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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM: TO
1-11714
(COMMISSION FILE NUMBER)
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CITIZENS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3178765
(STATE OR OTHER JURISDICTION, (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
440 LINCOLN STREET, WORCESTER, 01653
MASSACHUSETTS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
(508) 855-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
COMMON STOCK, $0.01 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
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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 March 13, 1998 the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$205,296,705.
The number of shares outstanding of the registrant's common stock, $0.01 par
value, was 35,275,100 shares outstanding as of March 13, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Citizens Corporation's Proxy Statement for Annual Meeting of
Shareholders to be held May 12, 1998 (the Proxy Statement) are incorporated by
reference in Part III.
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PART I
ITEM 1. BUSINESS
ORGANIZATION
Citizens Corporation is a Delaware Corporation and non-insurance holding
company with wholly-owned subsidiaries: Citizens Insurance Company of America
(Citizens Insurance), a Michigan corporation; Citizens Insurance Company of
the Midwest, an Indiana corporation; and Citizens Insurance Company of Ohio,
an Ohio corporation; (collectively Citizens Insurance Group) and Citizens
Management Inc. (CMI). Citizens Corporation and its subsidiaries are
hereinafter collectively referred to as "the Company." Approximately 82.5% of
the Company is owned by The Hanover Insurance Company (Hanover). Hanover is an
indirect wholly-owned subsidiary of Allmerica Financial Corporation (AFC), a
Delaware corporation.
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 14 and 15 in
Management's Discussion & Analysis of Results of Operations and Financial
Condition and in Note 14 on page 47 of the Notes to the Consolidated Financial
Statements included in Financial Statements and Supplementary Data of this
Form 10-K.
GENERAL
The Company, through Citizens Insurance, is one of the largest underwriters
of personal and commercial property and casualty insurance, in terms of market
share, in Michigan. The Company has a historically strong regional focus and
it places heavy emphasis on underwriting profitability and loss reserve
adequacy. Through an independent agency force, the Company underwrites
personal and commercial segments of insurance including: personal automobile,
homeowners, workers' compensation, commercial automobile and commercial
multiple peril.
The Company maintains 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
existing markets and, as opportunities arise, in new markets which offer long-
term growth potential. In addition, by focusing on its established major
segment product lines, the Company typically does not pursue the development
of new products with relatively unpredictable risk profiles.
Citizens Insurance's average premium growth rate was 7.0% for the ten year
period ended December 31, 1997 and its average statutory combined ratio for
the same period was 100.6. The industry average premium growth rate was 3.7%
for the ten year period ended December 31, 1997 and the industry average
statutory combined ratio for the same period was 107.8. (Industry estimates
are based on data published by A.M. Best.)
The property and casualty insurance industry is highly cyclical. 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 affect
investment returns, and other general economic conditions and trends, such as
inflationary pressures, that may affect the adequacy of reserves.
In 1996, the Company began the process of consolidating certain operations
which are intended to achieve process improvements and efficiencies of
operations. These operations include the claims, finance, policy processing
and administrative functions. In 1997, the Company upgraded its claims
processing automation and consolidated many of its Michigan claims offices
into a regional claims center based in Howell. Additionally,
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the Company increased claim draft authority for its agents and implemented a
network of auto repair facilities to streamline damage appraisal and repair.
The Company also began reengineering its processing of commercial lines
business, redefining underwriting roles and providing more authority to agents
to price and bind standard accounts.
SEGMENT PRODUCT LINES
Citizens underwrites 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 against 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.
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 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.
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.
The Company also offers a variety of other products, such as inland marine,
umbrella, fire, other liability and surety insurance. The Company provides
self-insurance administration services for individual risks and groups, and
writes excess reinsurance coverage for the self-insurance programs it
administers through its wholly-owned subsidiary, CMI.
CUSTOMERS, MARKETING AND DISTRIBUTION
The Company seeks to maintain long-term pricing and underwriting integrity
in order to remain a stable market for its independent agents. In order to
complement the Company's property and casualty focus and increase customer
contact, agents will seek to market employer benefit programs, including group
medical and life, dental, and asset management. The Company 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.
The Company's insurance products are marketed in Michigan through
approximately 3,600 licensed independent insurance agents, who are paid on a
commission basis, associated with approximately 530 insurance agencies. The
Company also markets its products in Indiana and Ohio through approximately
1,800 licensed independent insurance agents associated with approximately 220
insurance agencies. In 1997, each agency representing the Company wrote an
average of approximately $1.6 million in Michigan, $0.5 million in Indiana,
and $0.3 million in Ohio of Company premiums. In 1997, 287 agencies wrote
Company premiums in excess of $1.0 million, 126 agencies wrote over $2.0
million, 62 agencies wrote over $3.0 million and 27 wrote over $4.0 million.
The three largest agencies wrote approximately $20.3 million, $16.9 million,
and $16.1 million of Company premiums, respectively.
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The Company seeks to pursue profitable growth in existing markets by
establishing long-term relationships with larger, well-established agencies.
To solidify its relationship with higher quality agents, the Company offers
enhanced profit sharing agreements, recognition awards, and maintains local
presence through five branch offices and four claims offices in Michigan,
Indiana and Ohio.
In 1997, the Company completed the process of consolidating certain
operations with Hanover to achieve process improvements and efficiencies in
operations including claims, finance, policy processing and administrative
functions. Additionally, during 1997 the Company relocated many of its claims
functions to a regional office in Michigan to provide for better client
service and gain operational efficiencies.
The Company has been successful in developing and marketing groups in both
personal and commercial segments that are tailored for members of
associations, financial institutions and employers in Michigan, Indiana and
Ohio. The organizations may choose to make the Company's programs available to
their members or employees based on an evaluation of the Company's 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
or employees. As of December 31, 1997, the Company had approximately 144 group
programs in-force, 114 of which were in personal segments and 30 of which were
in commercial segments. Revenue from personal and commercial lines groups
accounts for nearly 50 percent of the Company's total premium volume.
Citizens continues its use of agency-company interface ("ACI") technology,
which enables agents to electronically submit personal lines policies for
review and rating. In addition, agents are authorized to bind the Company on
risks. The agents are guided by the Company's 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 the Company.
The Company is not dependent upon a single customer or any few customers for
which the loss of any one or more would have a material adverse effect upon
the Company's operations.
MICHIGAN CATASTROPHIC CLAIMS ASSOCIATION
As a condition to the ability to conduct personal automobile business in the
state of Michigan, the Company is required under Michigan law to participate
in a pooling arrangement with the Michigan Catastrophic Claims Association
(MCCA). The Company is indemnified by the MCCA for 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 1997, 1996, and 1995 were $9.8 million, $50.5 million and
$66.8 million, respectively. The decrease in ceded premiums earned to MCCA
reflects a reduction in premiums charged per policyholder by MCCA. Losses and
LAE ceded to MCCA in 1997, 1996, and 1995 were ($0.8) million, ($52.9) million
and $62.9 million, respectively. In 1997 and 1996, the MCCA's favorable
development on prior year reserves exceeded the losses and LAE incurred during
the year.
At December 31, 1997 and 1996, the Company had reinsurance recoverable from
the MCCA on paid and unpaid losses of $280.2 million and $292.0 million,
respectively. 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
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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, 1997, 1996 and
1995, the MCCA had estimated surplus of $2.5 billion, $1.7 billion and $666.2
million, respectively. 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.
COMPETITION
The property and casualty industry is highly competitive among national
agency companies, direct writers, and regional and local insurers on the basis
of both price and service. Many of these companies are larger and have greater
financial and technical resources than Citizens. National agency companies
sell insurance through independent agents and usually concentrate on
commercial lines of property and casualty insurance. Direct writers, including
those with exclusive agent representation, dominate the personal lines of
property and casualty insurance and operate on a national, regional, or single
state basis. Regional and local companies sell through independent agents in
one or several states in the same region and usually compete in both personal
and commercial lines. In addition, because the Company markets exclusively
through independent agents, Citizens competes with other independent agency
companies for business in each of the agencies representing it.
In Michigan, the Company competes in personal lines with a number of direct
writers and regional and local companies, several of which are larger than the
Company. Citizens Insurance is the largest writer of property and casualty
insurance in Michigan through independent agents. The Company's principal
competition in the Michigan homeowners line is from direct writers, including
State Farm Group. The Company also faces competition from the two largest
direct writers in Michigan, Auto Club Michigan Group and State Farm Group, in
the personal automobile line. 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. This new legislation has removed
barriers to entrance into the market for national agency companies, which have
not been significant competitive forces in Michigan in the personal lines of
property and casualty insurance in previous years. This was, in part, due to
Michigan's prior insurance regulatory environment which required 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. Although the Company
believes that this new legislation will encourage national companies to return
or enter into the state, they do not believe that the impact of this law is
yet measurable.
The Company faces commercial lines competition principally from national
agency companies, and regional and local companies, many of which have
financial resources substantially greater than those of the Company. The
Company is the second leading writer in Michigan in its three primary
commercial lines combined: commercial automobile, workers' compensation, and
commercial multiple peril. The commercial lines 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. 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 workers' compensation insurance rates four times; 8.5%, 7.0%, 6.4% and
8.7% effective May 1, 1995, December 1, 1995, June 1, 1996 and March 1, 1997,
respectively. In March 1997, the Company introduced workers' compensation
product and pricing alternatives, written through Citizens Insurance Company
of Ohio and Citizens Insurance Company of the Midwest. These vehicles enable
greater pricing flexibility, particularly for writing preferred risks in
medium and large workers' compensation accounts. By the end of 1997, rate
filings effective January 1, 1998 by companies indicated either small
decreases for selected classes of business or even some rate increases.
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Consistent with industry response to high loss ratios in the homeowners
insurance market, Citizens increased rates in this line of business in
November 1997. Because many of the Company's national and regional competitors
took similar rate increases, it is difficult to determine at present the
impact of this increase.
Beginning in 1995, Citizens Insurance Group experienced an increase in
competition in affinity franchise group sales as a result of the January 1995
order by the Michigan Insurance Commissioner which allowed competitors to
offer similar products. While management has taken steps to increase
penetration in affinity franchise groups and initiated other marketing
programs, the Company believes that competition for affinity group business
and for other premiums in the property and casualty insurance market will
continue and may have an adverse impact on rates and profitability.
UNDERWRITING
Pricing
Citizens Insurance Group seeks to apply profit-driven underwriting and
pricing practices in both hard and soft markets, expand its quality agency
relationships and maintain a consistent presence in the markets for its five
core product lines. This strategy seeks to achieve measured growth and
consistent profitability on a continuous basis.
The Company's position as one of the largest insurers in terms of net
premiums written in Michigan allows it to use its own loss experience in
determining premium rates. The Company's rates for personal and commercial
automobile and homeowners insurance in Michigan are based on its own
experience.
In Michigan, and in Indiana, the Company develops rates for commercial lines
of general liability and property by using loss cost data from the Insurance
Service Office (ISO), an independent organization providing industry-wide loss
experience in all major product lines. To this cost data, the Company adds its
own experience in these lines. In the workers' compensation line in Michigan,
the Company uses its own experience to determine rates for its largest
classifications, and uses industry-wide experience to help set rates for
smaller classifications. In Ohio, the Company has not yet developed enough
loss experience on which to make rate calculations, and uses loss cost
information from the ISO, along with market comparisons.
Claims
The Company employs experienced claims adjusters, appraisers, medical
specialists, and attorneys in order to manage its claims. The Company has
field claims staff strategically located throughout its operating territories,
as well as a central customer service center in Howell, Michigan where claims
are reported and most first party losses are quickly resolved. All claims
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 a
special unit which investigates suspected insurance fraud and abuse.
Citizens Insurance has instituted a program under which participating agents
have settlement authority for many property loss claims. Based upon the
program experience, the Company believes that this program contributes to
lower experience and to its higher customer satisfaction ratings by permitting
the early and direct settlement of such claims. Approximately 30.1% and 26.6%
of the number of total paid claims reported to Citizens Insurance in the years
ended December 31, 1997 and 1996, respectively, were settled under this
program.
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Citizens Insurance has increased usage of the managed care expertise of the
AFC's Corporate Risk Management Services segment in the analysis of medical
services and pricing in the management of workers' compensation and medical
claims on its automobile policies. The Company's use of this capability has
demonstrated reduced costs and serves its customers more efficiently. Citizens
Insurance has introduced Citizens/Care, which is a network of Preferred
Provider Agreements which focuses on managing medical cost claims and serving
customers more efficiently.
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.
RESERVES FOR UNPAID LOSSES AND LAE
See "Reserve for Losses and Loss Adjustment Expenses" on pages 16-18 of
Management's Discussion & Analysis of Results of Operations and Financial
Condition of this Form 10-K which are 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
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 Company regularly reviews its reserving techniques, its overall reserve
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 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.
