.A.R. decreased
$14,000 or 16.3% during 1997 compared to 1996. Earned premiums
attributable to Commerce West increased $531 to $28,159 for 1997
compared to 1996.
Net investment income increased $3,570 or 4.6%, compared to 1996,
principally as a result of an increase in average invested assets (at
cost). Net investment income as a percentage of total average
investments was 6.8% in both 1997 and 1996. Net investment income after
tax as a percentage of total average investments was 5.5% in 1997
compared to 5.6% in 1996.
Premium finance and service fees decreased $2,639 or 27.2% during
1997. The decrease was primarily attributable to a change from interest
based finance fees to a "late payment" based system for personal lines
policies with effective dates of January 1, 1996 and forward. The
change was initiated in direct response to competitive forces that
occurred in the Massachusetts marketplace. In 1997, the Company
received state regulatory approval to charge a $3.00 installment on each
invoice following the down payment for all personal lines policies with
effective dates on or after January 1, 1998.
The market value of the Company's investment portfolio totaled
$1,242,695, at December 31, 1997 compared to $1,167,671 at December 31,
1996. Management's investment philosophy is to emphasize investment
yield while maintaining investment quality. Fixed maturities comprised
47.5% of the portfolio at December 31, 1997 compared to 61.4% at
December 31, 1996. Equity investments comprised 26.3% at December 31,
1997 compared to 20.0% at December 31, 1996. Cash and short-term
investments comprised 19.2% at December 31, 1997 compared to 12.0% at
December 31, 1996. The decrease in fixed maturities was the result of
the maturities and sales of fixed maturities with proceeds redeployed to
cash and short-term investments. The shift in the mix of investments
was partially driven by the current low interest rate environment and by
the Company's previously announced change in investment strategy. 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 forgo
current investment yield in favor of potential higher yielding capital
appreciation in the future.
The market value of the fixed maturities, which totaled $590,597
at December 31, 1997, is comprised of 69.3% tax-exempt and 30.7% taxable
investments as compared to total fixed maturities of $716,702, comprised
of 68.5% tax-exempt and 31.5% taxable investments at December 31, 1996.
The market value of equity investments, which totaled $326,588 at
December 31, 1997, is comprised of 45.5% preferred stocks and 54.5%
common stocks as compared to total equity investments of $233,721,
comprised of 63.2% preferred stocks and 36.8% common stocks at December
31, 1996. The increase in equity investments and decrease in fixed
maturities at December 31, 1997 compared to December 31, 1996 was
primarily attributable to a change in the mix of investments from
municipal and government bonds and GNMA mortgage-backed bonds to higher
yielding preferred stock mutual funds which are classified as common
stocks. Of the common stock portfolio approximately two-thirds of the
balance is comprised of preferred stock mutual funds versus pure common
stocks.
14
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Gross realized gains and losses on fixed maturity investments
amounted to $4,306 and $2,887, respectively, for the year ended December
31, 1997 compared to gross realized gains and losses on fixed maturity
investments of $487 and $7,851, respectively, for the year ended
December 31, 1996. Gross realized investment gains and losses on
preferred stocks amounted to $2,688 and $2,682, respectively, for the
year ended December 31, 1997 compared to gross realized gains and losses
on preferred stocks of $22 and $371, respectively, for the year ended
December 31, 1996. Gross realized gains on common stocks amounted to
$21,440 for the year ended December 31, 1997 compared to gross realized
gains on common stocks of $456 for the year ended December 31, 1996.
Net realized investment gains totalled $22,770 during 1997 as compared
to net realized investment losses of $7,574 for 1996. A significant
portion of the realized gains in 1997 was primarily the result of a
merger of a major New England financial corporation and its property and
casualty subsidiary. The merger election and exchange of stock resulted
in realized investment gains of $15,178. Subsequent post merger sales
of this corporation's common stock resulted in additional realized
investment gains of $3,790. The remainder of the realized investment
gains were primarily the result of sales of non-taxable bonds offset by
minimal realized investment losses in the sales of GNMA's and preferred
stocks. Also included were realized losses on mortgage activity of $95
in 1997 compared to $317 in 1996.
Gross unrealized gains and losses on fixed maturity investments
totalled $24,190 and $377, respectively, at December 31, 1997 compared
to $17,890 and $1,699, respectively, at December 31, 1996. The
unrealized gains on fixed maturities increased, despite fewer fixed
maturity holdings, as a result of the favorable bond market in 1997.
Gross unrealized gains and losses on preferred stocks totaled $1,599 and
$1,235, respectively, at December 31, 1997 compared to $2,034 and
$2,837, respectively, at December 31, 1996. Gross unrealized gains and
losses on common stocks totaled $17,888 and $170, respectively, at
December 31, 1997 compared to $20,305 and $187, respectively, at
December 31, 1996.
Losses and LAE incurred as a percentage of insurance premiums
earned ("loss and LAE ratio") was 71.4% in 1997 compared to 70.9% in
1996. The ratio of net incurred losses, excluding LAE, to premiums
earned ("pure loss ratio") on personal automobile decreased to 61.3% in
1997 compared to 63.9% in 1996. The commercial automobile pure loss
ratio decreased to 45.4% in 1997 compared to 46.7% in 1996. For
homeowners, the pure loss ratio decreased to 48.9% in 1997 compared to
72.4% in 1996. The overall decrease to the homeowner pure loss ratio
for 1997 was due to more normal weather conditions during 1997 as
compared to the severe weather experienced during the first half of
1996, coupled with favorable development in the homeowners liability
area. For further discussion refer to Note E in the Consolidated
Financial Statements.
Policy acquisition costs expensed increased by 3.6% in 1997,
compared to 8.6% in 1996. The increase in policy acquisition costs was
primarily due to higher volumes of business written during 1997 and
fewer acquisition costs being deferred as compared to 1996. This was
due to a higher rate of growth in 1996 primarily from affinity groups.
As a percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) were 25.1% during 1997 as
compared to 27.1% for 1996. On a consolidated financial statement
basis, 1997 and 1996 policy acquisition costs, as a percentage of net
written premiums, were approximately equal. This occurred because lower
commission and contingent commission expenses in 1997 were offset by
higher management incentive compensation expenses and computer service
expenses. The higher management compensation expense was the direct
result of the increase in the average three month share price of the
Company's common stock during 1997 as compared to 1996.
The Company's effective tax rate was 24.7% and 19.6% for the years
ended December 31, 1997 and 1996, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends deduction. The
higher 1997 effective tax rate was primarily due to tax-exempt interest
comprising a lesser percentage of net income before taxes and more
realized gains in 1997 than in 1996.
Net earnings increased $22,251 or 30.1% to $96,215, during 1997 as
compared to $73,964 in 1996 and operating earnings increased $2,528 or
3.2% to $81,415 as compared to $78,887 in 1996 both as a result of the
factors previously mentioned.
15
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Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is
on the Consolidated Balance Sheets on page 25 and the Consolidated
Statements of Cash Flows on pages 28 and 29. Stockholders' equity
increased by $55,989, or 8.6%, in 1998 as compared to 1997. Growth
stemmed from $96,492 in net earnings partially offset by changes in net
unrealized losses, net of income taxes (known as Other Comprehensive
Income), on fixed maturities and preferred and common stocks of $1,937
and dividends paid to stockholders of $38,566. Total assets at December
31, 1998 increased to $1,755,983 as compared to total assets of
$1,754,753 at December 31, 1997. Although total assets remained
virtually unchanged, certain asset categories changed considerably
during 1998 as reflected in an increase of invested assets of $15,205,
or 1.2%, an increase in deferred policy acquisition costs of $3,495 or
4.1%, and an increase in receivable from reinsurers of $18,517, or
101.9%, offset by a decrease in residual market receivable of $27,579 or
15.3% and a decrease in all other assets of $8,408 or 3.7% as compared
to December 31, 1997. The increase in receivable from reinsurers was
primarily a result of increased levels of coverage provided through the
new other than automobile quota share reinsurance treaty which the
Company implemented July 1, 1998. The new quota share contract provides
for a 75% cession of other than automobile property and liability
premium and related losses. This contract replaced the former contract
which 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 up
to $1,000. The decrease in residual market receivable was primarily
attributable to lower case reserves ceded to C.A.R. in 1998, as compared
to 1997.
The Company's fixed maturity portfolio is comprised of GNMAs
(18.2%) and municipal bonds (81.8%). Of the Company's bonds, 100.0% are
rated in either of the two highest quality categories provided by the
National Association of Insurance Commissioners ("NAIC"). As of
December 31, 1998, the market value of the Company's fixed maturity
portfolio exceeded its book value by $18,785 ($12,210 after taxes, or
$0.34 per share). At December 31, 1997 the market value of the
Company's fixed maturity portfolio exceeded its book value by $23,813
($15,478 after taxes, or $0.43 per share). At December 31, 1998, the
cost of the Company's preferred stocks exceeded market value by $2,845
($1,849 after taxes, or $0.05 per share). At December 31, 1997, the
market value of preferred stocks exceeded cost by $364 ($237 after
taxes, or $0.01 per share). At December 31, 1998, the market value of
the Company's common stocks exceeded cost by $22,601 ($14,691 after
taxes, or $0.41 per share). At December 31, 1997, the market value of
common stocks exceeded cost by $17,718 ($11,517 after taxes, or $0.32
per share).
Preferred stocks increased $48,926 or 32.9% and common stocks
(primarily composed of closed-end preferred stock mutual funds)
increased $105,872 or 59.4%, during 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 of these
increases to preferred and common stocks, the Company is now carrying
$75,912 million in cash and short-term investments which is a decrease
of $162,976 or 68.2% as compared to December 31, 1997.
16
<page
The Company's liabilities totalled $1,050,198 at December 31, 1998
as compared to $1,104,957 at December 31, 1997. Loss and loss
adjustment expense reserves comprised 56.8% of the Company's liabilities
at December 31, 1998 compared with 58.8% at December 31, 1997. Unearned
premiums comprised 37.3% of the Company's liabilities at December 31,
1998 compared with 34.4% at December 31, 1997. All other liabilities
comprised 5.9% of the Company's liabilities at December 31, 1998
compared with 6.8% at December 31, 1997. Although unearned premium and
contingent commission liabilities increased $11,825 or 3.1% and $8,206
or 59.2%, respectively, the $54,759 or 5.0%, decrease in total
liabilities was primarily due to decreases of $52,477 or 8.1%, in losses
and loss adjustment expense reserves, $8,269 or 51.4%, to income tax
liabilities and $14,044 or 30.6%, to all other liabilities. The
decrease in the liability for loss and loss adjustment expenses is
attributed primarily to better current year underwriting results coupled
with increased net loss payments during 1998, as described below.
However, $17,353 of the $52,477 decrease in the liability for loss and
loss adjustment expenses relates to the decrease in losses and loss
adjustment expense receivable from the residual market. The increase in
unearned premiums primarily resulted from the increase in Massachusetts
personal automobile direct premiums written and the expected seasonality
impact of policy effective dates.
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 28 and 29. The discussion of these items can be found under "Year
Ended December 31, 1998 Compared to Year Ended December 31, 1997",
herein.
The Company's operating activities provided cash of $65,324 in
1998 as compared to $80,006 in 1997. These cash flows were primarily
impacted by the fact that while premiums collected increased $34,009 or
4.7% in 1998 as compared to an increase of $51,847 or 7.7% in 1997,
losses and LAE paid increased $56,531 or 11.0% in 1998 as compared to an
increase of $87,589 or 20.4% in 1997 and policy acquisition costs paid
decreased $11,142 or 5.6% in 1998 as compared to a decrease of $2,911 or
1.4% in 1997. 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. Federal income tax payments
increased $13,368 or 61.2% in 1998 as compared to an increase of $4,883
or 28.8% in 1997 due to additional payments made in 1998 applicable to
prior years.
The increase in net losses and LAE paid, which includes the change
in the losses and LAE liability, resulted primarily from a decrease in
the loss and loss adjustment expense liability. Additionally, direct
payments on automobile liability claims increased $29,400 or 11.7%. 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
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.
17
<page
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 $38,566 during
1998 compared to $37,611 during 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 $37,124 in dividends paid to stockholders and $487 used to
purchase 20,000 shares of Treasury Stock under the Company's stock
buyback program. There were 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. The carrying value (at market) of total
investments at December 31, 1998 was $1,257,900. At December 31, 1998,
the Company held cash and cash equivalents of $72,243 and short-term
investments of $3,669. These funds 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.
Every Massachusetts insurance company seeking to make any dividend or
other distributions to its stockholders may, within certain limitations,
pay such dividends and then file a report with the Commissioner.
Dividends in excess of these limitations are called extraordinary
dividends. An extraordinary dividend is any dividend or other property,
whose fair value together with other dividends or distributions made
within the preceding twelve months exceeds the greater of ten percent of
the insurer's surplus as regards to policyholders as of the end of the
preceding year, or the net income of a non-life insurance company for
the preceding year. No pro-rata distribution of any class of the
insurer's own securities is to be included. No Massachusetts insurance
company shall pay an extraordinary dividend or other extraordinary
distribution until thirty days after the Commissioner has received
notice of the intended distribution and has not objected. No
extraordinary dividends were paid in 1998, 1997 and 1996.
