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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM: TO
0-20668
(COMMISSION FILE NUMBER)
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
04-3164595
DELAWARE
(IRS EMPLOYER
(STATE OR OTHER JURISDICTION, IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
440 LINCOLN STREET,
WORCESTER, MASSACHUSETTS 01653
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(508) 855-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE NEW YORK STOCK EXCHANGE
(TITLE OF EACH CLASS OF STOCK) (NAME OF EXCHANGE ON WHICH
REGISTERED)
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 the 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. [_]
Based on the closing sales price of February 28, 1997 the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$758,578,663.
The number of shares outstanding of the registrant's common stock, $1.00 par
value, was 59,650,406 shares outstanding as of February 28, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
Total number of pages, including cover page 1 of 87
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PART I
ITEM 1
BUSINESS
ORGANIZATION
Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C") is a non-
insurance holding company organized as a Delaware corporation in 1992 to hold
all of the outstanding shares of The Hanover Insurance Company ("Hanover").
First Allmerica Financial Life Insurance Company ("FAFLIC"), formerly State
Mutual Life Assurance Company ("State Mutual") owned 35.5 million shares or
59.5% of Allmerica P&C at December 31, 1996. FAFLIC became a wholly-owned
subsidiary of Allmerica Financial Corporation ("AFC") on October 16, 1995.
Allmerica P&C and its subsidiaries are hereinafter collectively referred to as
"the Company."
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and
Plan of Merger (the "Merger Agreement") pursuant to which AFC will acquire all
of the outstanding Common Stock, $1.00 par value per share, of Allmerica P&C
that it does not already own for consideration consisting of $33.00 per share
of Common Stock, subject to adjustment, payable in cash and shares of common
stock, $0.01 per share, of AFC (the "AFC Common Stock"). In addition, a
shareholder of Allmerica P&C may elect to receive the consideration in cash,
without interest, or in shares of AFC Common Stock, subject to proration as
set forth in the Merger Agreement. The maximum number of shares of AFC Common
Stock to be issued in the Merger is approximately 9.67 million shares. The
acquisition will be accomplished by merging a newly created, wholly-owned
subsidiary of AFC with and into Allmerica P&C (the "Merger") resulting in
Allmerica P&C becoming a wholly-owned subsidiary of AFC. Also, immediately
prior to the Merger, Allmerica P&C's Certificate of Incorporation will be
amended to authorize a new class of Common Stock, one share of which will be
exchanged for each share of Common Stock currently held by SMA Financial
Corp., a wholly-owned subsidiary of AFC. The consummation of the Merger is
subject to the satisfaction of various conditions, including the approval of
regulatory authorities.
Allmerica P&C, through its primary insurance operating subsidiaries, Hanover
and Citizens Insurance Company of America ("Citizens Insurance"), is engaged
in the business of underwriting personal and commercial property and casualty
insurance.
Hanover is a New Hampshire insurance company formed in 1972 by the merger of
The Hanover Insurance Company, a New York insurance company chartered in 1852,
and The Hanover Insurance Company, Inc., a New Hampshire corporation.
Citizens Corporation ("CitCorp") is a non-insurance holding company
organized as a Delaware corporation to hold all of the outstanding stock of
Citizens Insurance, a property and casualty insurance company located in
Michigan (collectively, "Citizens"). Prior to 1993, Citizens Insurance was a
wholly-owned subsidiary of Hanover. In March and April 1993, CitCorp sold
approximately 19.35% of its common stock to the public and issued 1.0 million
shares of Series A Preferred stock to Hanover. On June 30, 1995 Citizens
Insurance redeemed 1.0 million shares of Series A Preferred Stock from the
Hanover Insurance Company for $100.0 million. At December 31, 1996, Hanover
owned 82.5 % of the common stock of CitCorp.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company's insurance operations are segmented into personal and
commercial lines based on common underlying risks and customer types for
individual products in those lines. Information with respect to each of the
Company's segments is included in "Segment Results" on pages 20-25 in
Management's Discussion & Analysis of Results of Operations and Financial
Condition and in Note 18 on page 56 of the Notes to the Consolidated Financial
Statements included in Financial Statements and Supplementary Data of this
Form 10-K.
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GENERAL
The Company primarily underwrites personal and commercial property and
casualty insurance, with Hanover's principal operations located in the
Northeast and Citizens' in Michigan. Both Hanover and Citizens Insurance have
an historically strong regional focus and both place heavy emphasis on
underwriting profitability and loss reserve adequacy. As of December 31, 1995,
according to A.M. Best, the Company ranks as one of the 30 largest property
and casualty insurance groups in the United States based on net premiums
written.
The Company strives to maintain a clear focus on the core disciplines of
underwriting, pricing, claims adjusting, marketing and sales. In particular,
the Company seeks to achieve and maintain underwriting profitability in each
of its five major product lines. The Company's overall strategy is to improve
profitability through operating efficiencies and to pursue measured growth in
profitable markets.
Hanover's average premium growth rate for the ten-year period ended December
31, 1996 was 3.2% compared to an industry average of 6.2% for the same period.
Hanover's average statutory combined ratio for the same ten-year period was
107.1, compared to an industry average of 108.2. Over the last ten years,
Citizens has consistently reported stronger growth in statutory net premiums
written than the property and casualty industry as a whole. Citizens' average
premium growth rate was 8.9% for the ten-year period ended December 31, 1996
and its average statutory combined ratio for the same period was 100.1.
(Industry estimates are based on data published by A.M. Best.)
The industry's profitability can be affected significantly by price
competition, volatile and unpredictable developments such as extreme weather
conditions and natural disasters, legal developments affecting insurer
liability and the size of jury awards, fluctuations in interest rates and
other factors that may affect investment returns and other general economic
conditions and trends, such as inflationary pressures that may affect the
adequacy of reserves.
SEGMENT PRODUCT LINES
Hanover and Citizens both underwrite personal and commercial property and
casualty insurance coverage. The personal segment principally includes
personal automobile and homeowners' coverage. The commercial segment
principally includes workers' compensation, commercial automobile and
commercial multiple peril coverage.
Personal automobile coverage insures individuals against losses incurred
from personal bodily injury, bodily injury to third parties, property damage
to an insured's vehicle, and property damage to other vehicles and other
property.
Homeowners coverage insures individuals for losses to their residences and
personal property, such as those caused by fire, wind, hail, water damage
(except for flooding), theft and vandalism, and against third party liability
claims.
Commercial automobile coverage insures businesses against losses incurred
from personal bodily injury, bodily injury to third parties, property damage
to an insured's vehicle, and property damage to other vehicles and other
property.
Workers' compensation coverage insures employers against employee medical
and indemnity claims resulting from injuries related to work. Workers'
compensation policies are often written in conjunction with other commercial
policies.
Commercial multiple peril coverage insures businesses against third party
liability from accidents occurring on their premises or arising out of their
operations, such as injuries sustained from products sold. It also insures
business property for damage, such as that caused by fire, wind, hail, water
damage (except for flooding), theft and vandalism.
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Both Hanover and Citizens Insurance also offer a variety of other products,
such as inland marine, fire, and fidelity and surety insurance. The Company
provides self-insurance administration services for individual and group risks
and writes excess reinsurance coverage for the self-insurance programs it
administers through its wholly-owned subsidiary, Citizens Management, Inc.
Hanover's Amgro, Inc. ("Amgro"), is an insurance premium finance company
which provides short-term installment loans to small and medium-sized
businesses that do not wish to prepay property and casualty insurance
premiums. In exchange for advancing full policy premiums to the insurance
carrier or its agent, the insured executes a promissory note with Amgro which
enables Amgro to cancel the insurance and receive the unearned premium in the
event of default in payment by the insured.
CUSTOMERS, MARKETING AND DISTRIBUTION
Through its insurance subsidiaries, the Company is licensed to sell property
and casualty insurance in all fifty states in the United States, as well as
the District of Columbia and all provinces of Canada except Prince Edward
Island. Hanover's business is concentrated in the Northeast, primarily
Massachusetts, New York, New Jersey and Maine. Citizens' business is
predominantly in Michigan and has recently expanded into Indiana and Ohio.
The Company markets property and casualty insurance products through
approximately 2,600 independent insurance agencies and seeks to establish
long-term relationships with larger, well-established agencies. In selecting
agencies for new appointments, the Company considers the following criteria: a
record of profitability and financial stability, an experienced and
professional staff, a marketing plan for future growth and a succession plan
for management. Once appointed, each agency's performance is carefully
monitored.
Since the Company offers property and casualty insurance products
predominately through independent agents, fostering a close, supportive
relationship with each agency is critical to the continued growth of the
business. The Company compensates agents based on profitability, in addition
to regular commission. This practice motivates its agents to write policies
for customers with above-average profit characteristics. By offering its
independent agents a consistent source of products demanded by the agents'
customers, the Company believes that an increasing number of its agents will
rely on it as their principal supplier of insurance products. Hanover has
implemented a number of programs designed to strengthen its relationship with
its agencies. These initiatives include the formation of a National Agency
Advisory Council, which is intended to provide agents a role in coordinating
marketing efforts and implementing Hanover strategies, as well as remaining
committed to maintaining the local market presence which provides agents
access to experienced Company personnel with expertise in the local markets.
Citizens' position as a preferred provider with many of its agencies is
evidenced by its high average premiums written per agency of over $1.2 million
in 1996.
In 1995, Hanover began to exploit the benefits of worksite marketing as a
distribution channel for personal property and casualty lines. This worksite
distribution channel offers discounted insurance products that are
individually written to employees and members of organizations which have
established a marketing agreement with the Company. Management believes that
advantages of competitive pricing, effective consumer awareness campaigns at
sponsoring organizations, the convenience of payroll deducted premiums and
word of mouth advertising will contribute to the effectiveness of the worksite
distribution channel. Additionally, the Company expects to be well positioned
to integrate other insurance products offered by other subsidiaries of AFC in
order to maximize corporate worksite marketing relationships.
Citizens also develops and markets franchise programs that are tailored for
members of associations and organizations, including its Citizens Best program
for senior citizens.
The Company is not dependent upon a single customer or a few customers, for
which the loss of any one or more would have an adverse effect upon the
Company's insurance operations.
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Hanover
Hanover accounted for approximately $1,062.8 million, or 56.0%, of
consolidated net premium earned in 1996. Hanover's products are marketed
through independent agencies which provide specialized knowledge of property
and casualty products, local market conditions and targeted customer
characteristics.
Hanover seeks to pursue measured growth in existing markets through local
management operations that apply extensive knowledge of markets to offer
competitive products and services. Hanover also seeks to increase operating
efficiencies through centralized strategic planning, marketing and
administrative support functions and increased use of sophisticated risk
selection and operational technologies. During 1996, the Company began the
process of consolidating certain operations of Hanover and Citizens which is
intended to achieve process improvements and efficiencies in operations. These
operations include claims, finance, policy processing and administration
functions.
Hanover has substantially enhanced the level of automation of functions such
as risk selection, policy processing, customer service and claims settlement.
Over the past few years, Hanover introduced an automated risk selection
program for the private passenger automobile business which rates the
probability of future claims potential and increases the efficiency of the
underwriting process. Hanover also introduced a similar program for its
homeowners' business. Hanover is also expanding its use of agency-company
interface ("ACI") technology, which enables agents to electronically submit
personal lines policies for review and rating. In addition, Hanover has
established automated client centers for centralizing the back office
processing functions of most of its branches. The Company believes that these
investments in technology will, over time, create technological efficiencies
and provide capacity for enhanced service to customers.
Although Hanover's strategic planning and certain of its administrative
functions are centralized in the home office, the Company is committed to
maintaining the local market presence afforded by Hanover's twelve branch
offices. These branches provide knowledge of local regulatory and competitive
conditions, and have developed close relationships with Hanover's independent
agents, who provide specialized knowledge of property and casualty products,
local market conditions and target market characteristics. Hanover believes
that the selection of attractive markets in which to pursue profitable growth
depends upon maintaining its local market presence to enhance underwriting
results and identify favorable markets.
Citizens
Citizens' insurance products are marketed in Michigan through approximately
3,800 licensed independent insurance agents, who are paid on a commission
basis, associated with approximately 525 insurance agencies. Citizens also
markets its products in Indiana and Ohio through approximately 1,700 licensed
independent insurance agents associated with approximately 200 insurance
agencies. In 1996, each agency representing Citizens wrote an average of
approximately $1.2 million of Company premiums. The three largest agencies
wrote approximately $19.3 million, $12.9 million, and $10.7 million of Company
premiums, respectively.
Citizens seeks to establish long-term relationships with larger, well-
established agencies. In selecting agencies for new appointments, Citizens
considers the following criteria: a record of profitability and financial
stability; an experienced and professional staff; a marketing plan for future
growth; and a perpetuation plan for successor management. Citizens believes
that by improving its relationship and stature with its most productive
agents, it will receive a greater share of its agent's higher quality
writings. To solidify its relationships with higher quality agencies and take
advantage of local knowledge of operating territories, Citizens maintains four
branch offices and twenty five claims offices located throughout Michigan, one
branch office and three claims offices in Indiana and one branch office in
Ohio.
Since Citizens offers its products only through independent insurance
agencies, its relationships with those agencies is critical to the continued
growth of its business. Accordingly, Citizens establishes strong relationships
with quality agencies by offering enhanced profit sharing arrangements,
recognition awards and internal support
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for agency operations. Citizens seeks to become the preferred provider for
quality insurance agents who Citizens believes will provide it with customers
with average or above-average profit characteristics. Citizens has a
comprehensive program to recognize and honor those agents who excel, as
measured by profitability and premium volume. By offering its independent
agents a consistent source of personal and commercial property and casualty
insurance products, Citizens believes that an increasing number of its agents
will rely on Citizens as their principal supplier of insurance products.
Citizens has been successful in developing and marketing affinity franchise
programs in both the personal and commercial segments that are tailored for
members of associations and organizations in Indiana and Michigan. The
associations may choose to make Citizens' programs available to their members
based on an evaluation of Citizens' rates, service and regulation, but each
risk is individually underwritten and each customer is issued a separate
policy. Associations and organizations receive no payment for making Citizens'
franchise programs available to their members. As of December 31, 1996,
Citizens had approximately 110 affinity franchise programs in-force, 82 of
which were in personal segments and 28 of which were in commercial segments.
Agents are authorized to bind Citizens on risks. The agents are guided by
Citizens' written underwriting rules and practices. These rules and practices
set forth eligibility rules for various policies and coverages, unacceptable
risks, and maximum and minimum limits of liability. Violation of these rules
and practices is grounds for termination of the agency's contract to represent
Citizens.
RESIDUAL MARKETS AND POOLING ARRANGEMENTS
As a condition of its license to do business in various states, the Company
is required to participate in mandatory property and casualty shared market
mechanisms or pooling arrangements which provide various insurance coverages
to individuals or other entities that otherwise are unable to purchase such
coverage voluntarily provided by private insurers. For example, since most
states compel the purchase of a minimal level of automobile liability
insurance, states have developed shared market mechanisms to provide the
required coverages and in many cases, optional coverages, to those drivers
who, because of their driving records or other factors, cannot find insurers
who will write them voluntarily. The Company's participation in such shared
markets or pooling mechanisms is generally in amounts related to the amount of
the Company's direct writings for the type of coverage written by the specific
pooling mechanism in the applicable state. The Company incurred an
underwriting loss from participation in such mechanisms, mandatory pools and
underwriting associations of $0.2 million and $0.7 million in 1996 and 1995,
and underwriting profit of $1.3 million in 1994 relating primarily to
coverages for personal and commercial automobile, personal and commercial
property, and workers' compensation.
Assigned Risk Plans
Assigned risk plans are the most common type of shared market mechanism.
Many states, including California, Illinois, New Jersey, New York, and Texas
operate assigned risk plans. The plan assigns applications from drivers who
are unable to obtain insurance in the voluntary market to insurers licensed in
the applicant's state. Each insurer is required to accept a specific
percentage of applications based on its market share of voluntary business in
the state. Once an application has been assigned to an insurer, the insurer
issues a policy under its own name and retains premiums and pays losses as if
the policy were voluntarily written.
Reinsurance Facilities and Pools
Reinsurance facilities are currently in operation in various states and
require an insurer to write all applications submitted by an agent. As a
result, an insurer could be writing policies for applicants with a higher risk
of loss than it would normally accept. The reinsurance facility allows the
insurer to cede this high risk business to the reinsurance facility, thus
sharing the underwriting experience with all other insurers in the state. If a
claim is paid on a policy issued in this market, the facility will reimburse
the insurer. Typically, reinsurance facilities operate at a deficit, which is
then recouped by levying assessments against the same insurers.
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A type of reinsurance mechanism that exists in New Jersey, The New Jersey
Unsatisfied Claim and Judgment Fund ("NJUCJF"), covers no-fault first party
losses in excess of $0.3 million. All no-fault insurers in this state are
required to participate in the reinsurance mechanism. Insurers are reimbursed
for their covered losses in excess of the threshold. Funding for such
facilities comes from assessments against automobile insurers based upon their
proportionate market share of the state's no-fault insurance market. The
NJUCJF currently has an unfunded liability for future payment years. It
calculates assessments against insurers on the basis of a two-year cash flow
analysis.
Michigan's no-fault law requires insurers to provide unlimited medical
coverage to automobile accident victims. In response, the Michigan
Catastrophic Claims Association (MCCA) was established to spread the costs of
medical coverage to all insureds. The MCCA acts as a reinsurer for all
Michigan automobile insurers, reimbursing for amounts paid on personal
protection insurance losses in excess of $0.25 million. Participation is
required for all Michigan-licensed automobile and motorcycle insurers. The
MCCA assesses its member companies an annual premium on each of such member
company's policies covering automobile and motorcycles written in Michigan.
The assessment is passed on directly to policyholders. The Company cedes a
significant portion of its private passenger automobile premiums to the MCCA.
Ceded premiums earned to MCCA in 1996, 1995 and 1994 were $50.5 million, $66.8
million and $80.0 million, respectively. Losses and LAE ceded to MCCA in 1996,
1995, and 1994 were ($52.9) million, $62.9 million and $24.2 million,
respectively. In 1996, the MCCA's favorable development on prior year reserves
exceeded the losses and LAE incurred during the year. The aggregate losses and
LAE ceded to the MCCA have no impact on the Company's consolidated statements
of income.
At December 31, 1996 and 1995, the Company had reinsurance recoverable on
paid and unpaid losses of $292.0 million and $355.0 million, respectively,
from the MCCA. The amount recoverable from the MCCA is a current estimate of
future payments to be made to the Company by the MCCA for reimbursements of
amounts for currently pending personal protection insurance (PIP) claims and
PIP claims incurred but not yet reported. The Company bills the MCCA on a
quarterly basis and all amounts have been paid when due. Because PIP claims,
whose payments will be reimbursed by the MCCA, involve amounts to be paid over
many years, actual amounts to be owed to the Company by the MCCA in the future
are subject to change based on claims paid. The Company bills the MCCA based
upon amounts actually paid by the Company to policyholders, however, there can
be no assurance that the Company will recover the full amount of reinsurance
payments owed to it by the MCCA. As of June 30, 1996 and 1995, the MCCA
estimated surplus of $1.7 billion and $666.2 million, respectively, compared
to an estimated deficit of $22.0 million, as of December 31, 1994. Management
believes that in the current regulatory climate, the Company is unlikely to
incur any material loss or become unable to pay claims as a result of
nonpayment of amounts owed to it by the MCCA because (i) the MCCA is currently
in a surplus position, (ii) the payment obligations of the MCCA are extended
over many years, resulting in relatively small current payment obligations in
terms of MCCA total assets, (iii) all amounts owed to the Company by the MCCA
have been paid when due, and (iv) the MCCA is supported by assessments
permitted by statute.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool ("MWCRP"), which is administered by
The National Council on Compensation Insurance ("NCCI"). The Company was
involved in legal proceedings regarding the MWCRP's deficit which through a
legislative settlement issued on June 23, 1995, provided for an initial
funding of $220.0 million of which the insurance carriers were responsible for
$65.0 million. Hanover paid its allocation of $4.2 million in December 1995.
Some of the smaller carriers appealed this decision. See "Legal Proceedings"
on pages 14-15 of this Form 10-K which is incorporated by reference.
As a servicing carrier in Massachusetts, the Company cedes a significant
portion of its private passenger and commercial automobile premiums to the
Massachusetts Commonwealth Automobile Reinsurers ("CAR"). Net premiums earned
and losses and loss adjustment expenses ceded to CAR in 1996, 1995 and 1994
were $38.0
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million and $21.8 million, $49.1 million and $33.7 million, and $50.0 million
and $29.8 million, respectively. At December 31, 1996, CAR and the MCCA were
the only two reinsurers which represented 10% or more of the Company's
reinsurance business.
See Note 8 on pages 47-49 and Note 16 on page 55 of the Notes to
Consolidated Financial Statements included in Financial Statements and
Supplementary Data of this Form 10-K which is incorporated into this item by
reference.
Joint Underwriting Associations
A joint underwriting association ("JUA") is similar to a reinsurance pool.
Generally, a JUA allows an insurer to share with other insurers the
underwriting experience of drivers that reflect a higher risk of loss than the
insurer would normally accept. Under a JUA, a limited number of insurers are
designated as "servicing carriers." The servicing carrier is responsible for
collecting premiums and paying claims for the policies issued in the JUA, and
such insurers receive a fee for these administrative services. The
underwriting results of the servicing carrier are then shared with all
insurers in the state. Like reinsurance facilities, JUA's typically operate at
a deficit, and fund that deficit by levying assessments on insurers.
The New Jersey legislature passed automobile insurance reform legislation
that eliminated the New Jersey JUA ("NJJUA") and imposed taxes and assessments
on the insurance industry to fund a portion of the NJJUA deficit. The deficit
resulted primarily from the inadequate rate level of the NJJUA and the
contraction of the voluntary auto market, which increased the number of risks
requiring insurance through the NJJUA. The reform legislation also established
a Market Transition Facility ("MTF") to manage business from the NJJUA that is
not transferred to the voluntary market. During 1994, the Company released a
reserve of $7.0 million as a result of the resolution of the funding of the
New Jersey Market Transition Facility deficit. Legislation passed in New
Jersey during the third quarter of 1994 substantially relieved insurers of
responsibility for funding the deficit.
Other Mechanisms
The principal shared market mechanisms for property insurance are the Fair
Access to Insurance Requirements Plans ("FAIR Plans"), the formation of which
was required by the federal government as a condition to an insurer's ability
to obtain federal riot reinsurance coverage following the riots and civil
disorder that occurred during the 1960's. These plans, created as mechanisms
similar to automobile assigned risk plans, were designed to increase the
availability of property insurance in urban areas. The federal government
reinsures those insurers participating in FAIR Plans against excess losses
sustained from riots and civil disorders. The individual state FAIR Plans are
created pursuant to statute or regulation. The property shares market
mechanisms provide basic fire insurance and extended coverage protection for
dwellings and certain commercial properties that could not be insured in the
voluntary market. A few states also include a basic homeowners form of
coverage in their shared market mechanism.
With respect to commercial automobile coverage, another pooling mechanism, a
Commercial Auto Insurance Plan ("CAIP"), uses a limited number of servicing
carriers to handle assignments from other insurers. The CAIP servicing carrier
is paid a fee by the insurer who otherwise would be assigned the
responsibility of handling the commercial automobile policy and paying claims.
Approximately 40 states have CAIP mechanisms, including California,
Connecticut, Illinois, New Hampshire, New Jersey, New York and Rhode Island.
COMPETITION
The property and casualty industry is highly competitive among national
agency companies, direct writers, and regional and local insurers on the bases
of both price and service. Many of these companies are larger and have greater
financial and technical resources than Hanover and Citizens. National agency
companies sell insurance through independent agents and usually concentrate on
commercial lines of property and casualty insurance. Direct writers dominate
the personal lines of property and casualty insurance and operate on a
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national, regional or single state basis. Regional and local companies sell
through independent agents in one or several states in the same region and
compete in both personal and commercial lines. In addition, because both
companies market through independent agents, Hanover and Citizens compete with
other independent agency companies for business in each of the agencies
representing them.
Hanover faces competition in personal lines primarily from direct writers
and regional and local companies. In its commercial lines, Hanover faces
competition primarily from national agency companies and regional and local
companies. Due to the number of companies in Hanover's principal property and
casualty insurance marketplace, there is no single dominant competitor in any
of Hanover's markets. Management believes that its emphasis on maintaining a
local presence in its markets, coupled with investments in operating and
client technologies, will enable Hanover to compete effectively.
During the past two years, the competitive environment in Massachusetts has
increased substantially. Approximately 39% of Hanover's personal automobile
business is currently written in this state. In 1995 and 1996, Massachusetts
personal automobile rates decreased 4.5% and 6.2%, respectively, as mandated
by the Massachusetts Division of Insurance. In 1995, the Massachusetts
Division of Insurance began to allow sponsoring organizations to receive
discounts on their auto insurance. Today, Hanover currently offers more than
70 group programs throughout the state, including the second largest group
plan in the state with approximately 347,000 eligible members. On February 24,
1997, Hanover submitted its request to the Massachusetts Division of Insurance
to offer a 10% discount on automobile insurance for its safest drivers. If
approved, qualified Hanover policyholders would reduce their insurance
premiums by as much as 20% by combining "safe driver" and "group" discounts.
Management has implemented these discounts in an effort to retain its market
share in Massachusetts. These discounts, together with mandated rate decreases
may unfavorably impact premium growth.
In Michigan, Citizens competes in personal segments with a number of direct
writers and regional and local companies, several of which are larger than
Citizens. National agency companies have not been important factors in
Michigan in the personal segments of property and casualty insurance because
of their tendency to emphasize commercial segments and because Michigan's
insurance regulatory environment would require such companies to develop and
implement special incentive programs designed to encourage agents to identify
and sell insurance to individuals with lower risk profiles consistent with the
constraints of Michigan law. However, in February 1996, an amendment to the
Essential Insurance Act became effective in Michigan. This amendment
eliminates personal automobile and homeowners insurance territorial rating
restrictions and limits merit ratings for automobile policies. The Company
cannot predict the effect of this new legislation, but believes this law may
encourage national companies to return or enter into the state in commercial
and personal lines.
Citizens also faces competition from the two largest direct writers in
Michigan, Auto Club Michigan Group and State Farm Group companies, in the
personal automobile line. In the homeowners line, Citizens' principal
competition in Michigan is also from direct writers, including State Farm
Group. Citizens is the second leading writer in Michigan in its three primary
commercial lines combined: commercial automobile, workers' compensation, and
commercial multiple peril. Citizens faces competition principally from
national agency companies, and regional and local companies, many of which
have financial resources substantially greater than those of Citizens.
The industry has been in a downturn over the past several years due
primarily to price competition. Premium rate levels are related to the
availability of insurance coverage, which varies according to the level of
excess capacity in the industry. The current commercial lines market is
extremely competitive due to a continuing soft market in which capacity is
high and prices are low. Because of the commitment at both Hanover and
Citizens to focus on underwriting profitability and a refusal to write
business at inadequate prices, this highly competitive commercial lines market
has impacted the Company's growth in commercial lines. In Michigan, Citizens
workers' compensation line is the largest commercial line in terms of premiums
written. Over the past few years, competition has caused Citizens to reduce
rates four times; 8.5%, 7.0%, 6.4% and 8.7% effective May 1, 1995,
9
<PAGE>
December 1, 1995, June 1, 1996, and March 1, 1997 respectively. The Company
believes that competition for premiums in its markets may continue to have an
adverse impact on rates and profitability.
Since there is no one dominant competitor in any of the markets in which the
Company competes, management believes there is opportunity for future growth.
UNDERWRITING
Pricing
The manner in which the Company prices products takes into consideration the
expected frequency and severity of losses, the costs of providing the
necessary coverage (including the cost of administering policy benefits, sales
and other administrative and overhead costs) and a margin for profit.
The Company seeks to achieve an underwriting profit in each of its segment
product lines regardless of market conditions. This strategy seeks to achieve
consistent profitability with substantial growth in net premiums written
during hard markets and more modest growth during soft markets. The Company
concentrates on its established major product lines, and accordingly, does not
typically pursue the development of products with relatively unpredictable
risk profiles. In addition, the Company utilizes its extensive knowledge of
local markets, including knowledge of regulatory requirements, to achieve
superior underwriting results. Hanover and Citizens rely on information
provided by their local agents and Hanover also relies on the knowledge of its
staff in the local branch offices. As a regional company with significant
market share, Citizens can apply its extensive knowledge and experience in
making underwriting and rate setting decisions.
Claims
The Company employs experienced claims adjusters, appraisers, medical
specialists, managers and attorneys in order to manage its claims. The Company
has field claims offices strategically located throughout its operating
territories. All claims office staff members work closely with the agents to
settle claims rapidly and cost-effectively.
Claims office adjusting staff are supported by general adjusters on large
property losses, automobile and heavy equipment damage appraisers on
automobile material damage losses and medical specialists whose principal
concentration is in workers' compensation and no-fault automobile injury
cases. In addition, the claims offices are supported by staff attorneys who
specialize in litigation defense and claim settlements. The Company also has
special units which investigate suspected insurance fraud and abuse.
Hanover utilizes advanced claims processing technology to allow smaller and
more routine claims to be processed at centralized locations. Hanover expects
that approximately 70% of its personal lines claims will be processed at these
locations in the future, thereby increasing efficiency and reducing operating
costs.
Citizens has instituted a program under which participating agents have
settlement authority for small property loss claims. Based upon program
experience, the Company believes that this program contributes to low loss
adjustment expense ("LAE") experience and to its higher customer satisfaction
ratings by permitting the early and direct settlement of such small claims.
Approximately 26.6% and 28.1% of the number of total paid claims reported to
Citizens in the years ended December 31, 1996 and 1995, respectively, were
settled under this program.
Hanover and Citizens have also begun using the managed care expertise of the
Allmerica Financial's Corporate Risk Management Services ("CRMS") segment in
the analysis of the provision of medical services in the management of
workers' compensation and medical claims on its automobile policies. Hanover
and Citizens believe that their use of this capability reduces costs and
serves their customers more efficiently.
10
<PAGE>
Property and casualty insurers are subject to claims arising out of
catastrophes which may have a significant impact on their results of operations
and financial condition. The Company may experience catastrophe losses in the
future which could have a material adverse impact on the Company. Catastrophes
can be caused by various events including hurricanes, earthquakes, tornadoes,
wind, hail, fires and explosions, and the incidence and severity of
catastrophes are inherently unpredictable. Although catastrophes can cause
losses in a variety of property and casualty lines, homeowners and business
property insurance have in the past generated the vast majority of catastrophe-
related claims.
RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
See "Reserve for Losses and Loss Adjustment Expenses" on pages 25-27 of
Management's Discussion & Analysis of Results of Operations and Financial
Condition of this Form 10-K which is incorporated into this item by reference.
The Company's actuaries review the reserves each quarter and certify the
reserves annually as required for the Company's statutory filings.
The Company regularly reviews its reserving techniques, its overall reserving
position and its reinsurance. Based on (i) review of historical data,
legislative enactments, judicial decisions, legal developments in impositions
of damages, changes in political attitudes and trends in general economic
conditions, (ii) review of per claim information, (iii) historical loss
experience of the Company and the industry, (iv) the relatively short-term
nature of most policies and (v) internal estimates of required reserves,
management believes that adequate provision has been made for loss reserves.