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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 1987 through 1997 for the Company.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserve for losses
and LAE(1)............ $ 747.5 $ 772.1 $ 772.7 $ 739.9 $ 673.7 $ 598.8 $ 534.9 $ 429.6 $ 387.8 $ 329.8 $ 265.2
Cumulative amount paid
as of(2):
One year later........ -- 280.4 239.1 223.4 204.5 195.3 196.2 160.2 152.4 130.8 108.5
Two years later....... -- -- 368.2 333.4 309.0 295.0 295.4 255.4 227.9 202.7 167.6
Three years later..... -- -- -- 397.5 363.3 351.4 349.2 306.8 281.4 240.7 203.8
Four years later...... -- -- -- -- 394.9 378.3 380.0 334.7 310.8 269.7 220.9
Five years later...... -- -- -- -- -- 396.4 393.4 351.0 325.1 287.8 237.0
Six years later....... -- -- -- -- -- -- 405.6 360.1 335.9 296.5 246.9
Seven years later..... -- -- -- -- -- -- -- 370.2 343.0 303.7 254.0
Eight years later..... -- -- -- -- -- -- -- -- 351.5 308.9 259.4
Nine years later...... -- -- -- -- -- -- -- -- -- 315.7 263.4
Ten years later....... -- -- -- -- -- -- -- -- -- -- 268.3
Net reserve re-
estimated as of(3):
End of year............ 747.5 772.1 772.7 739.9 673.7 598.8 534.9 429.6 387.8 329.8 265.2
One year later........ -- 702.6 714.3 692.9 661.3 592.4 530.3 436.2 376.8 330.7 275.2
Two years later....... -- -- 646.7 634.0 609.3 578.4 530.5 451.0 388.1 326.9 272.9
Three years later..... -- -- -- 588.4 562.6 543.9 518.6 457.9 404.5 329.3 266.1
Four years later...... -- -- -- -- 533.7 518.4 507.7 454.4 415.2 353.5 277.4
Five years later...... -- -- -- -- -- 504.7 496.4 443.9 413.3 361.4 293.7
Six years later....... -- -- -- -- -- -- 491.4 437.8 407.0 361.4 300.8
Seven years later..... -- -- -- -- -- -- -- 437.9 405.0 359.2 302.5
Eight years later..... -- -- -- -- -- -- -- -- 407.2 359.2 300.7
Nine years later...... -- -- -- -- -- -- -- -- -- 362.1 303.9
Ten years later....... -- -- -- -- -- -- -- -- -- -- 309.3
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Cumulative Redundancy
(Deficiency)(4)....... $ -- $ 69.5 $ 126.0 $ 151.5 $ 140.0 $ 94.1 $ 43.5 $ (8.3) $ (19.4) $ (32.3) $ (44.1)
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- --------
(1) Sets forth the net estimated liability for unpaid losses and LAE recorded
at the balance sheet date for each of the indicated years; represents the
net estimated amount of 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 the
remaining unpaid claims.
(4) Cumulative deficiency or redundancy at December 31, 1997 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 more 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.
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(5) The following table sets forth the development of gross reserve for unpaid
losses and LAE from 1992 through 1997 for the Company:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Reserve for losses and
LAE:
Gross Liability.......... $1,206.1 $1,238.5 $1,291.6 $1,196.6 $1,076.7 $ 867.8
Reinsurance recoverable.. 458.6 466.4 518.9 456.7 403.0 269.0
-------- -------- -------- -------- -------- -------
Net liability............ $ 747.5 $ 772.1 $ 772.7 $ 739.9 $ 673.7 $ 598.8
======== ======== ======== ======== ======== =======
One year later:
Gross re-estimated
liability............... $1,110.1 $1,111.0 $1,063.8 $1,004.6 $ 898.2
Re-estimated recoverable. 407.5 396.7 370.9 343.3 305.8
-------- -------- -------- -------- -------
Net re-estimated
liability............... $ 702.6 $ 714.3 $ 692.9 $ 661.3 $ 592.4
======== ======== ======== ======== =======
Two years later:
Gross re-estimated
liability............... $1,003.6 $ 986.5 $ 896.9 $ 853.0
Re-estimated recoverable. 356.9 352.5 287.6 274.6
-------- -------- -------- -------
Net re-estimated
liability............... $ 646.7 $ 634.0 $ 609.3 $ 578.4
======== ======== ======== =======
Three years later:
Gross re-estimated
liability............... $ 910.5 $ 862.0 $ 785.4
Re-estimated recoverable. 322.1 299.4 241.5
-------- -------- -------
Net re-estimated
liability............... $ 588.4 $ 562.6 $ 543.9
======== ======== =======
Four years later:
Gross re-estimated
liability............... $ 809.0 $ 780.9
Re-estimated recoverable. 275.3 262.5
-------- -------
Net re-estimated
liability............... $ 533.7 $ 518.4
======== =======
Five years later:
Gross re-estimated
liability............... $ 750.3
Re-estimated recoverable. 245.6
-------
Net re-estimated
liability............... $ 504.7
=======
</TABLE>
RATING AGENCIES
From 1970 to 1996, Citizens Insurance had been rated "A+ (Superior)" by A.M.
Best. This was the second highest rating out of fifteen rating levels
established by A.M. Best for the insurance industry. Ratings range from "A++
(Superior)" to "F (In Liquidation)." In 1997, A.M. Best decided to no longer
rate Citizens independently from its majority parent, The Hanover Insurance
Company, but instead rated the two separate companies as a group.
Consequently, Citizens was assigned Best's "A (Excellent)" rating. 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 policy holders. The
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.
EMPLOYEES
At December 31, 1997, the Company had approximately 1,387 employees, none of
whom were represented by a labor union. Management believes that its relations
with employees are good.
REINSURANCE
See "Reinsurance" on pages 18 and 19 of Management's Discussion and Analysis
of Results of Operations and Financial Condition and Note 6 on pages 38, 39
and 40, respectively, of the Notes to Consolidated Financial Statements
included in Financial Statements and Supplementary Data of this Form 10-K
which are incorporated into this item by reference. See also "Michigan
Catastrophic Claims Association" on page 4 of this Form 10-K which is
incorporated into this item by reference.
9
<PAGE>
INVESTMENT OPERATIONS
See "Investment Portfolio" on page 19 of Management's Discussion and
Analysis of Results of Operations and Financial Condition and Note 3 on pages
34-36 of the Notes to Consolidated Financial Statements included in Financial
Statements and Supplementary Data of this Form 10-K which are incorporated
into this item by reference.
ITEM 2. PROPERTIES
The Company owns a 110,600 square foot office building in Howell, Michigan,
approximately 40 miles outside of Detroit. This building serves as the
Company's headquarters and accommodates corporate administration, marketing,
information services, and treasury. The Company also owns a 175,000 square
foot facility in Howell near its current headquarters which accommodates
underwriting, claims, marketing functions, and the Eastern Michigan branch
operations.
In addition, the Company leases an aggregate of approximately 55,000 square
feet in three Michigan branch offices--in Grand Rapids, Gaylord, and
Escanaba--one branch office located in Indianapolis, Indiana--and one branch
office located in Columbus, Ohio. The Company also leases space for its claims
offices throughout Michigan and Indiana.
Management believes that the Company's owned and leased office space is
adequate for its current needs.
ITEM 3. LEGAL PROCEEDINGS
None
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.
10
<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 Citizens Corporation is traded on the New York Stock
Exchange under the symbol "CZC." On March 13, 1998, the Company had 166
shareholders of record and 35.3 million shares outstanding. On the same date,
the trading price of the Company's common stock was $33 1/4 per share.
COMMON STOCK PRICES AND DIVIDENDS
<TABLE>
<CAPTION>
HIGH LOW DIVIDENDS
---- ---- ---------
<S> <C> <C> <C>
1997
First Quarter....................................... $25 1/8 $22 $0.05
Second Quarter...................................... $28 $23 3/4 $0.05
Third Quarter....................................... $30 3/8 $27 3/8 $0.05
Fourth Quarter...................................... $31 1/2 $27 3/4 $0.05
1996
First Quarter....................................... $20 1/4 $18 1/2 $0.05
Second Quarter...................................... $19 5/8 $17 5/8 $0.05
Third Quarter....................................... $22 3/8 $18 3/8 $0.05
Fourth Quarter...................................... $22 3/4 $20 1/8 $0.05
</TABLE>
1998 DIVIDEND SCHEDULE
Citizens Corporation declared a cash dividend of $0.05 on December 16, 1997,
which is payable on February 16, 1998. The record date for such dividend is
February 2, 1998.
Dividends by the Company are funded from dividends paid to the Company from
Citizens Insurance, which are subject to restrictions imposed by state
insurance laws and regulations with respect to dividends paid to the Company.
See "Liquidity and Capital Resources" on pages 19 and 20 of Management's
Discussion & Analysis of Results of Operations and Financial Condition and
Note 13 on page 46 of the Notes to Consolidated Financial Statements included
in Financial Statements and Supplementary Data of this Form 10-K which are
incorporated into this item by reference.
The payment of any future dividends will be a business decision to be made
by the Board of Directors from time to time based upon the results of
operations and financial condition of the Company and such other factors as
the Board of Directors consider to be relevant.
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net premiums written.................... $ 864 $ 838 $ 834 $ 779 $ 743
REVENUE:
Net premiums earned.................... 855 836 818 763 713
Net investment income.................. 102 89 79 75 74
Net realized gain (loss) on
investments........................... 29 15 4 (1) 31
Total revenues......................... 992 946 907 842 819
Statutory underwriting (loss) gain..... (12) (3) 7 (39) 0
GAAP underwriting gain (loss).......... (11) 1 13 (31) 10
STATUTORY COMBINED RATIO(1):
Losses and loss adjustment expenses.... 74.6 72.3 71.0 76.2 71.2
Underwriting expenses.................. 25.7 27.2 26.8 27.6 27.0
Dividends to policyholders............. 0.8 0.9 0.8 0.7 0.7
Combined ratio......................... 101.1 100.4 98.6 104.5 98.9
Industry combined ratio................ 101.8 105.8 106.5 108.5 106.9
Income before cumulative effect of
changes in accounting................. 94 84 75 45 88
Net income............................. 94 84 75 45 83
PER COMMON SHARE DATA (BASIC AND
DILUTED)(2):
Income before realized gain (loss) on
investments, net of federal income
taxes................................. 2.14 2.10 1.95 1.16 1.82
Realized gain (loss) on investments,
net of federal income taxes........... 0.53 0.27 0.07 (0.01) 0.57
Cumulative effect of changes in
accounting............................ -- -- -- (0.02) (0.14)
Net income............................. 2.67 2.37 2.02 1.13 2.25
Dividends declared to common
shareholders.......................... 0.20 0.20 0.20 0.20 0.20
Book value per share................... 24.75 21.39 19.04 15.13 14.96
Market value per share................. 28.75 22.50 18.63 17.00 19.63
AT YEAR END:
Total assets........................... 2,605 2,503 2,471 2,334 2,153
Total shareholders' equity............. 873 755 683 646 640
Total statutory surplus................ 726 624 504 539 532
RESERVES:
Losses and loss adjustment expenses.... 1,206 1,239 1,292 1,197 1,077
Unearned premiums...................... 379 362 351 332 310
</TABLE>
- --------
(1) Industry data is from A.M. Best.
(2) All earnings per share amounts for all years have been presented to
conform with Statement of Financial Accounting Standards No. 128, Earnings
Per Share. The adoption of the aforementioned standard had no effect on
previously reported earnings per share. For further discussion of
Statement No. 128, see Note 1 on page 29 of the Notes to Consolidated
Financial Statements included in Financial Statements.
12
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
INTRODUCTION
The results of operations for Citizens Corporation and subsidiaries ("the
Company") include the accounts of Citizens Corporation ("Citizens"), a non-
insurance holding company, Citizens Insurance Company of America ("Citizens
Insurance"), Citizens Insurance Company of Ohio, Citizens Insurance Company of
the Midwest, and Citizens Management Inc.
RESULTS OF OPERATIONS
Consolidated Overview
1997 COMPARED TO 1996
Net income in 1997 increased $10.1 million to $94.2 million, compared to
$84.1 million in 1996. Excluding net realized gains of $18.7 million and
claims office restructuring charges of $1.4 million, both net of taxes, net
income increased $1.8 million to $76.9 million in 1997. The increase in net
income is primarily attributable to an increase in investment income and
realized gains of $12.9 million and $13.8 million, respectively, partially
offset by a decrease in underwriting profit of $11.9 million. The increases in
investment income and realized gains were primarily the result of the
company's portfolio shift from equity securities to higher yielding debt
securities, begun in 1996 and substantially completed in the first quarter of
1997. The decrease in underwriting profit primarily reflects an increase in
claims activity in the commercial multiple peril and homeowners lines and an
increase in catastrophes. Catastrophe losses were $17.8 million in 1997
compared to $15.3 million in 1996. The increases in catastrophes and claims
activity were partially offset by favorable claims experience on current and
prior accident years in the personal automobile and workers' compensation
lines. Federal income tax expense increased $3.2 million to $24.6 million,
while the effective tax rate increased from 20.3% in 1996 to 20.7% in 1997.
Net premiums earned increased $19.8 million, or 2.4%, to $855.3 million
during 1997, representing increases of $28.7 million, or 5.2% in the personal
segment, partially offset by decreases of $8.9 million, or 3.2%, in the
commercial segment. This overall growth is due to increases in net premiums
earned of $16.8 million, or 27.1%, to $78.9 million in Ohio and Indiana
resulting from expansion in these states. Rate increases contributed to net
premium growth in all major lines except the workers' compensation line where
rate reductions and competitive conditions continue in Michigan. Continued
growth in policies in force in the commercial multiple peril, homeowners, and
commercial automobile lines of 16.6%, 2.8%, and 2.7%, respectively, were
offset by a 0.6% decrease in personal automobile policies in force.
1996 COMPARED TO 1995
Net income in 1996 increased $9.2 million to $84.1 million, compared to
$74.9 million in 1995. Excluding net realized gains of $9.7 million and
severance charges of $0.7 million, both net of taxes, net income increased
$2.6 million to $75.1 million in 1996. The increase in net income is primarily
attributable to an increase in investment income and realized gains of $10.1
million and $11.2 million, respectively, partially offset by a decrease in
underwriting profit of $12.7 million. The increase in investment income and
realized gains was primarily the result of the Company's portfolio shift, in
1996, from equity securities to higher yielding debt securities. The decrease
in underwriting profit primarily reflects an increase in catastrophes and an
increase in claims activity in the commercial multiple peril and homeowners
lines. Catastrophe losses were $15.3 million in 1996 compared to $8.0 million
in 1995. The increases in catastrophes and claims activity were partially
offset by favorable claims experience on current and prior accident years in
the personal automobile line. Federal income tax expense decreased $0.3
million to $21.4 million, while the effective tax rate decreased from 22.5% in
1995 to 20.3% in 1996.