Periodically, sales have been made from the Company's fixed
maturity investment portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to
realize gains. This practice will continue in the future.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.32 to 1.00, 1.43 to 1.00, and
1.53 to 1.00 for the years ended December 31, 1998, 1997 and 1996,
respectively.
The Company's long-term growth objective has been to expand its
writings outside of Massachusetts. In continued pursuit of this
objective Commerce has become licensed in the states of Connecticut,
Rhode Island, Vermont and New Hampshire and Maine.
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. This objective
has been exemplified by the 1995 acquisition of Commerce West, a
personal automobile insurer, located in Pleasanton, California and, most
recently, by the Company's formation of a joint venture (ACIC Holding
Co., Inc.) in November 1998, and the subsequent acquisition, in January
1999, of ACIC, located in Columbus, Ohio.
ACIC writes automobile and homeowners insurance solely through 38
AAA automobile clubs. Commerce and AAA SNE intend that ACIC will retain
its management team and staff and continue to have its principle office
in Columbus, Ohio.
18
<page
In early 1999, Commerce, a subsidiary of the Company, invested
$90.8 million in the joint venture (ACIC Holding Co., Inc.) to fund the
ACIC acquisition and to capitalize the joint venture that is owned
together with AAA SNE. Of this $90.8 million, Commerce invested $90
million in the form of preferred stock and an additional $800
representing its 80% common stock ownership. The terms of the preferred
stock call for quarterly cash dividends at the rate of 10% per annum.
AAA SNE invested $200 representing its 20% common stock ownership.
Commerce intends to consolidate ACIC Holding Co., Inc. and it's wholly-
owned subsidiary, ACIC, for financial reporting purposes. Since 1995,
Commerce has maintained an affinity group marketing relationship with
AAA Insurance Agency, Inc., a subsidiary of AAA SNE. AAA Insurance
Agency, Inc. has been an agent of Commerce since 1985.
Internal Software Development Project with PMSC
The Company previously announced that it had entered into an
agreement with, and purchased software, known as Series III, from Policy
Management Services Corporation ("PMSC") to allow for development of
internal operating systems to enable the Company to first process
policies in states outside of Massachusetts and eventually to replace
the Company's systems for Massachusetts business. Although the Company
began writing business in Rhode Island in early 1998 on the Series III
system, in early 1999 the Company stopped work on all development. The
Company is currently in the process of negotiating with PMSC as to the
future continuation of the Series III system. Costs to date for this
effort have been approximately $47.0 million, of which $18.4 million is
applicable to 1998. Funds expended to date included the purchase of a
main frame computer, license fees and the costs associated with
programming, implementation and training. The vast majority of these
costs were expensed as incurred.
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. The
Company subsequently initiated the Century Change project to address all
internal/external systems, software, agents, third parties and vendors
in dealing with year 2000 compliance.
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 four sub-categories: Data Exchange, 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 will primarily conclude at the end of second quarter 1999.
19
<page
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. This program includes
sending out questionnaires to our major business partners, including our
agents, regarding their year 2000 readiness. Based on the responses
received to date, the Company does not anticipate any material impact on
its operations or financial condition. If there are instances where the
Company ascertains 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. The
Company expects that the implementation of the contingency plans, if
necessary, will not have a material adverse effect on the Company's
ability to conduct its business or on its operating results or financial
condition.
The Company's Executive Committee, as well as all departments in
the Company, are 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 scenarios.
Contingency Plans will be discussed and developed, where deemed
appropriate, for all material systems and relationships during the first
half of 1999. At a minimum, contingency plans will be developed for the
continuation of policy and claim processing in the event that the
Company's computer systems are not available due to a year 2000 related
failure.
The project to date has involved internal staff costs as well as
consulting expenses to prepare the systems for the year 2000. Total
costs to date for the Century Change project have been approximately
$4.9 million ($3.6 million of which relate to 1998). Costs to date
applicable to internal staff and external consulting have been
approximately $1.6 million and $3.3 million, respectively ($1.1 million
and $2.5 million, respectively, relate to 1998). Administration,
programming, testing and implementation of system applications relating
to the Century Change project are expected to cost an additional $1.9
million in 1999.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield
while maintaining investment quality. The Company's investment
objective is to maintain high quality diversified investments structured
to maximize after-tax investment income while minimizing risk. The
Company's funds are generally invested in securities with maturities
intended to provide adequate funds to pay claims and meet other
operating needs without the forced sale of investments. Periodically
sales have been made from the Company's fixed maturity portfolio to
actively manage portfolio risks, including credit-related concerns, to
optimize tax planning and to realize gains. This practice will continue
in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of
risk assumed by the Company is a function of the Company's overall
objectives, liquidity needs and market volatility.
The Company manages its overall market risk by focusing on higher
quality equity and fixed income investments, by continuously reviewing
the credit strength of all companies in which investments are made, by
limiting exposure in any one investment and by monitoring the quality of
the investment portfolio by taking into account credit ratings assigned
by recognized rating organizations.
20
<page
As part of its investing activities, the Company assumes positions
in fixed maturity, equity, short-term and cash equivalents markets.
The Company is, therefore, exposed to the impacts of interest rate
changes in the market value of investments. For 1998, the Company's
exposure to interest rate changes and equity price risk has been
estimated using sensitivity analysis. The interest rate impact is
defined as the effect of a hypothetical interest rate change of plus-or-
minus 200 basis points on the market value of fixed maturities and
preferred stocks. The equity price risk is defined as a hypothetical
change of plus-or-minus 10% in the fair value of common stocks. Changes
in interest rates would result in unrealized gains or losses in the
market value of the fixed maturity and preferred stock portfolio due to
differences between current market rates and the stated rates for these
investments. Based on the results of the sensitivity analysis at
December 31, 1998, the Company's estimated market exposure for a 200
basis point increase (decrease) in interest rates was calculated. A 200
basis point increase results in a $42,665 decrease in the market value
of the fixed maturities and preferred stocks. A 200 basis point
decrease results in a $46,732 increase in the market value of the same
securities. The equity price risk at December 31, 1998, based upon a
10% increase in the fair value of common stocks would increase $28,396.
Based upon a 10% decrease, common stocks would decrease $28,396.
Recent Accounting Developments
In 1997, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position 97-3 Accounting by Insurance and Other
Enterprise for Insurance-Related Assessments ("SOP 97-3") effective for
financial statements issued for periods ending after December 31, 1998.
This statement provides guidance on accounting by insurance companies on
the timing of recognition, the methods of measurement, and the required
disclosures for guaranty fund and other related assessments. The
Company believes that the adoption of this statement will not have a
material impact on the Consolidated Financial Statements.
In 1998, the AcSEC issued Statement of Position 98-1, Accounting
for Costs of Computer Software Developed or Obtained for Internal use
("SOP 98-1") effective for financial statements issued for periods
beginning after December 15, 1998. This statement establishes guidance
on accounting for the costs incurred related to internal use software.
The Company expenses these costs as incurred and believes that the
adoption of this statement will not have a material impact on the
Consolidated Financial Statements.
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation
in its Massachusetts personal automobile insurance line since the
premiums it charges are subject to state regulation. The premium rates
charged by the Company for personal automobile insurance are adjusted by
the Commissioner only at annual intervals. Such annual adjustments in
premium rates may lag behind related cost increases. Economic
recessions will also have an impact upon the Company, primarily through
the policyholder's election to decrease non-compulsory coverages
afforded by the policy and decreased driving, each of which tends to
decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these
environments affect current market rates of return, previously committed
investments may rise or decline in value depending on the type and
maturity of investment.
Inflation and recession must also be considered by the Company in
the creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of
continually adjusting reserves is even more pronounced in periods of
changing economic circumstances.
21
<page
COMMON STOCK PRICE AND DIVIDEND INFORMATION
The Company's common stock trades on the NYSE under the symbol
"CGI". The high, low and close prices for shares of the Company's
Common Stock for 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
1998
1997
High Low Close High
Low Close
<S> <C> <C> <C> <C>
<C> <C>
First Quarter........... $37-3/8 $31-3/4 $35-1/4 $29
$22-7/8 $23-1/4
Second Quarter.......... 39-5/8 34-3/8 38-3/4 24-
3/4 21-3/8 24-5/8
Third Quarter........... 39 24-7/8 27-5/8 33-
3/8 23-7/8 30-7/8
Fourth Quarter.......... 36-1/2 22-11/16 35-7/16 36
30 32-5/8
</TABLE>
As of March 1, 1999, there were 1,241 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name" or
held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.07 per share
and $1.03 per share in 1998 and 1997, respectively. On May 15, 1998,
the Board voted to increase the quarterly stockholder dividend from
$0.26 to $0.27 per share to stockholders of record as of June 5, 1998.
Prior to that declaration, the Company had paid quarterly dividends of
$0.26 per share dating back to May 30, 1997 when the Board voted to
increase the dividend from $0.25 to $0.26 per share.
The Company purchased no additional Treasury Stock under the stock
buyback program during 1998. The stock buyback program, authorized by
the Board on May 19, 1995, enables the Company to purchase up to
3,000,000 shares of the Company's common stock. As of December 31,
1998, 1,957,348 shares of Treasury Stock were purchased under the
program. Since December 31, 1998, the Company completed its share
purchases under that program. Additionally, under prior Board of
Director authorizations, the Company purchased 143,248 shares through
March 19, 1999.
22
<page
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
generally accepted accounting principles determined by management to be
appropriate in the circumstances and include amounts based on
management's informed estimates and judgments. Financial information
presented elsewhere in this Annual Report is consistent with the
financial statements. The appropriateness of data underlying such
financial information is monitored through internal accounting controls,
an internal audit department, independent auditors and the Board of
Directors through its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are executed
in accordance with management's authorization and recorded properly.
The system of internal accounting controls is supported by the selection
and training of qualified personnel combined with the appropriate
division of responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to
the highest standards of personal and corporate conduct. Management
encourages open communication within the Company and requires the
confidential treatment of proprietary information and compliance with
all domestic laws, including those relating to financial disclosure.
The 1998 consolidated financial statements were audited by the
Company's independent auditors, Ernst & Young LLP, in accordance with
generally accepted auditing standards. In addition, Ernst & Young LLP
performs reviews of the unaudited quarterly financial statements.
Management has made available to Ernst & Young LLP all the Company's
financial records and related data, as well as the minutes of
stockholders' and directors' meetings. Furthermore, management believes
that all representations made to Ernst & Young LLP were valid and
appropriate.
23
<page
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheets of
The Commerce Group, Inc. and Subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of earnings, stockholders'
equity and cash flows for each of the two years ended December 31, 1998.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
financial statements based on our audits. The accompanying consolidated
financial statements of the Company for the year ended December 31,
1996, was audited by other auditors whose report dated January 24, 1997,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the 1998 and 1997 financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of The Commerce Group, Inc. and Subsidiaries at
December 31, 1998 and 1997, and the consolidated results of their
operations and their cash flows for each of the two years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
ERNST &
YOUNG LLP
Boston, Massachusetts
January 22, 1999
24
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars Except Per Share Data)
<TABLE>
<CAPTION>
1998 1997
ASSETS
<S>
<C> <C>
Investments (notes A2, A3, A4 and B)
Fixed maturities, at market (cost: $600,482 in 1998 and $566,784
in 1997).......................................................... $
619,267 $ 590,597
Preferred stocks, at market (cost: $200,270 in 1998 and $148,135
in 1997)..........................................................
197,425 148,499
Common stocks, at market (cost: $261,360 in 1998 and $160,371 in
1997).............................................................
283,961 178,089
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $2,301 in 1998
and $2,812 in 1997)...............................................
73,510 82,839
Short-term investments.............................................
3,669 132,700
Cash and cash equivalents..........................................
72,243 106,188
Other investments (cost: $7,450 in 1998 and $3,783 in 1997)........
7,825 3,783
Total investments..............................................
1,257,900 1,242,695
Accrued investment income............................................
13,662 12,237
Premiums receivable (less allowance for doubtful receivables of
$1,450 in 1998 and $1,451 in 1997).................................
162,878 169,469
Deferred policy acquisition costs (notes A5 and C)...................
88,759 85,264
Property and equipment, net of accumulated depreciation
(notes A6 and D)...................................................
35,854 36,280
Residual market receivable (note F)
Losses and loss adjustment expenses................................
111,784 129,137
Unearned premiums..................................................
41,436 51,662
Due from reinsurers (note F).........................................
36,687 18,170
Other assets.........................................................
7,023 9,839
Total assets...................................................
$1,755,983 $1,754,753
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses (notes A7, E and F)............ $
596,996 $ 649,473
Unearned premiums (note A8)........................................
391,424 379,599
Current income taxes (notes A9 and G)..............................
4,061 2,656
Deferred income taxes (notes A9 and G).............................
3,769 13,443
Deferred income (notes A10 and F)..................................
6,948 7,271
Contingent commissions accrued (note A11)..........................
22,067 13,861
Payable for securities purchased...................................
62 11,500
Other liabilities and accrued expenses.............................
24,871 27,154
Total liabilities..............................................
1,050,198 1,104,957
Stockholders' Equity (notes B, J, K and L)
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 accumulated other comprehensive income, net of income taxes of
$13,621 in 1998 and $14,663 in 1997...............................
25,295 27,232
Retained earnings..................................................