However, establishment of appropriate reserves is an inherently uncertain
process and there can be no certainty that current established reserves will
prove adequate in light of subsequent actual experience. A significant change
to the estimated reserves could have a material impact on the results of
operations.
Significant periods of time often elapse between the occurrence of an insured
loss, the reporting of the loss to the Company and the Company's payment of
that loss. To recognize liabilities for unpaid losses, the Company establishes
reserves as balance sheet liabilities representing estimates of amounts needed
to pay reported and unreported losses and LAE.
The Company does not use discounting techniques in establishing reserves for
losses and LAE, nor has it participated in any loss portfolio transfers or
other similar transactions.
The following table reconciles reserves determined in accordance with
accounting principles and practices prescribed or permitted by insurance
statutory authorities ("Statutory Reserve") to reserves determined in
accordance with generally accepted accounting principles ("GAAP Reserve") at
December 31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Statutory reserve for losses and LAE................ $2,113.2 $2,123.0 $2,093.6
GAAP adjustments:
Reinsurance recoverable on unpaid losses.......... 626.9 763.5 712.4
Other (*)......................................... 4.0 9.5 15.7
-------- -------- --------
GAAP reserve for losses and LAE..................... $2,744.1 $2,896.0 $2,821.7
======== ======== ========
</TABLE>
- - --------
(*) Primarily other statutory liabilities reclassified as loss adjustment
expense reserves for GAAP reporting.
11
<PAGE>
Analysis of Losses and Loss Adjustment Expenses Reserve Development
The following table sets forth the development of net reserves for unpaid
losses and LAE from 1986 through 1996 for the Company.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserve for
losses and LAE
(1)............ $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9 $1,772.4 $1,550.6 $1,326.3 $1,150.9 $1,008.0 $ 793.0
Cumulative
amount paid as
of (2):
One year later.. -- 627.6 614.3 566.9 564.3 569.0 561.5 521.1 465.3 384.3 319.6
Two years lat-
er............. -- -- 940.7 884.4 862.7 888.0 874.5 820.2 725.3 616.4 509.9
Three years lat-
er............. -- -- -- 1,078.1 1,068.4 1,077.1 1,074.3 1,009.3 901.5 764.5 643.6
Four years lat-
er............. -- -- -- -- 1,184.1 1,207.1 1,186.4 1,130.1 1,009.7 862.1 722.3
Five years lat-
er............. -- -- -- -- -- 1,279.4 1,265.4 1,192.7 1,078.8 926.0 780.8
Six years lat-
er............. -- -- -- -- -- -- 1,314.2 1,240.9 1,116.2 969.7 817.3
Seven years lat-
er............. -- -- -- -- -- -- -- 1,271.4 1,147.4 993.5 844.5
Eight years lat-
er............. -- -- -- -- -- -- -- -- 1,170.4 1,016.5 860.5
Nine years lat-
er............. -- -- -- -- -- -- -- -- -- 1,034.6 878.1
Ten years lat-
er............. -- -- -- -- -- -- -- -- -- -- 892.9
Net reserve re-
estimated as of
(3):
End of year..... 2,117.2 2,132.5 2,109.3 2,019.6 1,936.9 1,772.4 1,550.6 1,326.3 1,150.9 1,008.0 793.0
One year later.. -- 1,991.1 1,971.7 1,891.5 1,868.1 1,755.0 1,601.5 1,412.4 1,220.4 1,058.3 865.0
Two years lat-
er............. -- -- 1,859.4 1,767.4 1,762.8 1,717.7 1,601.9 1,449.0 1,262.0 1,096.4 904.4
Three years lat-
er............. -- -- -- 1,691.5 1,703.3 1,670.8 1,614.3 1,471.7 1,290.2 1,125.3 937.0
Four years lat-
er............. -- -- -- -- 1,658.9 1,654.1 1,597.6 1,484.7 1,312.3 1,155.1 963.5
Five years lat-
er............. -- -- -- -- -- 1,634.6 1,594.3 1,482.3 1,322.1 1,175.2 983.3
Six years lat-
er............. -- -- -- -- -- -- 1,588.7 1,486.9 1,328.6 1,188.5 999.5
Seven years lat-
er............. -- -- -- -- -- -- -- 1,488.4 1,340.7 1,201.2 1,009.5
Eight years lat-
er............. -- -- -- -- -- -- -- -- 1,403.7 1,215.4 1,025.0
Nine years lat-
er............. -- -- -- -- -- -- -- -- -- 1,226.8 1,039.6
Ten years lat-
er............. -- -- -- -- -- -- -- -- -- -- 1,056.1
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------
(Deficiency)
Redundancy, net
(4,5,6)........ $ -- $ 141.4 $ 249.9 $ 328.1 $ 278.0 $ 137.8 $ (38.1) $ (162.1) $ (252.8) $ (218.8) $(263.1)
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== =======
</TABLE>
- - --------
(1) Sets forth the estimated net liability for unpaid losses and LAE recorded
at the balance sheet date for each of the indicated years; represents the
estimated amount of net losses and LAE for claims arising in the current
and all prior years that are unpaid at the balance sheet date, including
incurred but not reported ("IBNR") reserves.
(2) Cumulative loss and LAE payments made in succeeding years for losses
incurred prior to the balance sheet date.
(3) Re-estimated amount of the previously recorded liability based on
experience for each succeeding year; increased or decreased as payments
are made and more information becomes known about the severity of
remaining unpaid claims.
(4) In 1987, Hanover adopted a new actuarial-based reserve methodology
designed to result in a more accurate reflection of underwriting trends
and a more appropriate basis for assessing current reserve adequacy. The
new method is based on groupings of claims using the period in which the
accident occurred rather than loss experience in the financial reporting
period. This method tracks the development of claims from a given accident
period and provides management with continuous updates of losses incurred.
Management believes that this change to actuarial reserving methodologies
has resulted in improved reserve adequacy.
(5) Cumulative deficiency or redundancy at December 31, 1996 of the net
reserve amounts shown on the top line of the corresponding column. A
redundancy in reserves means the reserves established in prior years
exceeded actual losses and LAE or were reevaluated at less than the
original reserved amount. A deficiency in reserves means the reserves
established in prior years were less than actual losses and LAE or were
reevaluated at more than the original reserved amount.
12
<PAGE>
(6) The following table sets forth the development of gross reserve for unpaid
losses and LAE from 1992 through 1996 for the Company:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Reserve for losses and LAE:
Gross liability.............. $2,744.1 $2,896.0 $2,821.7 $2,717.3 $2,598.9
Reinsurance recoverable...... 626.9 763.5 712.4 697.7 662.0
-------- -------- -------- -------- --------
Net liability................ $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9
======== ======== ======== ======== ========
One year later:
Gross re-estimated liabili-
ty.......................... $2,587.8 $2,593.5 $2,500.5 $2,460.5
Re-estimated recoverable..... 596.7 621.8 609.0 592.4
-------- -------- -------- --------
Net re-estimated liability... $1,991.1 $1,971.7 $1,891.5 $1,868.1
======== ======== ======== ========
Two years later:
Gross re-estimated liabili-
ty.......................... $2,339.2 $2,333.3 $2,341.9
Re-estimated recoverable..... 479.8 565.9 579.1
-------- -------- --------
Net re-estimated liability... $1,859.4 $1,767.4 $1,762.8
======== ======== ========
Three years later:
Gross re-estimated liabili-
ty.......................... $2,145.5 $2,257.3
Re-estimated recoverable..... 454.0 554.0
-------- --------
Net re-estimated liability... $1,691.5 $1,703.3
======== ========
Four years later:
Gross re-estimated liabili-
ty.......................... $2,168.2
Re-estimated recoverable..... 509.3
--------
Net re-estimated liability... $1,658.9
========
</TABLE>
RATINGS
Hanover's rating from Standard & Poor's Corporation ("S&P") is "AA-
(Excellent)". Claims-paying ability ratings range from "AAA (Superior)" to "R
(Regulatory Action)." Hanover's rating of AA- (Excellent) is the fourth
highest rating. S&P considers insurers with a rating of BBB- or better to have
a secure claims-paying ability. According to S&P, its claims-paying ability
rating represents its opinion of an insurance company's financial ability to
meet its obligations under its insurance policies. Claims-paying ability
ratings are assigned by S&P at the request of the insurer. The ratings are
based on current information provided by the insurance subsidiaries or
obtained by S&P from other reliable sources and on extensive quantitative and
qualitative analysis. S&P does not perform an audit in connection with the
assignment of these ratings and may rely on unaudited financial information.
The A.M. Best rating for Hanover was "A (Excellent)" and Citizens was "A+
(Superior)." These are the third and second highest ratings, respectively, out
of the fifteen rating levels established by A.M. Best for the insurance
industry. Ratings range from "A++ (Superior)" to "F (In Liquidation)."
According to A.M. Best, the objective of this rating is to evaluate factors
that effect the overall performance of an insurance company. A.M. Best uses
this information to provide an opinion of a company's operating performance,
financial strength and ability to meet the obligations to policyholders.
Quantitative and qualitative evaluations are used to determine financial
condition and operating performance. The quantitative evaluations are based on
an analysis of each company's reported financial performance for at least the
previous five fiscal years. Management believes that its A.M. Best and S&P
ratings are an important factor in marketing its products to its agents and
customers.
13
<PAGE>
EMPLOYEES
The Company has branches across the country and employed approximately 4,400
employees as of December 31, 1996. Management believes that its relations with
employees are good.
REINSURANCE
See "Reinsurance" on pages 27 and 28 of Management's Discussion and Analysis
of Results of Operations and Financial Condition and to Notes 8 and 16 on
pages 47-49 and 55, respectively, of the Notes to Consolidated Financial
Statements included in Financial Statements and Supplementary Data of this
Form 10-K which is incorporated into this item by reference. See also "Legal
Proceedings" on pages 14-15 of this Form 10-K which is incorporated into this
item by reference.
INVESTMENT OPERATIONS
See "Investment Portfolio" on pages 28-29 of Management's Discussion and
Analysis of Results of Operations and Financial Condition and to Note 4 on
pages 42-45 of the Notes to Consolidated Financial Statements included in
Financial Statements and Supplementary Data of this Form 10-K which is
incorporated into this item by reference.
ITEM 2
PROPERTIES
During 1984, Hanover entered into a lease agreement for a 109,000 square
foot home office building in Worcester, Massachusetts, with its ultimate
parent company, Allmerica Financial Corporation. This lease expires in 2006.
The lease provides for no further renewals, no option to buy, and no free
terminations. Hanover leases an aggregate of approximately 454,000 square feet
at 15 field offices located in Atlanta, GA; Bedford, NH; Chicago, IL; Dallas,
TX; Kansas City, KS; Meriden, CT; New Orleans, LA; Piscataway, NJ; Portland,
ME; Richmond, VA; Sacramento, CA; St. Louis, MO; Syracuse, NY; Tulsa, OK; and
Worcester, MA. Hanover also leases an aggregate of approximately 109,000
square feet at claims offices in various sites across the United States.
Citizens owns three office buildings located in Howell, Michigan. One
building occupies 110,600 square feet and serves as Citizens' headquarters and
accommodates corporate administration, marketing, information services, claims
and treasury. Citizens also owns a 175,000 square foot facility near its
current headquarters which accommodates underwriting, claims and marketing
functions. The third building occupies 20,000 square feet and facilitates the
print, services, and supply functions. In addition, Citizens leases an
aggregate of approximately 55,000 square feet in three branch offices located
in Grand Rapids, MI; Gaylord, MI; and Escanaba, MI. and one branch office
located in Indianapolis, IN. Citizens also leases an aggregate of
approximately 96,500 square feet of space for its claims offices in various
sites in Michigan, Indiana, and Ohio.
Management believes that its owned and leased office space is adequate for
its current needs.
ITEM 3
LEGAL PROCEEDINGS
See Note 16 "Contingencies" on page 55 of the Notes to Consolidated
Financial Statements included in Financial Statements and Supplementary Data
of this Form 10-K which is incorporated into this item by reference.
14
<PAGE>
MAINE WORKERS COMPENSATION RESIDUAL MARKET POOL
On June 23, 1995, the governor of Maine approved a legislative settlement
for the Maine Workers' Compensation Residual Market Pool deficit for the Years
1988 through 1992. The settlement provides for an initial funding of $220.0
million toward the deficit. The insurance carriers were liable for $65.0
million and employers would contribute $110.0 million payable through
surcharges on premiums over the course of the next ten years. The major
insurers are responsible for 90% of the $65.0 million. Hanover's allocated
share of the settlement is approximately $4.2 million, which was paid in
December 1995. The remainder of the deficit of $45.0 million will be paid by
the Maine Guaranty Fund, payable in quarterly contributions over ten years. A
group of smaller carriers filed litigation to appeal the settlement. The
Company believes that adequate reserves have been established for any
additional liability.
APY AND AFC MERGER
Shortly after AFC publicly disclosed its proposal regarding the Merger
Transactions, three separate stockholders of the Company, Leslie Susser,
Harbor Finance Partners and William A. Kass, IRA-Simplified Employee Pension,
filed lawsuits in the Delaware Chancery Court against AFC, APY and the
directors of APY and the directors of AFC who are also on the board of
directors of the Company (the "Delaware Actions"). An additional lawsuit
challenging the Merger Transactions was filed by another stockholder of the
Company, Daniel Bruno, in the Worcester County (Massachusetts) Superior Court
(the "Massachusetts Action" and, together with the Delaware Actions, the
"Actions"). The named plaintiff in each of the Actions purports to maintain
each individual action as a class action on behalf of the public stockholders
of the Company (excluding AFC, the Company and other defendants and any
person, firm, trust, corporation or any other entity related to or affiliated
with any of the defendants) (the "Public Stockholders"). In each of the
Actions, the plaintiff alleges that under the terms of the initial AFC Merger
proposal made in December 1996, AFC will acquire the Company Common Stock at a
price that is substantially below the fair price of such stock and that
certain officers and/or directors of AFC and/or the Company have breached
fiduciary duties owed to the Company and the public stockholders in connection
with the proposed Merger Transactions. The plaintiffs sought injunctive relief
prohibiting AFC from completing the Merger transactions or, in the
alternative, compensatory damages. On February 19, 1997, the parties to the
Delaware Actions executed a Memorandum of Understanding (the "MOU")
memorializing an agreement-in-principle to settle the Delaware Actions. Under
the terms of the MOU, the parties to the Delaware Action have agreed to use
their best efforts to execute and present to the Delaware Chancery Court on or
before April 30, 1997, a formal Stipulation of Settlement. In the event that
the Delaware Chancery Court approves the proposed settlement, it is
anticipated that the Delaware Actions will be dismissed with prejudice as to
the individual plaintiffs and the class of the Company's public stockholders.
In connection with the MOU, AFC and the Company have agreed that they will not
oppose an application to the Delaware Court by the plaintiffs counsel for an
aggregate award of attorneys' fees and expenses in an amount not to exceed
$995,000.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the opinion of management, based
on the advice of legal counsel, the ultimate resolution of these proceedings
will not have a material effect on the Company's consolidated financial
statements. However, liabilities related to these proceedings could be
established in the near term if estimates of the ultimate resolution of these
proceedings are revised.
ITEM 4
SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth
quarter of the fiscal year covered by this Form 10-K.
15
<PAGE>
PART II
ITEM 5
MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED SHAREHOLDER MATTERS
COMMON STOCK AND SHAREHOLDER OWNERSHIP
The common stock of Allmerica Property & Casualty Companies, Inc. is traded
on the New York Stock Exchange under the symbol "APY." On February 28, 1997,
the Company had 1,080 shareholders of record and 59.7 million shares
outstanding. On the same date, the trading price of the Company's common stock
was $31 3/8 per share.
COMMON STOCK PRICES AND DIVIDENDS
<TABLE>
<CAPTION>
1996 HIGH LOW DIVIDENDS
---- ------- ------- ---------
<S> <C> <C> <C>
First Quarter...................................... $27 1/4 $24 1/4 $0.04
Second Quarter..................................... $27 1/4 $25 $0.04
Third Quarter...................................... $30 1/2 $25 5/8 $0.04
Fourth Quarter..................................... $30 1/2 $27 1/4 $0.04
<CAPTION>
1995 HIGH LOW DIVIDENDS
---- ------- ------- ---------
<S> <C> <C> <C>
First Quarter...................................... $20 1/8 $16 3/4 $0.04
Second Quarter..................................... $22 3/8 $18 1/2 $0.04
Third Quarter...................................... $24 3/4 $22 $0.04
Fourth Quarter..................................... $27 $21 7/8 $0.04
</TABLE>
1997 DIVIDEND SCHEDULE
Allmerica Property & Casualty declared a cash dividend of $0.04 on March 4,
1997, which is payable on May 15, 1997. The record date for such dividend is
May 1, 1997.
Allmerica Property and Casualty and Allmerica Financial Corporation ("AFC")
have entered into an Agreement and Plan of Merger dated as of February 19,
1997 (the "Merger Agreement") pursuant to which AFC will acquire all of the
outstanding Common Stock, $1.00 par value per share, of the Company that it
does not already own ("the Merger"). Upon consummation of the Merger,
Allmerica Property and Casualty will no longer have any public stockholders
and therefore will pay no further dividends to such stockholders.
Dividends by the Company are funded from dividends paid to the Company from
Hanover, which are subject to restrictions imposed by state insurance laws and
regulations with respect to dividends paid to the Company. See "Liquidity and
Financial Resources" on pages 29-30 of Management's Discussion & Analysis of
Results of Operations and Financial Condition and to Note 17 on page 55 of the
Notes to Consolidated Financial Statements included in Financial Statements
and Supplementary Data of this Form 10-K which is incorporated into this item
by reference.
16
<PAGE>
ITEM 6
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net premiums written......... $ 1,914 $ 1,885 $ 1,823 $ 1,745 $ 1,700
REVENUE:
Net premiums earned........ 1,898 1,863 1,791 1,678 1,678
Net investment income...... 235 210 202 202 211
Net realized gain on in-
vestments................. 48 15 4 67 29
Total revenues............. 2,194 2,095 2,005 1,953 1,923
Statutory underwriting
loss...................... (90) (26) (106) (66) (82)
GAAP underwriting loss..... (88) (26) (100) (46) (80)
STATUTORY COMBINED RATIO (1):
Losses and loss adjustment
expenses.................. 72.3 69.4 73.1 71.8 74.8
Underwriting expenses...... 31.6 31.1 31.7 30.5 29.4
Dividends to policyhold-
ers....................... 0.6 0.5 0.5 0.4 0.3
Combined ratio............. 104.5 101.0 105.3 102.7 104.5
Industry combined ratio.... 107.0 106.5 108.5 106.9 115.8
Income before extraordinary
item and cumulative effect
of accounting changes..... 146 140 101 252 134
Net income................. 146 140 99 256 134
PER SHARE DATA (2) :
Income before realized gain
on investments, net of
federal income taxes...... 1.95 2.14 1.60 3.37 1.85
Realized gain on
investments, net offederal
income taxes.............. 0.49 0.14 0.04 0.71 0.31
Cumulative effect of
accounting changes........ -- -- (0.03) 0.07 --
Net income................. 2.44 2.28 1.61 4.15 2.16
Dividends declared to
shareholders.............. 0.16 0.16 0.16 0.19 0.15
Book value per share....... 26.99 24.82 19.91 19.47 15.65
Market value per share..... 30.50 27.00 16.88 21.75 16.83
AT YEAR END :
Total assets............... 5,704 5,742 5,409 5,198 4,693
Total shareholders' equi-
ty........................ 1,609 1,509 1,230 1,203 969
Total statutory surplus.... 1,202 1,128 974 954 772
RESERVES:
Losses and loss adjustment
expenses.................. 2,744 2,896 2,822 2,717 2,599
Unearned premiums.......... 815 797 793 755 741
</TABLE>
Note: Data includes Beacon Insurance Company of America through February 19,
1993.
- - --------
1) Industry data is from Best's Aggregates and Averages for the Property
Casualty Industry-Stock Companies.
2) Per share amounts are adjusted for stock splits for the five year period
presented.
17
<PAGE>
ITEM 7
MANAGEMENT'S DISCUSSION & ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The results of operations for Allmerica Property & Casualty Companies, Inc.
and subsidiaries (the "Company") include the accounts of Allmerica Property &
Casualty Companies, Inc. ("Allmerica P&C"), a non-insurance holding company;
The Hanover Insurance Company ("Hanover"), a property and casualty insurance
company wholly owned by Allmerica P&C; Citizens Corporation, a non-insurance
holding company for Citizens Insurance Company of America (collectively,
"Citizens"); and certain other insurance and non-insurance subsidiaries.
Hanover owns 82.5% of the outstanding common stock of Citizens Corporation.
RESULTS OF OPERATIONS
Consolidated Overview
1996 COMPARED TO 1995
Net Income
The Company's consolidated net income increased $6.3 million, to $146.4
million, or $2.44 per share in 1996, compared to net income of $140.1 million,
or $2.28 per share in 1995. The increase in net income is primarily
attributable to a $33.5 million increase in realized gains, primarily related
to the sale of equity securities, reflecting the Company's decision during the
first quarter of 1996 to increase the proportion of debt securities in the
portfolio. Excluding realized gains and losses, net of taxes and minority
interest, net income decreased $13.5 million, to $117.6 million. This decrease
resulted from catastrophes and other severe weather related losses which
contributed to a $82.2 million increase in losses and loss adjustment expenses
to $1,371.9 million. Catastrophe losses increased $27.3 million, to $62.9
million in 1996 from $35.6 million during the previous year. The increase in
losses and LAE was partially offset by an increase in net investment income of
$25.8 million, or 12.3%, to $235.4 million, attributable to an increase in
higher-yielding debt securities in the portfolio and earnings from a limited
partnership. Net income during 1996 was also favorably impacted by a $5.7
million arbitrated settlement from a voluntary pool during the third quarter.
Federal income tax expense decreased $15.7 million, to $36.4 million during
1996, and the effective tax rate decreased from 25.3% in 1995, to 18.4%, in
1996. Net realized investment gains, net of federal income taxes, were $31.3
million and $9.5 million in 1996 and 1995, respectively. Minority interest in
Citizens' net income was $14.9 million in 1996, compared to $14.1 million
during 1995.
Underwriting results
Consolidated net premiums earned increased $35.1 million, or 1.9%, to
$1,898.3 million in 1996. Personal segment net premiums earned increased $48.6
million, or 4.4%, to $1,161.9 million, reflecting the accounting effects of
restructuring a reinsurance contract at Hanover, increasing both losses and
net premiums earned by approximately $19.0 million. In addition, a 2.0%
increase in policies in force in Hanover's homeowners line as well as moderate
price increases in this line contributed to the increase in net premiums
earned. The growth in Citizens' personal segment is due to increases in net
premiums earned in Ohio and Indiana resulting from expansion in these states
as well as price increases in the personal automobile and homeowners lines.
Commercial segment net premiums earned decreased $13.5 million, to $736.4
million. This decrease is primarily attributable to rate decreases in the
workers' compensation line at Hanover and Citizens and to the withdrawal from
a large voluntary pool on December 1, 1995 at Hanover, as well as continued
competitive market conditions in this segment.
The consolidated underwriting loss for 1996 increased $62.6 million, to a
loss of $88.2 million. The increase in the underwriting loss is primarily
attributable to the increases in catastrophes and severe weather related
losses. These factors contributed to an $82.2 million, or 6.4% increase in
losses and LAE to $1,371.9 million in 1996.
18
<PAGE>
Policy acquisition expenses increased $13.5 million, or 3.3%, to $422.6
million and other underwriting expenses increased $2.0 million, or 1.1% to
$192.0 million in 1996. Hanover's policy acquisition expenses increased $9.0
million, or 3.6%, to $258.5 million, primarily attributable to higher
acquisition costs assessed by voluntary and involuntary pools, as well as the
overall increase in net earned premium at Hanover. Other underwriting expenses
at Hanover increased $2.2 million as a result of an increase of approximately
$7.0 million in expenses associated with an ongoing policy administration
technology project that is intended to redesign information systems used to
serve customers, underwriting and claims. This was partially offset by a
decrease in assessment expenses from the withdrawal of a large voluntary pool.
Policy acquisition expenses at Citizens increased $4.5 million, or 2.8%, to
$164.1 million, reflecting growth in net premiums earned. Citizens' other
underwriting expenses decreased $0.2 million to $66.3 million in 1996,
resulting from reductions in employee related expenses and commissions,
partially offset by expenses associated with the aforementioned policy
administration technology project. Management anticipates an increase in its
expense levels due to further planned investments in technology consolidation
and enhancement.
Investment results
Net investment income before taxes increased $25.8 million, or 12.3%, to
$235.4 million during 1996, compared to $209.6 million in 1995. The increase
in 1996 is primarily the result of an increase in average invested assets,
$10.0 million of income from limited partnerships, and the Company's portfolio
shift to higher yielding debt securities, including longer duration and non-
investment grade securities. The average pre-tax yield on debt securities was
6.4% and 6.1% for 1996 and 1995, respectively. Average invested assets
increased $385.8 million, or 11.0%, to $3,891.0 million.
Net realized gains on investments before taxes were $48.1 million and $14.6
million in 1996 and 1995, respectively. Net realized investment gains in 1996
primarily resulted from sales of appreciated equity securities due to the
Company's strategy of shifting to a higher level of debt securities.
Federal Income Taxes
The provision for federal income taxes was $36.4 million in 1996 compared to
$52.1 million in 1995. The decrease in 1996 represents a decrease in the
effective tax rate from 25.3% in 1995 to 18.4% in 1996. This is attributable
to deteriorating underwriting results and an increase in the proportion of
pre-tax income attributable to tax-exempt interest. Federal income tax in 1995
was adversely impacted by reserves provided for revisions in estimated prior
year tax liabilities, including $7.2 million provided during the fourth
quarter of 1995.
1995 COMPARED TO 1994
Net Income
The Company's consolidated net income increased $40.9 million to $140.1
million in 1995, compared to $99.2 million in 1994. Excluding realized gains
and losses and the effect of accounting changes, all net of taxes and minority
interest, net income increased $32.4 million to $131.1 million in 1995. The
increase in net income resulted primarily from favorable current year claims
experience attributable to a return to more normal weather conditions in the
Northeast and in Michigan. Catastrophe losses decreased $10.5 million, to
$35.6 million in 1995, from $46.1 million during the previous year. The
improved underwriting results were partially offset by a $48.2 million
increase in federal income taxes. The effective tax rate increased to 25.3% in
1995 from 3.5 % in 1994. This increase is attributable to improved
underwriting results, a decrease in the proportion of pre-tax income
attributable to tax-exempt interest, and to reserves provided for revisions in
estimated prior year tax liabilities. Net realized investment gains, net of
federal income taxes, were $9.5 million and $2.3 million in 1995 and 1994,
respectively. Minority interest in Citizens net income was $14.1 million and
$7.9 million in 1995 and 1994, respectively. Net income for 1994 includes a
cumulative effect charge of $2.0 million, net of federal income taxes, from
the adoption of Statement of Financial Accounting Standards No. 112,
"Employers' Accounting for Postemployment Benefits."
19
<PAGE>
Underwriting Results
Consolidated net premiums earned increased $71.9 million, or 4.0%, to
$1,863.2 million in 1995. Personal segment net premiums earned increased $69.0
million, or 6.6%, to $1,113.3 million, in 1995, reflecting price increases in
the personal automobile and homeowners lines and a modest increase in policies
in force in the homeowners line. Commercial segment net premiums earned
increased $2.9 million, or 0.4%, to $749.9 million in 1995.
The consolidated underwriting loss improved $74.8 million, from a loss of
$100.4 million in 1994, to a loss of $25.6 million in 1995. This improvement
reflects a return to more normal weather conditions in the first half of 1995
and improved claims experience at both Hanover and Citizens. Losses and LAE
decreased $17.0 million, or 1.3%, to $1,289.7 million in 1995, primarily
attributable to improved claims experience in both the personal and commercial
segments, especially the homeowners and workers' compensation lines. Policy
acquisition expenses, which consist primarily of commissions, premium taxes
and other policy issuance costs, increased $18.8 million, or 4.8%, to $409.1
million in 1995, resulting primarily from the growth in net earned premiums.
Other underwriting expenses decreased $4.7 million, or 2.4%, to $190.0 million
in 1995. The 1994 results reflect expansion costs into Ohio and Indiana at
Citizens, and higher agents' profit sharing expenses at Hanover.
Investment Results
Net investment income before tax increased $7.2 million, or 3.6%, to $209.6
million in 1995. This increase is attributable to an increase in average
invested assets, partially offset by a decrease in the portfolio's average
pre-tax yield from 6.2% in 1994, to 6.0% in 1995. This decrease resulted
primarily from lower yields available on new investments relative to the
yields on maturing investments. Net investment income after tax remained
relatively unchanged at $170.7 million in 1995, versus $170.5 million in 1994.
The effective tax rate on investment income increased from 15.8% to 18.6%
during 1995. Net realized gains on investments increased $11.1 million to
$14.6 million in 1995 due to increased gains on the sale of equity securities.
Federal Income Taxes
The provision for federal income taxes was $52.1 million in 1995 compared to
$3.9 million in 1994. The increase in 1995 represents an increase in the
effective tax rate from 3.5% in 1994 to 25.3% in 1995. This is attributable to
improved underwriting results, a decrease in the proportion of pre-tax income
attributable to tax-exempt interest, and to reserves provided for revisions in
estimated prior year tax liabilities, including $7.2 million provided during
the fourth quarter of 1995.
SEGMENT RESULTS
PERSONAL SEGMENT
The personal segment represented 61.2%, 59.8% and 58.3% of total net
premiums earned in 1996, 1995 and 1994 respectively.
<TABLE>
<CAPTION>
HANOVER CITIZENS CONSOLIDATED
--------------------- ---------------------- ----------------------------
FOR THE YEARS ENDEDDECEMBER 31,
--------------------------------------------------------------------------
1996 1995 1994 1996 1995 1994 1996 1995 1994
------ ------ ------ ------ ------ ------ -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned..... $607.3 $577.1 $548.2 $554.6 $536.2 $496.1 $1,161.9 $1,113.3 $1,044.3
Losses and loss
adjustment expenses.... 452.0 368.6 366.0 404.1 413.6 391.0 856.1 782.2 757.0
Policy acquisition ex-
penses................. 150.8 135.2 125.9 112.5 108.1 99.5 263.3 243.3 225.4
Other underwriting ex-
penses................. 51.7 49.7 50.0 39.3 41.1 37.9 91.0 90.8 87.9
------ ------ ------ ------ ------ ------ -------- -------- --------
Underwriting (loss)
profit................. $(47.2) $ 23.6 $ 6.3 $ (1.3) $(26.6) $(32.3) $ (48.5) $ (3.0) $ (26.0)
====== ====== ====== ====== ====== ====== ======== ======== ========
</TABLE>
20
<PAGE>
1996 COMPARED TO 1995
Revenues
Personal segment net premiums earned increased $48.6 million, or 4.4%, to
$1,161.9 million in 1996, compared to $1,113.3 million in 1995. Hanover's
personal segment net premiums earned increased $30.2 million, or 5.2%, to
$607.3 million during 1996. This increase is primarily attributable to an
increase in the personal automobile line associated with the accounting
effects of restructuring a reinsurance contract, increasing net premiums
earned by $19.0 million. A 2.0% increase in policies in force in Hanover's
homeowners line as well as moderate price increases in this line also
contributed to the increase in net premiums earned. These increases were
partially offset by a mandated 4.5% decrease in Massachusetts personal
automobile rates which became effective January 1, 1996. Effective January 1,
1997, Massachusetts personal automobile rates were decreased an additional
6.2% as mandated by the Massachusetts Insurance Commissioner. In addition, in
response to increasing price competition in Massachusetts, Hanover, in
February 1997, requested the Massachusetts Division of Insurance to approve a
plan to offer a safe driver's discount of 10% on automobile insurance
premiums. Management believes these rate decreases may unfavorably impact
premium growth in Massachusetts. Approximately 39% of Hanover's personal
automobile business is currently written in Massachusetts.