13
<PAGE>
Net premiums earned increased $17.7 million, or 2.2%, to $835.5 million
during 1996, representing increases of $18.4 million, or 3.4% in the personal
segment, partially offset by decreases of $0.7 million, or 0.2%, in the
commercial segment. This overall growth is due to increases in net premiums
earned of $11.4 million, or 22.5%, to $62.1 million in Ohio and Indiana
resulting from expansion in these states. Rate increases contributed to net
premium growth in all major lines except the workers' compensation line where
rate reductions and competitive conditions continue in Michigan. Continued
growth in policies in force in the commercial multiple peril and commercial
automobile lines of 13.2% and 3.7%, respectively, were offset by decreases in
personal automobile and workers' compensation policies in force of 3.0% and
1.4% respectively.
SEGMENT RESULTS
Personal Segment
Personal segment premiums represented 68.2%, 66.4% and 65.6% of total net
premiums earned in 1997, 1996 and 1995, respectively.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------
1997 1996 1995
------ ------ -------
(IN MILLIONS)
<S> <C> <C> <C>
Net premiums earned.................................... $583.3 $554.6 $ 536.2
Losses and loss adjustment expenses (LAE) incurred..... 440.1 404.1 413.6
Policy acquisition expenses............................ 112.1 112.5 108.1
Other underwriting expenses............................ 39.9 39.3 41.1
------ ------ -------
Underwriting loss...................................... $ (8.8) $ (1.3) $ (26.6)
====== ====== =======
</TABLE>
Personal segment net premiums earned increased $28.7 million, or 5.2%, to
$583.3 million in 1997. This growth is attributable to rate increases in the
personal automobile and homeowners lines and a 2.8% increase in policies in
force in the homeowners line. The growth is partially offset by a 0.6%
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 result in
reduced growth in the personal segment.
Personal segment net premiums earned increased $18.4 million, or 3.4%, to
$554.6 million in 1996. This growth is attributable to rate 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 aforementioned competitive factors in Michigan.
The personal segment underwriting loss in 1997 was $8.8 million compared to
$1.3 million in 1996. The decline in underwriting results reflects a decrease
in prior year favorable development in the personal automobile line of $10.5
million and an increase in catastrophe losses of $0.9 million, to $14.3
million, primarily in the homeowners line. The decrease in policy acquisition
expenses of $0.4 million, or 0.4%, to $112.1 million in 1997 primarily
reflects lower commission rates for 1997 partially offset by higher earned
premiums. Other underwriting expenses increased $0.6 million, or 1.5%, to
$39.9 million due to an increase in net premiums earned offset by reductions
in employee related expenses.
The personal segment underwriting loss in 1996 was $1.3 million compared to
$26.6 million in 1995. The improvement in underwriting results reflects
favorable claims activity in both current and prior accident years in the
personal automobile line attributable to 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. The increase in policy
acquisition expenses of $4.4 million, or 4.1%, to $112.5 million in 1996
primarily reflects the growth in net premiums earned. Other underwriting
expenses decreased $1.8 million, or 4.4%, to $39.3 million due to reductions
in employee related expenses and commissions, partially offset by expenses
associated with a policy administration technology project.
14
<PAGE>
Commercial Segment
Commercial segment premiums represented 31.8%, 33.6% and 34.4% of total net
premiums earned in 1997, 1996 and 1995, respectively.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
Net premiums earned.......................... $ 272.0 $ 280.9 $ 281.6
Losses and LAE incurred...................... 197.0 200.3 164.7
Policy acquisition expenses.................. 52.8 51.6 51.5
Other underwriting expenses(1)............... 24.6 27.0 25.4
---------- ---------- ----------
Underwriting (loss) profit................... $ (2.4) $ 2.0 $ 40.0
========== ========== ==========
</TABLE>
- --------
(1) Includes policyholders' dividends
Commercial segment net premiums earned decreased $8.9 million, or 3.2%, to
$272.0 million in 1997. This decrease primarily reflects rate reductions in
the workers' compensation line. Rates in the workers' compensation line were
decreased 8.5%, 7.0%, 6.4% and 8.7% effective May 1, 1995, December 1, 1995,
June 1, 1996 and March 1, 1997, respectively. This decrease is partially
offset by an increase in policies in force in the commercial multiple peril
and commercial automobile lines of 16.6% and 2.7%, respectively. Management
believes competitive conditions in Michigan in the workers' compensation line
may impact future growth in net premiums earned.
Commercial segment net premiums earned decreased $0.7 million, or 0.2%, to
$280.9 million in 1996. This decrease primarily reflects the aforementioned
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. 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.
The commercial segment underwriting loss in 1997 was $2.4 million compared
to a $2.0 million profit in 1996. The decline in underwriting profit is
primarily attributable to lower net premiums earned in the workers'
compensation line, an increase in current year severity and frequency in the
commercial multiple peril line, less favorable development of prior year
reserves in the commercial automobile line, and an increase in catastrophe
losses of $1.6 million. These decreases were offset by a $13.9 million
increase in favorable development of prior year claims in the workers'
compensation line. Policy acquisition expenses increased $1.2 million, or
2.3%, primarily as a result of higher commission rates, offset by a decrease
in net premiums earned. Other underwriting expenses decreased $2.4 million, or
8.9%, to $24.6 million due to reductions in employee related expenses.
The commercial segment underwriting profit in 1996 was $2.0 million compared
to $40.0 million in 1995. The decline in underwriting profit is primarily
attributable to an increase in loss severity and frequency in the commercial
multiple peril line, lower net premiums earned in the workers' compensation
line, less favorable development of prior year reserves in the workers'
compensation line, an increase in catastrophe losses of $0.8 million,
partially offset by an increase in net premiums earned in the commercial
multiple peril line. Policy acquisition expenses 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 due to investments
in technology and increased policyholders' dividends, partially offset by
reductions in employee related expenses and commissions.
15
<PAGE>
INVESTMENT RESULTS
Net investment income before taxes was $101.8 million, $88.9 million and
$78.8 million in 1997, 1996, and 1995, respectively. The increase of $12.9
million in 1997 is due to an increase in average invested assets and the
company's portfolio shift from equity securities to higher yielding debt
securities, including longer duration and non-investment grade securities,
partially offset by a $1.2 million decrease in investment income from limited
partnership investments. The average pre-tax yields on debt securities were
6.7% in 1997, 6.3% in 1996 and 5.9% in 1995. Average invested assets increased
$111.8 million, or 7.3%, to $1,648.1 million in 1997 primarily attributable to
cash from operations and market value appreciation. The increase in 1996 is
primarily the result of an increase in average invested assets, $4.4 million
of income from limited partnerships, and the aforementioned portfolio shift.
Net investment income after taxes was $83.8 million in 1997, $73.4 million in
1996 and $64.9 million in 1995.
Net realized gains on investments before taxes were $28.8 million, $15.0
million, and $3.8 million, in 1997, 1996, and 1995, respectively. Net realized
gains in 1997 and 1996 primarily resulted from sales of appreciated equity
securities due to the Company's strategy of shifting to a higher level of debt
securities. Net realized gains in 1995 were primarily the result of the sales
of equity securities impacted by the overall rise in the market.
FEDERAL INCOME TAXES
The provision for federal income taxes was $24.6 million, $21.4 million, and
21.7 million in 1997, 1996, and 1995, respectively. These provisions resulted
in consolidated effective federal tax rates of 20.7%, 20.3%, and 22.5% in
1997, 1996, and 1995, respectively. The increase in the effective tax rate in
1997 from 1996 resulted from higher capital gains partially offset by higher
tax-exempt interest. The decrease in the effective tax rate in 1996 from 1995
resulted from higher tax-exempt interest, partially offset by higher pre-tax
income.
FINANCIAL CONDITION
Reserve for Losses and Loss Adjustment Expenses
The Company maintains reserves to provide for its estimated ultimate
liability for losses and 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 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 claims 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, where a longer period may elapse before a
definitive determination of ultimate liability may be made, and liability
lines, 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.
16
<PAGE>
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Reserve for losses and LAE, beginning of year.... $1,238.5 $1,291.6 $1,196.6
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of current year.... 708.2 662.8 625.3
Decrease in provision for insured events of
prior years.................................... (69.5) (58.4) (47.0)
-------- -------- --------
Total incurred losses and LAE.................... 638.7 604.4 578.3
======== ======== ========
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events of
current year................................... 382.9 365.9 322.1
Losses and LAE attributable to insured events of
prior years.................................... 280.4 239.1 223.4
-------- -------- --------
Total payments................................... 663.3 605.0 545.5
-------- -------- --------
Change in reinsurance recoverable on unpaid
losses.......................................... (7.8) (52.5) 62.2
-------- -------- --------
Reserve for losses and LAE, end of year.......... $1,206.1 $1,238.5 $1,291.6
======== ======== ========
</TABLE>
As part of an ongoing process, the reserves, net of reinsurance, have been
re-estimated for all prior accident years and were decreased by $69.5 million,
$58.4 million and $47.0 million in 1997, 1996, and 1995, respectively. The
increase in favorable development of $11.1 million in 1997 reflects improved
severity in the workers' compensation line where favorable development
increased $13.9 million to $35.7 million and in the commercial multiple peril
line where favorable development increased $7.0 million to $4.3 million,
partially offset by less favorable development in the personal automobile
line, where favorable development decreased $10.5 million to $22.5 million in
1997. The increase in 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 of $10.9 million.
Citizens favorable development in 1997 primarily reflects a modest shift
over the past few years of the workers' compensation business to Western and
Northern Michigan, which have demonstrated more favorable loss experience than
Eastern Michigan. The favorable development in 1996 and 1995 primarily
reflects the initiatives taken by the Company to manage medical costs in both
the automobile and workers' compensation lines, as well as the impact of the
Michigan Supreme Court ruling on workers' compensation indemnity payments in
1995, which decreases the maximum amount to be paid for indemnity cases on all
existing and future claims.
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 business written by the Company, the exposure to
environmental liabilities is relatively small. Losses and LAE reserves related
to environmental damage and toxic tort liability, included in the total
reserve for losses and LAE were $19.0 million and $20.6 million at the end of
1997 and 1996, respectively, both net of reinsurance of $7.0 and $3.5 million,
respectively. 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 has been required to
defend such claims. Due to their unusual nature and absence of historical
claims data, reserves for these claims are not determined using historical
experience to project future losses. The Company estimated its ultimate
liability for these claims based upon currently known facts, reasonable
assumptions where the facts are not known, current law and methodologies
currently available. 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 environmental liability could be
revised in the near term if the estimates used in determining the liability
are revised. Management believes that,
17
<PAGE>
notwithstanding the evolution of case law expanding liability in environmental
claims, recorded reserves related to these claims are adequate and the Company
is not aware of any litigation or pending claims that may result in additional
material liabilities in excess of recorded reserves.
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 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 reserve
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 allocated LAE activity. This includes pro-rata,
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 analyses 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 1997 casualty reinsurance program, the reinsurers are responsible
for 100% of the amount of each loss in excess of $0.5 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. Amounts in excess of $60.5
million are retained 100% by the Company. Under the Company's 1997 catastrophe
reinsurance program, the Company retains 5% of losses in excess of $10.0
million, up to $25.0 million. For losses in excess of $25.0 million and up to
$180.0 million, the Company retains 10% of the loss. Amounts in excess of
$180.0 million are retained 100% by the Company. In 1996, the Company had
additional catastrophe coverage which reinsured 90% of $5.0 million for
aggregated catastrophe losses in excess of $5.0 million which individually
exceed $1.0 million. In 1997 and 1996, the Company recovered $1.2 million and
$4.6 million on its catastrophe coverage, respectively. In 1995, the Company
did not exceed the minimum catastrophe levels.
Effective January 1, 1998, the Company modified its catastrophe reinsurance
program to include a higher retention. Under the Company's 1998 catastrophe
reinsurance program, the Company retains the first $45 million. For losses in
excess of $45 million and up to $180.0 million, the Company retains 10% of the
loss. Amounts in excess of $180.0 million are retained 100% by the Company.
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 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.
18
<PAGE>
As a condition to the ability to conduct personal automobile business in the
state of Michigan, the Company is required under Michigan law to participate
in a pooling arrangement with the Michigan Catastrophic Claims Association
(MCCA). The Company is indemnified by the MCCA for personal protection
insurance losses in excess of $0.25 million.
The Company cedes a portion of its private passenger automobile premiums to
the MCCA. Ceded premiums earned to MCCA in 1997, 1996 and 1995 were $9.8
million, $50.5 million and $66.8 million, respectively. The decrease in ceded
premiums earned to MCCA reflects a reduction in premiums charged per
policyholder by MCCA. Losses and LAE ceded to MCCA in 1997, 1996 and 1995 were
($0.8) million, ($52.9) million and $62.9 million, respectively. In 1997 and
1996, the MCCA's favorable development on prior year reserves exceeded the
losses and LAE incurred during the current year.
At December 31, 1997 and 1996, the Company had reinsurance recoverable from
the MCCA on paid and unpaid losses of $280.2 million and $292.0 million,
respectively. Because MCCA is supported by assessments permitted by statute
and all amounts billed by the Company to MCCA have been paid when due, the
Company believes that it has no significant exposure to uncollectible
reinsurance balances.
The reserve for losses and LAE at December 31, 1997 and 1996, is shown gross
of reinsurance recoverable on unpaid losses of $458.6 million and $466.4
million, respectively. Losses and LAE ceded were $97.4 million, $51.4 million
and $134.1 million in 1997, 1996, and 1995, respectively. Ceded premiums
earned were $181.3 million, $201.1 million and $206.3 million in 1997, 1996,
and 1995, 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 5.0 years. During
1997, average durations shortened as interest rates fell and bonds began
pricing at their call dates rather than maturity. The Company continually
evaluates credit quality throughout the investment holding period. The
Company's investment portfolio increased $116.4 million to $1,721.6 million at
December 31, 1997, from $1,605.2 million at December 31, 1996, primarily
attributable to the investment of cash provided by operations of $48.6 million
and total invested asset market appreciation of $47.8 million. Approximately
88.4% of the portfolio was invested in debt securities at December 31, 1997,
compared to 87.1% at December 31, 1996.