670,556 612,630
744,472 688,483
Treasury Stock, 1,957,348 shares in 1998 and 1997, at cost
(note A13)........................................................
(38,687) (38,687)
Total stockholders' equity.....................................
705,785 649,796
Total liabilities and stockholders' equity.....................
$1,755,983 $1,754,753
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
25
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Share and Per Share Data)
<TABLE>
<CAPTION>
1998
1997 1996
<S> <C> <C>
<C>
Revenues
Earned premiums (notes A8 and F)..................... $ 745,620 $
730,497 $ 668,716
Net investment income (note B)....................... 86,501
80,972 77,402
Premium finance and service fees..................... 13,440
7,074 9,713
Net realized investment gains (losses) (note B)...... 6,769
22,770 (7,574)
Total revenues.................................. 852,330
841,313 748,257
Expenses
Losses and loss adjustment expenses
(notes A7, E and F)................................. 531,429
526,127 475,231
Policy acquisition costs (notes A5 and C)............ 196,434
187,491 181,013
Total expenses.................................. 727,863
713,618 656,244
Earnings before income taxes.................... 124,467
127,695 92,013
Income taxes (notes A9 and G).......................... 27,975
31,480 18,049
NET EARNINGS.................................... $ 96,492 $
96,215 $ 73,964
COMPREHENSIVE INCOME............................ $ 94,555 $
100,368 $ 80,539
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE
(note A12)..................................... $ 2.68 $
2.67 $ 2.04
CASH DIVIDENDS PAID PER SHARE................... $ 1.07 $
1.03 $ 0.81
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING............................. 36,042,652
36,044,679 36,311,887
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
26
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
Net
Accumulated
Other
Common Paid-in Comprehensive Retained
Treasury
Stock Capital Income/(Loss) Earnings
Stock Total
<S> <C> <C> <C> <C>
<C> <C>
Balance January 1, 1996...... $19,000 $29,621 $ 16,504 $508,948
$(24,359) $549,714
Net earnings................ 73,964
73,964
Other comprehensive income:
Net unrealized gains arising
during the period, net of
taxes of $3,540........... 6,575
6,575
Comprehensive income........
80,539
Stockholder dividends....... (29,373)
(29,373)
Treasury stock purchased....
(13,841) (13,841)
Balance December 31, 1996.... 19,000 29,621 23,079 553,539
(38,200) 587,039
Net earnings................ 96,215
96,215
Other comprehensive income:
Net unrealized gains arising
during the period, net of
taxes of $2,236........... 4,153
4,153
Comprehensive income........
100,368
Stockholder dividends....... (37,124)
(37,124)
Treasury stock purchased....
(487) (487)
Balance December 31, 1997.... 19,000 29,621 27,232 612,630
(38,687) 649,796
Net earnings................ 96,492
96,492
Other comprehensive income (loss):
Unrealized holding gains arising
during the period, net
of taxes of $1,455........ 2,702
2,702
Reclassification adjustment
net of tax benefits of
($2,498).................. (4,639)
(4,639)
Other comprehensive loss... (1,937)
(1,937)
Comprehensive income........
94,555
Stockholder dividends....... (38,566)
(38,566)
Balance December 31, 1998.... $19,000 $29,621 $ 25,295 $670,556
$(38,687) $705,785
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
27
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1998
1997 1996
<S> <C>
<C> <C>
Cash flows from operating activities
Premiums collected..................................... $ 761,539 $
727,530 $ 675,683
Net investment income received......................... 85,076
81,376 79,269
Premium finance and service fees received.............. 13,440
7,074 9,713
Losses and loss adjustment expenses paid............... (572,661)
(516,130) (428,541)
Policy acquisition costs paid.......................... (186,869)
(198,011) (200,922)
Federal income tax payments............................ (35,201)
(21,833) (16,950)
Net cash provided by operating activities.......... 65,324
80,006 118,252
Cash flows from investing activities
Proceeds from maturity of fixed maturities............. 64,004
108,592 170,646
Proceeds from sale of fixed maturities................. 34,034
124,653 122,431
Proceeds from sale of equity securities................ 80,420
224,059 11,326
Purchase of fixed maturities........................... (134,540)
(98,098) (200,113)
Purchase of equity securities.......................... (224,896)
(296,714) (85,480)
Purchase of other investments.......................... (3,616)
(1,752) (700)
Net (increase) decrease in short-term investments,
net of payable for securities purchased.............. 117,531
(121,200) -
Payments received on mortgage loans and collateral
notes receivable..................................... 26,788
11,386 8,311
Mortgage loans and collateral notes originated......... (16,450)
(19,816) (7,446)
Purchase of property and equipment..................... (4,293)
(8,133) (4,477)
Other proceeds from investing activities............... 315
281 235
Net cash provided by (used in) investing activities (60,703)
(76,742) 14,733
Cash flows from financing activities
Dividends paid to stockholders......................... (38,566)
(37,124) (29,373)
Purchase of treasury stock............................. -
(487) (15,742)
Net cash used in financing activities.............. (38,566)
(37,611) (45,115)
Increase (decrease) in cash and cash equivalents......... (33,945)
(34,347) 87,870
Cash and cash equivalents at beginning of year........... 106,188
140,535 52,665
Cash and cash equivalents at end of year................. $ 72,243 $
106,188 $ 140,535
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
28
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating
Activities
For the years ended December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1998
1997 1996
<S> <C>
<C> <C>
Cash flows from operating activities
Net earnings........................................... $ 96,492 $
96,215 $ 73,964
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable.................................. 6,591
(11,634) (30,788)
Deferred policy acquisition costs.................... (3,495)
(2,296) (15,808)
Residual market receivable........................... 27,579
14,414 4,911
Due from reinsurers.................................. (18,517)
1,489 2,238
Losses and loss adjustment expenses.................. (52,477)
(13,359) 36,803
Unearned premiums.................................... 11,825
11,608 37,537
Current income taxes................................. 1,405
2,485 (1,009)
Deferred income taxes................................ (8,632)
6,984 2,098
Deferred income...................................... (323)
(703) (980)
Contingent commissions............................... 8,206
(11,851) (6,838)
Other assets, liabilities and accrued expenses....... 533
4,992 3,017
Net realized investment (gains) losses............... (6,769)
(22,770) 7,574
Other - net.......................................... 2,906
4,432 5,533
Net cash provided by operating activities......... $ 65,324 $
80,006 $ 118,252
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
29
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc.
(the "Company") have been prepared in accordance with generally accepted
accounting principles ("GAAP").
The consolidated financial statements include The Commerce Group,
Inc. and its wholly-owned subsidiaries, Bay Finance Company, Inc.,
Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI").
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation") are wholly-owned subsidiaries of CHI. Commerce
West Insurance Company ("Commerce West") is a wholly-owned subsidiary of
Commerce. All intercompany transactions and balances have been
eliminated in consolidation. Certain prior year account balances have
been reclassified to conform to 1998 presentation.
The insurance subsidiaries, Commerce, Citation and Commerce West
prepare statutory financial statements in accordance with accounting
practices prescribed by the National Association of Insurance
Commissioners ("NAIC"), the Commonwealth of Massachusetts, and the State
of California.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Investments
All investment transactions have credit exposure to the extent
that a counterparty may default on an obligation to the Company. Credit
risk is a consequence of carrying investment positions. The financial
instruments that potentially subject the Company to credit risk consist
primarily of cash and cash equivalents, premium receivables, investments
and mortgage loans on real estate. Concentrations of credit risk with
respect to premiums receivable result from the fact that the Company's
policyholders are concentrated primarily in one geographic area, as the
Company, the largest writer of personal automobile insurance in the
state of Massachusetts, writes primarily in Massachusetts. To manage
credit risk, the Company focuses on higher quality fixed-income
securities and preferred stocks, reviews the credit strength of all
companies which it invests in, limits its exposure in any one investment
and monitors the portfolio quality, taking into account credit ratings
assigned by recognized statistical rating organizations.
Investments in fixed maturities, which include taxable and non-
taxable bonds, and investments in common and preferred stocks, are
carried at fair market value and are classified as available for sale.
Unrealized investment gains and losses on common and preferred stocks
and fixed maturities, to the extent that there is no permanent
impairment of value, are credited or charged to a separate component of
stockholders' equity, known as "net accumulated other comprehensive
income", until realized, net of any tax effect. When investment
securities are sold, the realized gain or loss is determined based upon
specific identification. Fair market value of fixed maturities and
common and preferred stocks is based on quoted market prices. For other
securities held as investments, fair market value equals quoted market
price, if available. If a quoted market price is not available, fair
market value is estimated using quoted market prices for similar
securities. The Company has not invested more than 5% in fixed
maturities of any one state or political subdivision.
The Company originates and holds mortgage loans on real estate on
properties located in the Commonwealth of Massachusetts and the State of
Connecticut. The Company controls credit risk through credit approvals,
credit limits and monitoring procedures. The Company performs in-depth
credit evaluations on all new mortgage customers. Bad debt expenses
have not been material in recent years.
30
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by Management. Factors considered in
evaluating the adequacy of the allowance include previous loss
experience, current economic conditions and their effect on borrowers
and the performance of individual loans in relation to contract terms.
The provision for possible loan losses charged to operating expenses is
based upon Management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses
are charged against the allowance when Management believes the
collectibility of the principal is unlikely and recoveries are credited
to the allowance when received.
Interest on mortgage loans is included in income as earned based
upon rates applied to principal amounts outstanding. Accrual of
interest on mortgage loans is discontinued either when reasonable doubt
exists as to the full, timely collection of interest or principal, or
when a loan becomes contractually past due more than ninety days. When
a loan is placed on nonaccrual status, all unpaid interest previously
accrued is reversed against current period earnings.
3. Short-Term Investments
Short-term investments which consist of Commercial Paper, Auction
Rate Preferred Stocks and Variable Rate Municipal Bonds, are carried at
cost, which approximates market value.
4. Cash and Cash Equivalents
Cash and cash equivalents include cash currently on hand to cover
operating expenses. The Company held $13,572 and $27,476 in U.S.
Government Repurchase Agreements at various banks in 1998 and 1997.
When the Company enters into a repurchase agreement through its
custodian, it receives delivery of the underlying collateral. The
amount of collateral, at the time of purchase and each subsequent
business day, is required to be maintained at such a level that market
value is equal to 102% of the resale price.
5. Deferred Policy Acquisition Costs
Policy acquisition costs relating to unearned premiums, consisting
of commissions, premium taxes and other underwriting expenses incurred
at the policy issuance, are deferred and amortized over the period in
which the related premiums are earned, the amount being reduced by any
potential premium deficiency. If any potential premium deficiency
exists, it represents future estimated losses, loss adjustment expenses
and amortization of deferred acquisition costs in excess of the related
unearned premiums. There was no premium deficiency in 1998, 1997 and
1996. In determining whether a premium deficiency exists, the Company
considers anticipated investment income on unearned premiums.
31
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
6. Property and Equipment
Property and equipment are stated at cost and are depreciated on
the straight line method over the estimated useful lives of the assets
using the following rates:
<TABLE>
<CAPTION>
Percent
Asset Classification Per
Annum
<S>
<C>
Buildings.......................................
2.5
Building improvements (prior to 1992)...........
2.5
Building improvements (1992 and subsequent).....
5.0
Equipment and office furniture..................
10.0
EDP equipment and copiers.......................
20.0
Automobiles.....................................
33.3
</TABLE>
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon are eliminated from the related
property and accumulated depreciation accounts and any resulting gain or
loss is credited or charged to income.
7. Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses
("LAE") represents the accumulation of individual case estimates for
reported losses and estimates for incurred but not reported ("IBNR")
losses and LAE. Assumed losses and LAE are recorded as reported by the
ceding organization with additional adjustments for IBNR. The liability
for losses and LAE is intended to cover the ultimate net cost of all
losses and loss adjustment expenses incurred through the balance sheet
date. Liability estimates are continually reviewed and updated, and
therefore, the ultimate liability may be more or less than the current
estimate. The effects of changes in the estimates are included in the
results of operations in the period in which the estimates are revised.
8. Premiums
Insurance premiums are recognized as income ratably over the terms
of the policies. Unearned premiums are determined by prorating policy
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's premiums written is derived through the
American Automobile Association Clubs of Massachusetts ("AAA clubs")
affinity group marketing program. Of the Company's total direct
premiums written, the portion attributable to the AAA group business was
$457,430 or 57% in 1998 as compared to $423,243 or 55% in 1997. Of
these amounts, 11% were written through insurance agencies owned by the
AAA clubs and 89% were written through the Company's network of
independent agents in both 1998 and 1997, respectively.
9. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized.
10. Deferred Income
Income consisting of group marketing service fees and expense
reimbursements which include servicing carrier fees from Commonwealth
Automobile Reinsurers ("C.A.R."), a state-mandated reinsurance
mechanism, on policies written for C.A.R., are deferred and amortized
over the term of the related insurance policies (see note F).
32
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
11. Contingent Commissions
In addition to state mandated commissions on policies written, the
Company pays certain of its agencies compensation in the form of profit
sharing. This is based, in part, on the underwriting profits of an
individual agent's business written with the Company. This arrangement
utilizes a three year rolling plan, with one third of each of the
current and the two prior years profit or loss calculations, summed to a
single amount. This amount, if positive, is multiplied by the profit
sharing commission rate and paid to the agent.