Citizens' personal segment net premiums earned increased $18.4 million, or
3.4%, to $554.6 million in 1996. This growth is attributable to price
increases in the personal automobile and homeowners lines. The growth is
partially offset by a 3.0% decrease in policies in force in the personal
automobile line, attributable to the Company's selective reduction of writings
in Michigan when rates were viewed as inadequate and to continued strong
competition in Michigan. While management has taken steps to increase
penetration in affinity groups and has initiated other marketing programs,
heightened competition may continue to result in reduced growth in the
personal segment.
Underwriting results
The personal segment underwriting loss in 1996 increased $45.5 million, to a
loss of $48.5 million. Hanover's underwriting results deteriorated $70.8
million to a loss of $47.2 million, while Citizens' underwriting loss improved
$25.3 million to a loss of $1.3 million.
Hanover's personal segment losses and LAE increased $83.4 million, or 22.6%,
to $452.0 million in 1996. This increase is partially attributable to a $28.8
million increase in losses and LAE in the homeowners line, resulting from
increased catastrophes and severe weather. Catastrophe losses in Hanover's
personal segment increased $17.2 million, to $30.6 million in 1996 from $13.4
million in 1995. Losses and LAE in the personal automobile line increased
$49.6 million, or 17.8%, to $328.0 million, primarily reflecting the
accounting effects of restructuring a reinsurance contract, increasing losses
by $19.0 million, in addition to a moderate increase in claims frequency and a
$4.7 million reduction in favorable reserve development.
The improvement in Citizens' underwriting results reflects favorable claims
activity in both current and prior accident years in the personal automobile
line attributable to continued improvements in severity. This was partially
offset by an increase in catastrophe losses of $6.2 million to $13.4 million,
primarily in the homeowners line.
Policy acquisition expenses in the personal segment increased $20.0 million,
or 8.2%, to $263.3 million and other underwriting expenses increased $0.2
million to $91.0 million in 1996. This increase in policy acquisition expenses
is primarily attributable to an increase of $15.6 million, or 11.5%, to $150.8
million at Hanover resulting from a reapportionment of certain acquisition
expenses to the personal segment from the commercial segment, as well as an
increase in net premium earned. The $2.0 million increase in Hanover's other
underwriting expenses resulted from an increase of approximately $4.0 million
in expenses associated with the policy administration technology project,
offset by a decrease in assessment expenses associated with the
reapportionment of an involuntary pool. Policy acquisition expenses in the
personal segment at Citizens increased $4.4 million, or 4.1%, to $112.5
million in 1996, reflecting growth in net premiums earned. The $1.8 million
21
<PAGE>
decline in Citizens' other underwriting expenses is primarily attributable to
reductions in employee related expenses and commissions, partially offset by
expenses associated with a policy administration technology project.
Management anticipates an increase in its expense levels due to further
planned investments in technology.
1995 COMPARED TO 1994
Revenues
Personal segment net premiums earned increased $69.0 million, or 6.6%, to
$1,113.3 million in 1995. Hanover's net premiums earned increased $28.9
million, or 5.3%, to $577.1 million in 1995. The increase is primarily
attributable to a 2.0% and 1.3% increase in policies in force in the personal
automobile and homeowners lines, respectively, and a 2.5% rate increase in the
homeowners line. Hanover's premium growth in the personal segment in 1995 was
partially offset by a mandated 6.5% decrease in Massachusetts automobile
insurance rates, which was effective January 1, 1995.
Citizens' personal segment net premiums earned increased $40.1 million, or
8.1%, to $536.2 million in 1995. This increase reflects price increases in the
personal automobile and homeowners lines, and was partially offset by a 5.8%
decrease in personal automobile policies in force. This decrease is
attributable to the Company's selective reduction of writings in Michigan when
rates were viewed as inadequate and to increased competition in affinity group
franchise sales as a result of the January 1995 order by the Michigan
Insurance Commissioner which has permitted competitors to offer similar
products.
Underwriting Results
The personal segment underwriting loss decreased $23.0 million, from $26.0
million in 1994, to $3.0 million in 1995. Hanover's underwriting results
improved $17.3 million, from a profit of $6.3 million in 1994, to a profit of
$23.6 million in 1995. Citizens' underwriting loss improved $5.7 million, or
17.6%, from $32.3 million in 1994, to $26.6 million in 1995.
The improvement in Hanover's underwriting results is primarily attributable
to favorable claims experience on current years claims in the homeowners line
resulting from a decrease in catastrophe losses from $27.2 million in 1994 to
$13.4 million during 1995, and to a return to more normal weather conditions
during the first half of 1995. This resulted in a decrease in losses and LAE
in the homeowners line of $17.8 million, or 17.9%, from $99.2 million in 1994,
to $81.4 million in 1995.
The change in Citizens' underwriting results reflects a return to more
normal weather conditions in Michigan as well as favorable claims activity in
both current and prior accident years in the personal automobile line
attributable to improvements in severity. Citizens' underwriting results
improved despite a $3.4 million increase in catastrophe losses in the personal
segment, primarily in the homeowners line. Catastrophe losses were $7.2
million and $3.8 million in Citizens' personal segment in 1995 and 1994,
respectively.
The increase in policy acquisition expenses in the personal segment of $17.9
million, or 7.9%, to $243.3 million in 1995, reflects the growth in net earned
premiums at both Hanover and Citizens. Other underwriting expenses at Hanover
remained relatively unchanged at $49.7 million in 1995, compared to $50.0
million in 1994. Other underwriting expenses at Citizens increased by $3.2
million, or 8.4%, to $41.1 million in 1995, reflecting the growth in net
premiums earned in 1995.
22
<PAGE>
COMMERCIAL SEGMENT
The commercial segment represented 38.8%, 40.2% and 41.7% of total net
premiums earned in 1996, 1995 and 1994, respectively.
<TABLE>
<CAPTION>
HANOVER CITIZENS CONSOLIDATED
---------------------- -------------------- ----------------------
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
1996 1995 1994 1996 1995 1994 1996 1995 1994
------ ------ ------ ------ ------ ------ ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned..... $455.5 $468.3 $480.4 $280.9 $281.6 $266.6 $736.4 $749.9 $747.0
Losses and loss adjust-
ment expenses.......... 315.5 342.8 361.2 200.3 164.7 188.5 515.8 507.5 549.7
Policy acquisition ex-
penses................. 107.7 114.3 117.6 51.6 51.5 47.3 159.3 165.8 164.9
Other underwriting ex-
penses (1)............. 74.0 73.8 77.6 27.0 25.4 29.2 101.0 99.2 106.8
------ ------ ------ ------ ------ ------ ------ ------ ------
Underwriting (loss)
profit................. $(41.7) $(62.6) $(76.0) $ 2.0 $ 40.0 $ 1.6 $(39.7) $(22.6) $(74.4)
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
- - --------
(1) Includes policyholders' dividends
1996 COMPARED TO 1995
Revenues
Commercial segment net premiums earned in 1996 decreased $13.5 million, or
1.8%, to $736.4 million. Hanover's commercial segment net premiums earned
decreased $12.8 million, or 2.7%, to $455.5 million. This decrease is
primarily attributable to Hanover's withdrawal from a large voluntary pool on
December 1, 1995, and to aggregate rate decreases of 14.6% since January 1,
1995, in the workers' compensation line. Citizens' commercial segment net
premiums earned decreased $0.7 million, or 0.2%, to $280.9 million in 1996.
This decrease primarily reflects rate reductions and a 1.4% decrease in
policies in force in the workers' compensation line due to continuing
competition in this line in Michigan. Rates in the workers' compensation line
at Citizens were decreased 8.5%, 7.0% and 6.4% effective May 1, 1995, December
1, 1995, and June 1, 1996, respectively. This decrease is partially offset by
an increase in policies in force in the commercial multiple peril and
commercial automobile lines of 13.2% and 3.7%, respectively. Management
believes competitive conditions in the workers' compensation line may impact
future growth in net premiums earned.
Underwriting results
The commercial segment underwriting loss for 1996 increased $17.1 million,
or 75.7% to a loss of $39.7 million. Hanover's underwriting loss improved
$20.9 million, or 33.4%, to a loss of $41.7 million and Citizens' underwriting
profit decreased $38.0 million, to a profit of $2.0 million in 1996.
Hanover's commercial segment losses and LAE decreased $27.3 million, or
8.0%, to $315.5 million in 1996. This improvement is primarily attributable to
a $41.5 million decrease in losses and LAE resulting from the withdrawal from
a large voluntary pool. However, this decrease was partially offset by
increased losses in the workers' compensation line of $17.9 million, primarily
due to a $19.8 million decrease in favorable reserve development during 1996.
Citizens' underwriting profit decreased primarily due to an increase in loss
severity and frequency in the commercial multiple peril line. Commercial
multiple peril losses and LAE increased $16.9 million, or 42.4%, to $56.8
million in 1996, partially offset by a $5.1 million, or 9.4% increase to $59.1
million in net premiums earned. Workers' compensation net premiums earned
decreased $17.6 million, or 11.9%, to $130.7 million in 1996 while losses and
LAE increased $9.6 million, or 15.0%, to $73.4 million in this line, primarily
due to reduced favorable development of prior year reserves. Catastrophe
losses in this segment were $1.9 million in 1996 compared to $0.8 million
during 1995.
Policy acquisition expenses in the commercial segment decreased $6.5
million, or 3.9%, to $159.3 million in 1996 and other underwriting expenses
increased $1.8 million, or 1.8%, to $101.0 million. Hanover's policy
23
<PAGE>
acquisition expenses decreased $6.6 million, or 5.8%, to $107.7 million,
primarily attributable to a reapportionment of certain acquisition expenses
from the commercial segment to the personal segment, as well as the decrease
in net earned premium. Other underwriting expenses at Hanover increased $0.2
million, to $74.0 million as a result of an increase of approximately $3.0
million in expenses associated with the policy administration technology
project, which were partially offset by a net decrease in assessment expenses
associated with voluntary and involuntary pools. Citizens' policy acquisition
expenses in the commercial segment remained consistent between years,
primarily as a result of flat net earned premiums. Other underwriting expenses
increased $1.6 million, or 6.3%, to $27.0 million in 1996, due to investments
in technology and increased policyholders' dividends, partially offset by
reductions in employee related expenses and commissions. Management
anticipates an increase in its expense levels due to further planned
investment in technology.
1995 COMPARED TO 1994
Revenues
Commercial segment net premiums earned increased $2.9 million, to $749.9
million in 1995. Hanover's commercial segment net premiums earned decreased
$12.1 million, or 2.5%, to $468.3 million in 1995, reflecting decreases in
policies in force in all major commercial lines, particularly a $10.7 million,
or 9.4%, decrease in commercial automobile net premiums earned to $103.1
million, resulting from continued competitive market conditions affecting
Hanover. Workers' compensation net premiums earned at Hanover decreased $6.4
million, or 5.8%, to $104.4 million in 1995, primarily as a result of rate
decreases and an increasing level of large deductible policies.
Citizens' commercial segment net premiums earned increased $15.0 million, or
5.6%, to $281.6 million in 1995. This increase primarily reflects growth of
8.1% in total commercial policies in force. The overall growth includes
increases in policies in force in the commercial automobile and commercial
multiple peril lines of 12.5% and 11.6%, respectively, along with a decrease
in workers' compensation policies in force of 4.6% and rate decreases of 15.5%
in the workers' compensation line in 1995. The decrease in workers'
compensation premiums was more than offset by increased workforce coverage due
to full employment in Michigan. Price increases in the commercial automobile
line also contributed to the increase in net premiums earned.
Underwriting Results
The commercial segment underwriting loss improved $51.8 million to $22.6
million in 1995. Hanover's underwriting loss improved to a loss of $62.6
million, from $76.0 million, and Citizens' underwriting profit increased from
$1.6 million in 1994, to $40.0 million in 1995.
Hanover's commercial segment losses and LAE decreased by $18.4 million, or
5.1%, to $342.8 million in 1995. This improvement is primarily attributable to
decreased losses and LAE in the workers' compensation and commercial
automobile lines. Losses and LAE in the workers' compensation line decreased
$34.7 million, or 47.6%, from $72.9 million in 1994 to $38.2 million in 1995.
This decrease resulted from continued favorable claims experience for both the
current and prior years. Commercial automobile losses and LAE decreased $14.9
million, or 17.0%, from $87.7 million in 1994 to $72.8 million in 1995. This
decrease results from favorable claims experience in this line for both the
current and prior years, and a decrease in premiums earned. Losses and LAE in
Hanover's other commercial lines, which consist primarily of voluntary pools,
general liability and inland marine, increased $28.9 million, or 55.0%, from
$52.5 million in 1994, to $81.4 million in 1995. This segment was also
unfavorably impacted by a $25.9 million loss in an industrial voluntary pool,
including a $12.0 million charge during the fourth quarter of 1995.
The improvement in Citizens' underwriting results in 1995 reflects favorable
claims activity in both current and prior accident years in the workers'
compensation line attributable to improvements in severity and frequency, and
to severe weather and large claims in the first half of 1994 which had an
adverse impact on the commercial multiple peril and commercial automobile
lines.
24
<PAGE>
Policy acquisition expenses in the commercial segment decreased $0.9
million, or 0.5%, to $165.8 million in 1995. Policy acquisition expenses in
the commercial segment at Citizens increased $4.2 million, or 8.9%, from $47.3
million in 1994, to $51.5 million in 1995, reflecting the growth in net
premiums earned. Hanover's policy acquisition expenses decreased $3.3 million,
or 2.8%, from $117.6 million in 1994, to $114.3 million in 1995, reflecting
the decrease in net earned premiums. Other underwriting expenses at Hanover
decreased $3.8 million, or 4.9%, from $77.6 million in 1994, to $73.8 million
in 1995, reflecting the decrease in net premiums written. Other underwriting
expenses at Citizens decreased $3.8 million, or 13.0%, from $29.2 million in
1994, to $25.4 million in 1995. This decrease reflects the unusually high
level of expenses incurred during 1994 resulting from the expansion into Ohio
including the cost of preparing to write multi-state and cross-state
commercial line policies, as well as a reduction in 1995 administrative
expenses resulting from process improvements in the commercial segment.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company maintains reserves to provide for its estimated ultimate
liability for losses and loss adjustment expenses with respect to reported and
unreported claims incurred as of the end of each accounting period. These
reserves are estimates, involving actuarial projections at a given point in
time, of what management expects the ultimate settlement and administration of
claims will cost based on facts and circumstances then known, predictions of
future events, estimates of future trends in claim severity and judicial
theories of liability and other factors. The inherent uncertainty of
estimating insurance reserves is greater for certain types of property and
casualty insurance lines, particularly workers' compensation and other
liability lines, where a longer period of time may elapse before a definitive
determination of ultimate liability may be made and where the technological,
judicial and political climates involving these types of claims are changing.
The Company regularly updates its reserve estimates as new information
becomes available and further events occur which may impact the resolution of
unsettled claims. Changes in prior reserve estimates are reflected in results
of operations in the year such changes are determined to be needed and
recorded. The table below provides a reconciliation of the beginning and
ending reserve for unpaid losses and LAE as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
Reserve for losses and LAE, beginning of
year...................................... $ 2,896.0 $ 2,821.7 $ 2,717.3
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of current
year.................................... 1,513.3 1,427.3 1,434.8
Decrease in provision for insured events
of prior years.......................... (141.4) (137.6) (128.1)
---------- ---------- ----------
Total incurred losses and LAE.......... 1,371.9 1,289.7 1,306.7
---------- ---------- ----------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured
events of current year.................. 759.6 652.2 650.2
Losses and LAE attributable to insured
events of prior years................... 627.6 614.3 566.9
---------- ---------- ----------
Total payments......................... 1,387.2 1,266.5 1,217.1
---------- ---------- ----------
Change in reinsurance recoverable on unpaid
losses.................................... (136.6) 51.1 14.8
---------- ---------- ----------
Reserve for losses and LAE, end of year.... $ 2,744.1 $ 2,896.0 $ 2,821.7
========== ========== ==========
</TABLE>
LOSS DEVELOPMENT
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $141.4 million, $137.6 million and
$128.1 million in 1996, 1995, and 1994, respectively. The increase in
favorable development on prior years' reserves of $3.8 million in 1996 results
primarily from an $11.4 million increase in favorable development at Citizens.
The increase in Citizens' favorable development of $11.4 million in 1996
reflects improved severity in the personal automobile line, where favorable
development
25
<PAGE>
increased $28.6 million to $33.0 million in 1996, partially offset by less
favorable development in the workers' compensation line. In 1995, the workers'
compensation line had favorable development of $32.7 million, primarily as a
result of Citizens re-estimating reserves to reflect the new claims cost
management programs and the Michigan Supreme Court ruling, which decreases the
maximum to be paid for indemnity cases on all existing and future claims. In
1996, the favorable development in the workers' compensation line of $21.8
million also reflected these developments. Hanover's favorable development,
including voluntary and involuntary pools, decreased $7.7 million in 1996 to
$82.9 million, primarily attributable to a decrease in favorable development
in the workers' compensation line of $19.8. This decrease is primarily
attributable to a re-estimate of reserves with respect to certain types of
workers' compensation policies including large deductibles and excess of loss
policies. In addition, during 1995 Hanover refined its estimation of
unallocated loss adjustment expenses which increased favorable development in
that year. Favorable development in the personal automobile line also
decreased $4.7 million, to $42.4 million in 1996. These decreases were offset
by increases in favorable development of $1.9 million and $5.6 million, to
$12.6 million and $5.7 million, in the commercial automobile and commercial
multiple peril lines, respectively. Favorable development in other lines
increased by $8.8 million, primarily as a result of environmental reserve
strengthening in 1995. Favorable development in Hanover's voluntary and
involuntary pools increased $3.7 million to $4.1 million during 1996. The
Company expects reduced favorable development at Hanover to continue to impact
future earnings.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal
automobile and workers' compensation lines increased $16.6 million and $15.5
million, to favorable development of $4.4 million and $32.7 million,
respectively, due to the aforementioned change in claims cost management and
the Michigan Supreme Court ruling. Hanover's favorable development, not
including the effect of voluntary and involuntary pools, was relatively
unchanged at $90.2 million in 1995 compared to $91.7 million in 1994.
Favorable development in Hanover's workers' compensation line increased $27.7
million to $31.0 million during 1995. This was offset by decreases of $14.6
million and $12.6 million, to $45.5 million and $0.1 million, in the personal
automobile and commercial multiple peril lines, respectively. Favorable
development in Hanover's voluntary and involuntary pools decreased $23.6
million to $0.4 million during 1995.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future.
Due to the nature of the business written by the Company, the exposure to
environmental liabilities is relatively small and therefore its reserves are
relatively small compared to other types of liabilities. Loss and LAE reserves
related to environmental damage and toxic tort liability, included in the
reserve for losses and LAE were $50.8 million and $43.2 million, net of
reinsurance of $20.2 million and $8.4 million in 1996 and 1995, respectively.
During 1995, the Company redefined its environmental liabilities in conformity
with new guidelines issued by the NAIC. This had no impact on results of
operations. The Company does not specifically underwrite policies that include
this coverage, but as case law expands policy provisions and insurers'
liability beyond the intended coverage, the Company may be required to defend
such claims. During 1995, Hanover performed an actuarial review of its
environmental reserves. This resulted in Hanover's providing additional
reserves for "IBNR" (incurred but not reported) claims, in addition to
existing reserves for reported claims. Although these claims are not material,
their existence gives rise to uncertainty and is discussed because of the
possibility, however remote, that they may become material. The Company
believes that, notwithstanding the evolution of case law expanding liability
in environmental claims, recorded reserves related to these claims are
adequate. In addition, the Company is not aware of any litigation or pending
claims that may result in additional material liabilities in excess of
recorded reserves. The environmental liability could be revised in the near
term if the estimates used in determining the liability are revised.
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the Company varies by product. Property
and casualty insurance premiums are established before the amount of
26
<PAGE>
losses and LAE, and the extent to which inflation may affect such expenses,
are known. Consequently, the Company attempts, in establishing rates, to
anticipate the potential impact of inflation in the projection of ultimate
costs. The impact of inflation has been relatively insignificant in recent
years. However, inflation could contribute to increased losses and LAE in the
future.
The Company regularly reviews its reserving techniques, its overall
reserving position and its reinsurance. Based on (i) review of historical
data, legislative enactments, judicial decisions, legal developments in
impositions of damages, changes in political attitudes and trends in general
economic conditions, (ii) review of per claim information, (iii) historical
loss experience of the Company and the industry, (iv) the relatively short-
term nature of most policies and (v) internal estimates of required reserves,
management believes that adequate provision has been made for loss reserves.
However, establishment of appropriate reserves is an inherently uncertain
process and there can be no certainty that current established reserves will
prove adequate in light of subsequent actual experience. A significant change
to the estimated reserves could have a material impact on the results of
operations.
REINSURANCE
The Company maintains a reinsurance program designed to protect against
large or unusual losses and LAE activity. This includes both excess of loss
reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to
protect the ceding insurer from significant aggregate losses arising from a
single event such as windstorm, hail, hurricane, tornado, riot or other
extraordinary events. The Company determines the appropriate amount of
reinsurance based on the Company's evaluation of the risks accepted and
analysis prepared by consultants and reinsurers and on market conditions
including the availability and pricing of reinsurance. The Company has
reinsurance for casualty business. Under the 1996 casualty program, the
reinsurers are responsible for 100% of the amount of each loss in excess of
$1.0 million per occurrence up to $30.5 million for general liability and
workers' compensation. Additionally, this reinsurance covers workers'
compensation losses in excess of $30.5 million to $60.5 million per
occurrence. Under the Company's 1996 catastrophe reinsurance program, Hanover
and Citizens retain the first $25.0 million of loss per occurrence, all
amounts in excess of $180.0 million per occurrence and 10% of all aggregate
loss amounts in excess of $25.0 million up to $180.0 million. In addition,
Citizens retains 5% of losses in excess of $10.0 million, up to $25.0 million.
In 1996, Citizens purchased aggregate catastrophe coverage which reinsures 90%
of $5.0 million for aggregated catastrophe losses in excess of $5.0 million
which individually exceed $1.0 million. Under this aggregate catastrophe
coverage, Citizens is expected to recover $4.5 million. In the years ended
December 31, 1996, 1995 and 1994, the Company did not exceed the minimum
catastrophe levels, either individually or in the aggregate, to obtain
recovery under its reinsurance agreements, except as described above.
Effective January 1, 1997, the Company modified its reinsurance program. The
1997 modifications include the purchase of additional casualty reinsurance and
higher retention under the Company's catastrophe reinsurance program. Under
the 1997 casualty reinsurance program, the Company added a layer which
reinsured 100% of each loss in excess of $.5 million up to $1.0 million per
occurrence. Under the 1997 catastrophe reinsurance program, Hanover and
Citizens retain the first $25.0 million of loss per occurrence and all amounts
in excess of $180.0 million per occurrence, 55% of all aggregate loss amounts
in excess of $25.0 million up to $45.0 million, and 10% of all aggregate loss
amounts in excess of $45.0 million up to $180.0 million. In addition, Citizens
retains 5% of losses in excess of $10.0 million, up to $25 million.
The Company cedes to reinsurers a portion of its risk and pays a fee based
upon premiums received on all policies subject to such reinsurance.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company. The Company determines the appropriate amount of
reinsurance based on evaluation of the risks accepted and analyses prepared by
consultants and reinsurers and on market conditions (including the
availability and pricing of reinsurance). The Company also 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,
limit and retention, arbitration and occurrence. Based on its review of its
reinsurers' financial statements and reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially sound.
The Company is subject to concentration of risk with respect to reinsurance
ceded to various residual market mechanisms. As a condition to the ability to
conduct certain business in various states, the Company is required
27
<PAGE>
to participate in various residual market mechanisms and pooling arrangements
which provide various insurance coverages to individuals or other entities
that are otherwise unable to purchase such coverage voluntarily provided by
private insurers. These market mechanisms and pooling arrangements include the
Massachusetts Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers'
Compensation Residual Market Pool ("MWCRP") and the Michigan Catastrophic
Claims Association ("MCCA"). At December 31, 1996, the MCCA and CAR were the
only two reinsurers which represented 10% or more of the Company's reinsurance
business. As a servicing carrier in Massachusetts, the Company cedes a
significant portion of its private passenger and commercial automobile
premiums to CAR. Net premiums earned and losses and loss adjustment expenses
ceded to CAR for the years ended December 31, 1996, 1995 and 1994 were $38.0
million and $21.8 million, $49.1 million and $33.7 million, and $50.0 million
and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool, which is administered by The
National Council on Compensation Insurance ("NCCI"). The Company was involved
in legal proceedings regarding the MWCRP's deficit which through a legislative
settlement issued on June 23, 1995, provided for an initial funding of $220.0
million of which the insurance carriers were responsible for $65.0 million.
Hanover paid its allocation of $4.2 million in December 1995. Some of the
smaller carriers appealed this decision. The Company's right to recover
reinsurance balances for claims properly paid is not at issue in any such
proceedings. The Company expects to collect its reinsurance balance; however,
funding of the cash flow needs of the MWCRP may in the future be affected by
issues related to certain litigation, the outcome of which the Company cannot
predict.
The Company ceded to MCCA premiums earned and losses and loss adjustment
expenses in 1996, 1995 and 1994 of $50.5 million and $(52.9) million, $66.8
million and $62.9 million, and $80.0 million and $24.2 million, respectively.
Because the MCCA is supported by assessments permitted by statute and all
amounts billed by the Company to CAR, MWCRP and MCCA have been paid when due,
the Company believes that it has no significant exposure to uncollectible
reinsurance balances.
The reserve for losses and loss adjustment expenses at December 31, 1996 and
1995 is shown gross of recoverable on unpaid losses of $626.9 million and
$763.5 million, respectively. The significant decrease in the reinsurance
recoverable on unpaid losses is primarily attributable to an overall decrease
in reinsurance activity at both Hanover and Citizens. The decrease at Hanover
is specifically related to a decrease in ceded losses on its servicing carrier
business. The decrease at Citizens in 1996 is due to the MCCA's favorable
development on prior year reserves exceeding the losses and LAE incurred
during the current year. The aggregate losses and LAE ceded have no impact on
the Company's consolidated statements of income. Losses and LAE ceded were
$2.2 million, $229.1 million and $160.4 million in 1996, 1995 and 1994,
respectively. Ceded premiums earned were $232.6 million, $296.2 million and
$291.9 million in 1996, 1995 and 1994, respectively.
INVESTMENT PORTFOLIO
The Company's investment policy is structured with emphasis on maximizing
after tax income while providing liquidity and preserving asset quality. The
portfolio is dominated by fixed income securities. The fixed income portfolio
maintains a laddered maturity structure with a duration of 5.6 years. The
Company continually evaluates credit quality throughout the investment holding
period. Approximately 89.0% of the portfolio was invested in debt securities
at December 31, 1996, compared to 87.9% at December 31, 1995. At December 31,
1996, $3,110.2 million, or 88.2%, of the debt securities held by the Company
were rated by the National Association of Insurance Commissioners ("NAIC") as
investment grade (1 or 2). In 1995, $3,179.5 million, or 94.7% of debt
securities were rated investment grade. At December 31, 1996, 64.1% of debt
securities were tax-exempt investments compared to 64.0% at December 31, 1995.
The Company may continue to make adjustments to its taxable and tax-exempt
positions in the future to seek to maximize after tax income.
The Company's investment portfolio increased $142.8 million, to $3,962.4
million at December 31, 1996 from $3,819.6 million at December 31, 1995.
Hanover's investment portfolio increased $28.4 million, to $2,357.2 million,
and Citizens' investment portfolio increased $114.4 million, to $1,605.2
million. These
28
<PAGE>
increases were primarily attributable to the investment of cash provided by
operations. Debt Securities increased $171.1 million, to $3,527.6 million,
from $3,356.5 million and represented 89.0% and 87.9% of the carrying value of
all investments at December 31, 1996 and 1995, respectively. This increase is
consistent with the Company's strategy of increasing the level of debt
securities in the portfolio which was accomplished, in part, by reducing the
level of equities. Tax-exempt securities increased $114.5 million, to $2,261.2
million, from $2,146.7 million during 1996 and represented 64.1% and 64.0% of
the total debt securities at December 31, 1996 and 1995, respectively. The
Company may make modest extensions in portfolio incremental credit risk and
adjustments to its taxable and tax-exempt positions in the future to seek to
maximize after tax income.
At December 31, 1996, $402.9 million, or 10.2% of the investment portfolio
was invested in equity securities compared to $438.1 million, or 11.5% at
December 31, 1995. Dividend income from equity securities was $9.6 million, or
4.1% of investment income in 1996 as compared to $12.5 million, or 6.0% in
1995.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity describes the ability of a company to generate sufficient cash
flows to meet the cash requirements of business operations. As a holding
company, Allmerica P&C's primary source of cash for the payment of dividends
to its shareholders is dividends from its insurance subsidiaries. However,
dividend payments to Allmerica P&C by its insurance subsidiaries are subject
to limitations imposed by state regulators, such as the requirement that cash
dividends be paid only out of unreserved and unrestricted earned surplus and
restrictions on the payment of "extraordinary" dividends, as defined. Based on
the 1996 statutory financial statements of Hanover, the maximum dividend that
may be paid to Allmerica P&C at January 1, 1997, without prior approval from
the New Hampshire Commissioner of Insurance, is $15.4 million, which considers
dividends declared to Allmerica P&C of $105.0 million during 1996, including
$80.0 million which was declared in December. On January 2, 1997, Hanover
declared an extraordinary dividend in the amount of $120.0 million, payable on
or after January 21, 1997 to Allmerica P&C. The dividend, which was approved
by the New Hampshire Insurance Department on January 9, 1997, is to be paid in
a lump sum or in such installments as Allmerica P&C, in its discretion, may
determine.
Sources of cash for the Company's insurance subsidiaries are from premiums
collected, investment income and maturing investments. Primary cash outflows
are paid losses and loss adjustment expenses, policy acquisition expenses,
other underwriting expenses, and investment purchases. Cash outflows related
to claim losses and loss adjustment expenses can be variable because of
uncertainties surrounding settlement dates for liabilities for unpaid losses
and because of the potential for large losses either individually or in the
aggregate. The Company periodically adjusts its investment policy to respond
to changes in short-term and long-term cash requirements.