At December 31, 1997, $1,311.7 million, or 86.2%, of debt securities held by
the Company were rated by the National Association of Insurance Commissioners
("NAIC") as investment grade (1 or 2 by the NAIC). The remaining $210.7
million were rated non-investment grade. At December 31, 1996, $1,233.5
million, or 88.2%, of the debt securities were rated investment grade. At
December 31, 1997, 66.1% of debt securities were tax-exempt investments,
compared to 69.9% at December 31, 1996. 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, 1997, $182.7 million, or 10.6%, of the investment portfolio
was invested in equity securities compared to $192.3 million, or 12.0%, at
December 31, 1996. Dividend income from equity securities was $4.3 million, or
4.0%, of total investment income in 1997, compared to $4.2 million, or 4.5%,
and $4.5 million, or 5.3%, in 1996 and 1995, respectively.
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, Citizens' primary source of cash for payment of dividends to its
shareholders is dividends from its insurance subsidiaries, which are subject
to limitations imposed by state regulators. Such limitations require that
dividends be paid only out of statutory earned surplus (unassigned funds) and
impose a restriction on the payment of "extraordinary" dividends without prior
approval of the state authorities. The maximum dividend that may be paid to
Citizens Corporation at January 1, 1998, without prior approval from the
Michigan Commissioner of Insurance, is $86.9 million.
19
<PAGE>
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 LAE, policy acquisition expenses, other underwriting
expenses and investment purchases. Cash outflows related to claim losses and
LAE can be variable because of uncertainties regarding settlement dates for
liabilities for unpaid losses and because of the potential for large losses
either individually or in the aggregate. Accordingly, the Company's strategy
is to monitor available cash and short-term investment balances in relation to
projected cash needs by matching maturities of its investments with expected
payments of current and longer term liabilities. 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 $48.6 million,
$73.5 million and $120.0 million in 1997, 1996, and 1995, respectively. The
decrease in cash provided by operating activities in all periods is
attributable primarily to the increase in payments for losses and LAE of $58.3
million to $663.3 million in 1997 and $59.5 million to $605.0 million in 1996
compared to $545.5 million in 1995.
Net cash used for investing activities for the Company was $31.3 million,
$78.3 million, and $89.2 million in 1997, 1996, and 1995, respectively. Net
cash used for investing activities has declined in 1997 from 1996 and in 1996
from 1995 primarily due to the decrease in cash flow from operations.
Net cash used for financing activities was $6.9 million, $18.2 million and
$113.1 million in 1997, 1996, and 1995, respectively. Net cash used in 1997
reflects dividends paid to shareholders of $7.1 million partially offset by
the reissuance of 7,800 shares of treasury stock, or $0.2 million, upon
employees' exercising stock options. Net cash used in 1996 reflects the
purchase of $11.1 million of treasury stock and dividends paid to shareholders
of $7.1 million.
Shareholders' equity was $872.9 million, or $24.75 per share, at December
31, 1997, compared to $754.5 million, or $21.39 per share, at December 31,
1996. Shareholders' equity reflects net income for the year, the reissuance of
treasury stock and the impact of a net increase of $31.1 million in the fair
values of available-for-sale debt and equity securities. Changes in
shareholders' equity related to changes in the fair value of the investment
portfolio will continue to be volatile as market prices of debt and equity
securities fluctuate with changes in interest rates and economic conditions.
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 dependent upon earnings and the financial condition of the
Company.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it will be
required to modify or replace significant portions of its software so that its
computer systems will properly utilize dates beyond December 31, 1999. The
Company presently believes that with modifications to existing software and
conversions to new software, the Year 2000 Issue can be resolved. However, if
such modifications and conversions are not made, or are not completed timely,
the Year 2000 Issue could have a material impact on the operations of the
Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. The Company's total Year 2000 project cost and estimates to complete
the project include the estimated costs and time associated with the impact of
a third party's Year 2000 Issue, and are based on presently
20
<PAGE>
available information. However, there can be no guarantee that the systems of
other companies on which the Company's systems rely will be timely converted,
or that a failure to convert by another company, or a conversion that is
incompatible with the Company's systems, would not have material adverse
effect on the Company. The Company does not believe that it has material
exposure to contingencies related to the Year 2000 Issue for the products it
has sold. Although the Company does not believe that there is a material
contingency associated with the Year 2000 project, there can be no assurance
that exposure for material contingencies will not arise.
The Company will utilize both internal and external resources to reprogram,
or replace, and test the software for Year 2000 modifications. The Company
plans to complete the mission critical elements of the Year 2000 project by
December 31, 1998. The cost of the Year 2000 project will be expensed as
incurred over the next two years, and is being funded through a reallocation
of resources from discretionary projects. Therefore, the Year 2000 project is
not expected to result in significant incremental technology costs or to have
material effect on the results of operations. Through December 31, 1997, the
Company has incurred and expensed approximately $6.3 million related to the
assessment of, and preliminary efforts in connection with, the project and the
development of a remediation plan. The total remaining cost of the Year 2000
project is estimated at $16.1 million.
The costs of the project and the date on which the Company plans to complete
the Year 2000 modifications are based on management's best estimates, which
were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates
will be achieved and actual results could differ materially from those plans.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer codes, and similar
uncertainties.
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 1998
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, forecasted, 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 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
and Poors and A.M. Best; and (xiv) uncertainty related to the Year 2000 Issue.
21
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Report of Independent Accountants...................................... 23
Consolidated Statements of Income for the years ended December 31,
1997, 1996 and 1995................................................... 25
Consolidated Balance Sheets as of December 31, 1997 and 1996........... 26
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1997, 1996 and 1995...................................... 27
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995................................................... 28
Notes to Consolidated Financial Statements............................. 29-48
</TABLE>
INDEX TO FINANCIAL STATEMENT SCHEDULES
<TABLE>
<S> <C>
Schedule I--Summary of Investments--Other than Investments in Related
Parties................................................................. 56
Schedule II--Condensed Financial Information of the Registrant........... 57-59
Schedule III--Supplementary Insurance Information........................ 60-62
Schedule IV--Reinsurance................................................. 63
Schedule V--Valuation and Qualifying Accounts............................ 64
Schedule VI--Supplemental Information Concerning Property/Casualty
Insurance Operations.................................................... 65
</TABLE>
22
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholdersof Citizens Corporation
In our opinion, the consolidated financial statements and financial
statement schedules listed in the accompanying index present fairly, in all
material respects, the financial position of Citizens Corporation and its
subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997, 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.
/s/ Price Waterhouse LLP
Boston, Massachusetts
February 3, 1998
23
<PAGE>
CITIZENS CORPORATION
MANAGEMENT REPORT ON RESPONSIBILITY
FOR FINANCIAL REPORTING
The management of Citizens Corporation 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.
Citizens Corporation'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 Citizens Corporation 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. Citizens Corporation 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 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. Citizens Corporation
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 Officer Vice President, Chief Financial
Accounting Officer Officer, Treasurer and Principal
24
<PAGE>
CITIZENS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------
1997 1996 1995
--------- --------- ---------
(IN MILLIONS,
EXCEPT PER COMMON SHARE DATA)
<S> <C> <C> <C>
Revenues
Net premiums written.......................... $ 863.7 $ 838.2 $ 833.7
Change in unearned premiums, net of prepaid
reinsurance premiums......................... 8.4 2.7 15.9
--------- --------- ---------
Net premiums earned........................... 855.3 835.5 817.8
Net investment income......................... 101.8 88.9 78.8
Net realized gains on investments............. 28.8 15.0 3.8
Other income.................................. 6.5 6.2 6.1
--------- --------- ---------
Total revenues.............................. 992.4 945.6 906.5
--------- --------- ---------
Expenses
Losses and loss adjustment expenses........... 638.7 604.4 578.3
Policy acquisition expenses................... 164.9 164.1 159.6
Other operating expenses...................... 63.4 64.4 65.4
Policyholders' dividends...................... 6.6 7.2 6.6
--------- --------- ---------
Total expenses.............................. 873.6 840.1 809.9
--------- --------- ---------
Income before federal income taxes.............. 118.8 105.5 96.6
Federal income tax expense Current..............
Current....................................... 19.6 20.3 17.6
Deferred...................................... 5.0 1.1 4.1
--------- --------- ---------
Total federal income tax expense............ 24.6 21.4 21.7
--------- --------- ---------
Net income...................................... 94.2 84.1 74.9
Dividends on Series A preferred stock........... -- -- (2.0)
--------- --------- ---------
Net income available to common shareholders..... $ 94.2 $ 84.1 $ 72.9
========= ========= =========
Per common share data (basic and diluted)
Net income available to common shareholders... $ 2.67 $ 2.37 $ 2.02
========= ========= =========
Weighted average common shares outstanding
(basic and diluted)............................ 35.3 35.5 36.1
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE>
CITIZENS CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
---------- ----------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
ASSETS
Investments:
Debt securities available-for-sale, at fair value
(amortized cost of $1,453.1 and $1,366.9)........... $ 1,522.4 $ 1,398.3
Equity securities available-for-sale, at fair value
(cost of $110.2 and $132.3)......................... 182.7 192.3
Other investments, at fair value (cost of $17.7 and
$13.2).............................................. 16.5 14.6
---------- ----------
Total investments.................................. 1,721.6 1,605.2
Cash and cash equivalents............................ 46.5 36.1
Accrued investment income............................ 26.5 25.3
Premiums and notes receivable (less allowance for
doubtful accounts of $0.9).......................... 139.4 140.3
Reinsurance recoverable on paid and unpaid losses.... 474.3 476.8
Prepaid reinsurance premiums......................... 70.4 62.8
Deferred policy acquisition expenses................. 54.8 54.3
Deferred federal income taxes........................ 3.7 25.4
Other assets......................................... 68.1 76.8
---------- ----------
Total assets....................................... $ 2,605.3 $ 2,503.0
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses...... $ 1,206.1 $ 1,238.5
Unearned premiums.................................... 378.5 362.3
Other liabilities.................................... 147.8 147.7
---------- ----------
Total liabilities.................................. 1,732.4 1,748.5
---------- ----------
Commitments and contingencies (Note 12)
Shareholders' equity:
Series A preferred stock, $0.01 par value per share;
authorized 10.0 million shares; none issued or
outstanding in 1997 and 1996........................ -- --
Common stock, $0.01 par value per share; authorized
100.0 million shares; 36.1 million shares issued.... 0.4 0.4
Additional paid-in capital........................... 156.1 156.1
Retained earnings.................................... 639.6 552.5
Unrealized appreciation on investments, net of
deferred federal income taxes....................... 91.6 60.5
Treasury stock, at cost (0.8 million shares)......... (14.8) (15.0)
---------- ----------
Total shareholders' equity......................... 872.9 754.5
---------- ----------
Total liabilities and shareholders' equity......... $ 2,605.3 $ 2,503.0
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
26
<PAGE>
CITIZENS CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
PREFERRED STOCK
Balance at beginning of year......................... -- -- $100.0
Redemption of preferred stock........................ -- -- (100.0)
------ ------ ------
Balance at end of year............................... -- -- --
------ ------ ------
COMMON STOCK
Balance at beginning and end of year................. $ 0.4 $ 0.4 $ 0.4
------ ------ ------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning and end of year................. 156.1 156.1 156.1
------ ------ ------
RETAINED EARNINGS
Balance at beginning of year......................... 552.5 475.5 409.8
Net income........................................... 94.2 84.1 74.9
Dividends declared to shareholders................... (7.1) (7.1) (9.2)
------ ------ ------
Balance at end of year............................... 639.6 552.5 475.5
UNREALIZED APPRECIATION (DEPRECIATION) ON INVESTMENTS,
NET OF DEFERRED FEDERAL INCOME TAXES
Balance at beginning of year......................... 60.5 54.7 (20.4)
Effect of transfer of securities from held-to-matu-
rity to available-for- sale:
Net appreciation on available-for-sale debt securi-
ties............................................... -- -- 1.5
Provision for deferred federal income taxes........ -- -- (0.5)
------ ------ ------
Total................................................ -- -- 1.0
------ ------ ------
Appreciation on investments during the year:
Net appreciation on available-for-sale securities.. 47.8 9.0 114.1
Provision for deferred federal income taxes........ (16.7) (3.2) (40.0)
------ ------ ------
Total................................................ 31.1 5.8 74.1
------ ------ ------
Balance at end of year............................... 91.6 60.5 54.7
------ ------ ------
TREASURY STOCK
Balance at beginning of year......................... (15.0) (3.9) --
Shares purchased at cost............................. -- (11.1) (3.9)
Shares reissued...................................... 0.2 -- --
------ ------ ------
Balance at end of year............................... (14.8) (15.0) (3.9)
------ ------ ------
Total shareholders' equity............................. $872.9 $754.5 $682.8
====== ====== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE>
CITIZENS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................. $ 94.2 $ 84.1 $ 74.9
Adjustments to reconcile net income to net cash
provided by operating activities:
Net realized gains on investments.................... (28.8) (15.0) (3.8)
Deferred federal income tax provision................ 5.0 1.1 4.1
Changes in assets and liabilities:
Deferred policy acquisition expenses............... (0.5) (2.1) (2.9)
Premiums and notes receivable, net of reinsurance
payable........................................... 0.6 5.4 (23.1)
Unearned premiums, net of prepaid reinsurance pre-
miums............................................. 8.6 2.6 15.9
Reserve for losses and loss adjustment expenses,
net of reinsurance recoverable.................... (29.9) (8.1) 35.3
Other, net......................................... (0.6) 5.5 19.6
------ ------ ------
Net cash provided by operating activities............ 48.6 73.5 120.0
------ ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of available-for-sale debt securi-
ties.................................................. 306.1 470.4 511.3
Proceeds from available-for-sale debt securities ma-
tured or called....................................... 95.4 148.3 95.2
Proceeds from held-to-maturity debt securities matured
or called............................................. -- -- 10.6
Proceeds from sale of available-for-sale equity
securities and other investments...................... 76.3 73.7 47.8
Purchases of available-for-sale debt securities........ (487.0) (741.4) (637.2)
Purchases of available-for-sale equity securities and
other investments..................................... (31.3) (42.5) (93.9)
Change in net receivable from security transactions not
settled............................................... 12.1 16.1 (19.2)
Other investing activities, net........................ (2.9) (2.9) (3.8)
------ ------ ------
Net cash used for investing activities............... (31.3) (78.3) (89.2)
------ ------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders......................... (7.1) (7.1) (9.2)
Treasury stock purchased, at cost...................... -- (11.1) (3.9)
Treasury shares reissued............................... 0.2 -- --
Redemption of Series A preferred stock................. -- -- (100.0)
------ ------ ------
Net cash used for financing activities............... (6.9) (18.2) (113.1)
------ ------ ------
Net increase (decrease) in cash and cash equivalents... 10.4 (23.0) (82.3)
Cash and cash equivalents at beginning of year......... 36.1 59.1 141.4
------ ------ ------
Cash and cash equivalents at end of year............... $ 46.5 $ 36.1 $ 59.1
====== ====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year:
Federal income taxes................................. $ 15.1 $ 17.3 $ 20.8
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
28
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Citizens
Corporation, a Delaware corporation and non-insurance holding company;
Citizens Insurance Company of America (Citizens Insurance), a Michigan
corporation; Citizens Insurance Company of the Midwest, an Indiana
corporation; and Citizens Insurance Company of Ohio, an Ohio corporation;
(collectively, Citizens Insurance Operations) and Citizens Management Inc.