12. Net Earnings Per Common Share
Net earnings per common share is computed by dividing net earnings
by the weighted average number of common shares outstanding. The
weighted average number of common shares outstanding for the years ended
December 31, 1998, 1997 and 1996 was 36,042,652, 36,044,679 and
36,311,887, respectively. Weighted average number of common shares
outstanding is determined by taking the average of the following
calculation for a specified period of time: The daily amount of the
total issued and outstanding common shares minus the total Treasury
Stock purchased.
13. Treasury Stock (unaudited)
On May 19, 1995, the Board of Directors of the Company announced
the approval of a stock buyback program of up to 3,000,000 shares.
Through December 31, 1998, the Company had purchased 1,957,348 shares of
Treasury Stock under this program. Since December, 1998, the Company
completed its share repurchases under that program. Additionally, under
prior Board of Director authorizations, the Company purchased 143,248
shares through March 19, 1999.
14. New and Pending Accounting Pronouncements
During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("FAS 130") effective for financial statements issued for periods
beginning after December 15, 1997. FAS 130 requires that a public
company report changes in equity during a period except those resulting
from investment by owners and distributions by owners. The financial
information to be reported includes foreign currency transaction,
minimum pension liability adjustments and unrealized gains and losses on
certain investments in debt and equity securities (i.e. available for
sale securities).
During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("FAS 131"), effective for
financial statements issued for periods beginning after December 15,
1997. FAS 131 requires that a public company report financial and
descriptive information about its reportable operating segments pursuant
to criteria that differ from current accounting practice. The financial
information to be reported includes segment profit or loss, certain
revenue and expense items and segment assets and reconciliations to
corresponding amounts in the general purpose financial statements.
During 1998 the Financial Accounting Standards Board ("FASB")
issued statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("FAS 133") effective
for financial statements issued to fiscal years beginning after June 15,
1999. FAS 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives)
and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and
measure those instruments at fair value. The Company had no derivative
or hedging activity in 1998, 1997 or 1996.
33
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE B-Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market values of investments
in fixed maturities are as follows:
<TABLE>
<CAPTION>
Gross
Gross Estimated
Amortized Unrealized
Unrealized Fair Market
Cost Gains
Losses Value
<S> <C> <C> <C>
<C>
At December 31, 1998:
GNMA mortgage-backed bonds........... $109,624 $ 2,965 $
(1) $112,588
Obligations of states and
political subdivisions.............. 490,858 18,416
(2,595) 506,679
Totals.......................... $600,482 $ 21,381 $
(2,596) $619,267
At December 31, 1997:
GNMA mortgage-backed bonds........... $175,788 $ 5,292 $
(11) $181,069
Obligations of states and
political subdivisions.............. 390,996 18,898
(366) 409,528
Totals.......................... $566,784 $ 24,190 $
(377) $590,597
Proceeds from sales of investments in fixed maturities, gross
gains and gross losses realized on those sales were as follows:
Proceeds
Gross Gross
From
Realized Realized
Sales
Gains Losses
For the year ended December 31, 1998:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 34,034
25 (435)
Totals........................................ $ 34,034 $
25 $ (435)
For the year ended December 31, 1997:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 124,653
3,994 (390)
Totals........................................ $124,653 $
3,994 $ (390)
For the year ended December 31, 1996:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 122,431
367 (3,685)
Totals........................................ $122,431 $
367 $ (3,685)
</TABLE>
34
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
The amortized cost and approximate fair market value of fixed
maturities at December 31, 1998 and 1997, by contractual maturity, are
as follows:
<TABLE>
<CAPTION>
1998
1997
Fair
Fair
Amortized Market
Amortized Market
Cost Value
Cost Value
<S> <C> <C>
<C> <C>
Obligations of states and political subdivisions:
Due in one year or less.......................... $ - $ -
$ - $ -
Due after one year through five years............ 2,096 2,177
2,083 2,200
Due after five years through ten years........... 1,748 1,740
1,321 1,324
Due after ten years.............................. 487,014 502,762
387,592 406,004
490,858 506,679
390,996 409,528
GNMA mortgage-backed bonds....................... 109,624 112,588
175,788 181,069
Total fixed maturities.................... $600,482 $619,267
$566,784 $590,597
</TABLE>
Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations.
2. Common Stocks
The cost and approximate fair market value of common stocks at
December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998
1997
Fair
Fair
Market
Market
Cost Value
Cost Value
<S> <C> <C>
<C> <C>
Preferred stock mutual funds................ $169,394 $172,455
$115,943 $ 119,439
Common stocks............................... 91,966 111,506
44,428 58,650
Total common stocks............. $261,360 $283,961
$160,371 $ 178,089
</TABLE>
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 1998 and 1997, mortgage loans on real estate and
collateral notes receivable consisted of the following:
<TABLE>
<CAPTION>
December 31,
1998
1997
<S> <C>
<C>
Residential (1st Mortgages)............ $59,377
$58,430
Residential (2nd Mortgages)............ 261
523
Commercial (1st Mortgages)............. 13,762
14,755
Commercial (2nd Mortgages)............. 104
172
73,504
73,880
Collateral notes receivable............ 2,307
11,771
75,811
85,651
Allowance for possible loan losses..... (2,301)
(2,812)
Mortgage loans on real estate and
collateral notes receivable....... $73,510
$82,839
</TABLE>
35
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities.
The future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work
out arrangements or the disposition of collateral. The fair value of
mortgage loans on real estate and collateral notes receivable at
December 31, 1998 and 1997, prior to the allowance for possible loan
losses, was $78,382 and $87,867, respectively, which was estimated by
discounting the future cash flows.
At December 31, 1998 and 1997 mortgage loans which were on
nonaccrual status amounted to $1,638 and $2,021, respectively. The
reduction in interest income associated with nonaccrual loans was $205,
$207 and $152 for the years ended December 31, 1998, 1997 and 1996,
respectively.
The Company originates and services residential and commercial
mortgages in Massachusetts and Connecticut. The Company's exposure is
80% or less of the appraised value of any collateralized real property.
The ability and willingness of residential and commercial borrowers to
honor their repayment commitments is generally dependent upon the level
of overall economic activity and real estate values.
A summary of the changes in the allowance for possible loan losses
follows:
<TABLE>
<CAPTION>
Year
ended December 31,
1998 1997
<S> <C>
<C>
Balance, beginning of year........................ $
2,812 $ 2,760
Increase (decrease) in provision for possible
loan losses...................................
(511) 52
Balance, end of year.............................. $
2,301 $ 2,812
</TABLE>
The following table describes mortgage principal balances by
maturity, total mortgages over 90 days past due and total
mortgages in foreclosure:
<TABLE>
<CAPTION>
1998 1997
<S> <C>
<C>
Fixed rate mortgages maturing:
One year or less................................ $
- - $ 4
More than one year to five years................
1,886 2,062
More than five years to ten years...............
7,121 4,608
Over ten years..................................
48,053 46,868
Total fixed mortgages...................... $
57,060 $ 53,542
Adjustable rate mortgages maturing:
One year or less................................ $
- - $ -
More than one year to five years................
67 -
More than five years to ten years...............
395 498
Over ten years..................................
15,831 19,840
Total adjustable mortgages................. $
16,293 $ 20,338
Past due over 90 days............................. $
1,638 $ 2,021
Mortgages in foreclosure.......................... $
979 $ 1,459
</TABLE>
36
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
4. Net Investment Income
The components of net investment income were as follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Interest on fixed maturities.................. $ 41,368 $
46,449 $ 56,034
Dividends on common and preferred stocks...... 32,145
19,799 12,765
Interest on cash and short-term investments... 8,683
10,544 4,022
Interest on mortgage loans.................... 6,604
6,578 6,737
Other......................................... 119
122 105
Total investment income.............. 88,919
83,492 79,663
Investment expenses........................... 2,418
2,520 2,261
Net investment income................ $ 86,501 $
80,972 $ 77,402
</TABLE>
5. Net Realized and Unrealized Investment Gains (Losses)
Net realized investment gains (losses) were as follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Net realized investment gains (losses):
Fixed maturities................................. $ (2,804) $
1,419 $ (7,364)
Preferred stocks................................. (727)
6 (349)
Common stocks.................................... 9,313
21,440 456
Other............................................ 987
(95) (317)
Total........................................ $ 6,769 $
22,770 $ (7,574)
</TABLE>
6. Other Comprehensive Income (Loss)
Net increases (decreases) in other comprehensive income (loss)
less applicable income
tax expense were as follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Other comprehensive income (loss):
Fixed maturities................................. $ (5,028) $
7,622 $ 2,222
Preferred stocks................................. (3,209)
1,165 (424)
Common stocks.................................... 4,883
(2,398) 8,317
Other............................................ 375 -
- -
Tax expense...................................... $ 1,042 $
(2,236) $ (3,540)
Total........................................ $ (1,937) $
4,153 $ 6,575
</TABLE>
A summary of net accumulated other comprehensive income (loss) on
stocks and fixed maturity investments in 1998, 1997 and 1996 follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Unrealized gains................................ $ 49,184 $
43,675 $ 40,227
Unrealized losses............................... (10,268)
(1,780) (4,721)
Tax expense..................................... (13,621)
(14,663) (12,427)
Net accumulated other comprehensive
income..................................... $ 25,295 $
27,232 $ 23,079
</TABLE>
37
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE C-Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Balance, beginning of year............. $ 85,264 $
82,968 $ 67,160
Costs deferred during the year......... 199,929
189,787 196,821
Amortization charged to expense........ (196,434)
(187,491) (181,013)
Balance, end of year................... $ 88,759 $
85,264 $ 82,968
</TABLE>
NOTE D-Property and Equipment
A summary of property and equipment at December 31, is as follows:
<TABLE>
<CAPTION>
1998
1997
<S> <C>
<C>
Buildings................................. $ 30,719
$ 27,873
Equipment and office furniture............ 33,230
30,286
Building improvements..................... 838
828
64,787
58,987
Less accumulated depreciation.......
(29,907) (25,081)
34,880
33,906
Land...................................... 939
934
Construction in progress.................. 35
1,440
$ 35,854
$ 36,280
</TABLE>
Depreciation expense incurred was $4,706, $4,213 and $3,202 for
the years ended December 31, 1998, 1997 and 1996, respectively.
Depreciation expense is allocated evenly between losses and loss
adjustment expenses and policy acquisition costs.
NOTE E-Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at
December 31, consist of:
1998
1997
<TABLE>
<CAPTION>
<S> <C>
<C>
Unpaid loss and LAE reserves.............. $666,177
$725,886
Salvage and subrogation recoverable.......
(69,181) (76,413)
$596,996
$649,473
</TABLE>
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to annually obtain a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
38
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
When a claim is reported to the Company, claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon an
evaluation of the type of claim involved, the circumstances surrounding
the claim and the policy provisions relating to the loss. The estimate
reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims person. During the loss adjustment period, these estimates are
revised as deemed necessary by the Company's claims department based on
subsequent developments and periodic reviews of the cases.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR. IBNR reserves are determined on the basis
of historical information and the experience of the Company.
Adjustments to IBNR are made periodically to take into account changes
in the volume of business written, claims frequency and severity, the
mix of business, claims processing and other items that can be expected
to affect the Company's liability for losses and LAE over time.
When reviewing reserves, the Company analyzes historical data and
estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in general
economic conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for
predicting future events. There is no precise method, however, for
subsequently evaluating the impact of any specific factor on the
adequacy of reserves, because the eventual development of reserves is
affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company estimates
the ultimate net liability for losses and LAE. After taking into
account all relevant factors, management believes that the provision for
losses and LAE at December 31, 1998 is adequate to cover the ultimate
net cost of losses and claims incurred as of that date. The ultimate
liability, however, may be greater or lower than reserves.
Establishment of appropriate reserves is an inherently uncertain
process, and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience.
The Company does not discount to present value that portion of its loss
reserves expected to be paid in future periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known and
unknown losses. Because of the Company's limited exposure to these
types of claims, management believes they will not have a material
impact on the consolidated financial position of the Company in the
future. Loss reserves on environmental related claims amounted to
$5,687 and $6,924 in 1998 and 1997, respectively.
39
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expense, net of
reinsurance deductions from all reinsurers including C.A.R., as shown in
the Company's consolidated financial statements for the periods
indicated.
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C> <C>
<C>
Loss and loss adjustment expense reserves,
beginning of year, prior to effect of ceded
reinsurance recoverable............................. $530,077
$533,980 $493,911
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 592,796
609,930 562,997
Decrease in provision for insured events of
prior years...................................... (61,367)
(83,803) (87,766)
Total incurred losses and loss adjustment
expenses....................................... 531,429
526,127 475,231
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 335,047
322,882 267,653
Losses and loss adjustment expenses attributable
to insured events of prior years................. 227,630
207,148 167,509
Total payments.................................. 562,677
530,030 435,162
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 498,829
530,077 533,980
Ceded reinsurance recoverable..................... 98,167
119,396 128,852
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $596,996
$649,473 $662,832
</TABLE>
The provision for insured events of the current year is lower for
1998 compared to 1997 primarily due to better loss results in the
Company's bodily injury area mainly due to improved severity of bodily
injury claims coupled with slightly improved claim frequency.