Net cash provided by operating activities for the Company was $110.2
million, $182.1 million and $205.2 million in 1996, 1995 and 1994
respectively. The decrease in net cash provided by operating activities in
1996 is attributable primarily to an increase in underwriting losses during
1996 which resulted in an increase in claims payments. The decrease in net
cash provided by operating activities in 1995 is attributable primarily to the
timing of cash receipts and payments relating to reinsurance and other accrued
expenses.
Net cash used for investing activities for the Company was $87.6 million and
$385.2 million in 1996 and 1995, respectively. In 1994, net cash provided for
investing activities was $47.8 million. Cash used for investing activities
declined in 1996 due to decreases in cash flow from operations, as well as the
decision in 1995 to maintain lower cash balances which resulted in an increase
in investing activity during that year. Cash used for investment activities in
1995 increased primarily from increased purchases of debt and equity
securities to take advantage of the favorable investment environment during
1995.
Net cash used for financing activities for the Company was $51.2 million,
$39.7 million and $16.6 million in 1996, 1995 and 1994, respectively. These
changes primarily reflect incremental increases in share repurchases of 1.2
million shares of the Company's common stock in 1996 compared to 1.0 million
shares in 1995 and 0.05 million shares in 1994. In addition, in 1996 a
subsidiary of the Company repurchased 0.6 million shares of the subsidiary's
common stock compared to 0.2 million shares in 1995.
Shareholders' equity was $1,608.5 million, or $26.99 per share, at December
31, 1996 compared to $1,509.3 million, or $24.82 per share, at December 31,
1995. Shareholders' equity reflects net income for the year, the
29
<PAGE>
repurchase of treasury stock and the impact of a decrease of $6.8 million due
to a decrease in the fair values of available-for-sale debt and equity
securities. Changes in shareholders' equity related to the unrealized values
of underlying portfolio investments will continue to be volatile as market
prices of debt securities fluctuate with changes in the interest rate
environment.
The Company expects to continue to pay dividends in the foreseeable future.
However, payment of future dividends is subject to the Board of Directors'
approval and is dependent upon earnings and the financial condition of the
Company.
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and long-term cash
requirements. The Company maintains a high degree of liquidity within the
investment portfolio in fixed maturities, common stock and short-term
investments. The Company also has unsecured lines of credit with certain banks
to support its commercial paper borrowings. At December 31, 1996, these lines
totaled $40.0 million and are subject to annual renewal. There were no
borrowings under these lines of credit during 1996. In addition, the holding
company's financial structure provides the flexibility to obtain funds
externally through debt or equity financing, if needed.
RECENT DEVELOPMENTS
On February 19, 1997, Allmerica Financial Corporation ("AFC") and Allmerica
P&C entered into an Agreement and Plan of Merger (the "Merger Agreement")
pursuant to which AFC will acquire all of the outstanding Common Stock, $1.00
par value per share, of Allmerica P&C that it does not already own for
consideration consisting of $33.00 per share of Common Stock, subject to
adjustment, payable in cash and shares of common stock, par value $0.01 per
share, of AFC (the "AFC Common Stock"). In addition, a shareholder of
Allmerica P&C may elect to receive the consideration in cash, without
interest, or in shares of AFC Common Stock, subject to proration as set forth
in the Merger Agreement. The maximum number of shares of AFC Common Stock to
be issued in the Merger is approximately 9.67 million shares. The acquisition
will be accomplished by merging a newly created, wholly-owned subsidiary of
AFC with and into Allmerica P&C (the "Merger") resulting in Allmerica P&C
becoming a wholly-owned subsidiary of AFC. Also, immediately prior to the
Merger, Allmerica P&C's Certificate of Incorporation will be amended to
authorize a new class of Common Stock, one share of which will be exchanged
for each share of Common Stock currently held by SMA Financial Corp,. a
wholly-owned subsidiary of AFC. The consummation of the Merger is subject to
the satisfaction of various conditions, including the approval of regulatory
authorities.
On January 2, 1997, Hanover declared an extraordinary dividend in the amount
of $120.0 million, payable on or after January 21, 1997 to Allmerica P&C. The
dividend which was approved by the New Hampshire Insurance Department on
January 9, 1997, is to be paid in a lump sum or in such installments as
Allmerica P&C, in its discretion, may determine.
FORWARD LOOKING STATEMENTS
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected and in the future could affect, the
Company's actual results and could cause the Company's actual results for 1997
and beyond to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company. When used in the MD&A
discussion, the words "believes," "anticipated," "expects" and similar
expressions are intended to identify forward-looking statements. See
"Important Factors Regarding Forward-Looking Statements" filed herewith as
Exhibit 99.1 and incorporated herein by reference.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward-
looking statements include among others, the following possibilities: (i)
adverse catastrophe experience and severe weather; (ii) adverse loss
development for events the Company insured in prior years; (iii) heightened
competition, including the intensification of price competition, the entry of
new competitors and the introduction of new products by new and existing
competitors; (iv) adverse state and federal legislation, including decreases
in rates, limitations on premium levels, increases in minimum capital and
reserve requirements, benefit mandates, limitations on the ability to manage
care and utilization, and tax
30
<PAGE>
treatment of insurance products; (v) changes in interest rates causing a
reduction of investment income or in the market value of interest rate
sensitive investments; (vi) failure to obtain new customers, retain existing
customers or reductions in policies in force by existing customers; (vii)
higher service, administrative or general expense due to the need for
additional advertising, marketing, administrative or management information
systems expenditures; (viii) loss or retirement of key executives; (ix)
increases in medical costs, including increases in utilization, costs of
medical services, pharmaceuticals, durable medical equipment and other covered
items; (x) termination of provider contracts or renegotiation at less cost-
effective rates or terms of payment; (xi) changes in the Company's liquidity
due to changes in asset and liability matching; (xii) restrictions on
insurance underwriting, based on certain criteria; (xiii) adverse changes in
the ratings obtained by independent rating agencies such as Moody's, Standard
& Poor's and A.M. Best.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Report of Independent Accountants...................................... 32
Consolidated Statements of Income for the years ended December 31,
1996, 1995 and 1994................................................... 34
Consolidated Balance Sheets as of December 31, 1996 and 1995........... 35
Consolidated Statements of Shareholders' Equity for the years ended De-
cember 31, 1996, 1995
and 1994.............................................................. 36
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995
and 1994.............................................................. 37
Notes to Consolidated Financial Statements............................. 38-57
</TABLE>
INDEX TO FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Summary of Investments--Other Than Investments in Related Parties..... 78
Condensed Financial Information of the Registrant..................... 79-81
Supplementary Insurance Information................................... 82-84
Reinsurance........................................................... 85
Valuation and Qualifying Accounts..................................... 86
Supplemental Information Concerning Property/Casualty Insurance Opera-
tions................................................................ 87
</TABLE>
31
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Allmerica Property & Casualty Companies, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) present fairly, in all material
respects, the financial position of Allmerica Property & Casualty Companies,
Inc. and its subsidiaries at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The Company adopted certain new accounting pronouncements in 1994 as
discussed in Note 1 to the consolidated financial statements.
/s/ Price Waterhouse LLP
-------------------------------------
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 3, 1997, except as to Notes 1 and 2,
which are as of February 19, 1997
32
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
MANAGEMENT REPORT ON RESPONSIBILITY
FOR FINANCIAL REPORTING
The management of Allmerica Property & Casualty Companies, Inc. has the
responsibility for preparing the accompanying consolidated financial
statements and for their integrity and objectivity. The statements were
prepared in conformity with generally accepted accounting principles and
include amounts based on management's informed estimates and judgments. We
believe that these statements present fairly the Company's financial position
and results of operations and that the other information contained in the
annual report is accurate and consistent with the financial statements.
Allmerica Property & Casualty Companies, Inc.'s Board of Directors annually
appoints independent accountants to perform an audit of its consolidated
financial statements. The financial statements have been audited by Price
Waterhouse LLP, independent accountants, in accordance with generally accepted
auditing standards. Their audit included consideration of the Company's system
of internal control in order to determine the audit procedures required to
express their opinion on the consolidated financial statements.
Management of Allmerica Property & Casualty Companies, Inc. has established
and maintains a system of internal control that provides reasonable assurance
that assets are safeguarded and that transactions are properly authorized and
recorded. The system of internal control provides for appropriate division of
responsibility and is documented by written policies and procedures that are
communicated to employees with significant roles in the financial reporting
process and updated as necessary. Management continually monitors the system
of internal control for compliance. Allmerica Property & Casualty Companies,
Inc. and its subsidiaries maintain a strong internal audit program that
independently assesses the effectiveness of the internal controls and
recommends possible improvements thereto. Management recognizes the inherent
limitations in all internal control systems and believes that our system of
internal control provides an appropriate balance between the costs and
benefits desired. Management believes that the Company's system of internal
control provides reasonable assurance that errors or irregularities that would
be material to the financial statements are prevented or detected in the
normal course of business.
The Audit Committee of the Board of Directors, composed solely of outside
directors, oversees management's discharge of its financial reporting
responsibilities. The committee meets periodically with management, our
internal auditors and our independent accountants, Price Waterhouse LLP. Both
our internal auditors and Price Waterhouse LLP have direct access to the Audit
Committee.
Management recognizes its responsibility for fostering a strong ethical
climate. This responsibility is reflected in the Company's policies which
address, among other things, potential conflicts of interest; compliance with
all domestic and foreign laws including those relating to financial disclosure
and the confidentiality of proprietary information. Allmerica Property &
Casualty Companies, Inc. maintains a systematic program to assess compliance
with these policies.
/s/ John F. O'Brien /s/ Edward J. Parry, III
- - ------------------------------------- -------------------------------------
JOHN F. O'BRIEN EDWARD J. PARRY, III
President and Chief Executive Vice President, Chief Financial
Officer Officer, Treasurer and Principal
Accounting Officer
33
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
REVENUES
Net premiums written............... $ 1,914.4 $ 1,885.3 $ 1,822.9
Change in unearned premiums, net of
prepaid reinsurance premiums...... 16.1 22.1 31.6
------------ ------------ ------------
Net premiums earned.............. 1,898.3 1,863.2 1,791.3
Net investment income.............. 235.4 209.6 202.4
Net realized gains on investments.. 48.1 14.6 3.5
Other income....................... 11.9 7.7 7.6
------------ ------------ ------------
Total revenues................. 2,193.7 2,095.1 2,004.8
------------ ------------ ------------
EXPENSES
Losses and loss adjustment
expenses.......................... 1,371.9 1,289.7 1,306.7
Policy acquisition expenses........ 422.6 409.1 390.3
Other operating expenses........... 190.0 179.4 185.9
Policyholders' dividends........... 11.5 10.6 8.8
------------ ------------ ------------
Total expenses................. 1,996.0 1,888.8 1,891.7
------------ ------------ ------------
Income before federal income taxes,
minority interest and cumulative
effect of a change in accounting.... 197.7 206.3 113.1
Federal income tax expense (benefit)
Current............................ 44.4 54.4 24.4
Deferred........................... (8.0) (2.3) (20.5)
------------ ------------ ------------
Total federal income tax
expense....................... 36.4 52.1 3.9
Income before minority interest and
cumulative effect of a change in
accounting.......................... 161.3 154.2 109.2
Minority interest.................... (14.9) (14.1) (8.0)
------------ ------------ ------------
Income before cumulative effect of a
change in accounting................ 146.4 140.1 101.2
Cumulative effect of a change in
accounting.......................... -- -- (2.0)
------------ ------------ ------------
Net income........................... $ 146.4 $ 140.1 $ 99.2
============ ============ ============
PER SHARE DATA
Income before cumulative effect of
a change in accounting............ $ 2.44 $ 2.28 $ 1.64
Cumulative effect of a change in
accounting........................ -- -- (0.03)
------------ ------------ ------------
Net income......................... $ 2.44 $ 2.28 $ 1.61
============ ============ ============
Weighted average shares outstanding.. 59.9 61.4 61.8
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
34
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
---------- ----------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
ASSETS
Investments:
Debt securities available-for-sale, at fair value
(amortized cost of $3,444.7 and $3,237.6)........... $ 3,527.6 $ 3,356.5
Equity securities available-for-sale, at fair value
(cost of $277.3 and $340.8)......................... 402.9 438.1
Other investments, at fair value (cost of $29.3 and
$20.1).............................................. 31.9 25.0
---------- ----------
Total investments.................................. 3,962.4 3,819.6
Cash and cash equivalents.............................. 96.9 125.5
Accrued investment income.............................. 65.3 64.5
Premiums and notes receivable (less allowance for
doubtful accounts of $4.5 and $4.6)................... 410.2 400.3
Finance installment receivables........................ 29.3 30.2
Reinsurance recoverable on paid and unpaid losses...... 669.2 807.4
Prepaid reinsurance premiums........................... 45.5 43.8
Deferred policy acquisition costs...................... 164.2 157.5
Deferred federal income taxes.......................... 93.2 81.2
Other assets........................................... 167.7 211.8
---------- ----------
Total assets....................................... $ 5,703.9 $ 5,741.8
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses...... $ 2,744.1 $ 2,896.0
Unearned premiums.................................... 815.1 797.3
Reinsurance premiums payable......................... 31.4 42.0
Commercial paper..................................... 28.0 27.7
Other liabilities.................................... 344.7 340.6
---------- ----------
Total liabilities.................................. 3,963.3 4,103.6
---------- ----------
Minority interest...................................... 132.1 128.9
---------- ----------
Commitments and contingencies (Notes 15 and 16)
Shareholders' equity:
Preferred stock, par value $1.00 per share;
authorized 20.0 million shares; issued none......... -- --
Common stock, par value $1.00 per share; authorized
90.0 million shares; issued 61.9 million shares..... 61.9 61.9
Additional paid-in capital........................... 32.0 32.0
Retained earnings.................................... 1,441.8 1,304.9
Unrealized appreciation on investments, net of
deferred federal income taxes and minority
interest............................................ 127.1 133.9
Treasury stock at cost (2.3 million and 1.1 million
shares)............................................. (54.3) (23.4)
---------- ----------
Total shareholders' equity......................... 1,608.5 1,509.3
---------- ----------
Total liabilities and shareholders' equity......... $ 5,703.9 $ 5,741.8
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
35
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
COMMON STOCK
Balance at beginning and end of year.... $ 61.9 $ 61.9 $ 61.9
---------- ---------- ----------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning and end of year.... 32.0 32.0 32.0
---------- ---------- ----------
RETAINED EARNINGS
Balance at beginning of year............ 1,304.9 1,174.6 1,085.3
Net income.............................. 146.4 140.1 99.2
Dividends declared to shareholders...... (9.5) (9.8) (9.9)
---------- ---------- ----------
Balance at end of year.................. 1,441.8 1,304.9 1,174.6
---------- ---------- ----------
UNREALIZED APPRECIATION (DEPRECIATION) ON
INVESTMENTS, NET OF DEFERRED FEDERAL
INCOME TAXES AND MINORITY INTEREST
Balance at beginning of year............ 133.9 (36.3) 25.6
Cumulative effect of changes in account-
ing:
Net appreciation on available-for sale
debt securities....................... -- -- 149.7
Provision for deferred federal income
taxes and minority interest........... -- -- (59.2)
---------- ---------- ----------
Total................................. -- -- 90.5
---------- ---------- ----------
Effect of transfer of securities from
held-to-maturity to available-for-sale:
Net appreciation on available-for-sale
debt securities....................... -- 6.0 --
Provision for deferred federal income
taxes and minority interest........... -- (2.3) --
---------- ---------- ----------
Total................................. -- 3.7 --
---------- ---------- ----------
Appreciation (depreciation) during the
year:
Net appreciation (depreciation) on
available-for-sale securities......... (10.0) 277.9 (251.0)
(Provision) benefit for deferred
federal income taxes and minority
interest.............................. 3.2 (111.4) 98.6
---------- ---------- ----------
Total................................. (6.8) 166.5 (152.4)
---------- ---------- ----------
Balance at end of year.................. 127.1 133.9 (36.3)
---------- ---------- ----------
TREASURY STOCK
Balance at beginning of year............ (23.4) (2.5) (1.8)
Shares purchased at cost................ (31.0) (20.9) (0.7)
Shares reissued......................... 0.1 -- --
---------- ---------- ----------
Balance at end of year.................. (54.3) (23.4) (2.5)
---------- ---------- ----------
Total shareholders' equity............ $ 1,608.5 $ 1,509.3 $ 1,229.7
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
36
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
1996 1995 1994
----------- ----------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................... $ 146.4 $ 140.1 $ 99.2
Adjustments to reconcile net income to
net cash provided by operating
activities:
Minority interest....................... 14.9 14.1 8.0
Cumulative effect of a change in
accounting............................. -- -- 2.0
Net realized gains on investments....... (48.1) (14.6) (3.5)
Deferred federal income tax benefit..... (8.0) (2.3) (20.5)
Change in assets and liabilities:
Deferred policy acquisition expenses... (6.7) (2.5) (13.5)
Premiums and notes receivable, net of
reinsurance payable................... (20.5) (34.3) (21.4)
Unearned premiums, net of prepaid
reinsurance premiums.................. 16.1 22.2 31.6
Reserve for losses and loss adjustment
expenses, net of reinsurance
recoverable........................... (13.7) 27.9 91.9
Other, net............................. 29.8 31.5 31.4
----------- ----------- ---------
Net cash provided by operating
activities.............................. 110.2 182.1 205.2
=========== =========== =========
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of available-for-sale
debt securities......................... 1,252.7 1,131.5 612.5
Proceeds from available-for-sale debt
securities maturing or called........... 383.7 290.5 258.3
Proceeds from held-to-maturity debt
securities maturing or called........... -- 23.2 46.6
Proceeds from sale of available-for-sale
equity securities and other
investments............................. 194.6 117.9 105.8
Purchases of available-for-sale debt
securities.............................. (1,859.9) (1,707.2) (826.3)
Purchases of held-to-maturity debt
securities.............................. -- -- (4.0)
Purchases of available-for-sale equity
securities and other investments........ (84.7) (203.4) (154.5)
Change in net receivable from security
transactions not settled................ 32.4 (31.7) 25.1
Capital expenditures..................... (6.4) (6.0) (15.7)
----------- ----------- ---------
Net cash (used for) provided by investing
activities.............................. (87.6) (385.2) 47.8
----------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders........... (9.5) (9.8) (9.9)
Commercial paper issued (redeemed), net.. 0.3 (5.1) (6.0)
Subsidiary treasury stock purchased, at
cost.................................... (11.1) (3.9) --
Treasury stock purchased, at cost........ (31.0) (20.9) (0.7)
Treasury stock reissued.................. 0.1 -- --
----------- ----------- ---------
Net cash used for financing activities... (51.2) (39.7) (16.6)
----------- ----------- ---------
Net (decrease) increase in cash and cash
equivalents.............................. (28.6) (242.8) 236.4
Cash and cash equivalents at beginning of
year..................................... 125.5 368.3 131.9
----------- ----------- ---------
Cash and cash equivalents at end of year.. $ 96.9 $ 125.5 $ 368.3
=========== =========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid during the year:
Federal income taxes..................... $ 36.7 $ 47.4 $ 38.7
Interest................................. 1.3 1.6 1.6
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
37
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Basis of Consolidation
The consolidated financial statements of Allmerica Property & Casualty
Companies, Inc. and subsidiaries (collectively, the Company) at December 31,
1996 include the accounts of Allmerica Property & Casualty Companies, Inc.
(Allmerica P&C), a non-insurance holding company; The Hanover Insurance
Company (Hanover); Citizens Corporation (CitCorp), a non-insurance holding
company, and CitCorp's wholly-owned subsidiaries Citizens Insurance Company of
America (Citizens), Citizens Management, Inc., Citizens Insurance Company of
Ohio and Citizens Insurance Company of the Midwest; Massachusetts Bay
Insurance Company (Mass Bay); The Hanover American Insurance Company (Hanover
American); Hanover Lloyd's Insurance Company (Hanover Lloyd's); Hanover Texas
Insurance Management Company, Inc. (Hanover Texas); Allmerica Financial
Alliance Insurance Company ([AFAIC], formerly The Hanover National Insurance
Company [Hanover National]); Allmerica Financial Benefit Insurance Company
(AFBIC); Allmerica Financial Insurance Brokers, Inc.; Amgro, Inc. (Amgro), a
premium finance company, and Amgro's wholly-owned subsidiary Lloyds Credit
Corporation; Allmerica Employees' Insurance Agency (AEIA); and APC Funding
Corporation, a special-purpose financing company. The Company owns 100% of
Hanover, Allmerica Financial Insurance Brokers, Inc., and APC Funding
Corporation. Hanover owns 100% of Mass Bay, Hanover American, Hanover Lloyd's,
Hanover Texas, AFAIC, AFBIC, Amgro, and AEIA and approximately 82.5% of the
outstanding common stock of CitCorp. Minority interest relates to 17.5% of
CitCorp common stock publicly held. First Allmerica Financial Life Insurance
Company (FAFLIC, formerly State Mutual Life Assurance Company of America
[State Mutual]) indirectly owns 35.5 million shares (59.5%) of Allmerica P&C.
Concurrent with FAFLIC's conversion from a mutual life insurance company to a
stock life insurance company, FAFLIC became a wholly-owned subsidiary of
Allmerica Financial Corporation (AFC) on October 16, 1995.
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and
Plan of Merger pursuant to which AFC will acquire all of the outstanding
Common Stock of Allmerica P&C that it does not already own. Additional
information pertaining to the merger is included in Note 2, Proposed
Transaction.
The accounting and reporting policies of the Company are in accordance with
generally accepted accounting principles and the general practices within the
insurance industry. All significant intercompany transactions and balances
have been eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
B. Premium Revenue
Premiums are recognized as earned using the daily pro rata method over the
term of the policy. Unearned premiums represent the portion of premiums
written that relate to the unexpired terms of the policies in force.
C. Investments
Effective January 1, 1994, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for
Certain Investments in Debt and Equity Securities". SFAS No. 115 requires that
an enterprise classify debt and equity securities into one of three
categories: held-to-maturity, available-for-sale or trading. SFAS No. 115 also
requires that unrealized holding gains and losses for trading securities be
included in earnings, while unrealized gains and losses for available-for-sale
securities be
38
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
excluded from earnings and reported as a separate component of shareholders'
equity until realized. The effect of implementing SFAS No. 115, as of January
1, 1994, was an increase in the carrying value of debt securities of $149.7
million and an increase in shareholders' equity of $90.5 million, net of
deferred federal income taxes, which resulted from changing the carrying value
of the debt securities from amortized cost to fair value. The implementation
had no effect on net income.
In November 1995, the Financial Accounting Standards Board issued a Special
Report, A Guide to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities, which permitted companies to
reclassify securities, where appropriate, based on the new guidance. As a
result, the Company transferred all of its held-to-maturity category
securities, with amortized cost and fair value of $110.3 million and $116.3
million, respectively, to the available-for-sale category, which resulted in a
net increase in shareholders' equity of $3.7 million.
Fair values for debt and equity securities are primarily based on quoted
market prices. For securities not actively traded, fair values are estimated
using values obtained from independent pricing services.
Realized gains or losses on the sale of investments, which are included in
the determination of net income, are determined on the specific-identification
basis using amortized cost for debt securities and cost for equity securities
and other investments. Investments with other than temporary declines in fair
value are written down to estimated fair value resulting in losses which are
recognized as realized losses.
D. Financial Instruments
In the normal course of business, the Company enters into transactions
involving various types of financial instruments, including investments in
debt and equity securities. These instruments involve credit risk and also may
be subject to risk of loss due to currency and interest rate fluctuations.
Financial instruments that are subject to fair value disclosure requirements
are carried in the financial statements at amounts that approximate fair
value, unless otherwise indicated in the notes to consolidated financial
statements.
E. Cash and Cash Equivalents
Cash and cash equivalents includes cash on hand, amounts due from banks and
highly liquid short-term investments. The Company considers all short-term
investments with an original maturity of three months or less to be cash
equivalents.
F. Deferred Policy Acquisition Expenses
Deferred policy acquisition expenses consist of commissions, premium taxes,
and other costs that vary with and are primarily related to the production of
new and renewal business. The deferral is subject to ultimate recoverability
and charged to expense over the period in which the related premiums are
earned. Deferred policy acquisition expenses are reviewed to determine that
they do not exceed recoverable amounts after considering anticipated
investment income. The Company evaluates recoverability of premium
deficiencies separately for Hanover and Citizens on a product line basis,
considering expected investment income applied separately for Hanover and
Citizens on a product line basis.
Although realization of deferred policy acquisition costs is not assured,
management believes it is more likely than not that all these costs will be
realized. The amount of deferred policy acquisition costs considered
realizable, however, could be reduced in the near term if the estimates of
investment income discussed above are reduced, and this would impact the
amortization of deferred policy acquisition costs.
39
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
G. Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses (LAE) represents the
accumulation of individual case estimates for reported losses and actuarial
estimates for incurred but not reported losses and LAE. Assumed reserves are
recorded as reported by the ceding organization. The reserve for losses and
LAE is intended to cover the ultimate net cost of all losses and LAE incurred
through the balance sheet date. In establishing these reserves, consideration
is given to both current conditions and trends as well as past Company and
industry experience. The reserve is stated gross of reinsurance ceded and net
of anticipated salvage and subrogation recoverable. The reserve estimates are
continually reviewed and updated. The ultimate liability of claims may vary
from the current estimate. The effects of changes in the estimated reserve are
included in the results of operations in the period in which the estimates are
revised.
The Company periodically purchases annuity contracts from various life
insurance companies to settle claims currently. The present value of such
annuities, where the Company remains primarily liable, is recorded in the
accounts of the Company as both an other asset and other liability and
amounted to $51.6 million and $49.7 million at December 31, 1996 and 1995,
respectively.
H. Federal Income Taxes
The Company and its subsidiaries file a consolidated tax return. Current
taxes are allocated among all affiliated companies based on a written tax
sharing agreement. Under this agreement, allocations are made primarily on a
separate return basis with current payment for losses and other tax items
utilized in the consolidated return.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes, and
for other temporary taxable and deductible differences as defined by Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). These differences result primarily from loss reserves, policy
acquisition expenses, unearned premiums and unrealized appreciation or
depreciation on investments.
I. Earnings Per Share
Earnings per share are based on a weighted average of the number of shares
outstanding. On December 27, 1994, the Board of Directors of the Company
authorized the repurchase of up to three million shares, or nearly five
percent of its outstanding common stock. During 1996, 1995 and 1994, the
Company purchased 1.2 million, 1.0 million and 0.05 million shares,
respectively for the purpose of funding current and future stock option awards
and for other purposes.
J. Accounting Change
The cumulative effect of a change in accounting for postemployment benefits
was $2.0 million, net of federal income taxes, or $0.03 per share for the year
ended December 31, 1994.
K. Reclassification
Certain reclassifications have been made to the 1995 and 1994 consolidated
financial statements in order to conform to the 1996 presentation.
2. PROPOSED TRANSACTION
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and
Plan of Merger (the "Merger Agreement") pursuant to which AFC will acquire all
of the outstanding Common Stock, $1.00 par
40
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
value per share, of Allmerica P&C that it does not already own for
consideration consisting of $33.00 per share of Common Stock, subject to
adjustment, payable in cash and shares of common stock, par value $0.01 per
share, of AFC (the "AFC Common Stock"). In addition, a shareholder of
Allmerica P&C may elect to receive the consideration in cash, without
interest, or in shares of AFC Common Stock, subject to proration as set forth
in the Merger Agreement. The maximum number of shares of AFC Common Stock to
be issued in the Merger is approximately 9.67 million shares. The acquisition
will be accomplished by merging a newly created, wholly-owned subsidiary of
AFC with and into Allmerica P&C (the "Merger") resulting in Allmerica P&C
becoming a wholly-owned subsidiary of AFC. Also, immediately prior to the
Merger, Allmerica P&C's Certificate of Incorporation will be amended to
authorize a new class of Common Stock, one share of which will be exchanged
for each share of Common Stock currently held by SMA Financial Corp., a
wholly-owned subsidiary of AFC. The consummation of the Merger is subject to
the satisfaction of various conditions, including the approval of regulatory
authorities.
3. BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP), which may vary in certain
respects from statutory accounting practices followed by the Company that are
prescribed or permitted by the New Hampshire Insurance Department and Michigan
Insurance Bureau.
A reconciliation of the Company's statutory net income and surplus to GAAP
net income and shareholders' equity is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
NET INCOME
Statutory net income.......................... $ 155.3 $ 155.3 $79.9
Non-insurance company net loss.............. (1.3) (0.7) --
Minority interest........................... (14.9) (14.1) (8.0)
Deferred policy acquisition expenses........ 6.7 2.5 13.6
Cumulative effect of a change in accounting
for postemployment benefits................ -- -- (2.0)
Postretirement benefits..................... 4.3 (0.9) (1.4)
Deferred federal income tax benefit......... 8.0 2.3 20.5
Other, net.................................. (11.7) (4.3) (3.4)
-------- -------- --------
GAAP net income............................... $ 146.4 $ 140.1 $99.2
======== ======== ========
SHAREHOLDERS' EQUITY
Statutory surplus............................. $1,201.6 $1,128.4 $ 974.3
Non-insurance company equity................ 86.5 23.3 15.5
Deferred policy acquisition expenses........ 164.2 157.5 155.0
Non-admitted assets and statutory reserves.. 35.4 71.3 41.0
Deferred federal income taxes............... 92.7 81.2 189.1
Postretirement benefit obligation........... (31.6) (36.0) (35.1)
Minority interest........................... (22.8) (33.9) (20.7)
Fair value of available-for-sale debt
securities greater than (less than)
statutory carrying value................... 82.9 118.9 (87.4)
Other, net.................................. (0.4) (1.4) (2.0)
-------- -------- --------
GAAP shareholders' equity..................... $1,608.5 $1,509.3 $1,229.7
======== ======== ========
</TABLE>
41
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. INVESTMENTS
Summary of Investments
The Company accounts for its investments, all of which are classified as
available-for-sale, in accordance with the provisions of SFAS No. 115. The
amortized cost and fair value of available-for-sale investments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31 , 1996
--------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE
--------- ------------ ------------ --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
U.S. government obligations... $ 166.9 $ 7.5 $ (0.1) $ 174.3
States and political subdivi-
sions........................ 2,220.8 48.0 (7.7) 2,261.1
Foreign governments........... 10.1 1.7 -- 11.8
Corporate debt securities..... 892.0 34.7 (2.0) 924.7
Mortgage-backed securities.... 154.9 1.3 (0.5) 155.7
-------- ------ ------ --------
Total debt securities....... $3,444.7 $ 93.2 $(10.3) $3,527.6
-------- ------ ------ --------
Equity securities............. $ 277.3 $125.7 $ (0.1) $ 402.9
======== ====== ====== ========
<CAPTION>
DECEMBER 31 , 1995
--------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE
--------- ------------ ------------ --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
U.S. government obligations... $ 229.5 $ 16.4 $ -- $ 245.9
States and political subdivi-
sions........................ 2,099.2 60.6 (3.9) 2,155.9
Foreign governments........... 19.7 1.9 -- 21.6
Corporate debt securities..... 702.0 41.2 (1.5) 741.7
Mortgage-backed securities.... 187.2 4.2 -- 191.4
-------- ------ ------ --------
Total debt securities....... $3,237.6 $124.3 $ (5.4) $3,356.5
-------- ------ ------ --------
Equity securities............. $ 340.8 $ 98.5 $ (1.2) $ 438.1
======== ====== ====== ========
</TABLE>
Debt securities with an amortized cost of $82.8 million were on deposit with
various states or governmental authorities at December 31, 1996.