(collectively, the Company). Approximately 82.5% of the Company is owned by
The Hanover Insurance Company (Hanover). Hanover is an indirect wholly-owned
subsidiary of Allmerica Financial Corporation (AFC), a Delaware corporation.
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 amounts 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
terms of the policies. Unearned premiums represent the portion of premiums
written that relate to the unexpired term of the policies in force.
C. INVESTMENTS
In accordance with the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" (Statement No. 115), the Company is required to classify its
investments into one of three categories: held-to-maturity, available-for-sale
or trading. Statement 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 excluded from earnings and
reported as a separate component of shareholders' equity until realized.
In November 1995, the Financial Accounting Standards Board (FASB) 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 the held-to-maturity category
securities, with amortized cost and fair value of $35.0 million and $36.5
million, respectively, to the available-for-sale category, which resulted in a
net increase in shareholders' equity of $1.0 million in 1995.
Realized investment gains and losses are reported as a component of revenues
based upon the specific-identification basis, using amortized cost for fixed
maturities and cost for equity securities. Fixed maturities and equity
securities with other than temporary declines in fair value are written down
to estimated fair value resulting in the recognition of realized losses.
Fair values for debt and equity securities are based on quoted market
prices. For securities not actively traded, fair values are estimated using
values obtained from independent pricing services.
29
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Fixed maturities that are delinquent are placed on non-accrual status, and
thereafter interest income is recognized only when cash payments are received.
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 which are subject to fair value disclosure requirements
are carried in the financial statements at amounts which approximate fair
value, unless otherwise indicated in the notes to the 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 is charged to expense over the period in which the related premiums are
earned. Deferred policy acquisition expenses are reviewed for each segment to
determine that they do not exceed recoverable amounts, after considering
anticipated investment income. If such costs are determined to be
unrecoverable, they are expensed at the time of determination.
Although realization of deferred policy acquisition costs is not assured,
management believes 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.
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. The reserve is stated net of anticipated
salvage and subrogation and gross of reinsurance ceded. Reinsurance
recoverable on paid and unpaid losses is shown as a separate line of the
balance sheet. The reserve estimates are continually reviewed and updated. The
ultimate liability may be more or less than 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 non-
affiliated 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 $16.6 million and $16.8 million at December 31, 1997
and 1996, respectively.
30
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
H. FEDERAL INCOME TAXES
The Company and its subsidiaries are included in the consolidated federal
income tax return of its ultimate parent Allmerica Financial Corporation.
Current federal income taxes are allocated among all affiliated companies
based upon a written tax sharing agreement. This agreement requires the
consolidated group to allocate tax to each member of the group on a separate
return basis. Any tax losses or credits utilized by a profit member of the
group shall be reimbursed to a loss member of the group when such loss member,
on a separate return basis, could utilize the loss or credits incurred in a
prior year.
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
(Statement No. 109). These differences result primarily from loss reserves,
policy acquisition expenses, unearned premiums and unrealized appreciation or
depreciation on investments.
I. EARNINGS PER COMMON SHARE
Earnings per common share are based on the weighted average number of common
shares and common share equivalents. The Board of Directors authorized the
repurchase of 1.8 million shares or slightly less than five percent of its
issued common stock and has purchased a total of 0.8 million shares since the
implementation of the repurchase program in 1995. As of December 31, 1997, the
Company is holding these shares as treasury stock for the purpose of funding
current and future stock option awards and for other purposes.
In 1997, the FASB issued Statement of Financial Accounting Standards No.
128, Earnings Per Share (Statement No. 128) which supersedes Accounting
Principles Board Opinion No. 15, Earnings Per Share. This standard replaces
the primary and fully diluted earnings per share with a basic and diluted
earnings per share computation, and requires a dual presentation of basic and
diluted earnings per share for those companies with complex capital
structures. All earnings per share amounts for all periods have been presented
to conform to the Statement No. 128 requirements. The adoption of the
aforementioned standard had no effect on the Company's previously reported
earnings per share.
J. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, Reporting Comprehensive Income (Statement No. 130), which establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. All items
that are required to be recognized under accounting standards as components of
comprehensive income are to be reported in a financial statement that is
displayed with the same prominence as other financial statements. This
statement stipulates that comprehensive income reflect the change in equity of
an enterprise during a period from transactions and other events and
circumstances from non-owner sources. This statement is effective for fiscal
years beginning after December 15, 1997. The Company anticipates that the
adoption of Statement No. 130 will result primarily in reporting unrealized
gains and losses on investments in debt and equity securities in comprehensive
income.
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 131, Disclosures About Segments of an Enterprise and Related
Information (Statement No. 131). Statement No. 131 establishes standards for
the way that public enterprises report information about operating segments in
annual financial statements and requires that selected information about those
operating segments be reported in interim financial statements. This statement
supersedes Statement of Financial Accounting Standards No. 14, Financial
Reporting for Segments of a Business Enterprise. Statement No. 131 requires
that all public enterprises report financial and
31
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
descriptive information about their reportable operating segments. Operating
segments are defined as components of an enterprise about which separate
financial information is available that it is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. This statement is effective for fiscal years beginning
after December 15, 1997. The Company has determined that the adoption of
Statement No. 131 will not significantly change the Company's reportable
segments.
In December 1997, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 97-3, Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments (Statement No. 97-3). Statement
No. 97-3 provides guidance on when a liability should be recognized for
guaranty fund and other assessments and on how to measure the liability. This
statement allows for the discounting of the liability if the amount and timing
of the cash payments are fixed and determinable. In addition, it provides
criteria for when an asset may be recognized for a portion or all of the
assessment liability or paid assessment that can be recovered through premium
tax offsets or policy surcharges.
This statement is effective for fiscal years beginning after December 15,
1998. The Company believes that the adoption of this statement will not have a
material effect on the results of operations or financial position.
K. RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 and 1995 consolidated
financial statements in order to conform to the 1997 presentation.
32
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. 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 Michigan, Ohio and Indiana state insurance
regulatory authorities.
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
OR
AS OF DECEMBER 31,
-------------------------
1997 1996 1995
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
NET INCOME
Statutory net income................................ $ 102.2 $ 84.7 $ 71.2
Holding company net loss............................ (0.5) (0.8) (0.7)
Deferred policy acquisition expenses................ 0.5 2.1 2.9
Deferred federal income tax provision............... (5.0) (1.1) (4.1)
Postretirement benefits............................. 1.0 1.6 0.5
Other, net.......................................... (4.0) (2.4) 5.1
------- ------- -------
GAAP net income..................................... $ 94.2 $ 84.1 $ 74.9
======= ======= =======
SHAREHOLDERS' EQUITY
Statutory surplus................................... $ 724.1 $ 611.0 $ 496.2
Holding company investments......................... 1.5 13.3 7.3
Deferred policy acquisition expenses................ 54.8 54.3 52.2
Non-admitted assets and statutory reserves.......... 22.5 22.4 54.7
Deferred federal income taxes....................... 3.7 25.4 29.7
Postretirement benefit obligation................... (6.5) (7.5) (9.1)
Fair value of available-for-sale debt securities in
excess of
statutory carrying value........................... 69.3 31.4 42.0
Other, net.......................................... 3.5 4.2 9.8
------- ------- -------
GAAP shareholders' equity........................... $ 872.9 $ 754.5 $ 682.8
======= ======= =======
</TABLE>
33
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. 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 Statement No. 115.
The amortized cost and fair value of available-for-sale investments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE
--------- ------------ ------------ ---------
(IN MILLIONS)
<S> <C> <C> <C> <C>
U.S. government obligations...... $ 18.3 $ 1.1 $ -- $ 19.4
States and political subdivi-
sions........................... 955.2 45.2 (0.2) 1,000.2
Foreign government............... 5.2 0.7 -- 5.9
Corporate debt securities........ 427.5 22.9 (1.3) 449.1
Mortgage-backed securities....... 46.9 1.0 (0.1) 47.8
--------- ------ ------ ---------
Total debt securities avail-
able-for-sale................. $ 1,453.1 $ 70.9 $ (1.6) $ 1,522.4
========= ====== ====== =========
Equity securities................ $ 110.2 $ 73.8 $ (1.3) $ 182.7
========= ====== ====== =========
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE
--------- ------------ ------------ ---------
(IN MILLIONS)
<S> <C> <C> <C> <C>
U.S. government obligations...... $ 18.4 $ 1.2 $ -- $ 19.6
States and political subdivi-
sions........................... 955.0 19.2 (2.8) 971.4
Foreign government............... 4.2 0.7 -- 4.9
Corporate debt securities........ 334.6 13.4 (0.7) 347.3
Mortgage-backed securities....... 54.7 0.6 (0.2) 55.1
--------- ------ ------ ---------
Total debt securities avail-
able-for-sale................. $ 1,366.9 $ 35.1 $ (3.7) $ 1,398.3
========= ====== ====== =========
Equity securities................ $ 132.3 $ 60.1 $ (0.1) $ 192.3
========= ====== ====== =========
</TABLE>
Debt securities with an amortized cost of $8.5 million were on deposit with
various states or government authorities as of December 31, 1997. There were
no contractual fixed maturity investment commitments at December 31, 1997 and
1996, respectively.
Unrealized gains and losses on available-for-sale securities are summarized
as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
----------------------------------------
DEBT EQUITY OTHER
SECURITIES SECURITIES INVESTMENTS TOTAL
---------- ---------- ----------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Net appreciation, beginning of year.. $ 20.5 $ 39.0 $ 1.0 $ 60.5
Net appreciation (depreciation) on
available-for-sale securities..... 37.9 12.5 (2.6) 47.8
(Provision) benefit for deferred
federal income taxes.............. (13.3) (4.4) 1.0 (16.7)
------ ------ ------ ------
Net appreciation (depreciation), end
of year............................. $ 45.1 $ 47.1 $ (0.6) $ 91.6
====== ====== ====== ======
</TABLE>
34
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1996
-----------------------------------------
DEBT EQUITY OTHER
SECURITIES SECURITIES INVESTMENTS TOTAL
---------- ---------- ----------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Net appreciation, beginning of
year.............................. $ 27.2 $ 26.0 $ 1.5 $ 54.7
Net (depreciation) appreciation
on available-for-sale
securities...................... (10.4) 20.1 (0.7) 9.0
Provision (benefit) for deferred
federal income taxes............ 3.7 (7.1) 0.2 (3.2)
------- ------ ----- -------
Net appreciation, end of year...... $ 20.5 $ 39.0 $ 1.0 $ 60.5
======= ====== ===== =======
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1995
-----------------------------------------
DEBT EQUITY OTHER
SECURITIES SECURITIES INVESTMENTS TOTAL
---------- ---------- ----------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Net (depreciation) appreciation,
beginning of year................. $ (25.3) $ 4.7 $ 0.2 $ (20.4)
Effect of transfers of securities
from held-to-maturity to avail-
able-for-sale:
Net appreciation on available-
for-sale securities............. 1.5 -- -- 1.5
Provision for deferred federal
income taxes.................... (0.5) -- -- (0.5)
------- ------ ----- -------
1.0 -- -- 1.0
Net unrealized appreciation during
the year, net of deferred federal
income taxes:
Net appreciation................. 79.3 32.8 2.0 114.1
Provision for deferred federal
income taxes.................... (27.8) (11.5) (0.7) (40.0)
------- ------ ----- -------
51.5 21.3 1.3 74.1
------- ------ ----- -------
Net appreciation, end of year...... $ 27.2 $ 26.0 $ 1.5 $ 54.7
======= ====== ===== =======
</TABLE>
Expected Maturities of Debt Securities
The amortized cost and fair value of debt securities, by contractual
maturity, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------
AMORTIZED FAIR
COST VALUE
--------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Due in one year or less............................. $ 58.2 $ 58.6
Due after one year through five years............... 383.3 403.4
Due after five years through ten years.............. 298.4 311.0
Due after ten years................................. 713.2 749.4
--------- ---------
$ 1,453.1 $ 1,522.4
========= =========
</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.