The provision for loss and LAE reserves relating to prior years is
lower in 1998 due primarily to activity in the bodily injury area.
Redundancies from prior year losses realized in the current year,
relating to bodily injury claims, were approximately $18.0 million less
in 1998, as compared to 1997. Approximately $11.0 million of this
amount was attributable to voluntary personal automobile bodily injury
loss reserves and $7.0 million to fewer redundancies from C.A.R. assumed
reserves.
The increases in payments and incurred losses primarily resulted
from increases in total loss and loss adjustment expense payments on the
direct personal automobile lines of business of approximately 11.0%.
Net loss payments in the direct personal automobile lines of business
increased approximately 11.7% or $29,400 which were offset by a decrease
in payments for other than automobile lines of business of approximately
$18.2% or $5,748 compared to 1997. The decrease in other than
automobile loss payments was primarily the result of more favorable
weather in 1998 versus the weather experienced in 1997. The increase in
automobile loss payments was attributable primarily to three factors:
increased payments for collision coverages; 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 initiatives 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.
40
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
The Company's loss and LAE reserves reflect its share of the
aggregate loss and LAE reserves of all Servicing Carriers. The Company
is a defendant in various legal actions arising from the normal course
of its business. These proceedings are considered to be ordinary to
operations or without foundation in fact. Management is of the opinion
that these actions will not have a material adverse effect on the
consolidated financial statements of the Company.
NOTE F-Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses
from a single occurrence or event. The Company also has a combined
quota share and excess loss reinsurance contract on its other than
automobile property business.
Property, Catastrophe and Quota Share Reinsurance
From September 30, 1995 through June 30, 1998, the Company had a
combined property quota share and excess loss reinsurance contract which
was written with six reinsurance companies. Under the quota share
portion of the arrangement, the reinsurers indemnified the Company for
45% of the loss and LAE, and paid a commission allowance based on the
ratio of losses incurred to premiums earned. In exchange, the Company
paid to the reinsurers 49% of the net premium pertaining to the related
business. The maximum per occurrence loss reimbursement was $50.0
million and the maximum annual aggregate occurrence loss reimbursement
was $75.0 million. Under the excess loss reinsurance portion of the
arrangement, the Company reinsured each risk, retaining $125 and
reinsuring 100% of the next $875.
Various catastrophe only reinsurance programs were utilized from
1996 through May, 1998 in conjunction with the quota share and excess
loss program noted above.
Effective July 1, 1998, the Company expanded the quota share
portion of the program. A 75% quota-share reinsurance program was
incepted, covering all non-automobile property and liability business,
except umbrella policies. The excess loss portion of the program was
reduced on July 1, 1998 and completely eliminated on September 30, 1998.
The expanded program is split between Employers Reinsurance Corporation,
American Re-Insurance Company, Nationwide Mutual Insurance Company and
Swiss Reinsurance America Corporation. The maximum per occurrence loss
reimbursement is the higher of 350% of premium ceded under the program
or $175.9 million. The maximum annual aggregate occurrence loss
reimbursement is the higher of 450% of premium ceded under the program
or $226.1 million. A sliding scale commission, based on loss ratio, is
utilized under this program. This program provides the Company with
sufficient protection for catastrophe coverage so as to enable the
Company to forego pure catastrophe reinsurance coverage, which was
previously tailored in conjunction with the former quota share
arrangement.
41
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
The table below provides information depicting the approximate
recovery under the expanded quota share contract at various loss
scenarios, if a single catastrophe were to strike:
<TABLE>
<CAPTION>
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
<S> <C> <C>
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 175,875 74,125
</TABLE>
Under the above scenario, the Company has no reinsurance
recoveries for a single event catastrophe in excess of a total loss of
approximately $234.5 million. The Company's estimated total loss on its
other than automobile business for 100 and 250 year storms is $108.6
million and $184.2 million, respectively. The Company estimates were
derived through the services of Swiss Reinsurance America Corporation
who utilized the CLASIC model provided by Applied Insurance Research.
Written premiums ceded in 1998, 1997 and 1996 under the above
referenced programs were $54.0 million, $27.5 million and $26.6 million,
respectively. Ceding commission income is calculated on a ceded earned
premium basis.
Casualty Reinsurance
Through December 31, 1996, casualty reinsurance was on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$4.0 million over a net retention of $1.0 million. Effective January 1,
1997, casualty reinsurance is on an excess of loss basis for any one
event or occurrence with a maximum recovery of $9.0 million over a net
retention of $1.0 million. This coverage is placed with Swiss
Reinsurance America Corporation (rated A+ by A.M. Best).
Effective January 1, 1995, personal and commercial liability
umbrella policies are reinsured on a 95% quota share basis in regard to
limits up to $1.0 million and 100% quota share basis for limits in
excess of $1.0 million but not exceeding $5.0 million for policies with
underlying automobile coverage of $250/$500 or more. Effective January
1, 1996, the Company added personal liability umbrella reinsurance
coverage for policies with underlying automobile coverage of $100/$300,
on a 65% quota share basis in regard to limits up to $1.0 million and
100% quota share basis for limits in excess of $1.0 million but not
exceeding $3.0 million. These coverages are placed with American Re-
Insurance Company (rated A+ by A.M. Best).
Earned premiums and losses and loss adjustment expenses are stated
in the accompanying consolidated financial statements after deductions
for ceded reinsurance. Those deductions for reinsurance other than
C.A.R. are as follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C>
<C> <C>
Written premiums ceded............................ $56,341
$32,190 $ 31,289
Earned premiums ceded............................. 43,518
33,847 36,261
Losses and loss adjustment expenses ceded......... 16,542
10,616 22,453
</TABLE>
The Company, as primary insurer, would be required to pay losses
in their entirety in the event that the reinsurers were unable to
discharge their obligations under the reinsurance agreements.
42
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the
Company and approximately 40 other writers of automobile insurance in
Massachusetts ("Servicing Carriers") to reinsure any automobile risk
that the insurer perceives to be underpriced at the premium level
permitted by the Massachusetts Insurance Commissioner (the
"Commissioner"). Servicing Carriers, who are responsible for over 99.0%
of total direct premiums written for personal automobile insurance in
Massachusetts, are required to offer automobile insurance coverage to
all eligible applicants pursuant to "take-all-comers" regulations, but
may reinsure undesirable business with C.A.R.
The Company pays to C.A.R. all of the premiums generated by the
policies it has ceded and C.A.R. reimburses the Company for all losses
incurred on account of ceded policies. In addition, the Company
receives a fee for servicing ceded policies based on the expense
structure established by C.A.R. For the years ended December 31, 1998,
1997 and 1996, these servicing fees amounted to $15,574, $17,333 and
$17,127, respectively.
Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both the personal and commercial pools.
The Company is required to share in the underwriting results of C.A.R.
business for its respective product lines. Under current regulations,
the Company's share of the C.A.R. personal or commercial deficit is
based upon its market share for retained automobile risks for the
particular pool, adjusted by a "utilization" concept, such that, in
general, the Company is disproportionately and adversely affected if its
relative use of C.A.R. reinsurance exceeds that of the industry, and
favorably affected if its relative use of C.A.R. reinsurance is less
than that of the industry. The Company's strategy has been to
voluntarily retain more types of private passenger automobile business
that are factored as credits, thereby favorably impacting the
utilization formula. As a result of increased voluntary retention, the
credits impacting the utilization formula have favorably affected the
Company's participation ratio. During 1998, 1997 and 1996, the
Company's net participation in the C.A.R. personal automobile pool
approximated 16.7%, 18.0% and 19.0%, respectively.
Written premiums, earned premiums, losses incurred and the
liabilities for unearned premiums, unpaid losses ceded to and assumed
from C.A.R. were as follows:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997
1996
Ceded Assumed Ceded Assumed
Ceded Assumed
<S> <C> <C> <C> <C> <C>
<C>
Income Statement
Written premiums... $ 70,435 $ 74,644 $ 71,816 $ 76,530 $
82,861 $ 93,703
Earned premiums.... 68,383 75,718 71,977 82,866
85,977 92,469
Losses incurred.... 64,784 95,937 83,240 89,081
84,074 93,278
Balance Sheet
Unearned premiums.. $ 41,436 $ 39,271 $ 51,662 $ 40,345 $
49,487 $ 46,681
Unpaid losses...... 111,784 99,427 129,137 102,819
145,726 117,237
</TABLE>
The Company presents assets and liabilities gross of reinsurance.
The Residual Market Receivable represents the gross amount of
reinsurance recoverable from C.A.R. including unpaid losses, unearned
premiums, paid losses recoverable and unpaid ceded and assumed premiums.
The current C.A.R. utilization-based participation ratio has been
in place for the personal automobile market since 1993. During 1998,
1997 and 1996 the Company's amount of personal automobile exposures it
reinsured through C.A.R. approximated 6.4%, 6.6% and 8.1%, respectively.
43
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998 1997 and 1996
(Thousands of Dollars)
NOTE G-Income Taxes
The Company and its subsidiaries file a consolidated federal
income tax return.
The federal income tax expense consisted of the following:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C>
<C> <C>
Current............................ $ 36,607 $
24,496 $ 15,951
Deferred........................... (8,632)
6,984 2,098
$ 27,975 $
31,480 $ 18,049
</TABLE>
Deferred taxes arise from temporary differences in the basis of
assets and liabilities for tax and financial statement purposes. The
sources of these differences and the related tax effects consisted of
the following:
<TABLE>
<CAPTION>
Year ended
December 31,
1998
1997 1996
<S> <C>
<C> <C>
Unearned premiums.................................. $ 39 $
(769) $ (3,695)
Discounting of loss reserves....................... 2,782
2,421 (2,954)
Bad debt expense................................... (17)
129 131
Deferred policy acquisition costs.................. (782)
1,297 6,022
Salvage and subrogation recoverable................ (233)
(406) 425
Tax depreciation in excess of book depreciation.... 109
151 192
Book value rights/book value awards/stock
appreciation rights............................... (11,056)
4,912 1,686
Deferred items not included above.................. 526
(751) 291
Deferred income tax.......................... (8,632)
6,984 2,098
Other comprehensive income (loss).................. (1,042)
2,236 3,540
Change in deferred tax liability............. $ (9,674) $
9,220 $ 5,638
</TABLE>
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, Management believes it is more likely than not that all of the
deferred tax assets will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term
if estimates of future taxable income are reduced. Deferred tax
liabilities (assets) were comprised of the following components at
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
<S> <C>
<C>
Unearned premiums................................................
$(20,569) $(20,608)
Discounting of loss reserves.....................................
(18,597) (21,379)
Book value awards/stock appreciation rights......................
(2,857) -
Bad debt allowances..............................................
(789) (772)
Deferred tax assets........................................
(42,812) (42,759)
Deferred policy acquisition costs................................
25,050 25,832
Salvage and subrogation recoverable..............................
1,768 2,001
Tax depreciation in excess of book depreciation..................
2,965 2,856
Book value awards/stock appreciation rights......................
- - 8,199
Net accumulated comprehensive income.............................
13,621 14,663
Deferred items not included above................................
3,177 2,651
Deferred tax liabilities...................................
46,581 56,202
Net deferred tax liability................................. $
3,769 $ 13,443
</TABLE>
44
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE G-Income Taxes (continued)
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 1998, 1997 and
1996 for the following reasons:
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997
1996
<S> <C> <C> <C> <C>
<C> <C>
Tax at statutory rate.. $ 43,563 35.0% $44,693 35.0%
$32,205 35.0%
Tax exempt interest.... (8,429) (6.8) (8,036) (6.3)
(10,062) (10.9)
Dividends paid to ESOP
participants......... (762) (0.6) (782) (0.6)
(1,169) (1.3)
Dividends received
deduction............ (6,152) (4.9) (4,567) (3.6)
(3,167) (3.4)
Other.................. (245) (0.2) 172 0.2
242 0.2
Tax at effective rate.. $ 27,975 22.5% $31,480 24.7%
$18,049 19.6%
</TABLE>
NOTE H-Related-Party Transactions
The Company has made loans to insurance agencies and other
organizations with which the Company transacts business on a regular
basis. At December 31, 1998, eight of these loans, which had an
aggregate outstanding principal balance of $2,738, were collateralized
by the assets of the agencies. At December 31, 1997, seven of these
loans which had an aggregate outstanding principal balance of $12,161
were collateralized by the assets of the agencies. At December 31, 1998
and 1997 there were no mortgage loans outstanding to agents
collateralized by real estate.
One Director of the Company is the Chairman Emeritus and Assistant
Clerk of an insurance agency which is one of the Company's independent
insurance agencies. This Director sold his ownership interest in that
agency in 1994, although he remains associated with it in the above
stated capacity. This Director also continues to receive payments under
non-competition and loan agreements. This Director receives no direct
or indirect compensation based on the commissions paid to the agency by
the Company. During the years ended December 31, 1998, 1997 and 1996,
the agency received from the Company commissions of $940, $834 and $906,
respectively, in the aggregate, for policies written. The Company also
purchased certain insurance coverages through the agency and paid
premiums for these policies of $520, $367 and $360 in 1998, 1997 and
1996, respectively.