Unrealized gains and losses on available-for-sale securities are summarized
as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31, 1996
-------------------------------
EQUITY
DEBT SECURITIES
SECURITIES AND OTHER (1) TOTAL
---------- ------------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Net appreciation, beginning of year....... $71.7 $62.2 $133.9
Net (depreciation) appreciation on
available-for-sale securities............ (36.0) 26.0 (10.0)
Provision (benefit) for deferred federal
income taxes and minority interest....... 13.8 (10.6) 3.2
----- ----- ------
Net appreciation, end of year............. $49.5 $77.6 $127.1
===== ===== ======
</TABLE>
42
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31, 1995
-------------------------------
EQUITY
DEBT SECURITIES
SECURITIES AND OTHER (1) TOTAL
---------- ------------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Net (depreciation) appreciation, beginning
of year.................................. $(51.9) $15.6 $(36.3)
Effect of transfer of securities between
classifications:
Net appreciation on available-for-sale
debt securities........................ 6.0 -- 6.0
Provision for deferred federal income
taxes and minority interest............ (2.3) -- (2.3)
------ ----- ------
3.7 -- 3.7
------ ----- ------
Net appreciation on available-for-sale
securities............................... 199.8 78.1 277.9
Provision for deferred federal income
taxes and minority interest.............. (79.9) (31.5) (111.4)
------ ----- ------
119.9 46.6 166.5
------ ----- ------
Net appreciation, end of year............. $ 71.7 $62.2 $133.9
====== ===== ======
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31, 1994
-------------------------------
EQUITY
DEBT SECURITIES
SECURITIES AND OTHER (1) TOTAL
---------- ------------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Net appreciation, beginning of year....... $ -- $25.6 $ 25.6
------ ----- ------
Cumulative effect of accounting change:
Net appreciation on available-for-sale
securities............................. 149.7 -- 149.7
Provision for deferred federal income
taxes and minority interest............ (59.2) -- (59.2)
------ ----- ------
90.5 -- 90.5
------ ----- ------
Net depreciation on available-for-sale
securities............................... (237.0) (14.0) (251.0)
Benefit for deferred federal income taxes
and minority interest.................... 94.6 4.0 98.6
------ ----- ------
(142.4) (10.0) (152.4)
------ ----- ------
Net (depreciation) appreciation, end of
year..................................... $(51.9) $15.6 $(36.3)
====== ===== ======
</TABLE>
- - --------
(1) Includes net (depreciation) appreciation on other investments, net of
deferred federal income taxes and minority interest of $(1.4) million, $2.3
million and $1.0 million in 1996, 1995 and 1994, respectively.
43
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Expected Maturities of Debt Securities
The amortized cost and fair value of debt securities, by contractual
maturity are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------
AMORTIZED FAIR
COST VALUE
--------- --------
(IN MILLIONS)
<S> <C> <C>
Due in one year or less.................................. $ 155.6 $ 156.8
Due after one year through five years.................... 918.0 956.2
Due after five years through ten years................... 852.0 873.1
Due after ten years...................................... 1,519.1 1,541.5
-------- --------
$3,444.7 $3,527.6
======== ========
</TABLE>
Mortgage-backed securities are included above in the category representing
their ultimate maturity. Actual maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Net Investment Income
The following is a summary of the sources of net investment income:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1996 1995 1994
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Debt securities...................................... $215.5 $191.8 $193.1
Equity securities.................................... 9.6 12.5 8.6
Other investments.................................... 12.9 2.9 2.2
Cash and cash equivalents............................ 5.8 11.0 5.6
------ ------ ------
Total investment income............................ 243.8 218.2 209.5
Investment expenses.................................. (8.4) (8.6) (7.1)
------ ------ ------
Net investment income................................ $235.4 $209.6 $202.4
====== ====== ======
</TABLE>
Included in income from other investments was income from limited
partnerships of $10.0 million for the year ended 1996. The Company had no
income from limited partnerships for the years ended December 31, 1995 and
1994.
At December 31, 1996, fixed maturities with a carrying value of $1.9 million
were non-income producing for the twelve months ended December 31, 1996. The
Company had a concentration in U.S. treasuries at December 31, 1996 that
exceeded 10% of shareholders' equity at December 31, 1996.
Net Realized Gains and Losses
Realized gains and losses were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------
1996 1995 1994
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Debt securities..................................... $ (4.8) $ (3.9) $ (9.0)
Equity securities................................... 52.5 16.2 12.3
Other investments................................... 0.4 2.3 0.2
------ ------ ------
Net realized investment gains..................... $ 48.1 $ 14.6 $ 3.5
====== ====== ======
</TABLE>
44
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Voluntary Sales and Related Gross Gains and Gross Losses on Available-for-
Sale Securities
Proceeds from voluntary sales of debt securities in 1996, 1995 and 1994 were
$1,252.7 million, $1,131.5 million and $612.5 million, respectively. Gross
gains in 1996, 1995 and 1994 of $8.9 million, $13.7 million and $5.8 million
were realized on those sales, respectively. Gross losses in 1996, 1995 and
1994 of $13.6 million, $16.5 million and $14.8 million were realized on those
sales, respectively. Proceeds from voluntary sales of equity securities in
1996, 1995, and 1994 were $191.5 million, $112.7 million, and $105.1 million,
respectively. Gross gains in 1996, 1995 and 1994 were $53.5 million, $22.7
million and $16.6 million, respectively. Gross losses in 1996, 1995 and 1994
were $1.0 million, $6.5 million and $4.3 million, respectively.
5. DEFERRED POLICY ACQUISITION EXPENSES
The following reflects the amounts of policy acquisition expenses deferred
and amortized:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------
1996 1995 1994
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
Balance, beginning of year........................ $ 157.5 $ 155.0 $ 141.4
Amortization expense.............................. (422.6) (409.1) (390.3)
Acquisition expenses deferred..................... 429.3 411.6 403.9
------- ------- -------
Balance, end of year.............................. $ 164.2 $ 157.5 $ 155.0
======= ======= =======
</TABLE>
Deferred acquisition costs are reviewed for each product to determine if
they are recoverable. If such costs are determined to be unrecoverable, they
are expensed at the time of determination. The Company evaluates
recoverability of premium deficiencies separately for Hanover and Citizens on
a product line basis, considering expected investment income applied
separately for Hanover and Citizens on a product line basis. Deferred policy
acquisition expenses were reduced by $3.8 million, $3.6 million and $3.7
million in 1996, 1995 and 1994, respectively, due to premium deficiencies.
6. COMMERCIAL PAPER
A comparative summary of commercial paper is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
Face amount.................................................. $ 28.2 $ 27.9
Discount..................................................... (0.2) (0.2)
------ ------
$ 28.0 $ 27.7
====== ======
</TABLE>
Commercial paper normally matures within 90 days and had a weighted average
interest rate of 5.5% and 5.8% at December 31, 1996 and 1995, respectively.
Interest expense was $1.3 million, $1.6 million and $1.6 million in 1996, 1995
and 1994, respectively.
The Company has unsecured lines of credit with certain banks. At December
31, 1996, these lines totaled $40.0 million, of which $12 million was
available for borrowing. Under the terms of these agreements, the Company may
borrow funds on a short-term basis at the prevailing prime interest rate. The
Company is required to pay annual commitment fees of 0.07% on the unused
portion of its lines of credit. These lines are subject to annual renewal in
1997.
45
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. FEDERAL INCOME TAXES
Provision for federal income taxes have been calculated in accordance with
the provision of SFAS No. 109. A summary of the federal expense (benefit) in
the consolidated statements of income is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------
1996 1995 1994
------ ------ -------
(IN MILLIONS)
<S> <C> <C> <C>
Current............................................. $ 44.4 $ 54.4 $ 24.4
Deferred............................................ (8.0) (2.3) (20.5)
------ ------ -------
Total............................................. $ 36.4 $ 52.1 $ 3.9
====== ====== =======
</TABLE>
Deferred federal income tax assets and liabilities are comprised of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
DEFERRED FEDERAL INCOME TAX ASSETS
Discount of reserve for losses and loss adjustment expenses... $128.2 $125.3
Unearned premiums............................................. 53.9 52.7
Alternative minimum tax....................................... 16.3 9.8
Postretirement benefits....................................... 15.4 16.4
Pension benefits.............................................. 9.7 7.3
Other......................................................... 8.8 11.7
------ ------
Total deferred federal income tax assets.................... 232.3 223.2
====== ======
DEFERRED FEDERAL INCOME TAX LIABILITIES
Deferred policy acquisition expenses.......................... 57.5 55.1
Unrealized appreciation on available-for-sale securities...... 73.4 77.4
Other......................................................... 8.2 9.5
------ ------
Total deferred federal income tax liabilities............... 139.1 142.0
------ ------
Net deferred federal income tax asset......................... $ 93.2 $ 81.2
====== ======
</TABLE>
Management believes, based on the Company's recent earnings history and its
future expectations, that the Company's taxable income in future years will be
sufficient to realize all deferred tax assets. In determining the adequacy of
future income, management considered the future reversal of its existing
temporary differences and available tax planning strategies that could be
implemented, if necessary.
46
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The provision for federal income tax expense differs from the amount of
income tax determined by applying the applicable U.S. statutory federal income
tax rate (35%) to income before federal income taxes. The sources of the
difference and the tax effects of each were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1996 1995 1994
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Tax provision at statutory rate...................... $ 69.2 $ 72.2 $ 39.6
Tax-exempt interest.................................. (35.3) (32.2) (35.8)
Dividends received................................... (1.6) (2.3) (1.6)
Changes in tax reserve estimates..................... -- 12.8 --
Other, net........................................... 4.1 1.6 1.7
------ ------ ------
Federal income tax expense........................... $ 36.4 $ 52.1 $ 3.9
====== ====== ======
Effective tax rate................................... 18.4% 25.3% 3.5%
====== ====== ======
</TABLE>
The Company's federal income tax returns are routinely audited by the IRS,
and provisions are made in the financial statements in anticipation of the
results of these audits. The IRS has examined the Company's federal income tax
returns through 1991. The Company is currently considering its response to
certain adjustments proposed by the IRS with respect to the Company's federal
income tax returns for the years 1989 through 1991. If upheld, these
adjustments would result in additional payments; however, the Company will
vigorously defend its position with respect to these adjustments. In
management's opinion, adequate tax liabilities have been established for all
years. However, the amount of these tax liabilities could be revised in the
near term if estimates of the Company's ultimate liability are revised.
8. REINSURANCE
The Company maintains a reinsurance program designed to protect against
large or unusual losses and LAE activity. This includes both excess of loss
reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to
protect the ceding insurer from significant aggregate losses arising from a
single event such as windstorm, hail, hurricane, tornado, riot or other
extraordinary events. The Company determines the appropriate amount of
reinsurance based on the Company's evaluation of the risks accepted and
analysis prepared by consultants and reinsurers and on market conditions
including the availability and pricing of reinsurance. The Company has
reinsurance for casualty business. Under the 1996 casualty program, the
reinsurers are responsible for 100% of the amount of each loss in excess of
$1.0 million per occurrence up to $30.5 million for general liability and
workers' compensation. Additionally, this reinsurance covers workers'
compensation losses in excess of $30.5 million to $60.5 million per
occurrence. Under the Company's 1996 catastrophe reinsurance program, Hanover
and Citizens retain the first $25.0 million of loss per occurrence, all
amounts in excess of $180.0 million per occurrence and 10% of all aggregate
loss amounts in excess of $25.0 million up to $180.0 million. In addition,
Citizens retains 5% of losses in excess of $10.0 million, up to $25.0 million.
In 1996, Citizens purchased aggregate catastrophe coverage which reinsures 90%
of $5.0 million for aggregated catastrophe losses in excess of $5.0 million
which individually exceed $1.0 million. Under this aggregate catastrophe
coverage, Citizens is expected to recover $4.5 million. In the years ended
December 31, 1996, 1995 and 1994, the Company did not exceed the minimum
catastrophe levels, either individually or in the aggregate, to obtain
recovery under its reinsurance agreements, except as described above.
The Company cedes to reinsurers a portion of its risk and pays a fee based
upon premiums received on all policies subject to such reinsurance.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company. The
47
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Company determines the appropriate amount of reinsurance based on evaluation
of the risks accepted and analyses prepared by consultants and reinsurers and
on market conditions (including the availability and pricing of reinsurance).
The Company also 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, limit and retention, arbitration and
occurrence. Based on its review of its reinsurers' financial statements and
reputations in the reinsurance marketplace, the Company believes that its
reinsurers are financially sound.
The Company is subject to concentration of risk with respect to reinsurance
ceded to various residual market mechanisms. As a condition to the ability to
conduct certain business in various states, the Company is required to
participate in various residual market mechanisms and pooling arrangements
which provide various insurance coverages to individuals or other entities
that are otherwise unable to purchase such coverage voluntarily provided by
private insurers. These market mechanisms and pooling arrangements include the
Massachusetts Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers'
Compensation Residual Market Pool ("MWCRP") and the Michigan Catastrophic
Claims Association ("MCCA"). At December 31, 1996, the MCCA and CAR were the
only two reinsurers which represented 10% or more of the Company's reinsurance
business. As a servicing carrier in Massachusetts, the Company cedes a
significant portion of its private passenger and commercial automobile
premiums to CAR. Net premiums earned and losses and loss adjustment expenses
ceded to CAR for the years ended December 31, 1996, 1995 and 1994 were $38.0
million and $21.8 million, $49.1 million and $33.7 million, and $50.0 million
and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool, which is administered by The
National Council on Compensation Insurance ("NCCI"). The Company is currently
involved in legal proceedings regarding the MWCRP's deficit which through a
legislated settlement issued on June 23, 1995 provided for an initial funding
of $220.0 million, of which the insurance carriers were responsible for $65.0
million. Hanover paid its allocation of $4.2 million in December 1995. Some of
the smaller carriers appealed this decision. The Company's right to recover
reinsurance balances for claims properly paid is not at issue in any such
proceedings. The Company expects to collect its reinsurance balance; however,
funding of the cash flow needs of the MWCRP may in the future be affected by
issues related to certain litigation, the outcome of which the Company cannot
predict.
The Company ceded to MCCA premiums earned and losses and loss adjustment
expenses for the years ended December 31, 1996, 1995 and 1994 of $50.5 million
and $(52.9) million, $66.8 million and $62.9 million, and $80.0 million and
$24.2 million, respectively. Because the MCCA is supported by assessments
permitted by statute, and all amounts billed by the Company to CAR, MWCRP and
MCCA have been paid when due, the Company believes that it has no significant
exposure to uncollectible reinsurance balances.
48
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Net written and earned premiums and losses and LAE incurred included
reinsurance activity as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
NET PREMIUMS WRITTEN
Direct................................... $ 2,039.7 $ 2,039.4 $ 1,992.4
Assumed.................................. 108.7 125.0 128.6
Ceded.................................... (234.0) (279.1) (298.1)
---------- ---------- ----------
Net premiums written..................... $ 1,914.4 $ 1,885.3 $ 1,822.9
========== ========== ==========
NET PREMIUMS EARNED
Direct................................... $ 2,018.5 $ 2,021.7 $ 1,967.1
Assumed.................................. 112.4 137.7 116.1
Ceded.................................... (232.6) (296.2) (291.9)
---------- ---------- ----------
Net premiums earned...................... $ 1,898.3 $ 1,863.2 $ 1,791.3
========== ========== ==========
LOSSES AND LAE INCURRED
Direct................................... $ 1,288.3 $ 1,372.7 $ 1,364.4
Assumed.................................. 85.8 146.1 102.7
Ceded.................................... (2.2) (229.1) (160.4)
---------- ---------- ----------
Losses and LAE incurred.................. $ 1,371.9 $ 1,289.7 $ 1,306.7
========== ========== ==========
</TABLE>
Reinsurance recoverable on paid and unpaid losses and ceded prepaid premiums
were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------------------
UNPAID PAID PREPAID
LOSSES LOSSES TOTAL PREMIUMS
------ ------ ------ --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
MCCA........................................... $287.7 $ 4.3 $292.0 $ --
NCCI........................................... 63.0 6.0 69.0 --
CAR............................................ 64.9 10.1 75.0 17.4
Other.......................................... 211.3 21.9 233.2 28.1
------ ----- ------ -----
Total........................................ $626.9 $42.3 $669.2 $45.5
====== ===== ====== =====
<CAPTION>
DECEMBER 31, 1995
-----------------------------
UNPAID PAID PREPAID
LOSSES LOSSES TOTAL PREMIUMS
------ ------ ------ --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
MCCA........................................... $353.3 $ 1.7 $355.0 $ --
NCCI........................................... 96.0 6.6 102.6 --
CAR............................................ 62.7 20.7 83.4 18.7
Other.......................................... 251.5 14.9 266.4 25.1
------ ----- ------ -----
Total........................................ $763.5 $43.9 $807.4 $43.8
====== ===== ====== =====
</TABLE>
9. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company regularly updates its reserve estimates as new information
becomes available and further events occur which may impact the resolution of
unsettled claims. Changes in prior reserve estimates are reflected in results
of operations in the year such changes are determined to be needed and
recorded.
49
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE for the years ended December 31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Reserve for losses and LAE, beginning of
year........................................ $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of current
year...................................... 1,513.3 1,427.3 1,434.8
Decrease in provision for insured events of
prior years............................... (141.4) (137.6) (128.1)
-------- -------- --------
Total incurred losses and LAE............ 1,371.9 1,289.7 1,306.7
-------- -------- --------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured
events of current year.................... 759.6 652.2 650.2
Losses and LAE attributable to insured
events of prior years..................... 627.6 614.3 566.9
-------- -------- --------
Total payments........................... 1,387.2 1,266.5 1,217.1
-------- -------- --------
Change in reinsurance recoverable on unpaid
losses...................................... (136.6) 51.1 14.8
-------- -------- --------
Reserve for losses and LAE, end of year...... $2,744.1 $2,896.0 $2,821.7
======== ======== ========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $141.4 million, $137.6 million and
$128.1 million in 1996, 1995, and 1994, respectively. The increase in
favorable development on prior years' reserves of $3.8 million in 1996 results
primarily from an $11.4 million increase in favorable development at Citizens.
The increase in Citizens' favorable development of $11.4 million in 1996
reflects improved severity in the personal automobile line, where favorable
development increased $28.6 million to $33.0 million in 1996, partially offset
by less favorable development in the workers' compensation line. In 1995, the
workers' compensation line had favorable development of $32.7 million,
primarily as a result of Citizens re-estimating reserves to reflect the new
claims cost management programs and the Michigan Supreme Court ruling, which
decreases the maximum to be paid for indemnity cases on all existing and
future claims. In 1996, the favorable development in the workers' compensation
line of $21.8 million also reflected these developments. Hanover's favorable
development, including voluntary and involuntary pools, decreased $7.7 million
in 1996 to $82.9 million, primarily attributable to a decrease in favorable
development in the workers' compensation line of $19.8. This decrease is
primarily attributable to a re-estimate of reserves with respect to certain
types of workers' compensation policies including large deductibles and excess
of loss policies. In addition, during 1995 Hanover refined its estimation of
unallocated loss adjustment expenses which increased favorable development in
that year. Favorable development in the personal automobile line also
decreased $4.7 million, to $42.4 million in 1996. These decreases were offset
by increases in favorable development of $1.9 million and $5.6 million, to
$12.6 million and $5.7 million, in the commercial automobile and commercial
multiple peril lines, respectively. Favorable development in other lines
increased by $8.8 million, primarily as a result of environmental reserve
strengthening in 1995. Favorable development in Hanover's voluntary and
involuntary pools increased $3.7 million to $4.1 million during 1996.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal
automobile and workers' compensation lines increased $16.6 million and $15.5
million, to favorable development of $4.4 million and $32.7 million,
respectively, due to the aforementioned change in claims cost management and
the Michigan Supreme Court ruling. Hanover's favorable development, not
including the effect of voluntary and involuntary pools, was relatively
unchanged at $90.2 million in 1995 compared to $91.7 million
50
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in 1994. Favorable development in Hanover's workers' compensation line
increased $27.7 million to $31.0 million during 1995. This was offset by
decreases of $14.6 million and $12.6 million, to $45.5 million and $0.1
million, in the personal automobile and commercial multiple peril lines,
respectively. Favorable development in Hanover's voluntary and involuntary
pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future.
Due to the nature of the business written by the Company, the exposure to
environmental liabilities is relatively small and therefore its reserves are
relatively small compared to other types of liabilities. Loss and LAE reserves
related to environmental damage and toxic tort liability, included in the
reserve for losses and LAE were $50.8 million and $43.2 million, net of
reinsurance of $20.2 million and $8.4 million in 1996 and 1995, respectively.
During 1995, the Company redefined its environmental liabilities in conformity
with new guidelines issued by the NAIC. This had no impact on results of
operations. The Company does not specifically underwrite policies that include
this coverage, but as case law expands policy provisions and insurers'
liability beyond the intended coverage, the Company may be required to defend
such claims. During 1995, Hanover performed an actuarial review of its
environmental reserves. This resulted in Hanover's providing additional
reserves for "IBNR" (incurred but not reported) claims, in addition to
existing reserves for reported claims. Although these claims are not material,
their existence gives rise to uncertainty and is discussed because of the
possibility, however remote, that they may become material. The Company
believes that, notwithstanding the evolution of case law expanding liability
in environmental claims, recorded reserves related to these claims are
adequate. In addition, the Company is not aware of any litigation or pending
claims that may result in additional material liabilities in excess of
recorded reserves. The environmental liability could be revised in the near
term if the estimates used in determining the liability are revised.
10. PENSION PLANS
The Company provides retirement benefits to substantially all of its
employees, under two separate defined benefit pension plans. Through December
31, 1994, retirement benefits were based primarily on employees' years of
service and compensation during the highest five consecutive plan years of
employment. Benefits under this defined benefit formula were frozen for most
employees effective December 31, 1994. In their place, the Company adopted a
defined benefit cash balance formula, under which the Company annually
provides a contribution to each eligible employee as a percentage of that
employee's salary, similar to a defined contribution plan arrangement. The
1996 and 1995 contributions were based on 7% of each eligible employee's
salary. The Company's policy for the plans is to fund at least the minimum
amount required by the Employee Retirement Income Security Act of 1974.
Net pension expense included the following components:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
---------------------
1996 1995 1994
------ ------ -----
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits earned......................... $ 11.0 $ 10.9 $ 6.4
Interest cost on projected benefit obligation......... 8.2 6.7 6.4
Actual return on plan assets.......................... (12.2) (29.3) (0.7)
Net amortization and deferral......................... (0.4) 19.2 (6.7)
------ ------ -----
Net pension expense................................. $ 6.6 $ 7.5 $ 5.4
====== ====== =====
</TABLE>
51
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes the combined funded status of the two pension
plans and the amounts recognized in the Company's financial statements.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
ACTUARIAL PRESENT VALUE OF BENEFIT OBLIGATIONS
Vested benefit obligation................................... $118.9 $116.4
Unvested benefit obligation................................. 4.1 2.6
------ ------
Accumulated benefit obligation............................ $123.0 $119.0
====== ======
PENSION LIABILITY INCLUDED IN CONSOLIDATED BALANCE SHEETS
Projected benefit obligation................................ $132.5 $130.5
Plan assets at fair value................................... 122.0 114.5
------ ------
Plan assets less than projected benefit obligation........ (10.5) (16.0)
Unrecognized net loss from past experience.................. 3.0 22.4
Unrecognized prior service benefit.......................... (14.3) (17.8)
Unamortized transition asset................................ (9.1) (9.6)
------ ------
Net pension liability..................................... $(30.9) $(21.0)
====== ======
</TABLE>
Determination of the projected benefit obligations was based on a weighted
average discount rate of 7.0% at December 31, 1996 and 1995. The assumed long-
term rate of return on plan assets was 9% for both years. The actuarial
present value of the projected benefit obligations was determined using
assumed rates of increase in future compensation levels of 5.5% to 6.5%. Plan
assets are invested primarily in various separate accounts and the general
account of FAFLIC. The plans also hold stock of AFC. At December 31, 1996 and
1995, each plan's projected benefit obligation exceeded its plans assets.
The Company's major subsidiaries, The Hanover Insurance Company and Citizens
Insurance Company of America, have 401(k) and incentive compensation plans for
their eligible employees. The Company also had a profit sharing plan which was
discontinued in 1994 and a match feature was added to the continuing 401(k)
plan. The total cost of the incentive compensation plans in 1996, 1995 and
1994 was $3.2 million, $3.0 million and $3.8 million, respectively. The total
cost under the profit sharing and 401(k) plans in 1996, 1995 and 1994 was $4.0
million, $3.7 million and $6.4 million, respectively.
11. POSTRETIREMENT BENEFIT PLANS
In addition to the Company's pension plans, the Company provides
postretirement medical and death benefits to certain full-time employees and
dependents, under plans sponsored by Hanover and Citizens. Generally employees
become eligible at age 55 with at least 15 years of service. Spousal coverage
is generally provided for up to two years after death of retiree. Benefits
include hospital, major medical and a payment at death equal to retirees'
final compensation up to certain limits. Effective January 1, 1996, the
Company revised these benefits so as to establish limits on future benefit
payments, restrict eligibility for current employees and eliminate eligibility
for new employees. The medical plans have varying co-payments and deductibles,
depending on the plan. The life insurance plan is a non-contributory plan.
These plans are unfunded.
The plan changes effective January 1, 1996 resulted in a negative plan
amendment (change in eligibility and medical benefits) of $18.5 million and
curtailment (no future increases in life insurance) of $3.2 million. The
negative plan amendment will be amortized as prior service cost over the
average number of years to full eligibility (approximately 9 years or $2.0
million per year). Of the $3.2 million curtailment gain, $1.2 million
52
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
has been deducted from unrecognized loss and $2.0 million has been recorded as
a reduction of net periodic postretirement benefit expense.
The components of net periodic postretirement benefits expenses were as
follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1996 1995 1994
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost........................................... $ 1.5 $ 2.5 $ 2.8
Interest cost.......................................... 1.8 3.0 3.0
Net amortization and deferral.......................... (2.0) (0.5) 0.3
------ ------ -----
Net periodic postretirement benefit expense.......... $ 1.3 $ 5.0 $ 6.1
====== ====== =====
</TABLE>
The plan's status and the amounts recognized in the Company's consolidated
balance sheets were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees..................................................... $ 14.6 $ 15.1
Other fully eligible plan participants....................... 3.2 7.6
Other active plan participants............................... 10.4 24.7
------ ------
Accumulated postretirement benefit obligation................ 28.2 47.4
Unrecognized prior service cost.............................. 16.4 --
Unrecognized loss............................................ (0.6) (1.5)
------ ------
Accrued postretirement benefit cost.......................... $ 44.0 $ 45.9
====== ======
</TABLE>
For purposes of measuring the accumulated postretirement benefit obligation
at December 31, 1996, health care costs were assumed to decrease 9.0% in 1997,
declining thereafter until the ultimate rate of 5.5% is reached in 2001 and
remaining at that level thereafter. The health care cost trend rate assumption
has a significant effect on the amounts reported. To illustrate, increasing
the assumed health care cost trend rates by 1% in each year would increase the
medical accumulated postretirement benefit obligation as of December 31, 1996
by $1.6 million, or 8.5%, and the aggregate of the service and interest cost
components of annual net periodic postretirement benefit expense by $0.2
million or 9.6%.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0% as of December 31, 1996 and 1995.
The assumed rate of future annual salary increases was 5.5% at both valuation
dates.
12. POSTEMPLOYMENT BENEFITS
Effective January 1, 1994, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 112 (SFAS No. 112), "Employers'
Accounting for Postemployment Benefits," which requires employers to recognize
the costs and obligations of severance, disability and related life insurance
and health care benefits to be paid to inactive or former employees after
employment but before retirement. Prior to adoption, the Company had
recognized the cost of these benefits on an accrual or paid basis, depending
on the plan. Implementation of SFAS No. 112 resulted in a transition
obligation of $2.0 million, net of deferred federal
53
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
income taxes, and is reported as a cumulative effect of a change in accounting
principle in the consolidated statement of income. The 1996, 1995 and the 1994
expenses after recognition of the cumulative effect, are not significant.
13. STOCK OPTION PLANS
In October 1995, the FASB issued Statement of Financial Accounting Standards
(SFAS No. 123) "Accounting for Stock-Based Compensation." The standard is
effective for fiscal years beginning after December 15, 1995, and requires the
Company either to apply a fair value measure to any stock-based compensation
granted by the Company after December 31, 1994, or continue to apply the
valuation provisions of existing accounting standards, but with pro-forma net
income and earnings per share disclosures using a fair value methodology to
value the stock-based compensation. Beginning for the year ended December 31,
1996, the Company has elected to continue to apply the valuation provisions of
existing accounting standards (APB No. 25). The pro-forma effect of applying
SFAS No. 123 is not material.
Effective May 17, 1995, the Company adopted a Long Term Stock Incentive Plan
(the "Employees' Plan"). Key employees of the Company and its subsidiaries are
eligible for awards pursuant to the Plan administered by the Compensation
Committee of the Board of Directors (the "Committee") of the Company. Under
the terms of the Employees' Plan, options may be granted to eligible employees
at a price not less than the market price of the Company's common stock on the
date of grant. At December 31, 1996, 78,800, 92,000 and 3,000 option shares
were outstanding at an option price of $21.00, $25.50 and $26.625 per share,
respectively. At December 31, 1995, 110,000 option shares were outstanding at
an option price of $21.00 per share. Option shares may be exercised subject to
the terms prescribed by the Committee at the time of grant, otherwise options
vest at the rate of 20% annually for five consecutive years and must be
exercised not later than ten years from the date of grant. During 1996, there
were 6,000 options exercised. There were no options exercised in 1995. At
December 31, 1996, there were 14,800 options exercisable and 820,200 option
shares were available for future grant.
14. RELATED PARTY TRANSACTIONS
The Company has agreements under which FAFLIC provides management, space and
other services including accounting, electronic data processing, human
resources, legal and other staff functions. Charges for these services are
based on full cost including all direct and indirect overhead costs, and
amounted to $59.3 million, $52.1 million and $64.4 million in 1996, 1995 and
1994, respectively.
Hanover leases office space from FAFLIC under a lease agreement which
expires December 31, 2010. The annual lease cost was $1.0 million during each
of the years ended December 31, 1996, 1995 and 1994, respectively. The annual
lease cost of this agreement is included within the amount of charges above
for 1996, 1995 and 1994, respectively. Amgro leases office space from FAFLIC
as a tenant at will. The annual lease cost was $0.3 million during each of the
years ended December 31, 1996, 1995 and 1994, respectively and is included in
the charges above.
15. LEASE COMMITMENTS
Excluding related party occupancy and lease costs, the Company has certain
operating lease arrangements for property and equipment. As of December 31,
1996, future minimum rental payments under non-cancelable, long-term operating
leases were approximately $44.9 million payable as follows: 1997--$14.7
million; 1998--$11.7 million; 1999--$8.5 million; 2000--$5.7 million; 2001--
$2.9 million; and $1.4 million thereafter. All leases expire prior to the year
2005.