35
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Net Investment Income
The following is a summary of the sources of net investment income:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------
1997 1996 1995
------- ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Debt securities........................................ $ 95.7 $ 82.6 $ 73.1
Equity securities...................................... 4.3 4.2 4.5
Other investments...................................... 4.0 5.6 2.4
Cash and cash equivalents.............................. 2.2 1.8 4.4
------- ------ ------
Total investment income.............................. 106.2 94.2 84.4
Investment expenses.................................... (4.4) (5.3) (5.6)
------- ------ ------
Net investment income................................ $ 101.8 $ 88.9 $ 78.8
======= ====== ======
</TABLE>
Included in income from other investments was income from limited
partnerships of $3.2 million and $4.4 million for the years ended December 31,
1997 and 1996, respectively. The Company had no income from limited
partnerships for the year ended December 31, 1995.
There were no debt securities that were non-income producing for the twelve
months ended December 31, 1997. The Company had no concentration in an
individual issuer that exceeded 10% of shareholders' equity at December 31,
1997.
Net Realized Gains and Losses
Realized gains (losses) were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
---------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Debt securities.......................................... $ 1.5 $ (2.4) $ (1.7)
Equity securities........................................ 27.3 17.4 5.5
------ ------ ------
$ 28.8 $ 15.0 $ 3.8
====== ====== ======
</TABLE>
Voluntary Sales and Related Gross Gains and Gross Losses on Available-for-
Sale Securities
Proceeds from voluntary sales of debt securities in 1997, 1996, and 1995
were $306.1 million, $470.4 million and $511.3 million, respectively. Gross
gains in 1997, 1996, and 1995 of $3.9 million, $3.2 million and $6.3 million
were realized on those sales, respectively. Gross losses in 1997, 1996, and
1995 of $2.9 million, $5.6 million and $8.0 million were realized on those
sales, respectively. Proceeds from voluntary sales of equity securities in
1997, 1996, and 1995 were $69.3 million, $70.6 million and $45.8 million,
respectively. Gross gains in 1997, 1996, and 1995 of $27.5 million, $17.8
million, and $7.7 million were realized on these sales, respectively. Gross
losses in 1997, 1996, and 1995 of $0.2 million, $0.4 million, and $2.2 million
were realized on those sales, respectively.
36
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. DEFERRED POLICY ACQUISITION EXPENSES
The following reflects the amounts of policy acquisition expenses deferred
and amortized:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Balance, beginning of year........................ $ 54.3 $ 52.2 $ 49.3
Policy acquisition expenses deferred.............. 165.4 166.2 162.5
Amortization expense.............................. (164.9) (164.1) (159.6)
-------- -------- --------
Balance, end of year.............................. $ 54.8 $ 54.3 $ 52.2
======== ======== ========
</TABLE>
5. FEDERAL INCOME TAXES
Provisions for federal income taxes have been calculated in accordance with
the provisions of Statement No. 109. A summary of the federal income tax
expense in the consolidated statements of income is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Current.................................................... $ 19.6 $ 20.3 $ 17.6
Deferred................................................... 5.0 1.1 4.1
------ ------ ------
Total.................................................... $ 24.6 $ 21.4 $ 21.7
====== ====== ======
</TABLE>
Deferred federal income tax assets and liabilities are comprised of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
DEFERRED FEDERAL INCOME TAX ASSETS
Discount of reserve for losses and loss adjustment expenses....... $ 43.0 $ 46.1
Unearned premiums................................................. 21.5 21.0
Postretirement benefits........................................... 5.5 5.5
Pension benefits.................................................. 3.7 2.9
Alternative minimum tax carry forward............................. 0.4 1.2
Other............................................................. 2.6 5.6
------ ------
Total deferred federal income tax assets........................ 76.7 82.3
====== ======
Deferred federal income tax liabilities
Deferred policy acquisition expenses.............................. 19.2 19.0
Unrealized appreciation on available-for-sale securities.......... 49.1 32.5
Other............................................................. 4.7 5.4
------ ------
Total deferred federal income tax liabilities................... 73.0 56.9
------ ------
Net deferred federal income tax asset............................. $ 3.7 $ 25.4
====== ======
</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, including the
sale of investment assets, that could be implemented, if necessary.
37
<PAGE>
CITIZENS CORPORATION
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 and cumulative effect of
a change in accounting. The sources of the difference and the tax effects of
each were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Tax provision at statutory rate......................... $ 41.6 $ 36.9 $ 33.8
Tax-exempt interest..................................... (16.2) (15.0) (13.0)
Dividends received deduction............................ (1.5) (0.6) (0.7)
Other, net.............................................. 0.7 0.1 1.6
------ ------ ------
Federal income tax expense.............................. $ 24.6 $ 21.4 $ 21.7
------ ------ ------
Effective tax rate...................................... 20.7% 20.3% 22.5%
====== ====== ======
</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. 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.
6. REINSURANCE
The Company maintains a reinsurance program designed to protect against
large or unusual losses and allocated LAE activity. This includes pro-rata,
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. Most reinsurance treaties are
negotiated by the Company's parent through a broker and provide coverage for
all of the subsidiaries of Allmerica Property & Casualty Companies, Inc.,
including the Company. The Company remains contingently liable in the event
that a reinsurer is unable to meet the obligations assumed under the
reinsurance agreements.
Under the 1997 casualty reinsurance program, the reinsurers are responsible
for 100% of the amount of each loss in excess of $0.5 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. Amounts in excess of $60.5
million are retained 100% by the Company. Under the Company's 1997 catastrophe
reinsurance program, the Company retains 5% of losses in excess of $10.0
million, up to $25.0 million. For losses in excess of $25.0 million and up to
$180.0 million, the Company retains 10% of the loss. Amounts in excess of
$180.0 million are retained 100% by the Company. In 1996, the Company had
additional catastrophe coverage which reinsured 90% of $5.0 million for
aggregated catastrophe losses in excess of $5.0 million which individually
exceed $1.0 million. In 1997 and 1996, the Company recovered $1.2 million and
$4.6 million on its catastrophe coverage, respectively. In 1995, the Company
did not exceed the minimum catastrophe levels.
Effective January 1, 1998, the Company modified its catastrophe reinsurance
program to include a higher retention. Under the Company's 1998 catastrophe
reinsurance program, the Company retains the first $45 million. For losses in
excess of $45 million and up to $180.0 million, the Company retains 10% of the
loss. Amounts in excess of $180.0 million are retained 100% by the Company.
Citizens Insurance cedes 100% of business written in specific states to
Hanover. Citizens Insurance also assumes certain business from Hanover which
was written by Hanover on behalf of Citizens Insurance. Premiums receivable at
December 31, 1997 and 1996, include $0.9 million and $1.6 million,
respectively, of premiums due to Citizens Insurance from Hanover on assumed
business. In addition, other liabilities at December 31, 1997 and 1996,
include $1.8 million and $2.7 million, respectively, of claim payments due
from Citizens Insurance to Hanover on
38
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
business assumed. Unearned premiums at December 31, 1997 and 1996, include
$5.0 million and $4.1 million, respectively, and reserve for losses and LAE at
December 31, 1997 and 1996, include $24.5 million and $22.9 million,
respectively, from Hanover assumed business.
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, 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 through a pooling arrangement. As a condition to the ability to conduct
personal automobile business in the state of Michigan, the Company is required
under Michigan law to participate in a pooling arrangement with the Michigan
Catastrophic Claims Association (MCCA). The Company is indemnified by the MCCA
for personal protection insurance losses in excess of $0.25 million. The
Company cedes a significant portion of its private passenger automobile
premiums to the MCCA. Ceded premiums earned to MCCA in 1997, 1996, and 1995
were $9.8 million, $50.5 million and $66.8 million, respectively. The decrease
in ceded premiums earned to MCCA reflects a reduction in premiums charged per
policyholder by MCCA. Losses and LAE ceded to MCCA in 1997, 1996, and 1995
were ($0.8) million, ($52.9) million and $62.9 million, respectively. In 1997
and 1996, the MCCA's favorable development on prior year reserves exceeded the
losses and LAE incurred during the year.
Net written and earned premiums and losses and LAE incurred included
reinsurance activity as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
Net premiums written
Direct....................................... $ 1,038.4 $ 1,030.0 $ 1,024.3
Assumed...................................... 14.2 17.4 19.5
Ceded:
Hanover.................................... 143.5 124.2 112.3
Nonaffiliates.............................. 45.4 85.0 97.8
---------- ---------- ----------
Net premiums written..................... $ 863.7 $ 838.2 $ 833.7
========== ========== ==========
Net premiums earned
Direct....................................... $ 1,022.6 $ 1,019.6 $ 1,003.7
Assumed...................................... 14.0 17.0 20.4
Ceded:
Hanover.................................... 134.7 117.8 107.2
Nonaffiliates.............................. 46.6 83.3 99.1
---------- ---------- ----------
Net premiums earned...................... $ 855.3 $ 835.5 $ 817.8
========== ========== ==========
Losses and LAE incurred
Direct....................................... $ 710.8 $ 645.5 $ 695.6
Assumed...................................... 25.3 10.3 16.8
Ceded:
Hanover.................................... 81.6 85.1 63.5
Nonaffiliates.............................. 15.8 (33.7) 70.6
---------- ---------- ----------
Losses and LAE incurred.................. $ 638.7 $ 604.4 $ 578.3
========== ========== ==========
</TABLE>
39
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Reinsurance recoverables on paid and unpaid losses and ceded prepaid
premiums were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- -------
(IN MILLIONS)
<S> <C> <C>
Reinsurance recoverable on paid and unpaid losses
Hanover...................................................... $ 123.4 $ 115.7
MCCA......................................................... 280.2 292.0
Nonaffiliates................................................ 70.7 69.1
------- -------
$ 474.3 $ 476.8
======= =======
Prepaid premiums
Hanover...................................................... $ 65.6 $ 56.8
Nonaffiliates................................................ 4.8 6.0
------- -------
$ 70.4 $ 62.8
======= =======
</TABLE>
7. 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.
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Reserve for losses and LAE, beginning of year.... $1,238.5 $1,291.6 $1,196.6
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of current year... 708.2 662.8 625.3
Decrease in provision for insured events of
prior years................................... (69.5) (58.4) (47.0)
-------- -------- --------
Total incurred losses and LAE.................... 638.7 604.4 578.3
-------- -------- --------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events
of current year............................... 382.9 365.9 322.1
Losses and LAE attributable to insured events
of prior years................................ 280.4 239.1 223.4
-------- -------- --------
Total payments................................... 663.3 605.0 545.5
-------- -------- --------
Change in reinsurance recoverable on unpaid
losses.......................................... (7.8) (52.5) 62.2
-------- -------- --------
Reserve for losses and LAE, end of year.......... $1,206.1 $1,238.5 $1,291.6
======== ======== ========
</TABLE>
Loss Development
As part of an ongoing process, the reserves, net of reinsurance, have been
re-estimated for all prior accident years and were decreased by $69.5 million,
$58.4 million and $47.0 million in 1997, 1996, and 1995, respectively. The
increase in favorable development of $11.1 million in 1997 reflects improved
severity in the workers' compensation line where favorable development
increased $13.9 million to $35.7 million and in the commercial multiple peril
line where favorable development increased $7.0 million to $4.3 million,
partially offset by less favorable development in the personal automobile
line, where favorable development decreased $10.5 million to $22.5 million in
1997. The increase in 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 of $10.9 million.
40
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Citizens favorable development in 1997 primarily reflects a modest shift
over the past few years of the workers' compensation business to Western and
Northern Michigan, which have demonstrated more favorable loss experience than
Eastern Michigan. The favorable development in 1996 and 1995 primarily
reflects the initiatives taken by the Company to manage medical costs in both
the automobile and workers' compensation lines, as well as the impact of the
Michigan Supreme Court ruling on workers' compensation indemnity payments in
1995, which decreases the maximum amount to be paid for indemnity cases on all
existing and future claims.
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 business written by the Company, the exposure to
environmental liabilities is relatively small. Losses and LAE reserves related
to environmental damage and toxic tort liability, included in the total
reserve for losses and LAE were $19.0 million and $20.6 million at the end of
1997 and 1996, respectively, net of reinsurance of $7.0 million and $3.5
million, respectively. 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 has been
required to defend such claims. Due to their unusual nature and absence of
historical claims data, reserves for these claims are not determined using
historical experience to project future losses. The Company estimated its
ultimate liability for these claims based upon currently known facts,
reasonable assumptions where the facts are not known, current law and
methodologies currently available. 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 environmental
liability could be revised in the near term if the estimates used in
determining the liability are revised. Management believes that,
notwithstanding the evolution of case law expanding liability in environmental
claims, recorded reserves related to these claims are adequate and the Company
is not aware of any litigation or pending claims that may result in additional
material liabilities in excess of recorded reserves.
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 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 reserve
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.
8. PENSION PLANS
The Company provides retirement benefits to substantially all of its
employees, under a defined benefit pension plan (the "Plan"). Benefits under
this defined benefit formula were frozen for most employees effective December
31, 1994. In its place, the Company adopted a defined benefit cash balance
formula, under which the
41
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Company annually provides an allocation to each eligible employee as a
percentage of that employee's salary, similar to a defined contribution plan
arrangement. The 1997, 1996, and 1995 allocations were based on 7.0% of each
employee's salary. The Company's policy for the Plan 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,
----------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits earned........................... $ 4.0 $ 3.8 $ 4.0
Interest cost on projected benefit obligation........... 2.8 2.5 1.8
Actual return on Plan assets............................ (3.8) (1.3) (9.3)
Net amortization and deferral........................... -- (2.3) 6.4
------ ------ ------
Net pension expense................................... $ 3.0 $ 2.7 $ 2.9
====== ====== ======
</TABLE>
The following table sets forth the Plan's funded status and amounts
recognized in the Company's financial statements.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
Actuarial present value of benefit obligations
Vested benefit obligation.................................... $ 40.7 $ 36.0
Unvested benefit obligation.................................. 1.4 1.3
------ ------
Accumulated benefit obligation............................. $ 42.1 $ 37.3
====== ======
Pension liability included in consolidated balance sheets
Projected benefit obligation................................. $ 46.5 $ 41.2
Plan assets at fair value.................................... 36.4 34.1
------ ------
Plan assets less than projected benefit obligation......... (10.1) (7.1)
Unrecognized net loss from past experience................... 4.4 5.0
Unrecognized prior service benefit........................... (5.4) (6.0)
Unamortized transition asset................................. (1.6) (1.9)
------ ------
Net pension liability...................................... $(12.7) $(10.0)
====== ======
</TABLE>
Determination of the projected benefit obligation was based on a weighted
average discount rate of 7% at December 31, 1997 and 1996. The assumed long-
term rate of return on plan assets was 9% for both years. The actuarial
present value of the projected benefit obligation was determined using assumed
rates of increase in future compensation levels ranging from 5% to 5.5%. Plan
assets are invested primarily in various separate accounts and the general
account of First Allmerica Financial Life Insurance Company (FAFLIC), an
affiliate of the Company. The Plan also holds stock of Allmerica Financial
Corporation, the ultimate parent of the Company.