NOTE I-Employee Stock Ownership Plan and 401(k) Plan
The Company offers an Employee Stock Ownership Plan ("E.S.O.P.")
and 401(k) Plan for the benefit of substantially all employees,
including those of the Company's subsidiaries. The E.S.O.P. is
noncontributory on the part of participants and contributions are made
at the discretion of the Board of Directors. The Company is under no
obligation to make contributions or maintain the E.S.O.P. for any length
of time, and may completely discontinue or terminate the E.S.O.P at any
time without liability. Contributions by the Company and subsidiaries
to the E.S.O.P. for the years ending December 31, 1998, 1997 and 1996
were $5,412, $4,841 and $6,216, respectively. The E.S.O.P. owned
3,186,968 and 3,305,986 shares of the Company's common stock at December
31, 1998 and 1997, respectively.
The 401(k) Plan, implemented in September, 1998, enables eligible
employees to contribute up to 15% of eligible compensation on a pre-tax
basis up to the annual maximum limits under federal tax law. The
Company incurs no expenses in the form of matching contributions but
does pay for administration of the Plan.
45
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars Except for Per Share Data)
NOTE J-Stockholders' Equity
Book Value Rights, Book Value Awards and Stock Appreciation Rights
Program
The Board of Directors authorized a Book Value Rights Program
which provided for the payment of awards in cash to key employees based
upon specified increases in the book value of the Company at the end of
the program period, which is December 31st of the third year after the
rights granted. Expenses relating to this Book Value Rights Program
were $234 in 1996. The Book Value Rights Program was replaced by a Book
Value Awards Program in 1994 maturing on December 31, 1996 and beyond.
The Management Incentive Plan approved by the Company's
stockholders in May, 1994 provides for the award of incentive stock
options, non-qualified stock options, book value awards, stock
appreciation rights, restricted stock and performance stock units. Up
to 2,500,000 shares of common stock (subject to increase for anti-
dilution adjustments) may be issued under the Plan, including shares
that may be issued pursuant to awards of restricted stock or upon the
exercise of common stock equivalent awards such as stock options and
stock appreciation rights payable in the form of common stock (not in
the form of cash). All directors, officers and other senior management
employees of the Company or any of its subsidiaries are eligible to
participate in this Management Incentive Plan. Book value awards issued
relating to this Plan totalled 482,215, 453,488 and 468,381 in 1998,
1997 and 1996, respectively. Stock appreciation rights issued also
relating to this Plan totalled 509,872, 493,492 and 520,625 in 1998,
1997 and 1996, respectively. The outstanding book value awards and
stock appreciation rights entitle the holders to cash payments based
upon the extent to which, if at all, the per share book value or market
value, as applicable, of the common stock exceeds certain thresholds set
at the time the award was granted. Expenses relating to book value
awards were $470, $3,068 and $2,140 in 1998, 1997 and 1996. Expenses
(income) relating to stock appreciation rights were ($656), $15,657 and
$6,224 in 1998, 1997 and 1996. Aggregate liabilities for the combined
programs were $9,609 and $23,426 at year-end 1998 and 1997,
respectively.
NOTE K-Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established
by their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders may, within certain limitations, pay such dividends and
then file a report with the Commissioner. Dividends in excess of these
limitations are called extraordinary dividends. An extraordinary
dividend is any dividend or other property, whose fair value together
with other dividends or distributions made within the preceding twelve
months exceeds the greater of ten percent of the insurer's surplus as
regards policyholders as of the end of the preceding year, or the net
income of a non-life insurance company for the preceding year. No pro-
rata distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has
not objected. No extraordinary dividends were paid in 1998, 1997 and
1996.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to
its stockholders is limited. During 1998 Commerce and Citation paid
$43,300 and $8,338 in dividends, respectively, to CHI; CHI then paid
$51,345 to the Company in March 1998. During 1997, Commerce and
Citation paid $39,375 and $7,040 in dividends, respectively, to CHI; CHI
then paid $46,305 to the Company in March 1997.
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.07 per share
and $1.03 per share in 1998 and 1997, respectively. On May 15, 1998,
the Board voted to increase the quarterly stockholder dividend from
$0.26 to $0.27 per share to stockholders of record as of June 5, 1998.
Prior to that declaration, the Company had paid quarterly dividends of
$0.26 per share dating back to May 30, 1997 when the Board voted to
increase the dividend from $0.25 to $0.26 per share.
46
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars)
NOTE L-Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings
and policyholders surplus for the combined operations of Commerce,
Citation and Commerce West:
<TABLE>
<CAPTION>
1998 1997
1996
Earnings Equity Earnings Equity
Earnings Equity
<S> <C> <C> <C> <C>
<C> <C>
GAAP............................ $ 93,888 $649,751 $101,528
$609,416 $ 74,432 $550,151
Deferred income taxes........... (1,971) 5,423 4,039
8,352 929 2,165
Deferred acquisition costs...... (3,495) (88,759) (2,296)
(85,264) (15,808) (82,968)
Bonds-book versus market........ - (18,786) -
(23,812) - (16,194)
Preferred stock-market versus
book........................... - (1,307) -
(429) - (331)
Deferred income................. (326) 6,744 (697)
7,071 (963) 7,768
Deferred service fee income..... 91 3,411 1,784
3,139 1,538 1,538
Deferred reinsurance
commissions.................... 5,728 10,253 (1,267)
4,424 2,082 5,796
Statutory reserve over statement
reserves....................... - (4,072) -
(8,567) - (5,397)
Goodwill in subsidiary.......... (291) 1,936 (291)
2,226 (270) 2,515
Difference in GAAP to statutory
net income in subsidiary....... 80 - 57 -
416 -
Other........................... - (1,091) -
42 4 (304)
Total adjustments.......... (184) (86,248) 1,329
(92,818) (12,072) (85,412)
Statutory....................... $ 93,704 $563,503 $102,857
$516,598 $ 62,360 $464,739
</TABLE>
NOTE M-Segment Information
The Company has three reportable segments: (1) property and
casualty insurance; (2) real estate and commercial lending; and, (3)
corporate and other. The Company's property and casualty insurance
operations are written through Commerce, Citation and Commerce West and
are marketed to affinity groups, individuals, families and businesses
through the Company's relationships with professional independent
insurance agencies. The Company's real estate and commercial lending
operations are a result of insurance companies having the authorization
to invest in mortgages. The Company's wholly-owned subsidiary, Bay
Finance Company, Inc., originates and services residential and
commercial mortgages in Massachusetts and Connecticut. The corporate
and other segment represents the remainder of the Company's activities,
including those of the parent company.
The Company evaluates performance and allocates resources based
primarily on the property and casualty insurance segment which
represents 99.0% of the Company's total revenue for the past three
years. The accounting policies of the reportable segments are the same
as those described in Note A - Summary of Significant Accounting
Polices.
47
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars Except for Per Share Data)
NOTE M-Segment Information - (continued)
Selected information by industry segment for 1998, 1997 and 1996 is
summarized as follows:
<TABLE>
<CAPTION>
Earnings
Before Identifiable
Revenue Income
Taxes Assets
1998
<S> <C> <C>
<C>
Property and casualty insurance............ $843,798 $117,259
$1,672,999
Real estate and commercial lending......... 5,049 5,049
74,070
Corporate and other........................ 3,483 2,159
8,914
Consolidated........................... $852,330 $124,467
$1,755,983
1997
Property and casualty insurance............ $833,482 $132,722
$1,659,374
Real estate and commercial lending......... 4,448 4,448
83,420
Corporate and other........................ 3,383
(9,475) 11,959
Consolidated........................... $841,313 $127,695
$1,754,753
1996
Property and casualty insurance............ $740,707 $ 91,242
$1,590,695
Real estate and commercial lending......... 4,249 4,249
75,255
Corporate and other........................ 3,301
(3,478) 10,849
Consolidated........................... $748,257 $ 92,013
$1,676,799
</TABLE>
NOTE N-Supplement to Consolidated Statements of Cash Flows
During the years ended December 31, 1998 and 1997, the Company did
not acquire any property through foreclosure of mortgages. During 1996,
the Company acquired property through foreclosure of mortgages held with
remaining principal balances at the time of foreclosure of $245.
NOTE O-Insolvency Fund Assessments
As provided in the statutes, insurance companies which write
business in Massachusetts are assessed for losses attributable to the
insolvency of other insurance companies by the Massachusetts Insurers
Insolvency Fund ("M.I.I.F."). From its inception, on August 2, 1972
through December 31, 1998, the M.I.I.F. has approved assessments
totaling $126,822, of which the Company's share was approximately
$7,269. It is anticipated that there will be additional assessments
from time to time relating to various insolvencies. By statute, no
insurer may be assessed in any year an amount greater than two percent
of that insurer's net direct written premiums for the calendar year
preceding the assessment. Although the timing and amounts of any such
assessments are not known, Management is of the opinion that such
assessments will not have a material effect on the consolidated
financial position of the Company. According to statute, the assessed
insurance companies have the right to recoup amounts paid to the
M.I.I.F., over a reasonable length of time, through premium rates
approved by the Commissioner. The Company's policy has been to
recognize the recovery of the assessed amounts as received. Refunds of
assessments by the M.I.I.F. for the year ended December 31, 1998 and
1997 were $271 and $283, respectively. Assessments by the M.I.I.F. for
the year ended December 31, 1996 were $742.
In 1997, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position 97-3 Accounting by Insurance and Other
Enterprise for Insurance-Related Assessments ("SOP 97-3") effective for
financial statements issued for periods ending after December 31, 1998.
This statement provides guidance on accounting by insurance companies on
the timing of recognition, the methods of measurement, and the required
disclosures for guaranty fund and other related assessments. The
Company believes that the adoption of this statement will not have a
material impact on the Consolidated Financial Statements.
48
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(Thousands of Dollars Except for Per Share Data)
NOTE P-Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 1998 and 1997 quarterly
performance is as follows:
<TABLE>
<CAPTION>
1998 First Second
Third Fourth
Quarter Quarter
Quarter Quarter
<S> <C> <C>
<C> <C>
Total revenues................................. $214,380 $217,610
$206,060 $214,280
Net earnings................................... 25,235 19,585
29,861 21,811
Comprehensive income........................... 23,953 16,473
32,417 21,712
Net earnings excluding the after-tax impact
of net realized investment gains (losses)(1).. 22,764 18,752
29,862 20,714
Net earnings per weighted average common
share (basic and diluted).................... 0.70 0.54
0.83 0.61
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (losses)(1)........ 0.63 0.52
0.83 0.58
Cash dividends paid per share.................. 0.26 0.27
0.27 0.27
1997
Total revenues................................. $199,069 $205,589
$225,131 $211,524
Net earnings................................... 16,638 19,971
35,012 24,594
Comprehensive income........................... 12,355 30,328
27,722 30,283
Net earnings excluding the after-tax impact
of net realized investment gains (losses)(1).. 16,830 18,531
21,365 24,688
Net earnings per weighted average common
share (basic and diluted).................... 0.46 0.56
0.97 0.68
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (losses)(1)........ 0.47 0.52
0.59 0.68
Cash dividends paid per share.................. 0.25 0.26
0.26 0.26
</TABLE>
(1) The above figures are presented to provide information to the reader
due to the amount of,
and fluctuations in, net realized gains and losses. The amounts
noted, commonly known as
Operating Income, are important measures of corporate performance.
NOTE Q-Subsequent Events (Unaudited)
Commerce, a subsidiary of the Company, formed a joint venture
(ACIC Holding Co., Inc.) in November 1998 with AAA Southern New England
("AAA SNE") and completed the subsequent acquisition of ACIC, located in
Columbus, Ohio. in January 1999. ACIC writes automobile and homeowners
insurance solely through 38 AAA automobile clubs. Commerce and AAA SNE
intend that ACIC will retain its management team and staff and continue
to have its principle office in Columbus, Ohio. In early 1999, Commerce
invested $90.8 million in the joint venture (ACIC Holding Co., Inc.) to
fund the ACIC acquisition and to capitalize the joint venture that will
be owned together with AAA SNE. Of this $90.8 million, Commerce
invested $90 million in the form of preferred stock and an additional
$800 representing its 80% common stock ownership. The terms of the
preferred stock call for quarterly cash dividends at the rate of 10% per
annum. AAA SNE invested $200 representing its 20% common stock
ownership. Commerce intends to consolidate ACIC Holding Co., Inc., and
it's wholly-owned subsidiary, ACIC, for financial reporting purposes.
Since 1995, Commerce has maintained an affinity group marketing
relationship with AAA Insurance Agency, Inc., a subsidiary of AAA SNE.
AAA Insurance Agency, Inc. has been an agent of Commerce since 1985.
49
<page
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be read
in conjunction with the consolidated financial statements of the Company and
the notes thereto. This financial data has been extracted from financial
statements audited by Ernst & Young LLP in 1998 and 1997 and by other auditors
in 1994 through 1996. All dollar amounts set forth in the following tables
are in thousands except per share data.