54
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
It is expected that, in the normal course of business, leases that expire
will be renewed or replaced by leases on other property and equipment; thus,
it is anticipated that future minimum lease commitments will not be less than
the amounts shown for 1997. Certain equipment and fixtures leases are subject
to buyout options. Rent expense, excluding related party charges, was $16.7
million, $19.2 million and $20.6 million in 1996, 1995 and 1994, respectively.
16. CONTINGENCIES
Litigation
On June 23, 1995, the governor of Maine approved a legislative settlement
for the Maine Workers' Compensation Residual Market Pool deficit for the Years
1988 through 1992. The settlement provides for an initial funding of $220.0
million toward the deficit. The insurance carriers were liable for $65.0
million and employers would contribute $110.0 million payable through
surcharges on premiums over the course of the next ten years. The major
insurers are responsible for 90% of the $65.0 million. Hanover's allocated
share of the settlement is approximately $4.2 million, which was paid in
December 1995. The remainder of the deficit of $45.0 million will be paid by
the Maine Guaranty Fund, payable in quarterly contributions over ten years. A
group of smaller carriers filed litigation to appeal the settlement. The
Company believes that adequate reserves have been established for any
additional liability.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the opinion of management, based
on the advice of legal counsel, the ultimate resolution of these proceedings
will not have a material effect on the Company's consolidated financial
statements. However, liabilities related to these proceedings could be
established in the near term if estimates of the ultimate resolution of these
proceedings are revised.
17. DIVIDEND RESTRICTIONS
New Hampshire and Michigan limit the payment of dividends and other
distributions to shareholders. Under current law, extraordinary dividends and
other distributions may only be paid from statutory policyholders' surplus,
excluding dividends paid, as of the December 31st preceding. An extraordinary
dividend or distribution includes any dividend or distribution of cash or
other property, whose fair market value together with that of other dividends
or distributions made within the preceding 12 months exceeds 10% of such
insurers surplus as regards policyholders as of December 31, next preceding.
Based on the 1996 statutory financial statements of Hanover, the maximum
dividend that may be paid to Allmerica P&C at January 1, 1997, without prior
approval from the New Hampshire Commissioner of Insurance, is $15.4 million,
which considers dividends declared to Allmerica P&C of $105.0 million during
1996, including $80.0 million which was declared in December. On January 2,
1997, Hanover declared an extraordinary dividend in the amount of $120.0
million, payable on or after January 21, 1997 to Allmerica P&C. The dividend
which was approved by the New Hampshire Insurance Department on January 9,
1997, is to be paid in a lump sum or in such installments as Allmerica P&C, in
its discretion may determine.
Under the Michigan Insurance Code, cash dividends may be paid by Citizens
Insurance only from earnings and policyholders' surplus. In addition, a
Michigan insurer may not pay an "extraordinary" dividend to its stockholders
without the prior approval of the Michigan Insurance Commissioner. An
extraordinary dividend or distribution is defined as a dividend or
distribution of cash or other property whose fair market value, together with
that of other dividends and distributions made within the preceding 12 months,
exceeds the greater of 10% of policyholders' surplus as of December 31 of the
preceding year or the statutory net income less realized gains, for the
immediately preceding calendar year. At January 1, 1997, Citizens Insurance
could pay dividends of $39.9 million without approval of the Michigan
Insurance Commissioner.
55
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. SEGMENT INFORMATION
The Company is engaged primarily in the property and casualty insurance
business and operates in the United States. Substantially all of the Company's
earnings are generated in Michigan at Citizens and the Northeast (Connecticut,
Massachusetts, New York, New Jersey, New Hampshire, Rhode Island, Vermont and
Maine) at Hanover. The Company's insurance operations are segmented into
personal and commercial lines of business, based on common underlying risks
and customer types for individual products in those segments. The personal
segment includes products such as automobile insurance and homeowners
insurance. The commercial segment includes products such as automobile
insurance, commercial multiple-peril insurance, and workers' compensation
insurance. Investments are available for payments of claims and expenses for
all products. Investment income, realized gains and total assets have not been
identified to specific segments.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
INCOME
BEFORE
NET FEDERAL
PREMIUMS INVESTMENT REALIZED UNDERWRITING INCOME TOTAL
EARNED INCOME GAIN (LOSS) PROFIT (LOSS) TAXES ASSETS
-------- ---------- ----------- ------------- ------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
1996
Hanover
Personal...... $ 607.3 $(47.2)
Commercial.... 455.5 (41.7)
-------- ------ ----- ------ ------ --------
Total....... $1,062.8 $146.5 $33.1 $(88.9) $ 92.2 $3,200.9
======== ====== ===== ====== ====== ========
Citizens
Personal...... $ 554.6 $ (1.3)
Commercial.... 280.9 2.0
-------- ------ ----- ------ ------ --------
Total....... $ 835.5 $ 88.9 $15.0 $ (0.7) $105.5 $2,503.0
======== ====== ===== ====== ====== ========
1995
Hanover
Personal...... $ 577.1 $ 23.6
Commercial.... 468.3 (62.6)
-------- ------ ----- ------ ------ --------
Total....... $1,045.4 $130.8 $10.8 $(39.0) $109.7 $3,271.0
======== ====== ===== ====== ====== ========
Citizens
Personal...... $ 536.2 $(26.6)
Commercial.... 281.6 40.0
-------- ------ ----- ------ ------ --------
Total....... $ 817.8 $ 78.8 $ 3.8 $ 13.4 $ 96.6 $2,470.8
======== ====== ===== ====== ====== ========
1994
Hanover
Personal...... $ 548.2 $ 6.3
Commercial.... 480.4 (76.0)
-------- ------ ----- ------ ------ --------
Total....... $1,028.6 $127.6 $ 4.6 $(69.7) $ 67.8 $3,075.2
======== ====== ===== ====== ====== ========
Citizens
Personal...... $ 496.1 $(32.3)
Commercial.... 266.6 1.6
-------- ------ ----- ------ ------ --------
Total....... $ 762.7 $ 74.8 $(1.1) $(30.7) $ 45.3 $2,333.5
======== ====== ===== ====== ====== ========
</TABLE>
56
<PAGE>
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
19. QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)
A summary of unaudited quarterly results of consolidated operations for
1996, 1995 and 1994 is presented below:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED, 1996
-------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
--------- --------- --------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................. $ 563.3 $ 532.3 $ 539.3 $ 558.8
Net income..................... $ 49.6 $ 28.6 $ 40.8 $ 27.4
Net income per share........... $ 0.82 $ 0.48 $ 0.68 $ 0.46
Dividends declared per share... $ 0.04 $ 0.04 $ 0.04 $ 0.04
<CAPTION>
FOR THE THREE MONTHS ENDED, 1995
-------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
--------- --------- --------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................. $ 512.8 $ 516.8 $ 540.3 $ 525.2
Net income..................... $ 32.7 $ 36.4 $ 43.1 $ 27.9
Net income per share........... $ 0.53 $ 0.59 $ 0.70 $ 0.46
Dividends declared per share... $ 0.04 $ 0.04 $ 0.04 $ 0.04
<CAPTION>
FOR THE THREE MONTHS ENDED, 1994
-------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
--------- --------- --------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................. $ 494.2 $ 496.8 $ 509.0 $ 504.8
(Loss) income before cumulative
effect of a change in
accounting.................... $ (8.5) $ 28.8 $ 49.5 $ 31.4
Cumulative effect of a change
in accounting................. $ (2.0) -- -- --
Net (loss) income.............. $ (10.5) $ 28.8 $ 49.5 $ 34.1
(Loss) income before cumulative
effect of a change in
accounting per share.......... $ (0.14) $ 0.47 $ 0.80 $ 0.51
Cumulative effect of a change
in accounting per share....... $ (0.03) -- -- --
Net income (loss) per share.... $ (0.17) $ 0.47 $ 0.80 $ 0.51
Dividends declared per share... $ 0.04 $ 0.04 $ 0.04 $ 0.04
</TABLE>
- - --------
Note: Due to the use of weighted average shares outstanding when calculating
earnings per share, the sum of the quarterly per share data may not equal the
per share data for the year.
57
<PAGE>
PART III
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE.
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS OF THE REGISTRANT
Set forth below is biographical information concerning the directors of the
Company.
MICHAEL P. ANGELINI, 54
Director since 1992
Mr. Angelini is a partner in the law firm of Bowditch & Dewey, Worcester,
Massachusetts, with which he has been associated since 1968. Mr. Angelini is
also a Director of Allmerica Financial Corporation ("AFC"), which, through a
wholly-owned subsidiary, owns 59.5% of the Company's outstanding Common Stock.
DAVID A. BARRETT, 69
Director since 1992
Audit Committee
From October 1988 to April 1992, Mr. Barrett was President and Chief
Executive Officer of Medical Center of Central Mass., Inc. (health care
systems), Worcester, Massachusetts. He is currently a consultant to that
organization, now known as Memorial Health Care. He is also a Director of AFC.
JAMES A. COTTER, JR., 57
Director since 1996
Mr. Cotter has been a broker with the firm of H.C. Wainwright & Co. since
January 1994, and previously was a broker with the firm of Gruntal & Co. (June
1993--January 1994). He previously served as a Managing Director and Treasurer
of Schooner Trading Company. Mr. Cotter is also Chairman of Olde Port Bank and
Trust of Portsmouth, New Hampshire and a Director of Citizens Corporation, a
subsidiary of the Company.
GAIL L. HARRISON, 49
Director since 1992
Ms. Harrison is a Founding Principal of The Wexler Group (formerly Wexler,
Reynolds, Harrison & Shule, Inc.), a government relations consulting firm in
Washington, DC, and has been affiliated with that organization since February
1981. Ms. Harrison is also a Director of AFC.
M HOWARD JACOBSON, 63
Director since 1992
Audit Committee, Chair
Mr. Jacobson has been a Senior Advisor of, and Consultant to, Bankers Trust,
Private Bank, New York, New York since 1991. From August 1989 to August 1991,
he was a Senior Advisor to Prudential-Bache Capital Funding. Mr. Jacobson is
also a Director of Boston Chicken, Inc. and Wyman-Gordon Co.
58
<PAGE>
DONA SCOTT LASKEY, 53
Director since 1992
Audit Committee
Ms. Laskey is an attorney in private practice. From 1989 until December
1995, she practiced law with the firm of Tillman, McTier, Coleman, Talley,
Newbern & Kurrie, in Valdosta, Georgia. She is also a Director of the
Company's subsidiary, Citizens Corporation, and of FNB Bancorp, Inc.
JOHN F. O'BRIEN, 53
President and Chief Executive Officer and Director of the Company since 1992
John F. O'Brien has been a Director, President and Chief Executive Officer
of Allmerica P&C since August 1992, and has been a Director of Hanover since
September 1989, Citizens Insurance since March 1992 and Citizens, for which he
also serves as Chief Executive Officer, since December 1992. In addition, Mr.
O'Brien has served as a Director, Chief Executive Officer and President of
Allmerica Financial Corporation ("AFC") since February 1995 and a Director,
Chief Executive Officer and President of First Allmerica Financial Life
Insurance Company ("FAFLIC") since August 1989. Mr. O'Brien is also a trustee
or director and executive officer of Allmerica Investment Trust, Allmerica
Securities Trust, and Allmerica Funds. Additionally, Mr. O'Brien is a director
and/or holds offices at various other non-public FAFLIC affiliates including
SMA Financial Corp. and Allmerica Financial Life Insurance and Annuity
Company. Mr. O'Brien also currently serves as a Director of ABIOMED, Inc., a
medical device company, Cabot Corporation, a diversified specialty chemicals
and materials and energy company, the TJX Companies, Inc., an off-price family
apparel retailer, the Life Insurance Association of Massachusetts, and the
American Council of Life Insurance. He also currently serves as a member of
the executive committee of the Mass Capital Resource Company, a Massachusetts
investment partnership. Prior to joining FAFLIC, Mr. O'Brien served as an
officer of FMR Corp., the parent company of various financial services
companies in the Fidelity Group, and a director and/or an executive officer at
various other of FMR Corp.'s affiliates.
ERIC A. SIMONSEN, 51
Vice President and Director of the Company since 1992
Eric A. Simonsen has been a Director and Vice President of APY since August
1992, of Citizens since December 1992 and of AFLIAC since September 1990 and
was Chief Financial Officer of the Company from August 1992 to December 1996,
of Citizens from December 1992 to December 1996 and of FAFLIC and AFLIAC from
September 1990 to December 1996. He has been a Vice President of AFC since
February 1995 and was Chief Financial Officer from February 1995 to December
1996. In addition, Mr. Simonsen has been Vice President and a Director of
FAFLIC since September 1990, and April 1996, respectively, and has been
President of Allmerica Service Company, Inc. since December 1996. Mr. Simonsen
is also a director and/or executive officer at various other non-public
affiliates. From April 1987 to September 1990, Mr. Simonsen served as
Principal and Chief Financial Officer of The Lincoln Group, Inc., a privately
owned group of manufacturing companies.
ROBERT G. STACHLER, 67
Director since 1992
Mr. Stachler has been a partner at the law firm of Taft, Stettinius &
Hollister, Cincinnati, Ohio since 1964. He is also a Director of AFC.
HERBERT M. VARNUM, 59
Director since 1992
Compensation Committee, Chairman
Mr. Varnum served as Chairman and Chief Executive Officer of Quabaug
Corporation (manufacturers of rubber products) in North Brookfield,
Massachusetts, from January 1990 to his retirement in June 1995. He is also a
Director of AFC.
59
<PAGE>
RICHARD M. WALL, 68
Director since 1992
Compensation Committee
Mr. Wall has been General Counsel and Assistant to the Chairman and Chief
Executive Officer of FLEXcon Co., Inc. (plastics manufacturing company) in
Spencer, Massachusetts since November 1985. He is also a Director of AFC.
COMPENSATION OF DIRECTORS
Directors who are not officers or employees of the Company, Hanover,
Citizens Insurance or other affiliated companies receive $20,000 as an annual
retainer ($30,000 in the case of individuals who are Directors of both the
Company and AFC), $1,500 for each Board meeting attended and $1,000 for each
Committee meeting attended, in addition to reimbursable expenses for each
meeting attended. Directors who are salaried employees of FAFLIC or of any
affiliate or subsidiary receive no additional compensation for their services
as Directors of the Company.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires executive
officers and Directors, and persons who beneficially own more than ten percent
(10%) of the Common Stock, to file initial reports of ownership and reports of
changes in ownership with the Securities and Exchange Commission ("SEC") and
the New York Stock Exchange. Such persons are required by SEC regulations to
furnish the Company copies of all their Section 16(a) filings. Based solely on
a review of the forms furnished to the Company and written representations
from the executive officers and Directors, the Company believes that during
1996 there was full compliance with all Section 16(a) filing requirements.
60
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is biographical information concerning the executive
officers of the Company. Officers of the Company hold office until the first
meeting of the Board of Directors following the next annual meeting of the
stockholders and until their respective successor is chosen and qualified
unless a shorter period is specified by the terms of their election or
appointment.
JOHN F. O'BRIEN, 53
President and Chief Executive Officer and Director of the Company since 1992
See Mr. O'Brien's biography in "Directors of the Registrant" above.
BRUCE ANDERSON, 53
Vice President of the Company since 1997
Bruce C. Anderson has been Vice President of the Company since March 1997.
Mr. Anderson has also been Vice President of AFC and Citizens since February
1995 and March 1997, respectively. Mr. Anderson has been employed by FAFLIC
since 1967 and has been Vice President of FAFLIC since October 1984.
RICHARD J. BAKER, 65
Vice President and Secretary of the Company since 1995
Richard J. Baker has been Vice President and Secretary of the Company since
May 1995, and as Assistant Secretary from October 1992 to May 1995. Mr. Baker
has also been Vice President and Secretary of AFC since February 1995, Vice
President and Assistant Secretary of FAFLIC since 1973 and April 1996,
respectively, and has been employed by FAFLIC since 1959. He has also served
as Vice President and Secretary of Citizens since September 1993 and January
1993, respectively, Vice President of AFLIAC since January 1982 and as a
Director of AFLIAC from June 1993 to April 1996. In addition, Mr. Baker is a
director and/or executive officer at various other non-public affiliates.
JOHN P. KAVANAUGH, 42
Vice President and Chief Investment Officer of the Company since 1996
John P. Kavanaugh has been Vice President and Chief Investment Officer of
APY since September 1996, has been employed by FAFLIC since 1983, has been
Vice President of FAFLIC since December 1991 and Vice President of AFLIAC
since January 1992. Mr. Kavanaugh has also served as Director and Chief
Investment Officer of FAFLIC, Hanover, Citizens Insurance and AFLIAC since
August 1996, and Vice President and Chief Investment Officer of AFC and
Citizens since September 1996. Mr. Kavanaugh is also a director and/or
executive officer at various other non-public affiliates.
JOHN F. KELLY, 58
Vice President and General Counsel of the Company since 1992
John F. Kelly has been Vice President and General Counsel of Allmerica P&C
since August 1992, Assistant Secretary of Allmerica P&C since May 1995,
Assistant Secretary of Citizens since December 1992, and Vice President and
General Counsel of Citizens since September 1993. Mr. Kelly has been Vice
President, Assistant Secretary and General Counsel of AFC since February 1995,
has been employed by FAFLIC since July 1968, and has been Senior Vice
President and General Counsel of FAFLIC since February 1986. Mr Kelly served
as Secretary of Allmerica P&C from August 1992 to May 1995. In addition to his
positions with AFC and FAFLIC, Mr. Kelly has been a Director of AFLIAC since
October 1982, of Citizens Insurance since April 1996 and is a director and/or
executive officer at various other non-public affiliates.
61
<PAGE>
J. BARRY MAY, 49
Vice President of the Company since 1996
J. Barry May has been Vice President of APY and President of Hanover since
September 1996, and has been a Director of Hanover and Citizens Insurance
since September 1996. Mr. May has been Vice President of AFC and Citizens
since February 1997 and March 1997, respectively. Mr. May served as Vice
President of Hanover from May 1995 to September 1996, as Regional Vice
President from February 1993 to May 1995 and as a General Manager of Hanover
from June 1989 to May 1995. Mr. May has been employed by Hanover since 1985.
JAMES R. MCAULIFFE, 52
Vice President of the Company since 1992
James R. McAuliffe has been President of Citizens Insurance since December
1994. Mr. McAuliffe has been employed by FAFLIC since 1968, and served as Vice
President and Chief Investment Officer of FAFLIC from November 1986 through
December 1994. Mr. McAuliffe was a Vice President of AFC from February 1995 to
December 1995 and since February 1997, a Director of APY from August 1992
through December 1994, a Director and Vice President of Citizens since
December 1992, and a Director of AFLIAC from April 1987 through May 1995 and
since May 1996. Mr. McAuliffe also served as Vice President and Chief
Investment Officer of AFLIAC from December 1986 through May 1995, and Vice
President and Chief Investment Officer of APY from August 1992 through
December 1994. Additionally, Mr. McAuliffe is a director and/or executive
officer at various other non-public affiliates.
EDWARD J. PARRY, III, 37
Chief Financial Officer of the Company since 1996 and Vice President and
Treasurer of the Company since 1993
Edward J. Parry, III has been Chief Financial Officer of the Company since
December 1996 and Vice President and Treasurer of Allmerica P&C since February
1993 and of Citizens since September 1993 and December 1992, respectively, and
Chief Financial Officer of Citizens since December 1996. Mr. Parry has been
Vice President and Treasurer of FAFLIC and AFLIAC since February 1993 and of
AFC since February 1995, and Chief Financial Officer of AFC, FAFLIC, AFLIAC,
Hanover and Citizens Insurance since December 1996. Mr. Parry is also a
director and/or executive officer at various other non-public affiliates.
Prior to joining FAFLIC in July 1992, Mr. Parry was employed by the accounting
firm of Price Waterhouse from July 1987 through July 1992.
RICHARD M. REILLY, 58
Vice President of the Company since 1997
Richard M. Reilly has been Vice President of the Company since March 1997,
has been Vice President of Citizens, AFC and FAFLIC since March 1997, February
1997 and November 1990, respectively. He has also been a Director and Vice
President of AFLIAC since November 1990 and President and Chief Executive
Officer of AFLIAC since August 1995. Mr. Reilly was Vice President of AFC from
February 1995 through December 1995. Additionally, Mr. Reilly has been the
President of Allmerica Investment Trust, Allmerica Funds and Allmerica
Securities Trust, each a registered investment company, since February 1991,
April 1991 and February 1991, respectively. Mr. Reilly is also a director
and/or holds and executive office at various other non-public affiliates.
Prior to his affiliation with FAFLIC, he was an executive officer of Fidelity
Management and Research Company from 1969 to 1987 and Oppenheimer Capital from
1987 to 1990.
LARRY C. RENFRO, 46
Vice President of the Company since 1997
Larry C. Renfro has been Vice President of the Company since March 1997. Mr.
Renfro has also been a Vice President of Citizens, AFC and FAFLIC since March
1997, February 1997 and April 1990, respectively and has served as Director,
President and Chief Executive Officer of 440 Financial Group of Worcester,
Inc. (a
62
<PAGE>
former subsidiary of FAFLIC) from May 1990 to March 1995. Mr. Renfro has also
served as Vice President of APY from October 1992 through December 1995 and as
Vice President of AFC from February 1995 through December 1995. From August
1989 through March 1990, Mr. Renfro was an Executive Vice President of State
Street Bank & Trust Company. From March 1988 through July 1989, Mr. Renfro
served as President and Chief Executive Officer of Boston Financial Data
Services, Inc., a subsidiary of State Street Bank & Trust Company. From April
1981 through March 1988, Mr. Renfro held various executive offices at Fidelity
Investments, including Managing Director of Fidelity Management & Research
Company. Mr. Renfro is currently a Director of LoJack Corporation, a
manufacturer of anti-theft systems.
ERIC A. SIMONSEN, 51
Vice President and Director of the Company since 1992
See Mr. Simonsen's biography in "Directors of the Registrant" above.
PHILLIP E. SOULE, 47
Vice President of the Company since 1996
Phillip E. Soule has been Vice President of the Company since September 1996
and of FAFLIC since February 1987. Mr. Soule was Vice President of AFC from
February 1995 to December 1995 and since February 1997 and Vice President of
Citizens since March 1997. Mr. Soule has been employed by FAFLIC since 1972 in
various capacities.
63
<PAGE>
ITEM 11
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The Company does not pay any compensation to its officers directly. The
Company's operating subsidiaries, Hanover and Citizens Insurance, pay the
compensation of their respective employees. Pursuant to the terms of
intercompany services agreements, the Company, Hanover, Citizens Corporation
and Citizens Insurance are charged for an allocated portion of the
compensation FAFLIC pays to its employees who perform services for the
companies.
The following table sets forth all compensation for services rendered in all
capacities to the Company, its parent or subsidiaries for each of the fiscal
years ended December 31, 1996, 1995 and 1994, of: (i) the Chief Executive
Officer of the Company; (ii) each of the other four most highly compensated
individuals who received total compensation in excess of $100,000 directly or
indirectly attributable to the Company or its subsidiaries and who was serving
as an officer at December 31, 1996; and (iii) one individual who would have
been included in category (ii) above but for the fact that he was not serving
as an officer as of December 31, 1996 (collectively, "Named Executive
Officers").
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
----------------------- ------------------
OTHER
ANNUAL SECURITIES ALL OTHER
COMPEN- UNDERLYING LTIP COMPEN-
NAME AND SALARY BONUS SATION OPTIONS PAYOUTS SATION
PRINCIPAL POSITION YEAR ($)(1) ($)(2) ($)(3) ($)(4) ($)(5) ($)(6)
------------------ ---- ------- ------- ------- ---------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
John F. O'Brien(7)...... 1996 331,500 708,240 42,675 -- 195,000 46,889
President and CEO of 1995 263,500 263,500 37,203 -- 85,000 40,877
APY and AFC 1994 258,825 142,800 39,216 -- -- 65,822
James R. McAuliffe(9)... 1996 355,000 157,975 98,831 7,000 150,000 4,500
Vice President; CEO & 1995 305,000 114,985 67,560 14,000 190,000 4,500
President of Citizens 1994 305,000 88,755 13,869 -- 210,000 19,215
J. Barry May (8)........ 1996 158,278 146,523 -- 10,000 40,000 4,500
Vice President; CEO & 1995 145,229 57,173 -- 6,000 -- 4,500
President of Hanover 1994 132,898 50,577 -- -- -- 8,373
Theodore J. Rupley(8)... 1996 283,333 -- 2,067 9,000 -- 3,188
Vice President;
President 1995 365,000 131,217 -- 18,000 100,000 4,500
and CEO of Hanover 1994 365,000 137,240 -- -- -- 22,995
James F. Richardson(8).. 1996 208,526 44,531 -- 3,000 -- 4,500
Senior Vice President 1995 204,576 50,740 -- 4,000 -- 4,500
of Hanover 1994 199,586 44,653 -- -- -- 12,574
Francis S.
Porterfield(8)......... 1996 183,832 55,039 -- 7,000 30,000 4,500
Vice President of
Hanover 1995 177,735 59,803 -- 6,000 -- 4,500
1994 172,125 60,461 -- -- -- 10,844
</TABLE>
- - --------
(1) With the exception of Mr. O'Brien, amounts shown reflect annual salary
earned and received by each of the Named Officers from his respective
employer. Mr. O'Brien receives compensation from FAFLIC in his capacity as
an employee and executive officer of FAFLIC. Mr. O'Brien does not receive
compensation directly from the Company or any subsidiary of the Company.
The amounts shown in the table reflect the portions of Mr. O'Brien's
compensation that have been allocated as an expense to the Company and its
subsidiaries. See footnote 7.
(2) Amounts shown for 1996 include a special bonus payment for Mr. O'Brien and
Mr. May, discussed in more detail in the Compensation Committee Report,
which payments are intended by AFC to facilitate the purchase of AFC
common stock by the executive officers in 1997. The amount is $390,000 for
Mr. O'Brien representing an allocated portion of his special bonus payment
and is $100,000 for Mr. May. All other amounts shown are bonuses earned
pursuant to the annual incentive plans for managers and key executives.
64
<PAGE>
(3) The amounts shown for Mr. O'Brien reflect the portions of amounts
reimbursed for the payment of taxes that have been allocated as an expense
to the Company and its subsidiaries. See footnote 7. The amount reported
for Mr. McAuliffe in 1996 includes $82,825 for moving expenses paid by
Citizens Insurance. The amount reported for Mr. Rupley reflects interest
earned on disbursements from The Hanover Insurance Company Non-Qualified
Executive Retirement Plan.
(4) The securities underlying the options shown with respect to Messrs. May,
Rupley, Richardson and Porterfield are shares of the Company's Common
Stock and, with respect to Mr. McAuliffe, are shares of the common stock
of the Company's majority-owned subsidiary, Citizens Corporation.
(5) Amounts shown for Mr. McAuliffe, Mr. May and Mr. Porterfield represent
installment payments vesting and received in the respective year pursuant
to awards which were earned under FAFLIC's Long-Term Performance Unit Plan
(the "Long-Term Performance Plan") in 1992, 1993, 1995 and 1996 by Mr.
McAuliffe, and 1996 by Mr. May and Mr. Porterfield. No such cash amounts
were earned in 1994 by participants in respect of units granted under the
Long-Term Performance Plan with values determinable based on FAFLIC's
surplus level at the end of 1994. Amounts shown for Mr. O'Brien represent
an allocated portion of $500,000 of installment payments vested and
received under the Long-Term Performance Plan.
(6) This column includes amounts earned in 1996 but deferred by each of the
Named Executive Officers (other than Mr. O'Brien) pursuant to the terms of
his respective employer's 401(k) Matched Savings Plan. The amount shown
with respect to Mr. O'Brien for fiscal year 1996 represents an allocated
portion of $4,500 earned under FAFLIC's Non-Qualified Executive Retirement
Plan and a $115,727 payment of a premium on a life insurance policy.
(7) Mr. O'Brien receives compensation from FAFLIC in his capacity as an
employee of FAFLIC. Mr. O'Brien does not receive compensation directly
from the Company or any subsidiary of the Company. Mr. O'Brien's 1996
compensation from FAFLIC included $850,000 in base salary, $1,816,000 in
special bonus and annual incentive bonus, $4,500 earned under FAFLIC's
Non-Qualified Executive Retirement Plan, $115,727 for a life insurance
premium paid by FAFLIC, $109,422 in reimbursement for the payment of taxes
in connection therewith and $500,000 for installment payments vested and
received under the Long-Term Performance Plan. The amounts shown in the
table with respect to Mr. O'Brien for 1996 have been allocated as an
expense to the Company, its subsidiaries, Citizens Corporation and its
subsidiaries and equal 39% of Mr. O'Brien's total compensation.
(8) The amounts indicated are total compensation paid to Mr. May, Mr. Rupley,
Mr. Richardson and Mr. Porterfield directly by Hanover for services
rendered in their capacities as employees and executive officers of
Hanover. Mr. Rupley terminated employment with Hanover effective September
16, 1996.
(9) Beginning January 1, 1995, amounts paid to Mr. McAuliffe were paid by
Citizens Insurance.
65
<PAGE>
OPTION GRANTS TABLES
The following tables contains information concerning the grant of non-
qualified stock options in 1996 to the Named Executive Officers.
APY OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
GRANT
DATE
INDIVIDUAL GRANTS VALUE
------------------------ -------
NUMBER OF
SECURITIES PERCENT OF GRANT
UNDERLYING TOTAL OPTIONS DATE
OPTIONS GRANTED TO EXERCISE OR PRESENT
GRANTED EMPLOYEES IN BASE PRICE EXPIRATION VALUE
NAME (#) (1) 1996 ($ PER SHARE) DATE ($)(2)
---- ---------- ------------- ------------- ---------- -------
<S> <C> <C> <C> <C> <C>
John F. O'Brien......... 0 0 -- -- 0
James R. McAuliffe...... 0 0 -- -- 0
J. Barry May............ 10,000 8.8 25.50 05/21/06 117,620
Theodore J. Rupley...... 9,000 7.9 25.50 05/21/06 105,858
James F. Richardson..... 3,000 2.6 25.50 05/21/06 35,286
Francis S. Porterfield.. 7,000 6.1 25.50 05/21/06 82,334
</TABLE>
- - --------
(1) The options granted become exercisable in 20% increments on the first,
second, third, fourth and fifth anniversaries of the date of grant.
(2) In accordance with Securities and Exchange Commission rules, the Black-
Scholes option pricing model was chosen to estimate the grant date present
value of the options set forth in the table. The Company's use of the
model should not be construed as an endorsement of its accuracy at valuing
options. All stock option valuation models, including the Black-Scholes
model, require a prediction about the future movement of the stock price.
The following assumptions were made for purposes of calculating the Grant
Date Present Value: options exercised from 2.5 to 7 years, stock price
volatility of .2250, dividend yield of 0.63%, risk-free interest rates
between 5.29% and 6.33%, and no adjustment made for forfeitures or
transferability. The real value of the options depends upon the actual
performance of the Company's Common Stock during the applicable period.