The Company also has a 401(k) Matched Savings Plan, a defined contribution
plan. Effective with the 1995 plan year, the Company began matching employee
elective 401(k) contributions, up to a maximum percentage determined annually
by the Board of Directors. During 1997, 1996, and 1995, the Company matched
50% of employees' contributions up to 6% of eligible compensation. The total
expenses related to these plans were $0.3 million, $1.8 million and $1.4
million, in 1997, 1996, and 1995, respectively.
42
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On January 1, 1998, all of the employees of the Company will be transferred
to FAFLIC. In addition, the Company's benefit plans will be merged with the
existing benefit plans of FAFLIC. Accordingly, the assets and liabilities
related to the Company's plans will be transferred to FAFLIC. Beginning in
1998, the Company will be charged actual salaries and benefit costs for
services provided to the Company by FAFLIC employees. The transfer of
employees and benefit plans to FAFLIC will not have a material impact on the
results of operations or financial position of the Company.
9. 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. 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. Participation in the medical
plan requires some retiree contributions, which are defined in the plan. The
life insurance plan is a non-contributory plan. These plans are unfunded.
The plan changes effective January 1, 1996 resulted in an unrecognized
negative prior service cost (change in eligibility and medical benefits) of
$8.1 million and a curtailment (no future increases in life insurance) of $1.2
million. The negative prior service cost will be amortized over the average
number of years to full eligibility (approximately 9 years or $0.9 million per
year). The curtailment gain has been deducted from unrecognized loss.
The components of net periodic postretirement benefit expense were as
follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
----------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost............................................ $ 0.4 $ 0.6 $ 1.2
Interest cost........................................... 0.7 0.7 1.3
Net amortization........................................ -- 0.1 0.1
Prior service cost...................................... (0.9) (0.9) --
------ ------ ------
Net postretirement benefit expense...................... $ 0.2 $ 0.5 $ 2.6
====== ====== ======
</TABLE>
The plans' status and the amounts recognized in the Company's consolidated
balance sheets were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
------- -------
( IN MILLIONS)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees.................................................... $ 5.8 $ 6.4
Other fully eligible plan participants...................... 1.0 1.2
Other active plan participants.............................. 3.5 4.0
------- -------
Accumulated postretirement benefit obligation................. 10.3 11.6
Unrecognized prior service cost............................... 6.3 7.2
Unrecognized loss............................................. (1.1) (3.1)
------- -------
Accrued postretirement benefit cost........................... $ 15.5 $ 15.7
======= =======
</TABLE>
43
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
For purposes of measuring the accumulated postretirement benefit obligation
at December 31, 1997, health care costs were assumed to decrease to 8.0% in
1998, 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, 1997 by $0.6 million, or 8.5%, and the aggregate of the service
and interest cost components of annual net periodic postretirement benefit
expense by $0.1 million, or 8.6%.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7% as of December 31, 1997 and 1996. The
assumed rate of future annual salary increases range was 5.5% at both
valuation dates.
As described in Note 8, the liabilities related to the Company's plan, net
of the deferred tax asset, will be transferred to FAFLIC, effective January 1,
1998.
10. RELATED PARTY TRANSACTIONS
The Company declared dividends to Hanover as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Common stock dividends.................................... $ 5.8 $ 5.8 $ 5.8
Preferred stock dividends................................. -- -- 2.0
------ ------ ------
Total declared dividends to Hanover..................... $ 5.8 $ 5.8 $ 7.8
====== ====== ======
</TABLE>
The Company is a party to a consolidated service agreement along with all
other affiliates under which FAFLIC and Hanover provide management, space,
technology and other services. Charges for these services are based on full
cost including all direct and indirect overhead costs and amounted to $20.5
million, $13.3 million and $9.7 million in 1997, 1996, and 1995, respectively.
Also under the consolidated service agreement, Citizens provided technology
services to Hanover. Charges for these services amounted to $6.4 million and
$0.7 million in 1997 and 1996, respectively. Charges in 1995 were
insignificant.
The Company provides data processing, claims adjusting, underwriting, and
bond operation services to Hanover on business assumed from Hanover. These
items are treated as assumed expenses by the Company.
11. STOCK OPTIONS
In October 1995 the FASB issued Statement of Financial Accounting Standards
No. 123 Accounting for Stock-Based Compensation (Statement No. 123). 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 the year ended
December 31, 1996, the Company has elected to continue to apply the valuation
provisions of existing accounting standards (APB 25) in accounting for its
stock options and, accordingly, no compensation cost has been recognized for
stock options in the financial statements. The pro-forma effect of applying
Statement No. 123 is not material.
44
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Effective March 9, 1994, the Company adopted a Long Term Stock Incentive
Plan (the "Plan"). Key employees of the Company and Citizens Insurance 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 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. 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.
Information regarding the Company's stock option plan is summarized below:
<TABLE>
<CAPTION>
1997 1996 1995
---------------- ---------------- ----------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year....................... 100,500 $17.38 70,500 $16.46 33,500 $15.25
Granted..................... -- -- 52,000 18.36 56,500 16.84
Exercised................... 7,800 17.14 1,500 15.79 -- --
Forfeited................... 16,900 17.52 20,500 16.83 19,500 15.46
------- ------ ------- ------ ------ ------
Outstanding at end of year.. 75,800 $17.37 100,500 $17.38 70,500 $16.46
------- ------ ------- ------ ------ ------
Options exercisable at end
of year.................... 22,900 $16.89 12,700 $16.28 3,300 $15.25
======= ====== ======= ====== ====== ======
</TABLE>
No options expired during 1997, 1996, and 1995. Exercise prices for options
outstanding as of December 31, 1997 ranged from $15.25 to $18.875. The
weighted average remaining contractual life of these options is 7.8 years. At
December 31, 1997, there were 58,000 option shares available for future grant.
The fair value of each option is estimated at the date of grant using the
Black-Scholes option-pricing model. The weighted average fair values of
options granted in 1996 and 1995 were $7.98 and $9.22, respectively. There
were no options granted during 1997. Principal assumptions used in applying
the Black-Scholes model were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ -------- --------
<S> <C> <C> <C>
Risk-free interest rate................................ -- 5.3-6.3% 6.4-7.9%
Expected life, in years................................ -- 2.5-7 2.5-7
Expected volatility.................................... -- 18.8% 22.0%
Expected dividend yield................................ -- 1.1% 1.1-1.2%
</TABLE>
12. COMMITMENTS AND CONTINGENCIES
The Company has certain operating lease agreements for property and
equipment. At December 31, 1997, future minimum rental payments under non-
cancelable long-term operating leases were $9.9 million, payable as follows:
1998--$2.7 million; 1999--$2.3 million; 2000--$1.7 million; 2001--$1.1
million; 2002--$0.9 million; and $1.2 million thereafter. All leases expire
prior to the year 2005. 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 1998. Certain equipment and fixture
leases are subject to buy out options. Rent expense, excluding related party
charges, was $3.3 million, $3.3 million, and $3.3 million in 1997, 1996, and
1995, respectively.
Litigation
The Company has been named a defendant in various 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
45
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
proceedings will not have a material effect on the 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.
Year 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. Although the
Company does not believe that there is a material contingency associated with
the Year 2000 project, there can be no assurance that exposure for material
contingencies will not arise.
13. DIVIDEND RESTRICTION AND REGULATORY MATTERS
Michigan limits the payment of dividends and other distributions to
shareholders. Under current law, cash dividends may only be paid 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 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 immediately preceding year or the statutory net income
less realized gains, for the immediately preceding calendar year. Based upon
the 1997 statutory financial statements of Citizens Insurance, the maximum
dividend that may be paid to Citizens Corporation at January 1, 1998, without
prior approval from the Michigan Commissioner of Insurance, is $86.9 million.
46
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
14. SEGMENT INFORMATION
The Company is engaged primarily in the property and liability insurance
business. The Company operates predominately in Michigan, with operations in
the adjoining states of Indiana and Ohio. Substantially all of the Company's
earnings are generated in the state of Michigan. 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.
The following is a review of segment results. 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
NET PREMIUMS INVESTMENT REALIZED UNDERWRITING INCOME TOTAL
EARNED INCOME GAIN PROFIT (LOSS) TAXES ASSETS
------------ ---------- -------- ------------- ------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
1997
Personal.... $ 583.3 $ (8.8)
Commercial.. 272.0 (2.4)
------- ------- ------ ------- ------- ---------
Total..... $ 855.3 $ 101.8 $ 28.8 $ (11.2) $ 118.8 $ 2,605.3
======= ======= ====== ======= ======= =========
1996
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
Personal.... $ 536.2 $ (26.6)
Commercial.. 281.6 40.0
------- ------- ------ ------- ------- ---------
Total..... $ 817.8 $ 78.8 $ 3.8 $ 13.4 $ 96.6 $ 2,470.8
======= ======= ====== ======= ======= =========
</TABLE>
47
<PAGE>
CITIZENS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED, 1997
---------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
----------- ---------- ----------- ----------
(IN MILLIONS, EXCEPT COMMON SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................... $ 254.7 $ 237.1 $ 249.7 $ 250.9
Net income....................... $ 28.4 $ 16.6 $ 17.3 $ 31.9
Net income available to common
shareholders' per share (basic
and diluted).................... $ 0.80 $ 0.47 $ 0.50 $ 0.90
Dividends declared per common
share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05
<CAPTION>
FOR THE THREE MONTHS ENDED, 1996
---------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
----------- ---------- ----------- ----------
(IN MILLIONS, EXCEPT PER COMMON SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................... $ 240.4 $ 234.4 $ 234.8 $ 236.0
Net income....................... $ 22.5 $ 12.1 $ 27.1 $ 22.4
Net income available to common
shareholders' per share (basic
and diluted).................... $ 0.63 $ 0.34 $ 0.77 $ 0.63
Dividends declared per common
share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05
<CAPTION>
FOR THE THREE MONTHS ENDED, 1995
---------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
----------- ---------- ----------- ----------
(IN MILLIONS, EXCEPT PER COMMON SHARE DATA)
<S> <C> <C> <C> <C>
Total revenues................... $ 216.2 $ 226.0 $ 234.0 $ 230.3
Net income....................... $ 11.6 $ 24.0 $ 20.9 $ 18.4
Net income available to common
shareholders' per share (basic
and diluted).................... $ 0.29 $ 0.64 $ 0.58 $ 0.51
Dividends declared per common
share........................... $ 0.05 $ 0.05 $ 0.05 $ 0.05
</TABLE>
48
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A description of the directors, including those nominated for election as
directors at the Annual Meeting of Shareholders of the Registrant, is
incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934.
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
shareholders 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, 54
Chairman of the Board and Chief Executive Officer of the Company since 1992
President of the Company since 1994
John F. O'Brien has been a Director of Citizens Insurance since March 1992
and Citizens, for which he also serves as President and Chief Executive
Officer, since December 1992. Mr. O'Brien has also served as Director,
President and Chief Executive Officer of Allmerica Property & Casualty since
August 1992, and has also been a Director of Hanover since September 1989. In
addition, Mr. O'Brien has served as a Director, Chief Executive Officer and
President of Allmerica Financial Corporation ("AFC") since February 1995 and
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 ("AFLIAC"). Mr. O'Brien also
currently serves as a Director of The TJX Companies, Inc., an off-price family
apparel retailer, ABIOMED, Inc., a medical device company, Cabot Corporation,
a diversified specialty chemicals and materials and energy company, and The
Life Insurance Association of Massachusetts, and serves as a member on the
Steering Committee on Financial Services of The American Council of Life
Insurance. He also currently serves as a member of the executive committee of
the Massachusetts 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.
BRUCE C. ANDERSON, 53
Vice President of the Company since 1997
Bruce C. Anderson has been Vice President of Citizens and APY since March
1997 and of AFC since February 1995. Mr. Anderson has been employed by FAFLIC
since 1967 and has been Vice President and Director of FAFLIC since October
1984 and April 1996, respectively. In addition, Mr. Anderson is a director
and/or executive officer at various other non-public affiliates.
ROBERT E. BRUCE, 47
Vice President of the Company since 1997
Robert E. Bruce has been Vice President of Citizens and AFC since July 1997
and Vice President and Director of Citizens and Hanover since August 1997. In
addition, Mr. Bruce has served as Vice President and
49
<PAGE>
Director of FAFLIC since May 1995 and August 1997, respectively, and Chief
Information Officer of FAFLIC since February 1997. Mr. Bruce is also a
director and/or executive officer at various other non-public affiliates.
Prior to joining FAFLIC in May 1995, Mr. Bruce was Corporate Manager at
Digital Equipment Corporation, a computer manufacturer, from May 1979 to March
1995.
JOHN P. KAVANAUGH, 43
Vice President and Chief Investment Officer of the Company since 1996
John P. Kavanaugh has been Vice President and Chief Investment Officer of
Citizens, AFC and APY since September 1996. Mr. Kavanaugh has been employed by
FAFLIC since 1983, and 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. Mr. Kavanaugh is also a director
and/or executive officer at various other non-public affiliates.