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
1995 1994
<S> <C> <C> <C> <C>
<C>
Statement of Earnings Data:
Net premiums written........... $ 745,048 $ 741,501 $ 711,570 $
603,421 $ 589,197
(Increase) decrease in
unearned premiums............ 572 (11,004) (42,854)
(10,831) (17,144)
Earned premiums................ 745,620 730,497 668,716
592,590 572,053
Net investment income.......... 86,501 80,972 77,402
71,313 62,901
Premium finance and service
fees......................... 13,440 7,074 9,713
19,420 18,497
Net realized investment gains
(losses)...................... 6,769 22,770 (7,574)
712 45,612
Total revenues............ 852,330 841,313 748,257
684,035 699,063
Losses and loss adjustment
expenses...................... 531,429 526,127 475,231
367,552 369,660
Policy acquisition costs....... 196,434 187,491 181,013
166,741 157,415
Total expenses............ 727,863 713,618 656,244
534,293 527,075
Earnings before income taxes... 124,467 127,695 92,013
149,742 171,988
Income taxes................... 27,975 31,480 18,049
39,541 49,405
Net earnings.............. $ 96,492 $ 96,215 $ 73,964 $
110,201 $ 122,583
Comprehensive Income...... $ 94,555 $ 100,368 $ 80,539 $
169,119 $ 35,941
Per Share Data:
Basic and diluted
net earnings per share.. $ 2.68 $ 2.67 $ 2.04 $
2.93 $ 3.23
Cash dividends paid per
share................... $ 1.07 $ 1.03 $ 0.81 $
0.23 $ 0.15
Weighted average number of
shares outstanding.............. 36,042,652 36,044,679 36,311,887
37,632,236 38,000,000
</TABLE>
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
1995 1994
<S> <C> <C> <C> <C>
<C>
Balance Sheet Data:
Total investments.............. $1,257,900 $1,242,695 $1,167,671
$1,096,778 $ 905,031
Premiums receivable............ 162,878 169,469 157,835
127,047 102,432
Total assets................... 1,755,983 1,754,753 1,676,799
1,564,175 1,382,226
Unpaid losses and loss
adjustment expenses........... 596,996 649,473 662,832
626,029 599,502
Unearned premiums.............. 391,424 379,599 367,991
330,454 314,719
Stockholders' equity........... 705,785 649,796 587,039
549,714 413,589
Stockholders' equity per share. 19.58 18.03 16.28
14.96 10.88
</TABLE>
50
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following exhibits depict the progress of the insurance
operations of the Company over the past fifteen years. For these years
of operation, net premiums written amounted to $5,502,344. During this
period, the average statutory financial ratios were 68.2% for losses and
loss expenses and 26.8% for underwriting expenses resulting in an
average combined ratio of 95.0%. Total net investment income amounted
to $598,469 or 10.9% of net premiums written. Net realized gains were
$94,199. Stockholders' equity was $18,219 at the beginning of 1984 and
$649,751, at the end of 1998, resulting in an average annual increase in
excess of 26.9%. The progress of the insurance operations during the
most recent five year period, compared to the two previous five year
periods, can best be illustrated by the following comparison:
<TABLE>
<CAPTION>
5-Year
Period
1994-98
1989-93 1984-88
<S> <C> <C>
<C>
Direct premiums written............................ $3,549,019
$2,324,133 $795,206
Net premiums written............................... 3,390,737
1,743,511 368,096
Net investment income.............................. 379,053
172,448 46,968
Net realized gains................................. 54,436
33,629 6,134
Stockholders' equity at end of period.............. 649,751
351,631 67,205
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned...... 68.5%
66.1% 75.1%
Underwriting expenses to net premiums written.... 26.8
27.4 23.9
Combined ratio............................... 95.3%
93.5% 99.0%
Increase in Stockholders' Equity................... 84.8%
423.2% 268.9%
</TABLE>
The insurance operations of the Company include the operating results of
Commerce, its subsidiary company, Commerce West, and Citation. Citation
commenced business in 1981 as a wholly-owned subsidiary of Commerce. On
December 31, 1989, the ownership of Citation was transferred to The
Commerce Group, Inc. In September 1993, ownership of both Commerce and
Citation was transferred from The Commerce Group, Inc. to CHI, a
subsidiary of The Commerce Group, Inc. Results of Commerce West are
included since its acquisition by Commerce on August 31, 1995. The
combined balance sheets of these insurance subsidiaries appear on pages
52 and 53. The combined statements of earnings of insurance operations
appear on pages 54 and 55.
51
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1998 1997 1996
1995 1994
ASSETS
<S> <C> <C> <C>
<C> <C>
Cash and short-term investments..... $ 75,655 $ 238,685 $ 140,102
$ 52,308 $ 4,560
Bonds, at market (at amortized cost
prior to 1993)..................... 619,267 590,597 716,702
815,277 745,010
Preferred stocks, at market (at
amortized cost prior to 1993)...... 197,425 148,499 147,680
111,220 85,574
Common stocks, at market............ 283,961 178,089 86,041
40,359 9,656
Mortgage loans on real estate....... 46,573 57,425 45,398
31,404 35,715
Other investments................... 7,825 3,783 127
- - -
Premium balances receivable......... 162,704 169,311 157,673
126,090 101,529
Investment income receivable........ 13,544 12,103 12,655
14,440 13,285
Residual market receivable.......... 153,220 180,799 195,213
200,124 214,818
Reinsurance receivable.............. 36,687 18,170 19,659
21,897 16,892
Deferred acquisition costs.......... 88,759 85,264 82,968
67,160 59,066
Current income taxes................ 2,773 - -
- - -
Deferred income taxes............... - - -
2,100 38,180
Real estate, furniture and equipment 27,885 29,060 26,011
24,642 25,246
Total assets................. $1,716,278 $1,711,785 $1,630,229
$1,507,021 $1,349,531
LIABILITIES
Unpaid losses and loss expenses..... $ 592,174 $ 637,094 $ 657,854
$ 618,791 $ 592,373
Unearned premiums................... 391,424 379,599 367,991
330,454 314,719
Notes payable....................... - - -
- - -
Deferred income..................... 6,948 7,271 7,974
8,954 10,451
Accounts payable, accrued and other
liabilities........................ 70,558 60,332 41,368
34,351 43,433
Current income taxes................ - 9,635 2,726
1,596 10,254
Deferred income taxes............... 5,423 8,438 2,165
- - -
Total liabilities............ 1,066,527 1,102,369 1,080,078
994,146 971,230
STOCKHOLDERS' EQUITY
Capital stock....................... 3,620 3,600 3,600
3,450 3,450
Paid-in capital..................... 45,050 45,050 45,050
23,700 23,700
Retained earnings
Balance, January 1................ 560,766 501,501 485,725
351,151 339,481
Net earnings...................... 93,888 101,528 74,432
110,450 113,892
Other comprehensive income (loss). (1,935) 4,152 6,574
58,919 (77,622)
Dividends paid.................... (51,638) (46,415) (65,230)
(34,795) (24,600)
Balance, December 31................ 601,081 560,766 501,501
485,725 351,151
Total stockholders' equity... 649,751 609,416 550,151
512,875 378,301
Total liabilities and
stockholders' equity....... $1,716,278 $1,711,785 $1,630,229
$1,507,021 $1,349,531
</TABLE>
52
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989 1988 1987 1986
1985 1984
ASSETS
<S> <C> <C> <C> <C> <C> <C> <C>
<C>
$ 12,615 $ 25,809 $ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051 $
10,048 $ 11,802 $ 7,953
649,491 505,565 329,935 242,735 153,621 133,867 116,220
88,755 56,985 34,422
80,059 2,261 869 1,010 1,324 1,606 2,295
6,755 9,956 10,837
47,462 43,545 30,055 4,869 2,900 1,921 1,438
149 134 1,494
42,042 60,697 66,122 56,124 52,244 42,882 15,931 -
- - 7,825
- 67,876 55,510 57,733 56,713 33,727 19,329
11,817 8,194 6,028
94,333 - - - - - - -
- - -
10,205 9,710 6,063 4,235 3,093 2,889 2,370
2,485 1,722 1,286
220,312 274,426 277,196 290,440 268,951 198,177 132,725
87,178 50,327 29,187
12,868 365 - - - - - -
- - -
53,647 55,442 33,981 27,273 22,702 15,699 10,898
7,129 5,417 3,968
- - - - 341 266 -
2,209 1,294 -
- - 883 1,666 - - - -
- - -
22,371 23,183 24,163 25,046 23,118 9,684 8,356
7,370 5,648 3,136
$1,245,405 $1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613
$223,895 $151,479 $106,136
LIABILITIES
$ 567,797 $ 495,800 $439,551 $403,752 $345,020 $270,628 $169,539
$113,513 $ 71,525 $ 44,425
283,526 264,567 192,785 175,334 174,345 118,079 84,876
55,378 36,024 23,585
- - - 1,662 1,837 2,013 2,204
3,772 4,140 2,858
7,351 8,384 12,918 20,264 23,689 23,307 11,058
7,503 4,208 3,173
16,564 20,863 7,677 21,065 27,513 19,350 14,532
8,532 4,162 4,479
4,867 9,249 5,811 3,542 - - 470 -
- - 418
13,669 4,400 - - 1,623 1,021 1,853
3,736 3,623 2,610
893,774 803,263 658,742 625,619 574,027 434,398 284,532
192,434 123,682 81,548
STOCKHOLDERS' EQUITY
3,450 3,450 3,450 3,450 3,450 2,350 2,350
2,350 2,350 2,350
8,700 8,700 8,700 8,700 8,700 6,500 6,500
6,500 6,500 6,500
253,466 165,075 112,016 83,138 62,877 37,231 22,611
18,947 15,738 10,469
79,837 91,980 55,214 32,414 21,966 21,837 15,614
4,362 4,025 6,033
21,928 9,811 2,545 (86) 645 321 (54)
7 (158) (179)
(15,750) (13,400) (4,700) (3,450) (2,350) (1,034) (940)
(705) (658) (585)
339,481 253,466 165,075 112,016 83,138 58,355 37,231
22,611 18,947 15,738
351,631 265,616 177,225 124,166 95,288 67,205 46,081
31,461 27,797 24,588
$1,245,405 $1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613
$223,895 $151,479 $106,136
</TABLE>
53
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1998 1997 1996
1995 1994
<S> <C> <C> <C>
<C> <C>
Underwriting
Direct premiums written.............. $796,858 $768,649 $731,823
$626,666 $625,023
Net premiums written................. $745,048 $741,501 $711,570
$603,421 $589,197
Increase (decrease) in unearned
premiums............................ (572) 11,004 42,854
10,831 17,144
Earned premiums.................. 745,620 730,497 668,716
592,590 572,053
Expenses
Losses and loss expenses............. 533,523 521,775 474,173
367,258 369,764
Underwriting expenses................ 200,525 185,146 194,873
171,892 162,446
(Increase) decrease in deferred
acquisition costs................... (3,495) (2,296) (15,809)
(5,723) (5,420)
Total expenses................... 730,553 704,625 653,237
533,427 526,790
Underwriting income (loss)............. 15,067 25,872 15,479
59,163 45,263
Net investment income.................. 86,664 81,396 76,867
71,007 63,119
Premium finance fees................... 13,426 7,056 9,666
19,246 18,315
Net realized investment gains (losses). 6,645 22,909 (7,863)
720 32,025
Earnings before Federal income
taxes and withdrawing companies'
settlements...................... 121,802 137,233 94,149
150,136 158,722
Other income
Withdrawing companies' settlements... - - -
- - -
Earnings before Federal income taxes... 121,802 137,233 94,149
150,136 158,722
Federal income taxes (benefits)........ 27,914 35,705 19,717
39,686 44,830
Earnings before cumulative effect of
change in accounting principle........ 93,888 101,528 74,432
110,450 113,892
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes.......................... - - -
- - -
NET EARNINGS..................... $ 93,888 $101,528 $ 74,432
$110,450 $113,892
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned..................... 71.6% 71.4% 70.9%
62.0% 64.6%
Underwriting expenses to net
premiums written.................... 26.5 25.1 27.1
29.0 27.1
Combined ratio................... 98.1% 96.5% 98.0%
91.0% 91.7%
Underwriting profit (loss)....... 1.9% 3.5% 2.0%
9.0% 8.3%
</TABLE>
54
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989 1988 1987
1986 1985 1984
<S> <C> <C> <C> <C> <C> <C> <C>
<C> <C>
$601,289 $525,495 $429,780 $401,077 $366,492 $306,469 $206,231
$131,807 $85,000 $65,699
$563,416 $508,847 $310,999 $219,936 $140,313 $124,923 $ 99,193 $
60,808 $49,229 $33,943
14,856 98,353 30,193 34,692 12,655 9,678 13,428
6,775 6,392 2,137
548,560 410,494 280,806 185,244 127,658 115,245 85,765
54,033 42,837 31,806
373,243 271,848 173,901 125,219 88,564 80,203 65,299
44,205 33,548 19,567
147,290 138,669 85,655 55,551 44,181 33,115 25,882
18,460 15,177 11,241
1,796 (21,462) (6,708) (4,571) (7,003) (4,801) (3,769)
(1,712) (1,448) (911)
522,329 389,055 252,848 176,199 125,742 108,517 87,412
60,953 47,277 29,897
26,231 21,439 27,958 9,045 1,916 6,728 (1,647)
(6,920) (4,440) 1,909
52,868 39,685 32,661 25,978 21,256 15,999 10,896
7,554 6,835 5,684
16,486 13,734 11,165 10,074 8,095 4,592 3,021
1,436 531 324
13,040 12,368 7,529 74 618 2,298 3,423
185 336 (108)
108,625 87,226 79,313 45,171 31,885 29,617 15,693
2,255 3,262 7,809
- 43,168 - - - - -
- - - -
108,625 130,394 79,313 45,171 31,885 29,617 15,693
2,255 3,262 7,809
28,788 38,414 24,099 12,757 9,919 7,780 2,987
(2,107) (763) 1,776
79,837 91,980 55,214 32,414 21,966 21,837 12,706
4,362 4,025 6,033
- - - - - - 2,908
- - - -
$ 79,837 $ 91,980 $ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614 $
4,362 $ 4,025 $ 6,033
68.0% 66.2% 61.9% 65.7% 68.0% 69.5% 79.4%
83.5% 79.7% 63.6%
25.7 28.1 30.0 26.7 26.3 22.0 22.5
24.4 28.1 27.8
93.7% 94.3% 91.9% 92.4% 94.3% 91.5% 101.9%
107.9% 107.8% 91.4%
6.3% 5.7% 8.1% 7.6% 5.7% 8.5% (1.9%)
(7.9%) (7.8)% 8.6%
</TABLE>
55
<page
THE COMMERCE GROUP, INC.