CZC OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
GRANT
DATE
INDIVIDUAL GRANTS VALUE
------------------------ -------
NUMBER OF PERCENT OF GRANT
SECURITIES TOTAL OPTIONS DATE
UNDERLYING GRANTED TO EXERCISE OR PRESENT
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION VALUE
NAME GRANTED 1996 ($ PER SHARE) DATE ($)(2)
---- (#) (1) ------------- ------------- ---------- -------
<S> <C> <C> <C> <C> <C>
John F. O'Brien......... 0 0 -- -- 0
James R. McAuliffe...... 7,000 13.5 18.25 05/21/06 57,610
J. Barry May............ 0 0 -- -- 0
Theodore J. Rupley...... 0 0 -- -- 0
James F. Richardson..... 0 0 -- -- 0
Francis S. Porterfield.. 0 0 -- -- 0
</TABLE>
- - --------
(1) The securities underlying the options granted to Mr. McAuliffe were shares
of common stock of the Company's majority-owned subsidiary, Citizens
Corporation. The options granted become exercisable in 20% increments on
the first, second, third, fourth and fifth anniversaries of the date of
grant.
(2) The value indicated is based on the Black-Scholes option pricing model.
The following assumptions were made for purposes of calculating the Grant
Date Present Value: options exercised from 2.5 to 7 years, stock
66
<PAGE>
price volatility of 0.1875, dividend yield of 1.09%, risk free interest
rates between 5.29% and 6.33%, and no adjustment made for forfeitures or
transferability. The real value of the options depends upon the actual
performance of the Company's Common Stock during the applicable period.
YEAR-END 1996 OPTION VALUE TABLE
The following table sets forth information for the Named Executive Officers
regarding exercised and unexercised options to acquire shares of the Company's
Common Stock held as of December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
SHARES UNEXERCISED OPTIONS OPTIONS AT YEAR-END
ACQUIRED AT YEAR-END 1996(#) 1996 (2)($)
ON VALUE -------------------- --------------------
EXERCISE REALIZED EXERCISABLE/ EXERCISABLE/
NAME (#) ($)(1) UNEXERCISABLE UNEXERCISABLE
---- -------- -------- -------------------- --------------------
<S> <C> <C> <C> <C>
John F. O'Brien......... -- -- -- --
James R. McAuliffe...... -- -- -- --
J. Barry May............ 1,200 8,400 0 / 14,800 0 / 93,750
Theodore J. Rupley (3).. 3,600 26,100 -- --
James F. Richardson..... -- -- 800 / 6,200 7,500 / 44,625
Francis S. Porterfield.. -- -- 1,200 / 11,800 11,250 / 79,125
</TABLE>
- - --------
(1) Calculated based on the difference between the option exercise price and
the closing price of the Company's Common Stock on the New York Stock
Exchange on the date of exercise multiplied by the number of shares to
which the exercise relates.
(2) Calculated based on the difference between the option exercise price and
$30.375, the closing price per share of the Company's Common Stock on the
New York Stock Exchange on December 31, 1996.
(3) Mr. Rupley's unvested options were cancelled upon his resignation with
Hanover effective September 16, 1996.
The following table sets forth information for the Named Executive Officers
regarding unexercised options to acquire shares of Citizens Corporation common
stock held as of December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT YEAR-END
AT YEAR-END 1996(#) 1996 (1)($)
-------------------- --------------------
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
---- -------------------- --------------------
<S> <C> <C>
John F. O'Brien...................... -- --
James R. McAuliffe................... 2,800/18,200 16,200/94,550
J. Barry May......................... -- --
Theodore J. Rupley................... -- --
James F. Richardson.................. -- --
Francis S. Porterfield............... -- --
</TABLE>
- - --------
(1) Calculated based on the difference between the option exercise price and
$22.50, the closing price per share of Citizens Corporation's common stock
on the New York Stock Exchange on December 31, 1996.
67
<PAGE>
PENSION BENEFITS
FAFLIC, Hanover and Citizens each maintain a tax-qualified, non-contributory
defined benefit retirement plan ("Pension Plan") for the benefit of their
eligible employees.
Until December 31, 1994, annual benefits under the Pension Plan were based
primarily upon each employee's years of service and compensation during the
highest five consecutive plan years of employment or the last 60 months if
greater. Such benefits under the Pension Plan were frozen as of December 31,
1994 for most participants, with the exception of certain grandfathered
employees, including Mr. McAuliffe and Mr. Richardson. These benefits will be
paid to participants as a monthly annuity at age 65 unless a participant
terminates with 15 or more years of service in which case monthly benefits may
commence anytime after the participant's 55th birthday. Effective as of
January 1, 1995, the Pension Plan was converted into a cash balance plan, such
that benefits are no longer determined primarily by final average compensation
and years of service. Instead, annually each employee accrues a benefit that
is equal to a percentage of the employee's salary, similar to a defined
contribution plan arrangement. Amounts contributed by the employer to an
employee are allocated to a memorandum account as to which the employee is
permitted to make investment elections from among choices provided by the
employer. Upon termination of employment of a participant, the amount in the
participant's memorandum account as of such date is eligible for distribution.
If the amount in the participant's memorandum account plus the present value
of the benefit frozen under the Pension Plan as of December 31, 1994 is less
than $3,500, all benefits are distributed immediately in a lump sum.
The estimated annual benefits payable under the Pension Plan upon retirement
at normal retirement age for each of the Named Executive Officers is as
follows: Mr. O'Brien: $428,138; Mr. May: $79,848; Mr. McAuliffe: $408,166; Mr.
Richardson: $185,892; and Mr. Porterfield: $18,269. Such figures include
amounts that have accrued under the Pension Plan as in effect on December 31,
1994, including $332,466 and $160,639 for Mr. McAuliffe and Mr. Richardson,
respectively. No estimated benefit is included for Mr. Rupley due to his
termination from Hanover effective September 16, 1996. With respect to
benefits attributable to the cash balance component of the Pension Plan, it
was assumed that each individual's salary and bonus for the years until
retirement were as shown in the Summary Compensation Table; that employer
allocations were made to the Pension Plan at a rate of 7% of eligible
compensation (7% is the actual amount accrued in 1996, although the plan only
guarantees an accrual rate of 0.5%); and that investment earnings accrued to
each participant's memorandum account under the Pension Plan at a rate of 6%
per year.
The estimated annual benefits under the Pension Plan shown for each of the
Named Executive Officers are not reduced to reflect the limitations imposed by
Federal tax laws, which place upper limits on the benefits which may be
provided to any individual by tax-qualified pension plans. FAFLIC, Hanover and
Citizens have each adopted an Excess Benefit Plan, an unfunded, non-qualified
plan, which provides that it will pay directly the difference between the
retirement benefit normally calculated under the Pension Plan and the maximum
amount which may be paid from the Pension Plan consistent with Federal tax
law. In addition, certain employees may participate, in the discretion of the
Board of Directors, in either an unfunded, Non-Qualified Executive Retirement
Plan or an unfunded, Non-Qualified Executive Deferred Compensation Plan. Under
the Non-Qualified Executive Retirement Plan, participating employees may (i)
elect to defer compensation in an amount not to exceed the annual dollar
limitation set forth in the Internal Revenue Code in respect of defined
contribution plans, (ii) elect to defer additional compensation in an amount
not to exceed 12.5% of the participant's annual salary, (iii) receive and
defer the amount, if any, that the participant would have received as a
matching employer's contribution under his employer's 401(k) Matched Savings
Plan, and (iv) receive and defer the amount, if any, that the participant
would have been credited under his employer's Cash Balance and Excess Benefit
Plans had the participant participated in such plan during the year. Under the
Non-Qualified Executive Deferred Compensation Plan, certain other employees
may elect to defer up to 12.5% of their annual salaries. In both cases, AFC
shall from time to time designate one or more investments in which each
participant's accounts shall be deemed to be invested for the purpose of
determining the participant's gains and income on such account. Participation
in the Non-Qualified Executive Retirement Plan is in lieu of participation in
the corresponding qualified retirement and/or pension plans of FAFLIC, Hanover
or Citizens.
68
<PAGE>
COMPENSATION COMMITTEE REPORT
General. The Compensation Committee ("Committee") of the Board of Directors
is comprised of the Directors whose names appear at the end of this report,
none of whom is an employee of the Company or of any affiliate or subsidiary
of the Company. Among other duties, the Committee has oversight responsibility
with respect to compensation matters involving Directors and officers of the
Company and its subsidiaries. As a holding company, the Company has no
employees of its own and does not pay any compensation to its officers.
Officers who are employees of Hanover or Citizens Insurance are compensated
directly by their respective employers, and a portion of the salaries and
other compensation paid by FAFLIC to its employees, who provide services to
Hanover or Citizens Insurance, is allocated to such companies. This report
reflects the compensation philosophy of the Company, Hanover and Citizens
Insurance as endorsed by the Committee. The report also reflects the
Committee's review of the actions taken by the Board of Directors of FAFLIC
for the Chief Executive Officer, and by the Boards of Hanover and Citizens
Insurance with respect to the highest paid officers of Hanover and Citizens
Insurance during 1996 (the "Named Executive Officers").
Compensation Philosophy. The Executive Compensation Program is designed to
support the following objectives:
. to attract and retain individuals key to the future success of the
Company and its subsidiaries;
. to align the interests of executives with those of shareholders;
. to motivate and reward the profitable growth of the Company;
. to ensure that the Company has competitive opportunities for key
personnel.
The key elements of the Executive Compensation Program consist of base
salary, annual incentive compensation and long-term incentive compensation. A
general description of each element and the review taken by the Committee for
the 1996 fiscal period are presented in the following material. In addition,
general background and a summary of the actions taken by the Compensation
Committee and Board of Directors of FAFLIC with respect to Mr. O'Brien are
also described.
Base Salary. The chief goals of the Company and its subsidiaries are
achieving superior underwriting profitability in all phases of the
underwriting cycle, maintaining consistent market presence in core product
lines, growing market share in core markets, and enhancing shareowner value.
In furtherance of these goals, annual base salaries of the Named Executive
Officers and other key executives are generally set at levels considered to be
competitive with amounts paid to executive officers with comparable
qualifications, experience and responsibilities at similarly sized property
and casualty insurance companies, based on published surveys which include
base salary and total cash compensation data of over 100 participating
companies.
Annual Incentive Compensation. Annual incentive compensation is closely tied
to the Company's success in achieving significant financial performance goals.
Hanover and Citizens maintain a consolidated incentive plan with FAFLIC
which provides supplementary cash compensation as an incentive to key
employees who, through exceptional performance, contribute materially to the
success of the companies. For 1996, the Incentive Plan had two components,
corporate and business unit return on equity and the participant's successful
completion of personal performance goals. Awards under the incentive plan
could range from 0% to 100% of a participant's base salary.
Long-Term Compensation. The Boards of both Hanover and Citizens Insurance
have ratified the participation of certain officers in the FAFLIC Long-Term
Performance Unit Plan ("Long-Term Performance Plan").
The objectives of the Long-Term Performance Plan include providing
incentives to attract and retain top executives and achieving significant
long-term financial results for FAFLIC and its subsidiaries. Criteria
considered in determining participation in the Long-Term Performance Plan
include the direct and measurable
69
<PAGE>
impact the executive has on longer-term financial results, the influence the
individual has on strategic direction and the degree of risk inherent in the
individual's business decisions. Previously awarded units are payable
dependent upon specific increases in capital, surplus and equity position
determined at of the end of a three-year plan cycle and payments are made
subject to a subsequent three-year vesting cycle. The last three-year plan
cycle under the Long-Term Performance Plan began in 1995. Therefore, no Named
Executive Officers were awarded Long-Term Performance Plan units in 1996,
although certain awards made in 1995 will continue to vest through 1999.
Commencing in 1997, long-term incentive compensation awards will be made to
the Named Executive Officers pursuant to AFC's Long-Term Stock Incentive Plan.
The Company and Citizens Corporation also have in place Long Term Stock
Incentive Plans (the "Stock Plans"). The Citizen Stock Plan was adopted in
1994 and the Company's Stock Plan was adopted in 1995. The objectives of the
Stock Plans include providing incentives for participants to make substantial
contributions to the company's long-term business growth, enhancing the
company's ability to attract and retain executive officers and other key
employees, rewarding participants for their contributions to the success of
the company and aligning the interests of executive officers and other key
employees with those of the company's stockholders. Up to 200,000 shares are
available for awards under the Citizens Corporation Stock Plan. One million
shares are available under the APY Plan. Under the Citizens Corporation Long
Term Incentive Plan options covering 7,000 shares were granted to Mr.
McAuliffe. Under the Company's Long Term Incentive Plan, options were awarded
in 1996 as follows: options covering 10,000 shares to Mr. May; options
covering 9,000 shares to Mr. Rupley; options covering 3,000 shares to Mr.
Richardson; and options covering 7,000 shares to Mr. Porterfield. Factors
considered in determining the grant of options under the Stock Plans to Named
Executive Officers included the contribution of each executive to the long-
term performance of the respective corporation and the importance of each
executive's responsibilities within the organization.
Special Cash Bonus. In evaluating the total compensation of the Named
Executive Officers and certain other executive officers of FAFLIC and Hanover,
the Compensation Committee also considered the importance of individual stock
ownership of executive officers to the future performance of the Company. Due
to the restrictions imposed by the Plan of Reorganization prohibiting the
Named Executive Officers and certain other executive officers of AFC and
FAFLIC from acquiring AFC stock or participating in AFC's Stock Plan until
October 1996, the Compensation Committee approved a special cash bonus payment
to these executives with the intent that the bonus be used to purchase an
equal amount of AFC Common Stock. As an incentive to encourage such purchases,
for each share of AFC Common Stock purchased with such bonus funds, certain of
the Named Executive Officers will be awarded one share of restricted stock
pursuant to the AFC Stock Plan.
Compensation of the CEO. John F. O'Brien, President and Chief Executive
Officer of AFC, serves as President and Chief Executive Officer of the
Company, and currently serves as Chairman of the Board of Hanover and of
Citizens Insurance. Mr. O'Brien's compensation is established and reviewed by
the Compensation Committee of the Board of Directors of AFC. He receives no
compensation directly from the Company or its subsidiaries, but a portion of
his FAFLIC compensation is allocated among and charged to the Company and
those subsidiaries for which Mr. O'Brien provides services as a Director and
executive officer.
In approving the 1996 compensation package for Mr. O'Brien, AFC's
Compensation Committee compared Mr. O'Brien's compensation against the
comparative base salaries, annual and long-term incentives and other
compensation of chief executives of a peer group of companies. The peer group
companies included (i) insurance companies identified as having distribution
systems, products/product mix and/or markets similar to FAFLIC and its
subsidiaries; (ii) a subset of insurance companies that were identified by
scope of financial activity (such as assets, revenue, and net written
premium); and (iii) a subset of financial service companies that provide for a
stratification of salary data based on similarity in the nature and scope of
business activities. The Committee assumes (a) that such independent variables
are meaningful in determining CEO compensation, and (b) that a correlation
exists between pay and such variables. However, the approach does not consider
variances in the business strategies and goals of each company, the relative
competitive positions of the companies, and the personal characteristics and
accomplishments of the individual executives. Therefore, the review of Mr.
O'Brien's compensation by AFC's Compensation Committee also included an
assessment of the performance of FAFLIC and its subsidiaries in terms of
profitability and growth in the various business lines, as well as an
70
<PAGE>
evaluation of the capital positions of the companies, Mr. O'Brien's base
salary was near the median, while the potential for incentive compensation, as
a percentage of base salary, was below the median.
Mr. O'Brien's 1996 incentive compensation performance measures included a
corporate goal based upon GAAP Consolidated Net Income Return on Equity of
AFC, business unit Return on Equity, focus goals relating to earnings per
share, revenue, AFC's stock price and individual performance goals. Individual
performance goals included significant improvement in earnings and capital;
development of alternate distribution systems; initiatives to improve
technology; and continued development and implementation of a strategic plan
for the Company. Achievement of individual performance goals and other
initiatives undertaken by Mr. O'Brien during 1996 resulted in performance that
exceeded expectations.
The AFC Compensation Committee carefully reviewed Mr. O'Brien's personal
achievements against his 1996 goals and based on its evaluation, the Committee
approved Mr. O'Brien's annual incentive compensation award of 96% of his base
salary, out of a maximum potential of 100% of base salary. In addition, the
Committee approved a special bonus award to Mr. O'Brien in the amount of
$1,000,000, based on the reasons discussed in the paragraph entitled "Special
Cash Bonus" above.
The Committee believes that the executive compensation policies of the Board
of Directors of FAFLIC, Hanover and Citizens Insurance are appropriate both to
attract and retain corporate officers and other key employees of outstanding
abilities and to motivate them to perform to the full extent of their
abilities.
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of the
Internal Revenue Code, enacted in 1993, generally disallows a tax deduction to
public companies for compensation over $1 million paid to the corporation's
Chief Executive Officer and four other most highly compensated executive
officers. Qualifying performance-based compensation will not be subject to the
deduction limit if certain requirements are met. The Company intends to
monitor the impact of Section 162(m) in order to balance the benefits of
favorable tax treatment with a need to apply prudent judgment in carrying out
the Company's compensation philosophy.
Members of the Compensation Committee:
Herbert M. Varnum, Chairman
Richard M. Wall
71
<PAGE>
COMMON STOCK PERFORMANCE CHART
Set forth below is a line graph comparing the cumulative total shareholder
return for the five-year period ended December 31, 1996 of the common stock of
the Company against the cumulative total return of the S&P 500 Index and the
S&P Property-Casualty Insurance Index. The S&P Property-Casualty Insurance
Index includes the following companies: The Allstate Corporation, General Re
Corp., The Chubb Corporation, The St. Paul Companies, Inc., Safeco Corp. and
USF&G Corp.
The comparison of total return on investment assumes that $100 was invested
on the first day of the 5-year period in each of the Company, the S&P 500 Index
and the S&P Property-Casualty Insurance Index, and that dividends were
reinvested.
COMPARISON OF FIVE YEAR CUMULATICE TOTAL RETURN*
AMONG ALLMERICA PROPERTY & CASUALTY COMPANIES, INC., THE S&P 500 INDEX
AND THE S&P INSURANCE (PROPERTY-CASUALTY) INDEX
<TABLE>
<CAPTION>
12/91 12/92 12/93 12/94 12/95 12/96
<S> <C> <C> <C> <C> <C> <C>
Allmerica Property & Casualty Companies, Inc. $100 $143 $186 $146 $235 $226
S&P 500 100 117 118 121 165 203
S&P Insurance (Property & Casualty) 100 108 115 120 163 199
</TABLE>
* $100 invested on 12/31/91 in stock or index--including reinvestment of
dividends.
Fiscal year ending December 31.
- - --------
The Compensation Committee Report and Stock Price Performance Graph above
shall not be deemed incorporated by reference by any general statement
incorporating by reference this Annual Report on Form 10-K into any filing
under the Securities Act of 1933 or the Securities Exchange Act of 1934, except
to the extent that the Company specifically incorporates this information by
reference, and shall not otherwise be deemed filed under such Acts.
72
<PAGE>
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of Common Stock of the
Company owned as of March 15, 1997 by each Director, each individual named in
the Summary Compensation Table, and Directors and executive officers as a
group.
<TABLE>
<CAPTION>
NUMBER OF SHARES OF NUMBER OF SHARES OF NUMBER OF SHARES OF
NAME OF COMMON STOCK OF COMMON STOCK OF COMMON STOCK OF
BENEFICIAL OWNER AFC* APY* CZC*
---------------- ------------------- ------------------- -------------------
<S> <C> <C> <C>
Michael P. Angelini..... 54 3,000 --
David A. Barrett........ 285 600 1,000(1)
James A. Cotter, Jr..... -- 1,700(2) 1,100(2)
Gail L. Harrison........ 82 450 --
M. Howard Jacobson...... -- -- --
Dona Scott Laskey....... -- 1,040 --
J. Barry May............ 272(3) -- --
James R. McAuliffe...... 5,035(4) 1,600 1,500
John F. O'Brien......... 270(5) 16,000 1,000
Francis S. Porterfield.. -- 1,200(6) --
James F. Richardson..... 2,774(7) 7,122(8) --
Eric A. Simonsen........ 146(9) 9,000(10) 3,000(11)
Robert G. Stachler...... 171 -- --
Herbert M. Varnum....... 76 600(12) --
Richard M. Wall......... 180 -- --
Directors and executive
officers as a group of
23 persons............. 24,159(13) 48,262 7,900
</TABLE>
- - --------
* Each of the amounts represents less than 1% of the outstanding shares of
Common Stock as of March 15, 1997. As to shares beneficially owned, each
person has sole voting and investment power, except as indicated in other
footnotes to this table.
(1) Shares owned by Mr. Barrett's spouse. Mr. Barrett disclaims beneficial
ownership with respect to such shares.
(2) Includes 100 shares owned by Mr. Cotter's spouse.
(3) Shares held for the benefit of Mr. May by the trustees of the First
Allmerica Financial Life Insurance Company's Employees' 401(k) Matched
Savings Plan (the "FAFLIC Plan").
(4) Shares held for the benefit of Mr. McAuliffe by the trustees of the FAFLIC
Plan.
(5) Includes 198 shares held for the benefit of Mr. O'Brien by the trustees of
the FAFLIC Plan.
(6) Represents shares that Mr. Porterfield has the right to acquire within 60
days upon exercise of outstanding options.
(7) Shares held for the benefit of Mr. Richardson by the trustees of the
FAFLIC Plan.
(8) Includes 800 shares that Mr. Richardson has the right to acquire within 60
days upon exercise of outstanding options. The remaining shares are held
by Mr. Richardson as trustee for the James F. Richardson Revocable Trust.
(9) Shares held for the benefit of Mr. Simosen by the trustees of the FAFLIC
Plan.
(10) Includes an aggregate of 3,000 shares of Common Stock of APY held in
trusts for the benefit of Mr. Simonsen's children. Mr. Simonsen is
trustee of the trusts and he disclaims beneficial ownership of the shares
held in the trusts.
(11) Includes an aggregate of 1,000 shares of Common Stock of CZC held in
trusts for the benefit of Mr. Simonsen's children. Mr. Simonsen is
trustee of the trusts and he disclaims beneficial ownership of the shares
held in the trusts.
(12) Shares voting and investment power.
(13) Includes 21,429 shares held by the trustees of the FAFLIC Plan.
73
<PAGE>
Set forth below, as of March 15, 1997, is the name of the only person known
to the Company to be the beneficial owner of more than 5% of the outstanding
shares of the Company's Common Stock:
<TABLE>
<CAPTION>
AMOUNT AND NATURE
NAME AND ADDRESS OF BENEFICIAL PERCENT
OF BENEFICIAL OWNER OWNERSHIP OF CLASS
------------------- ----------------- --------
<S> <C> <C>
SMA Financial Corp.(1)............................... 35,472,600 59.5%
440 Lincoln Street
Worcester, MA 01653
</TABLE>
- - --------
(1) SMA Financial Corp. is a wholly-owned subsidiary of AFC.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company's subsidiaries or affiliates have, from time to time, retained
the services of Bowditch & Dewey, LLP, a law firm in which Mr. Angelini, a
Director of the Company, is a partner; such fees paid by the Company and its
subsidiaries or affiliates do not exceed 5% of the law firms gross revenues
for that firm's last fiscal year.
The Company has agreements under which FAFLIC provides administrative,
management, operating support, office space and other services to the Company
and its subsidiaries including portfolio management, investment services,
financial, accounting, electronic data processing, information systems, human
resources, legal and other staff functions. Charges for these services are
based FAFLIC's cost allocation policy, which is based upon state insurance law
requirements that all cost allocations be on a fair and reasonable basis, and
amounted to $59.3 million, $52.1 million and $64.4 million in 1996, 1995 and
1994, respectively.
Hanover leases office space from FAFLIC under a lease agreement which
expires December 31, 2010. The annual lease cost was $1.0 million during each
of the years ended December 31, 1996, 1995 and 1994, respectively. The annual
lease cost of this agreement is included within the amount of charges above
for 1996, 1995 and 1994, respectively. Amgro, a Company subsidiary, leases
office space from FAFLIC as a tenant at will. The annual lease cost was $0.3
million during each of the years ended December 31, 1996, 1995 and 1994,
respectively and is included in the charges above.
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS AND INDEX
The consolidated financial statements are listed under Item 8 of this Form
10-K.
(A)(2) FINANCIAL STATEMENT SCHEDULES AND INDEX
<TABLE>
<CAPTION>
PAGE NO.
IN THIS
SCHEDULE REPORT
- - -------- --------
<S> <C> <C>
I Summary of Investments--Other Than Investments in Related Parties 78
II Condensed Financial Information of the Registrant 79-81
III Supplementary Insurance Information 82-84
IV Reinsurance 85
V Valuation and Qualifying Accounts 86
VI Supplemental Information Concerning Property/Casualty Insurance Operations 87
</TABLE>
Schedules other than those listed above are omitted as they are not
required, not applicable, or the required information is disclosed elsewhere
in the financial statements and related notes.
74
<PAGE>
(A)(3) EXHIBITS
Exhibits filed as part of this Form 10-K are as follows:
(2) Agreement and Plan of Merger, dated as of February 19, 1997, among
Allmerica Property and Casualty, Allmerica Financial Corporation and
APY Acquisition, Inc. incorporated by reference to Exhibit 1 to the
Current Report on Form 8-K of Allmerica Financial Corporation
(Commission File No. 1-13754) dated February 19, 1997.
(3) 3.1 Articles of Incorporation. Filed as Appendix B to the Registrant's
Form S-4, No. 33-51696, filed on November 4, 1992, and incorporated
herein by reference.
3.2 By laws. Filed as Appendix C to the Registrant's Form S-4, No.
33-51696, filed on November 4, 1992, and incorporated herein by
reference.
(4) Form of Stock Certificate of Allmerica Property & Casualty Companies,
Inc. incorporated by reference to exhibit 3.3 to Amendment No. 1 to
the Registrant's Form S-4, No. 33-51696, filed on October 13, 1992.
(10) Material Contracts
(10.1) The Hanover Insurance Company's Management Reward Plan
(Executive Compensation Plan) and the Hanover Insurance
Company's Excess Benefit Retirement Plan filed as Exhibit
(10.1) to the Hanover Insurance Company's 1990 Annual Report
on Form 10-K and incorporated herein by reference.
(10.2) The Hanover Insurance Company's Supplemental Employee
Retirement Plan. Filed as Exhibit (10.2) to the Hanover
Insurance Company's 1990 Annual Report on Form 10-K and
incorporated herein by reference.
(10.3) Citizens Insurance Company of America's Management Reward Plan
(Executive Compensation Plan) filed as Exhibit (10.3) to the
Allmerica Property & Casualty Insurance Companies, Inc. 1992
Annual Report on Form 10-K and incorporated herein by
reference.
(10.4) Citizens Insurance Company of America's Excess Benefit
Retirement Plan filed as Exhibit (10.4) to the Allmerica
Property & Casualty Insurance Companies, Inc. 1992 Annual
Report on Form 10-K and incorporated herein by reference.
(10.5) Citizens Insurance Company of America's Supplemental Employee
Retirement Plan. Filed as Exhibit (10.5) to the Allmerica
Property & Casualty Insurance Companies, Inc. 1992 Annual
Report on Form 10-K and incorporated herein by reference.
(10.6) Allmerica Financial 1993 Annual Incentive Plan incorporated by
reference to Exhibit (10.6) to the Allmerica Property &
Casualty Companies, Inc. 1993 Annual Report on Form 10-K and
incorporated herein by reference.
(10.7) State Mutual Companies Long Term Performance Unit Plan
incorporated by reference to Exhibit (10.7) to the Allmerica
Property & Casualty Companies, Inc. 1993 Annual Report on Form
10-K and incorporated herein by reference.
(10.8) Consolidated Service Agreement between State Mutual Life
Assurance Company of America and their subsidiaries dated
September 30, 1993 incorporated by reference to Exhibit (10.8)
to the Allmerica Property & Casualty Companies, Inc. 1993
Annual Report on Form 10-K and incorporated herein by
reference.
(10.9) Indenture of Lease between First Allmerica Financial Life
Insurance Company and The Hanover Insurance Company of
America, dated July 3, 1984 and Corrected First Amendment to
Indenture Lease dated December 20, 1993 incorporated by
reference to Exhibit (10.10) to the Allmerica Property &
Casualty Companies, Inc. 1993 Annual Report on Form 10-K and
incorporated herein by reference.
75
<PAGE>
(10.10) Citizens Insurance Company of America Stock Option Plan dated
June 3, 1994, incorporated by reference to Exhibit (10.11) to
the Allmerica Property & Casualty Companies, Inc. 1994 Annual
Report on Form 10-K and incorporated herein by reference.
(10.11) Indenture of Lease between First Allmerica Financial Life
Insurance Company and The Hanover Insurance Company of
America, dated March 23, 1993, by and between Aetna Life
Insurance Company and First Allmerica Life Insurance Company,
including amendments thereto, relating to property in
Atlanta, Georgia incorporated by reference to Exhibit (10.12)
to the Allmerica Property & Casualty Companies, Inc. 1994
Annual Report on Form 10-K and incorporated herein by
reference.
(10.12) Allmerica Financial Cash Balance Plan incorporated by
reference to Exhibit (10/13) to the Allmerica Property &
Casualty Companies, Inc. third quarter report on Form 10-Q
and incorporated herein by reference.
(10.13) Allmerica Property & Casualty Companies, Inc. 1995 Long Term
Stock Incentive Plan incorporated by reference to Exhibit A
to Allmerica Property & Casualty Companies, Inc. definitive
Proxy Statement dated March 30, 1995 and incorporated herein
by reference.
(11) Statement regarding computation of per share earnings.
(21) Subsidiaries of the Registrant.
(23) Consent of Independent Accountants in reference to the Registration
Statement on Form S-8 (No. 333-11123)
(24) Power of Attorney
(99.1) Important factors regarding forward-looking statements
(B) REPORT ON FORM 8-K
On December 18, 1996, a report on Form 8-K was filed reporting under item 5,
Other Events, the announcement by the Registrant that AFC had made a proposal
to the Board of Directors of the Registrant to acquire the remaining shares of
common stock of the Registrant that it did not already own.
On February 20, 1997, a report on Form 8-K was filed reporting under item 5,
Other Events, the announcement that the Registrant and AFC entered into an
agreement and plan of merger, pursuant to which AFC will acquire all of the
remaining shares of common stock of the Registrant that it did not already
own.
76
<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.
Allmerica Property & Casualty
Companies, Inc. Registrant
/s/ John F. O'Brien
Date: March 18, 1997 By: _________________________________
JOHN F. O'BRIEN
CHIEF EXECUTIVE OFFICER AND
PRESIDENT
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
/s/ John F. O'Brien Chief Executive March 18, 1997
- - ------------------------------------- Officer and
JOHN F. O'BRIEN President
/s/ Edward J. Parry, III Vice President,
- - ------------------------------------- Chief Financial March 18, 1997
EDWARD J. PARRY, III Officer, Treasurer
and Principal
Accounting Officer
* Vice President and March 18, 1997
- - ------------------------------------- Director
ERIC A. SIMONSEN
* Director March 18, 1997
- - -------------------------------------
MICHAEL P. ANGELINI
* Director March 18, 1997
- - -------------------------------------
DAVID A. BARRETT
* Director March 18, 1997
- - -------------------------------------
JAMES A. COTTER JR.
* Director March 18, 1997
- - -------------------------------------
GAIL L. HARRISON
* Director March 18, 1997
- - -------------------------------------
M. HOWARD JACOBSON
* Director March 18, 1997
- - -------------------------------------
DONA SCOTT LASKEY
* Director March 18, 1997
- - -------------------------------------
ROBERT G. STACHLER
* Director March 18, 1997
- - -------------------------------------
HERBERT M. VARNUM
* Director March 18, 1997
- - -------------------------------------
RICHARD MANNING WALL
/s/ John F. O'Brien
*By: ________________________________
JOHN F. O'BRIEN
ATTORNEY IN FACT
77
<PAGE>
SCHEDULE I
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
IN THE
CONSOLIDATED
TYPE OF INVESTMENT COST (1) FAIR VALUE (1) BALANCE SHEET
- - ------------------ -------- -------------- -------------
(IN MILLIONS)
<S> <C> <C> <C>
Fixed maturities:
Bonds:
U.S. government obligations............ 299.7 307.8 307.8
States and political subdivisions...... 2,212.8 2,253.1 2,253.1
Foreign governments.................... 10.1 11.8 11.8
Public utilities....................... 92.4 96.3 96.3
Convertibles and bonds with
warrants.............................. 0.3 0.4 0.4
All other corporate bonds.............. 724.4 750.0 750.0
Redeemable Preferred Stock.............. 105.0 108.2 108.2
------- ------- -------
Total fixed maturities................ 3,444.7 3,527.6 3,527.6
------- ------- -------
Equity securities:
Common stocks:
Public utilities....................... 4.9 5.5 5.5
Banks, trusts and insurance companies.. 26.8 48.1 48.1
Industrial, miscellaneous and all
other................................. 234.3 337.8 337.8
Nonredeemable preferred stocks.......... 11.3 11.5 11.5
------- ------- -------
Total equity securities............... 277.3 402.9 402.9
------- ------- -------
Other investments........................ 29.3 31.9 31.9
------- ------- -------
Total investments..................... 3,751.3 3,962.4 3,962.4
======= ======= =======
</TABLE>
- - --------
(1) Original cost of equity securities and, as to fixed maturities, original
cost reduced by repayments and adjusted for amortization of premiums and
accretion of discounts.
78
<PAGE>
SCHEDULE II
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED STATEMENT OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ -----
(IN MILLIONS)
<S> <C> <C> <C>
REVENUES
Net investment income................................ $ 0.1 $ 0.2 $ 0.2
------ ------ -----
Total revenues..................................... 0.1 0.2 0.2
------ ------ -----
EXPENSES
Franchise tax expenses............................... 0.1 0.1 0.1
Other expenses....................................... 1.8 2.3 0.7
------ ------ -----
Total expenses..................................... 1.9 2.4 0.8
------ ------ -----
Loss before federal income taxes and equity in net
operating results of subsidiaries..................... (1.8) (2.2) (0.6)
Federal income tax benefit............................. 0.4 0.8 0.2
Equity in net operating results of subsidiaries........ 147.8 141.5 99.6
------ ------ -----
Net income............................................. $146.4 $140.1 $99.2
====== ====== =====
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
79
<PAGE>
SCHEDULE II
(CONTINUED)
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
---------- ----------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 3.4 $ 6.5
Investment in subsidiaries........................... 1,522.1 1,486.3
Dividend receivable.................................. 85.0 20.0
Other assets......................................... 0.6 --
---------- ----------
Total assets....................................... $ 1,611.1 $ 1,512.8
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Due to affiliate..................................... $ 0.2 $ 0.1
Dividends payable to shareholders.................... 2.4 2.4
Other accrued expenses............................... -- 1.0
---------- ----------
Total Liabilities.................................. 2.6 3.5
---------- ----------
SHAREHOLDERS' EQUITY
Common stock, par value $1.00 per share; authorized
90.0 shares; issued 61.9 shares..................... 61.9 61.9
Additional paid-in capital........................... 32.0 32.0
Retained earnings.................................... 1,441.8 1,304.9
Unrealized appreciation on investments, net of
deferred federal income taxes and minority
interest............................................ 127.1 133.9
Treasury stock, at cost (1.1 and 0.1 shares)......... (54.3) (23.4)
---------- ----------
Total shareholders' equity......................... 1,608.5 1,509.3
---------- ----------
Total liabilities and shareholders' equity......... $ 1,611.1 $ 1,512.8
========== ==========
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
80
<PAGE>
SCHEDULE II
(CONTINUED)
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.......................................... $ 146.4 $ 140.1 $ 99.2
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in undistributed earnings of
subsidiaries...................................... (107.6) (106.6) (94.6)
Change in assets and liabilities:
Increase in other assets.......................... (0.6) -- --
Increase (decrease) in due to affiliate........... 0.1 -- (0.1)
(Decrease) increase in other accrued expenses..... (1.0) 0.5 (0.1)
------- ------- ------
Net cash provided by operating activities......... 37.3 34.0 4.4
------- ------- ------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of subsidiary common stock--APC Funding.... -- (0.2) --
------- ------- ------
Net cash used for investing activities............ -- (0.2) --
------- ------- ------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders...................... (9.5) (9.8) (9.9)
Treasury stock purchased............................ (31.0) (20.9) (0.7)
Treasury stock reissued............................. 0.1 -- --
Net cash used for financing activities............ (40.4) (30.7) (10.6)
------- ------- ------
Net (decrease) increase in cash and cash
equivalents......................................... (3.1) 3.1 (6.2)
Cash and cash equivalent at beginning of the period.. 6.5 3.4 9.6
------- ------- ------
Cash and cash equivalents at end of the period....... $ 3.4 $ 6.5 $ 3.4
======= ======= ======
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
81
<PAGE>
SCHEDULE III
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
RESERVE FOR
LOSSES AND
DEFERRED POLICY LOSS
ACQUISITION ADJUSTMENT UNEARNED NET PREMIUMS NET INVESTMENT
EXPENSES (1) EXPENSES (1) PREMIUMS (1) EARNED INCOME (2)
--------------- ------------ ------------ ------------ --------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Private passenger
automobile............. $ 56.5 $1,027.9 $271.6 $ 888.4
Homeowners.............. 29.9 102.8 127.4 236.1
Other personal lines.... 8.4 17.4 76.5 37.4
-------- -------- ------ --------
Total personal lines.. 94.8 1,148.1 475.5 1,161.9
-------- -------- ------ --------
Commercial automobile... 18.4 265.4 73.3 170.9
Commercial multiple
peril.................. 32.2 488.9 123.3 243.3
Workers' compensation... 12.4 629.9 84.1 228.5
Other commercial lines.. 6.4 211.8 58.9 93.7
-------- -------- ------ --------
Total commercial
lines................ 69.4 1,596.0 339.6 736.4
-------- -------- ------ --------
Totals.............. $ 164.2 $2,744.1 $815.1 $1,898.3 $235.4
======== ======== ====== ======== ======
<CAPTION>
LOSSES AND
LOSS POLICY OTHER
ADJUSTMENT ACQUISITION UNDERWRITING NET PREMIUMS
EXPENSES EXPENSES EXPENSES (3) WRITTEN
--------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Private passenger
automobile............. $ 627.0 $ 194.3 $ 64.5 $ 738.4
Homeowners.............. 207.6 61.2 21.6 243.1
Other personal lines.... 21.5 7.8 5.6 185.9
-------- -------- ------ --------
Total personal lines.. 856.1 263.3 91.7 1,167.4
-------- -------- ------ --------
Commercial automobile... 123.5 39.3 17.2 155.2
Commercial multiple
peril.................. 204.1 62.5 35.8 252.4
Workers' compensation... 129.5 34.7 23.5 220.2
Other commercial lines.. 58.7 22.8 13.4 119.2
-------- -------- ------ --------
Total commercial
lines................ 515.8 159.3 89.9 747.0
-------- -------- ------ --------
Totals.............. $1,371.9 $ 422.6 $181.6 $1,914.4
======== ======== ====== ========
</TABLE>
- - --------
(1) As of December 31, 1996.
(2) Total invested assets which generate investment income are not recorded or
allocated by segment or line of business; therefore, net investment income
is stated in total.
(3) Includes severance charges of $1.1 and excludes policyholders' dividends of
$11.5.
82
<PAGE>
SCHEDULE III
(CONTINUED)
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
RESERVE FOR
LOSSES AND
DEFERRED POLICY LOSS
ACQUISITION ADJUSTMENT UNEARNED NET PREMIUMS NET INVESTMENT
EXPENSES (1) EXPENSES (1) PREMIUMS (1) EARNED INCOME (2)
--------------- ------------ ------------ ------------ --------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Private passenger
automobile............. $ 56.3 $1,056.4 $293.2 $ 855.7
Homeowners.............. 28.7 108.4 130.5 224.4
Other personal lines.... 3.6 10.7 20.2 33.2
-------- -------- ------ --------
Total personal lines.. 88.6 1,175.5 443.9 1,113.3
-------- -------- ------ --------
Commercial automobile... 16.4 309.2 85.3 164.2
Commercial multiple
peril.................. 29.1 479.6 124.7 157.1
Workers' compensation... 14.3 701.8 97.7 335.1
Other commercial lines.. 9.1 229.9 45.7 93.5
-------- -------- ------ --------
Total commercial
lines................ 68.9 1,720.5 353.4 749.9
-------- -------- ------ --------
Totals.............. $ 157.5 $2,896.0 $797.3 $1,863.2 $209.6
======== ======== ====== ======== ======
<CAPTION>
LOSSES AND
LOSS POLICY OTHER
ADJUSTMENT ACQUISITION UNDERWRITING NET PREMIUMS
EXPENSES EXPENSES EXPENSES (3) WRITTEN
--------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Private passenger
automobile............. $ 604.5 $ 179.6 $ 64.9 $ 871.9
Homeowners.............. 161.5 54.8 20.7 233.1
Other personal lines.... 16.2 8.9 5.2 36.3
-------- -------- ------ --------
Total personal lines.. 782.2 243.3 90.8 1,141.3
-------- -------- ------ --------
Commercial automobile... 89.5 33.0 18.6 162.8
Commercial multiple
peril.................. 112.7 38.3 20.3 244.5
Workers' compensation... 214.2 72.6 31.4 247.4
Other commercial lines.. 91.1 21.9 18.3 89.3
-------- -------- ------ --------
Total commercial
lines................ 507.5 165.8 88.6 744.0
-------- -------- ------ --------
Totals.............. $1,289.7 $ 409.1 $179.4 $1,885.3
======== ======== ====== ========
</TABLE>
- - --------
(1) As of December 31, 1995.
(2) Total invested assets which generate investment income are not recorded or
allocated by segment or line of business; therefore, net investment income
is stated in total.
(3) Excludes policyholders' dividends of $10.6.
83
<PAGE>
SCHEDULE III
(CONTINUED)
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
RESERVE FOR
LOSSES AND
DEFERRED POLICY LOSS
ACQUISITION ADJUSTMENT UNEARNED NET PREMIUMS NET INVESTMENT
EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2)
--------------- ----------- ------------ ------------ --------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Private passenger auto-
mobile................. $ 49.6 $1,007.3 $281.1 $ 802.7
Homeowners.............. 26.4 101.9 122.0 207.7
Other personal lines.... 3.4 19.2 20.2 33.9
-------- -------- ------ --------
Total personal lines.. 79.4 1,128.4 423.3 1,044.3
-------- -------- ------ --------
Commercial automobile... 20.3 300.2 89.0 165.6
Commercial multiple per-
il..................... 29.2 444.4 122.8 166.6
Workers' compensation... 15.8 768.5 102.2 330.9
Other commercial lines.. 10.3 180.2 55.9 83.9
-------- -------- ------ --------
Total commercial
lines................ 75.6 1,693.3 369.9 747.0
-------- -------- ------ --------
Totals.............. $ 155.0 $2,821.7 $793.2 $1,791.3 $202.4
======== ======== ====== ======== ======
<CAPTION>
LOSSES AND
LOSS POLICY OTHER
ADJUSTMENT ACQUISITION UNDERWRITING NET PREMIUMS
EXPENSES EXPENSES EXPENSES(3) WRITTEN
--------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Private passenger auto-
mobile................. $ 560.7 $ 164.7 $ 62.0 $ 815.7
Homeowners.............. 180.7 52.5 20.7 214.2
Other personal lines.... 15.6 8.2 5.2 33.6
-------- -------- ------ --------
Total personal lines.. 757.0 225.4 87.9 1,063.5
-------- -------- ------ --------
Commercial automobile... 117.5 32.7 20.4 174.6
Commercial multiple per-
il..................... 130.3 39.3 20.7 235.6
Workers' compensation... 235.5 71.1 37.1 249.6
Other commercial lines.. 66.4 21.8 19.8 99.6
-------- -------- ------ --------
Total commercial
lines................ 549.7 164.9 98.0 759.4
-------- -------- ------ --------
Totals.............. $1,306.7 $ 390.3 $185.9 $1,822.9
======== ======== ====== ========
</TABLE>
- - --------
(1) As of December 31, 1994.
(2) Total invested assets which generate investment income are not recorded or
allocated by segment or line of business; therefore, net investment income
is stated in total.
(3) Excludes policyholders' dividends of $8.8.
84
<PAGE>
SCHEDULE IV
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
DIRECT OTHER FROM OTHER ASSUMED
AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET
-------- --------- ---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1996
Property and liability
insurance premiums
earned.................. $2,018.5 $232.6 $112.4 $1,898.3 5.9%
======== ====== ====== ======== ===
1995
Property and liability
insurance premiums
earned.................. $2,021.7 $296.2 $137.7 $1,863.2 7.4%
======== ====== ====== ======== ===
1994
Property and liability
insurance premiums
earned.................. $1,967.1 $291.9 $116.1 $1,791.3 6.5%
======== ====== ====== ======== ===
</TABLE>
85
<PAGE>
SCHEDULE V
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
DEDUCTIONS
ADDITIONS FROM PREMIUM
BALANCE AT CHARGED TO BALANCES TO
BEGINNING OF COSTS AND ALLOWANCE BALANCE AT END
PERIOD EXPENSE ACCOUNT OF PERIOD
------------- ---------- ------------ --------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
1996
Allowance for doubtful
accounts................ $4.6 $6.8 $6.9 $4.5
==== ==== ==== ====
1995
Allowance for doubtful
accounts................ $4.7 $5.3 $5.4 $4.6
==== ==== ==== ====
1994
Allowance for doubtful
accounts................ $3.5 $4.1 $2.9 $4.7
==== ==== ==== ====
</TABLE>
86
<PAGE>
SCHEDULE VI
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY & CASUALTY
INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
DISCOUNT
IF ANY,
DEFERRED DEDUCTED
POLICY RESERVE FOR FROM NET NET
AFFILIATION WITH ACQUISITION LOSSES AND PREVIOUS UNEARNED PREMIUMS INVESTMENT
REGISTRANT EXPENSES LAE(2) COLUMN(1) PREMIUMS(2) EARNED INCOME
---------------- ----------- ----------- --------- ----------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Consolidated Property
and Casualty
Subsidiaries
1996.................. $164.2 $2,744.1 $-- $815.1 $1,898.3 $235.4
====== ======== ==== ====== ======== ======
1995.................. $157.5 $2,896.0 $-- $797.3 $1,863.2 $209.6
====== ======== ==== ====== ======== ======
1994.................. $155.0 $2,821.7 $-- $793.2 $1,791.3 $202.4
====== ======== ==== ====== ======== ======
</TABLE>
<TABLE>
<CAPTION>
AMORTIZATION OF
LOSSES AND LAE DEFERRED POLICY
----------------------- ACQUISITION PAID LOSSES NET PREMIUMS
CURRENT YEAR PRIOR YEAR EXPENSES AND LAE WRITTEN
------------ ---------- --------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
1996........ $1,513.3 $(141.4) $422.6 $1,387.2 $1,914.4
======== ======= ====== ======== ========
1995........ $1,427.3 $(137.6) $409.1 $1,266.5 $1,885.3
======== ======= ====== ======== ========
1994........ $1,434.8 $(128.1) $390.3 $1,217.1 $1,822.9
======== ======= ====== ======== ========
</TABLE>
- - --------
(1) The Company does not employ any discounting techniques.
(2) Reserves for losses and LAE are shown gross of $626.9 million, $763.5
million and $712.5 million of reinsurance recoverable on unpaid losses in
1996, 1995 and 1994, respectively. Unearned premiums are shown gross of
prepaid premiums of $45.5 million, $43.8 million and $61.9 million in 1996,
1995 and 1994, respectively.
87
<PAGE>
[ALLMERICA FINANCIAL LOGO, LIST OF SUBSIDIARIES
AND CORPORATE ADDRESS APPEARS HERE]
APY9610K
APY9610K
<PAGE>
EXHIBIT 11
ALLMERICA PROPERTY & CASUALTY COMPANIES, INC.
AND SUBSIDIARIES
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
FOR THE PERIODS ENDED DECEMBER 31, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED TWELVE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------- -------------------
1996 1995 1996 1995
------ ------ --------- ---------
<S> <C> <C> <C> <C>
Primary:
Average shares outstanding................. 59.6 61.1 59.9 61.4
Net effect of dilutive stock options based
on the treasury stock method using average
market price.............................. 0.1 -- -- --
------ ------ --------- ---------
TOTALS................................... 59.7 61.1 59.9 61.4
====== ====== ========= =========
Net income................................... $ 27.4 $ 27.9 $ 146.4 $ 140.1
Per share amount............................. $ 0.46 $ 0.46 $ 2.44 $ 2.28
Fully diluted:
Average shares outstanding................. 59.6 61.1 59.9 61.4
Net effect of dilutive stock options based
on the treasury stock method using average
market price.............................. 0.1 -- -- --
------ ------ --------- ---------
TOTALS................................... 59.7 61.1 59.9 61.4
====== ====== ========= =========
Net income................................... $ 27.4 $ 27.9 $ 146.4 $ 140.1
Per share amount............................. $ 0.46 $ 0.46 $ 2.44 $ 2.28
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
The Hanover Insurance Company (New Hampshire)
Citizens Corporation (Delaware)
Citizens Insurance Company of America (Michigan)
Citizens Insurance Company of Ohio (Ohio)
Citizens Management, Inc. (Michigan)
Citizens Insurance Company of the Midwest (Indiana)
Massachusetts Bay Insurance Company (New Hampshire)
The Hanover American Insurance Company (New Hampshire)
Hanover Lloyd's Insurance Company (Texas)
AMGRO, Inc. (Massachusetts)
Lloyds Credit Corporation (Massachusetts)
Hanover Texas Insurance Management Company, Inc. (Texas)
Allmerica Employees' Insurance Agency, Inc. (Massachusetts)
APC Funding Corporation (Massachusetts)
Allmerica Financial Insurance Brokers, Inc. (Massachusetts)
Allmerica Financial Alliance Insurance Company (New Hampshire)
Allmerica Financial Benefit Insurance Company (Pennsylvania)
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-11123) of Allmerica Property & Casualty
Companies, Inc. of our report dated February 3, 1997, except as to Notes 1 and
2, which are as of February 19, 1997, which appears in this Annual Report on
Form 10-K.
/s/ Price Waterhouse LLP
_____________________________________
Price Waterhouse LLP
Boston, Massachusetts
March 18, 1997
<PAGE>
EXHIBIT 24
POWER OF ATTORNEY
WE, THE UNDERSIGNED, HEREBY SEVERALLY CONSTITUTE AND APPOINT JOHN F.
O'BRIEN, JOHN F. KELLY, AND EDWARD J. PARRY, III, AND EACH OF THEM SINGLY, OUR
TRUE AND LAWFUL ATTORNEYS, WITH FULL POWER IN EACH OF THEM, SIGN FOR AND IN
OUR NAMES AND IN ANY AND ALL CAPACITIES, FORM 10-K OF ALLMERICA PROPERTY &
CASUALTY COMPANIES, INC. (THE "COMPANY") AND ANY OTHER FILINGS MADE ON BEHALF
OF SAID COMPANY PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF
1934, AND TO FILE THE SAME WITH ALL EXHIBITS AND OTHER DOCUMENTS IN CONNECTION
THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO SAID
ATTORNEYS AND EACH OF THEM, ACTING ALONE, FULL POWER AND AUTHORITY TO DO AND
PERFORM EACH AND EVERY ACT AND THING REQUISITE OR NECESSARY TO BE DONE, HEREBY
RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS OR ANY OF THEM MAY LAWFULLY
DO OR CAUSE TO BE DONE BY VIRTUE HEREOF. WITNESS OUR HANDS AND COMMON SEAL ON
THE DATE SET FORTH BELOW.
SIGNATURE TITLE DATE
/s/ John F. O'Brien Director, President 2/24/97
- - ------------------------------------- and CEO
JOHN F. O'BRIEN
/s/ Michael P. Angelini Director 2/24/97
- - -------------------------------------
MICHAEL P. ANGELINI
/s/ David A. Barrett Director 2/24//97
- - -------------------------------------
DAVID A. BARRETT
/s/ James A. Cotter, Jr. Director 2/24/97
- - -------------------------------------
JAMES A. COTTER, JR.
/s/ Gail L. Harrison Director 2/24/97
- - -------------------------------------
GAIL L. HARRISON
/s/ M Howard Jacobson Director 2/24/97
- - -------------------------------------
M HOWARD JACOBSON
/s/ Dona Scott Laskey Director 2/24/97
- - -------------------------------------
DONA SCOTT LASKEY
/s/ Eric A. Simonsen Director, Vice 2/24/97
- - ------------------------------------- President
ERIC A. SIMONSEN
/s/ Robert G. Stachler Director 2/24/97
- - -------------------------------------
ROBERT G. STACHLER
/s/ Herbert M. Varnum Director 2/24/97
- - -------------------------------------
HERBERT M. VARNUM
/s/ Richard Manning Wall Director 2/24/97
- - -------------------------------------
RICHARD MANNING WALL
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 3,528
<DEBT-CARRYING-VALUE> 3,445
<DEBT-MARKET-VALUE> 0
<EQUITIES> 403
<MORTGAGE> 0
<REAL-ESTATE> 4
<TOTAL-INVEST> 3,962
<CASH> 97
<RECOVER-REINSURE> 45
<DEFERRED-ACQUISITION> 164
<TOTAL-ASSETS> 5,704
<POLICY-LOSSES> 2,744
<UNEARNED-PREMIUMS> 815
<POLICY-OTHER> 31
<POLICY-HOLDER-FUNDS> 13
<NOTES-PAYABLE> 28
0
0
<COMMON> 62
<OTHER-SE> 1,547
<TOTAL-LIABILITY-AND-EQUITY> 5,704
1,898
<INVESTMENT-INCOME> 235
<INVESTMENT-GAINS> 48
<OTHER-INCOME> 12
<BENEFITS> 1,372
<UNDERWRITING-AMORTIZATION> 423
<UNDERWRITING-OTHER> 201
<INCOME-PRETAX> 198
<INCOME-TAX> 36
<INCOME-CONTINUING> 161
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 146
<EPS-PRIMARY> 2.44
<EPS-DILUTED> 2.44
<RESERVE-OPEN> 2,896
<PROVISION-CURRENT> 1,513
<PROVISION-PRIOR> (141)
<PAYMENTS-CURRENT> 760
<PAYMENTS-PRIOR> 627
<RESERVE-CLOSE> 2,744
<CUMULATIVE-DEFICIENCY> (137)
</TABLE>
<PAGE>
EXHIBIT 99.1
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected the Company's results and in the
future could cause actual results and needs of the Company to vary materially
from forward-looking statements made from time to time by the Company on the
basis of management's then-current expectations. The businesses in which the
Company is engaged are in rapidly changing and competitive markets and involve
a high degree of risk, and accuracy with respect to forward-looking
projections is difficult.
GEOGRAPHIC CONCENTRATION IN THE PROPERTY AND CASUALTY INSURANCE BUSINESS
Substantially all of the Company's net premiums written and earnings are
generated in Michigan. The revenues and profitability of the Company are
therefore subject to prevailing economic, regulatory, demographic and other
conditions, including adverse weather, in Michigan.
CYCLICALITY IN THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
Historically, the property and casualty insurance industry has been highly
cyclical. The property and casualty industry's profitability can be affected
significantly by price competition, volatile and unpredictable developments
such as extreme weather conditions and natural disasters, legal developments
affecting insurer liability and the size of jury awards, fluctuations in
interest rates and other factors that affect investment returns and other
general economic conditions and trends that may affect the adequacy of
reserves.
Over the past several years, the property and casualty insurance industry as
a whole has been in a soft market. Competition for premiums in the property
and casualty insurance markets may continue to have an diverse impact on the
Company's rates and profitability.
CATASTROPHES AND SEVERE WEATHER LOSSES IN THE PROPERTY AND CASUALTY INSURANCE
INDUSTRY
Property and casualty insurers are subject to claims arising out of
catastrophes, and other severe weather related losses, which may have a
significant impact on their results of operations and financial condition. The
Company may experience catastrophes and other severe weather losses in the
future which could have a material adverse impact on the Company. Catastrophes
and severe weather losses can be caused by various events including
hurricanes, earthquakes, tornadoes, wind, hail, fires, severe winter weather
and explosions, and the frequency and severity of catastrophes are inherently
unpredictable. The extent of losses from catastrophes and severe weather is a
function of two factors: the total amount of insured exposure in the area
affected by the event and the severity of the event. Although catastrophes and
severe weather can cause losses in a variety of property and casualty lines,
homeowners and commercial property insurance have in the past generated the
vast majority of the Company's catastrophe-related claims. The Company
purchases catastrophe reinsurance as protection against catastrophe losses.
The Company believes, based upon its review of its reinsurers' financial
statements and reputations in the reinsurance marketplace, that the financial
condition of its reinsurers is sound. However, there can be no assurance that
reinsurance will be adequate to protect the Company against such losses or
that such reinsurance will continue to be available to the Company in the
future at commercially reasonable rates.
UNCERTAINTY REGARDING ADEQUACY OF PROPERTY AND CASUALTY LOSS RESERVES
The Company maintains reserves to cover its estimated ultimate liability for
losses and loss adjustment expenses ("LAE") with respect to reported and
unreported claims incurred as of the end of each accounting period. These
reserves are estimates, involving actuarial projections at a given time, of
what the Company expects the ultimate settlement and administration of claims
will cost based on facts and circumstances then known, predictions of future
events, estimates of future trends in claims severity and judicial theories of
liability,
<PAGE>
legislative activity and other factors. The inherent uncertainties of
estimating reserves are greater for certain types of property and casualty
insurance lines, particularly workers' compensation, where a longer period of
time may elapse before a definitive determination of ultimate liability may be
made, and environmental liability, where the technological, judicial and
political climates involving these types of claims are changing.
The Company regularly reviews reserving techniques, reinsurance and overall
reserve adequacy. Based upon (i) review of historical data, legislative
enactments, judicial decisions, legal developments in imposition of damages,
changes in political attitudes and trends in general economic conditions;
(ii) review of per claim information; (iii) historical loss experience of the
Company and the industry; and (iv) the relatively short-term nature of most of
its property and casualty insurance policies, management believes that
adequate provision has been made for reserves. However, establishment of
appropriate reserves is an inherently uncertain process involving estimates of
future losses and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience. The
Company's reserves are annually certified as required by insurance regulatory
authorities.
REGULATORY, SURPLUS, CAPITAL, RATING AGENCY AND RELATED MATTERS
Insurance companies are subject to supervision and regulation by the state
insurance authority in each state in which they transact business. Such
supervision and regulation relate to numerous aspects of an insurance
company's business and financial condition, including limitations on the
authorization of lines of business, underwriting limitations, the setting of
premium rates, the establishment of standards of solvency, the licensing of
insurers and agents, concentration of investments, levels of reserves, the
payment of dividends, transactions with affiliates, changes of control and the
approval of policy forms. Such regulation is concerned primarily with the
protection of policyholders.
State regulatory oversight and various proposals at the federal level
(including the proposed adoption of a federal regulatory framework for
insurance companies) may in the future adversely affect the Company's ability
to sustain adequate returns in certain lines of business. In recent years, the
state insurance regulatory framework has come under increased federal
scrutiny, and certain state legislatures have considered or enacted laws that
alter and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. Further, the National
Association of Insurance Commissioners ("NAIC") and state insurance regulators
are reexamining existing laws and regulations, and as a condition to
accreditation have required the adoption of certain model laws which
specifically focus on insurance company investments, issues relating to the
solvency of insurance companies, risk-based capital ("RBC") guidelines,
interpretations of existing laws, the development of new laws, and the
definition of extraordinary dividends.
The capacity for an insurance company's growth in premiums is in part a
function of its statutory surplus. Maintaining appropriate levels of statutory
surplus, as measured by state insurance regulators, is considered important by
state insurance regulatory authorities and the private agencies that rate
insurers' claims-paying abilities and financial strength. Failure to maintain
certain levels of statutory surplus could result in increased regulatory
scrutiny, action by state regulatory authorities or a downgrade by the private
agencies referred to below.
The NAIC has created a new system for assessing the adequacy of statutory
capital for property and casualty insurers. The new system, known as risk-
based capital, is in addition to the states' fixed dollar minimum capital and
other requirements. The new system is based on risk-based formulas (separately
defined for life and health insurers and property and casualty insurers) that
apply prescribed factors to the various risk elements in an insurer's business
to report a minimum capital requirement proportional to the amount of risk
assumed by the insurer.
STATE GUARANTY FUNDS, SHARED MARKETS MECHANISMS AND POOLING ARRANGEMENTS
All fifty states of the United States have insurance guaranty fund laws
requiring all life and health and property and casualty insurance companies
doing business within the state to participate in guaranty associations,
<PAGE>
which are organized to pay contractual obligations under insurance policies
issued by impaired or insolvent insurance companies. These associations levy
assessments (up to prescribed limits) on all member insurers in a particular
state on the basis of the proportionate share of the premiums written by
member insurers in the lines of business in which the impaired or insolvent
insurer is engaged. Mandatory assessments by state guaranty funds are used to
cover losses to policyholders of insolvent or rehabilitated companies and can
be partially recovered through a reduction in future premium taxes in many
states. These assessments may increase in the future depending upon the rate
of insolvencies of insurance companies.
In addition, as a condition to the ability to conduct business in various
states, the Company is required to participate in mandatory property and
casualty shared market mechanisms or pooling arrangements, which provide
various insurance coverages to individuals or other entities that otherwise
are unable to purchase such coverage voluntarily provided by private insurers.
The Company cannot predict whether its participation in these shared market
mechanisms or pooling arrangements will provide underwriting profits or losses
to the Company.
COMPETITION
The Property and Casualty Insurance industry in general is highly
competitive. Many of the Company's competitors are larger and have greater
financial, technical and operating resources than those of the Company.
RETENTION OF KEY EXECUTIVES
The future success of the Company will be affected by its continued ability
to attract and retain qualified executives. The Company's success is dependent
in large part on John F. O'Brien, the loss of whom could adversely affect the
Company's business. The Company does not have an employment agreement with Mr.
O'Brien.