DIRECTORS
<TABLE>
<capton>
<S> <C>
Herman F. Becker......................... President and owner, Sterling
Realty and Huguenot Development
Corporation
Joseph A. Borski, Jr..................... Self-employed Certified Public
Accountant
Eric G. Butler........................... Retired Vice President and
General Claims Manager
of Commerce and Citation
Henry J. Camosse......................... Retired President, Henry
Camosse & Sons Co., Inc., a
building and masonry supplies company
Gerald Fels.............................. Executive Vice President and
Chief Financial Officer of
the Company
David R. Grenon.......................... Chairman Emeritus and
Assistant Clerk of The
Protector Group Insurance
Agency, Inc., a property
and casualty insurance agency
Robert W. Harris......................... Retired Treasurer, H.C.
Bartlett Insurance Agency, Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett
Insurance Agency, Inc.
John J. Kunkel........................... President and Treasurer,
Kunkel Buick and GMC
Truck, Treasurer, Kunkel Bus
Company
Raymond J. Lauring....................... Retired President, Lauring
Construction Company
Roger E. Lavoie.......................... Retired President and
Treasurer, Lavoie Toyota-
Dodge, Inc.
Normand R. Marois........................ Retired Chairman of the Board,
Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Physician specializing in
internal medicine
Arthur J. Remillard, Jr.................. President, Chief Executive
Officer and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and
Assistant Clerk of
the Company, Senior Vice
President of Commerce
and Citation in charge of
Policyholder Benefits
Regan P. Remillard....................... Senior Vice President and
General Counsel
of the Company; President and
Secretary of
Commerce West Insurance
Company; President of
ACIC Holding Co., Inc.; Vice
Chairman of the
Board and Chief Executive
Officer of American
Commerce Insurance Company
Antranig Sahagian........................ Retired Owner, A. Sahagian
Service Center
Gurbachan Singh.......................... Physician specializing in
general surgery
John W. Spillane......................... Clerk of the Company and
practicing attorney
</TABLE>
56
<page
DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Commerce West Insurance Company
Citation Insurance Company
<TABLE>
<CAPTION>
<S> <C>
Arthur J. Remillard, Jr........... President, Chief Executive
Officer and Chairman of
the Board
Gerald Fels....................... Executive Vice President and
Chief Financial Officer
Arthur J. Remillard, III (1)...... Senior Vice President and Clerk
Regan P. Remillard................ Senior Vice President and General
Counsel, President
and Secretary of Commerce West
Insurance Company
David R. Grenon (1)............... Chairman Emeritus and Assistant
Clerk of The Protector Group
Insurance Agency
John M. Nelson (1)................ Chairman of TJX Companies
Suryakant M. Patel (1)............ Physician specializing in
internal medicine
William G. Pike (1)............... Executive Vice President and
Chief Financial Officer
of Granite State Bankshares, Inc.
</TABLE>
DIRECTORS OF
ACIC Holding Co., Inc.(2)
American Commerce Insurance Company
<TABLE>
<CAPTION>
<S> <C>
H. Thomas Rowles.................. Chairman of the Board and Chief
Executive Officer of ACIC Holding
Co., Inc.; Chairman of the Board
of American Commerce Insurance
Company; President, Chief
Executive Officer and Director of
AAA Southern New England
Regan P. Remillard................ President of ACIC Holding Co.,
Inc.; Vice Chairman of the Board
and Chief Executive Officer of
American Commerce Insurance
Company; Senior Vice President
and General Counsel of The
Commerce Group, Inc.; President
and Secretary of Commerce West
Insurance Company
Mark A. Shaw...................... Treasurer of ACIC Holding Co.,
Inc., Executive Vice
President and Chief Operating
Officer of the AAA Southern New
England
Gerald Fels....................... Executive Vice President and
Chief Financial Officer of The
Commerce Group, Inc.
Patrick W. Doherty (3)............ President and Chief Executive
Officer of AAA Oklahoma
Terry R. Farias (3)............... President and Chief Executive
Officer of AAA Hoosier
Motor Club
Roger L. Graybeal (3)............. President and Secretary of AAA
Oregon/Idaho
Gerald P. Hogan(3)................ President and Chief Operating
Officer of American
Commerce Insurance Company
D. James McDowell (3)............. President of AAA Arizona
Peter C. Ohlheiser (3)............ President of Ohio Motorists
Association
</TABLE>
(1) Commerce Holdings, Inc., The Commerce Insurance Company and Citation
Insurance Company
only.
(2) Incorporated in November, 1998. 80% owned by The Commerce Insurance
Company and 20%
owned by AAA Southern New England.
(3) American Commerce Insurance Company only, which was acquired in
January 1999.
57
<page
DIRECTORS OF
BAY FINANCE COMPANY, INC.
<TABLE>
<CAPTION>
<S> <C>
Arthur J. Remillard, Jr................ President and Chairman of the
Board
Gerald Fels............................ Executive Vice President and
Chief Financial Officer
John W. Spillane....................... Clerk and practicing attorney
Arthur J. Remillard, III............... Assistant Clerk
Regan P. Remillard..................... Senior Vice President
</TABLE>
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
<TABLE>
<CAPTION>
<S> <C>
Arthur J. Remillard, Jr................ President and Chairman of the
Board
Gerald Fels............................ Executive Vice President and
Chief Financial Officer
John W. Spillane....................... Clerk and practicing attorney
Arthur J. Remillard, III............... Assistant Clerk
Elizabeth M. Edwards................... Vice President
</TABLE>
58
<page
THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Commerce West Insurance Company
ACIC Holding Co., Inc.(1)
American Commerce Insurance
Company(2)
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF THE COMMERCE GROUP, INC.
<TABLE>
<CAPTION>
<S> <C>
President, Chief Executive Officer and Chairman of the Board..... Arthur
J. Remillard, Jr.
Executive Vice President and Chief Financial Officer............. Gerald
Fels
Senior Vice President and Assistant Clerk........................ Arthur
J. Remillard, III
Senior Vice President and General Counsel........................ Regan
P. Remillard
Senior Vice President............................................ Mary
M. Fontaine
Vice President and Associate General Counsel..................... James
A. Ermilio
Clerk............................................................ John
W. Spillane
Treasurer and Chief Accounting Officer...........................
Randall V. Becker
Assistant Treasurer.............................................. Thomas
A. Gaylord
Assistant Vice President......................................... Robert
E. McKenna
Officers of Massachusetts Subsidiaries (3)
President, Chief Executive Officer and Chairman of the Board..... Arthur
J. Remillard, Jr.
Executive Vice President and Chief Financial Officer............. Gerald
Fels
Senior Vice Presidents........................................... David
H. Cochrane
Peter
J. Dignan
Mary
M. Fontaine
Arthur
J. Remillard, III
Joyce
B. Virostek
Senior Vice President and General Counsel........................ Regan
P. Remillard
Vice Presidents..................................................
Elizabeth M. Edwards
Karen
A. Lussier
Michael J. Richards
Angelos Spetseris
Henry
R. Whittier, Jr.
Vice President and Associate General Counsel..................... James
A. Ermilio
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
Assistant Vice Presidents.......................David P. Antocci Susan
A. Horan
Robert M. Blackmer John
V. Kelly
Stephen R. Clark Ronald
J. Lareau
Raymond J. DeSantis Donald
G. MacLean
Warren S. Ehrlich Robert
E. McKenna
Richard W. Goodus Robert
L. Mooney
James E. Gow
Kenneth E. Morrison
Emile
E. Riendeau
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Treasurer and Chief Accounting Officer...........................
Randall V. Becker
Assistant Treasurer.............................................. Thomas
A. Gaylord
</TABLE>
(1) Incorporated in November, 1998. 80% owned by The Commerce Insurance
Company and 20% owned by
AAA Southern New England.
(2) Acquired by ACIC Holding Co., Inc. in January, 1999.
(3) Massachusetts subsidiaries include The Commerce Insurance Company,
Citation Insurance
Company, Bay Finance Company, Inc. and Clark-Prout. Officers often hold
positions with
several operating subsidiaries. The titles listed represent their
primary office as of
March 1, 1999.
59
<page
Officers of ACIC Holding Co., Inc.
<TABLE>
<CAPTION>
<S>
<C>
Chairman of the Board and Chief Executive Officer............... H.
Thomas Rowles
President.......................................................
Regan P. Remillard
Treasurer.......................................................
Mark A. Shaw
Secretary.......................................................
James A. Ermilio
</TABLE>
Officers of American Commerce Insurance Company
<TABLE>
<CAPTION>
<S>
<C>
Chairman of the Board........................................... H.
Thomas Rowles
Vice Chairman of the Board and Chief Executive Officer..........
Regan P. Remillard
President and Chief Operating Officer...........................
Gerald P. Hogan
Senior Vice President and Secretary.............................
Thomas E. Berridge
Senior Vice President...........................................
Carol R. Blaine
Vice President, Chief Financial Officer and Treasurer...........
Curt C. Anderson
Vice Presidents.................................................
Timothy M. Montgomery
Thomas E. Timbrook
</TABLE>
Officers of Commerce West Insurance Company
<TABLE>
<CAPTION>
<S>
<C>
Chairman of the Board...........................................
Arthur J. Remillard, Jr.
President, Chief Executive Officer and Secretary................
Regan P. Remillard
Chief Financial Officer.........................................
Michael V. Vrban
Chief Reporting Officer.........................................
Albert E. Peters
Investment Officer..............................................
Gerald Fels
Vice Presidents.................................................
Howard M. Dreyfus
Albert H. Harris
Tushar M. Kothare
Assistant Vice President........................................
Michael J. Berryessa
Treasurer and Controller........................................
Joan M. Kelly
</TABLE>
60
<page
Stockholder Information
Annual Meeting
The Annual meeting of stockholders will be held at 9:00 a.m. on Friday,
May 21, 1999 at the Company's Underwriting Building, 11 Gore Road (Route
16), Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in the
Company's annual report on Form 10-K, as filed with the Securities and
Exchange Commission, may obtain a copy without charge, by writing to the
Assistant to the President at 211 Main Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o BANKBOSTON, NA
EquiServe, L.P.
P.O. Box 8040
Boston, MA 02266-8040
(781) 575-3100
http://www.equiserve.com
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Company Website
http://www.commerceinsurance.com
Trading of Common Stock
The Company's Common Stock trades on the NYSE under the symbol "CGI".
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
(617) 266-2000
http://www.ey.com
61
<page
vii
123
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<DEBT-HELD-FOR-SALE> 0 0
<DEBT-CARRYING-VALUE> 600,482 566,784
<DEBT-MARKET-VALUE> 619,267 590,597
<EQUITIES> 481,386 326,588
<MORTGAGE> 73,510 82,839
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 1,257,900 1,242,695
<CASH> 72,243 106,188
<RECOVER-REINSURE> 36,687 18,170
<DEFERRED-ACQUISITION> 88,759 85,264
<TOTAL-ASSETS> 1,755,983 1,754,753
<POLICY-LOSSES> 596,996 649,473
<UNEARNED-PREMIUMS> 391,424 379,599
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 0 0
0 0
0 0
<COMMON> 19,000 19,000
<OTHER-SE> 686,785 630,796
<TOTAL-LIABILITY-AND-EQUITY> 1,755,983 1,754,753
745,620 730,497
<INVESTMENT-INCOME> 86,501 80,972
<INVESTMENT-GAINS> 6,769 22,770
<OTHER-INCOME> 13,440 7,074
<BENEFITS> 531,429 526,127
<UNDERWRITING-AMORTIZATION> 196,434 187,491
<UNDERWRITING-OTHER> 0 0
<INCOME-PRETAX> 124,467 127,517
<INCOME-TAX> 27,975 31,302
<INCOME-CONTINUING> 96,492 96,215
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 96,492 96,215
<EPS-PRIMARY> 2.68 2.67
<EPS-DILUTED> 2.68 2.67
<RESERVE-OPEN> 530,077 533,980
<PROVISION-CURRENT> 592,796 609,930
<PROVISION-PRIOR> (61,367) (83,803)
<PAYMENTS-CURRENT> 335,047 (322,822)
<PAYMENTS-PRIOR> 227,630 (207,148)
<RESERVE-CLOSE> 596,996 649,473
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