JOHN F. KELLY, 59
Vice President, General Counsel and Assistant Secretary of the Company since
1993
John F. Kelly has been Assistant Secretary of Citizens since December 1992,
Vice President and General Counsel of Citizens since September 1993, Vice
President and General Counsel of APY since August 1992, and Assistant
Secretary of APY since May 1995. 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 and a Director of FAFLIC since April 1996. Mr.
Kelly also served as Secretary of APY 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 and is a director and/or executive officer at
various other non-public affiliates.
J. BARRY MAY, 50
Vice President of the Company since 1997
Director of the Company since 1996
J. Barry May has been Vice President and Director of Citizens since March
1997 and September 1996, respectively, and has served as President and
Director of Hanover since September 1996. Mr. May has also been Vice President
of APY since September 1996 and Vice President of AFC since February 1997. 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. In addition, Mr. May is a director and/or executive
officer at various other non-public affiliates.
JAMES R. MCAULIFFE, 53
Vice President and Director of the Company since 1992
James R. McAuliffe has been a Director and Vice President of Citizens since
December 1992, President of Citizens Insurance since December 1994 and Vice
President of APY since August 1992. 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 Vice
President of AFC from February 1995 to December 1995 and since February 1997.
Mr. McAuliffe was also a Director, Vice President and Chief Investment Officer
of APY from August 1992 through December 1994, 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. Additionally, Mr. McAuliffe is a director and/or executive
officer at various other non-public affiliates.
50
<PAGE>
EDWARD J. PARRY, III, 38
Chief Financial Officer of the Company since 1996
Vice President of the Company since 1993 Treasurer of the Company since 1992
Edward J. Parry, III has been Chief Financial Officer of Citizens and
Citizens Insurance since December 1996 and Vice President and Treasurer of
Citizens since September 1993 and December 1992, respectively. He has served
as Chief Financial Officer of APY, AFC, FAFLIC, AFLIAC and Hanover since
December 1996 and has been Vice President and Treasurer of APY, FAFLIC, AFLIAC
and Hanover since February 1993 and of AFC since February 1995. Mr. Parry is
also director and/or executive officer at various other non-public affiliates.
RICHARD M. REILLY, 59
Vice President of the Company since 1997
Richard M. Reilly has been Vice President of Citizens and APY since March
1997 and Vice President of AFC and FAFLIC since 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 an executive
office at various other non-public affiliates.
ERIC A. SIMONSEN, 52
Vice President and Director of the Company since 1992
Eric A. Simonsen has been a Director and Vice President of Citizens since
December 1992, of AFLIAC since September 1990 and a Vice President of AFC
since February 1995. Mr. Simonsen was a Director of APY from August 1992 to
July 1997. In addition, Mr. Simonsen has been Vice President and Director of
FAFLIC since September 1990 and April 1996, respectively. Mr. Simonsen has
been President of Allmerica Services Corporation since December 1996. Mr.
Simonsen was Chief Financial Officer of AFC from February 1995 to December
1996, of FAFLIC and AFLIAC from September 1990 to December 1996, of APY from
August 1992 to December 1996 and of Citizens from December 1992 to December
1996. Mr. Simonsen is also a director and/or executive officer at various
other non-public affiliates.
PHILLIP E. SOULE, 48
Vice President of the Company since 1997
Phillip E. Soule has been Vice President of Citizens, APY and FAFLIC since
March 1997, September 1996 and February 1987, respectively, and of AFC since
February 1997. He was a Vice President of AFC from February 1995 through
December 1995. Mr. Soule has been employed by FAFLIC since 1972 in various
capacities.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND MANAGEMENT
Incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934.
51
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Shareholders to be held May 12, 1998, to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS AND INDEX:
The consolidated financial statements of Citizens Corporation are listed
under Item 8 of this Form 10-K.
(a)(2) FINANCIAL STATEMENT SCHEDULES AND INDEX:
<TABLE>
<CAPTION>
PAGE NO. IN
SCHEDULE THIS REPORT
-------- -----------
<C> <S> <C>
Summary of Investments--Other than Investments in Re-
I lated Parties......................................... 56
II Condensed Financial Information of the Registrant..... 57-59
III Supplementary Insurance Information................... 60-62
IV Reinsurance........................................... 63
V Valuation and Qualifying Accounts..................... 64
Supplemental Information Concerning Property/Casualty
VI Insurance Operations.................................. 65
</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.
(a)(3) EXHIBITS:
Exhibits filed as part of this Form 10-K are as follows:
(3.1) Amended Articles of Incorporation*
(3.2) By-Laws of the Registrant*
(4) Form of Common Stock Certificate*
(10) Material Contracts*
<TABLE>
<C> <C> <S>
(10.1) The Hanover Insurance Company/Citizens Insurance Company
of America Excess Benefit Retirement Plan*
(10.2) Citizens Insurance Company of America Supplemental
Employee Retirement Plan.* Amended November 15, 1994.
(10.3) The Citizens Insurance Company of America Management
Reward Plan.* Amended November 15, 1994. Further amended
September 6, 1995.
(10.4) Consolidated Income Tax Agreement dated December 31,
1997.
(10.5) Citizens-Hanover Service Agreement dated December 18,
1979.*
(10.7) Intercompany Reinsurance Agreement between Hanover and
Citizens Insurance dated December 13, 1983, together with
addenda.*
(10.8) Intercompany Reinsurance Agreement between Citizens
Insurance and Hanover dated September 16, 1992, together
with addenda.* Further amended January 1, 1995.
</TABLE>
52
<PAGE>
<TABLE>
<C> <C> <S>
(10.10) Lease between Citizens Insurance and Bavarian Group
Partnership dated August 19, 1989 related to leased
premises in Gaylord, Michigan.*
(10.11) Lease between Citizens Insurance and Upper Peninsula
Commission for Area Progress, Inc. dated January 26, 1995
related to leased premises in Escanaba, Michigan,* with
addendum dated March 9, 1995. ***
(10.12) Addendum to the lease between Citizens Insurance and The
Precedent dated May 4, 1992 related to leased premises in
Indianapolis, Indiana.**
(10.13) Loan Agreement between Citizens Insurance and The
Economic Development Corporation of the County of
Livingston ("EDC") dated August 1, 1986.*
(10.14) Indenture between EOL and the First National Bank of
Howell dated August 1, 1986.*
(10.15) Consolidated Service Agreement between State Mutual Life
Assurance Company of America and their subsidiaries dated
September 30, 1993.*
(10.16) Lease between Citizens Insurance and CICOA, L.L.C.,
entered into November 7, 1994, related to leased premises
in construction in Grand Rapids, Michigan. **
(10.17) Citizens Insurance Company of America Stock Option Plan
dated June 3, 1994. **
(10.18) Lease between Citizens Insurance and Eastrich No. 152
Corporation, effective March 1, 1995, related to leased
premises in Columbus, Ohio.***
(10.19) Intercompany Reinsurance Agreement between Citizens
Insurance Company of America and Citizens Insurance
Company of Ohio dated January 1, 1995.***
(10.20) Citizens Insurance Company of America Employees' 401(k)
Matched Savings Plan.*****
(10.21) Allmerica Financial Cash Balance Pension Plan.*****
(10.22) Intercompany Reinsurance Agreement between Citizens
Insurance Company of America and Citizens Insurance
Company of the Midwest dated January 1, 1995.
(10.23) Consolidated Service Agreement dated January 1, 1998.
</TABLE>
(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. 33-97066)
(24) Power of Attorney
(99.1) Important factors regarding forward-looking statements
- --------
* Incorporated by reference to the similarly numbered exhibit in the
Company's Registration Statement on Form S-1, No. 33-56240, filed March
18, 1993.
** Incorporated by reference to the similarly numbered exhibit in the
Company's Annual Report for the year ended December 31, 1994 on Form 10-
K, filed March 29, 1995.
53
<PAGE>
*** Incorporated by reference to the similarly numbered exhibit in the
Company's Quarterly Report for the period ended March 31, 1995 on Form
10-K, filed May 11, 1995
**** Incorporated by reference to the similarly numbered exhibit in the
Company's Quarterly Report for the period ended June 30, 1995 on Form
10-K, filed August 10, 1995.
***** Incorporated by reference to the similarly numbered exhibit in the
Company's Quarterly Report for the period ended September 30, 1995 on
Form 10-K, filed November 10, 1995.
(b) REPORTS ON FORM 8-K FILED IN THE FOURTH QUARTER OF 1997:
None.
54
<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.
Citizens Corporation
Registrant
Dated March 18, 1998 /s/ John F. O'Brien
By___________________________________
JOHN F. O'BRIEN
PRESIDENT, CHIEF EXECUTIVE OFFICER
AND CHAIRMAN OF THE BOARD
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.
Dated March 18, 1998 /s/ John F. O'Brien
---------------------------------------
JOHN F. O'BRIEN
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD
Dated March 18, 1998 /s/ Edward J. Parry, III
---------------------------------------
EDWARD J. PARRY, III
VICE PRESIDENT, CHIEF FINANCIAL
OFFICER, TREASURER AND PRINCIPAL
ACCOUNTING OFFICER
Dated March 18, 1998 *
---------------------------------------
JAMES A. COTTER, JR.
DIRECTOR
Dated March 18, 1998 *
---------------------------------------
NEAL J. CURTIN
DIRECTOR
Dated March 18, 1998 *
---------------------------------------
DONA SCOTT LASKEY
DIRECTOR
Dated March 18, 1998 *
---------------------------------------
J. BARRY MAY
VICE PRESIDENT AND DIRECTOR
Dated March 18, 1998 *
---------------------------------------
JAMES R. MCAULIFFE
VICE PRESIDENT AND DIRECTOR
Dated March 18, 1998 *
---------------------------------------
ERIC A. SIMONSEN
VICE PRESIDENT AND DIRECTOR
*By:/s/ John F. O'Brien
------------------------------------
JOHN F. O'BRIEN,
ATTORNEY-IN-FACT
55
<PAGE>
SCHEDULE I
CITIZENS CORPORATION
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1997
<TABLE>
<CAPTION>
AMOUNT AT WHICH
SHOWN IN THE
FAIR CONSOLIDATED
TYPE OF INVESTMENT COST(1) VALUE(1) BALANCE SHEET
------------------ -------- -------- ---------------
(IN MILLIONS)
<S> <C> <C> <C>
Fixed Maturities:
Bonds:
U.S. government obligations................ $ 20.4 $ 21.5 $ 21.5
States and political subdivisions.......... 955.2 1,000.2 1,000.2
Foreign governments........................ 5.2 5.9 5.9
Public utilities........................... 27.0 28.4 28.4
Convertibles and bonds with warrants....... -- -- --
All other corporate bonds.................. 336.2 351.2 351.2
Redeemable preferred stock.................. 109.1 115.2 115.2
-------- -------- --------
Total fixed maturities................... 1,453.1 1,522.4 1,522.4
-------- -------- --------
Equity securities:
Common stocks:
Public utilities........................... 1.5 2.1 2.1
Banks, trusts and insurance companies...... 15.3 29.7 29.7
Industrial, miscellaneous and all other.... 88.4 145.5 145.5
Nonredeemable preferred stocks.............. 5.0 5.4 5.4
-------- -------- --------
Total equity securities.................. 110.2 182.7 182.7
======== ======== ========
Other investments............................ 17.7 16.5 16.5
-------- -------- --------
Total investments..................... $1,581.0 $1,721.6 $1,721.6
======== ======== ========
</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.
56
<PAGE>
SCHEDULE II
CITIZENS CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED STATEMENT OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
Revenues
Net investment income.................................... $ 0.2 $ 0.2 $ 0.6
----- ----- -----
Total revenues.......................................... 0.2 0.2 0.6
----- ----- -----
Expenses
Miscellaneous expenses................................... 1.1 1.2 1.7
----- ----- -----
Total expenses.......................................... 1.1 1.2 1.7
----- ----- -----
Loss before federal income taxes and equity in net operat-
ing results of subsidiaries.............................. (0.9) (1.0) (1.1)
Federal income tax benefit................................ 0.5 0.2 0.4
Equity in net operating results of subsidiaries........... 94.6 84.9 75.6
----- ----- -----
Net income................................................ $94.2 $84.1 $74.9
===== ===== =====
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
57
<PAGE>
SCHEDULE II
(CONTINUED)
CITIZENS CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
---------- ----------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 3.0 $ 5.1
Investment in subsidiaries........................... 871.4 741.2
Other assets......................................... 0.3 10.0
---------- ----------
Total assets....................................... $ 874.7 $ 756.3
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Total liabilities.................................. $ 1.8 $ 1.8
---------- ----------
SHAREHOLDERS' EQUITY
Common stock, $0.01 par value per share; authorized
100.0 million shares; 36.1 million shares issued;
35.9 million shares outstanding..................... 0.4 0.4
Additional paid-in capital........................... 156.1 156.1
Retained earnings.................................... 639.6 552.5
Unrealized appreciation on investments, net of de-
ferred federal income taxes......................... 91.6 60.5
Treasury stock, at cost (0.8 million shares)......... (14.8) (15.0)
---------- ----------
Total shareholders' equity......................... 872.9 754.5
---------- ----------
Total liabilities and shareholders' equity......... $ 874.7 $ 756.3
========== ==========
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
58
<PAGE>
SCHEDULE II
(CONTINUED)
CITIZENS CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- ------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................. $94.2 $84.1 $ 74.9
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in undistributed net income of subsidiaries.. (94.2) (54.9) (64.1)
Change in liabilities................................. -- (0.4) 0.5
Change in other assets................................ 9.7 (10.0) 4.0
----- ----- ------
Net cash provided by operating activities............ 9.7 18.8 15.3
----- ----- ------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in subsidiaries............................. (4.5) (5.0) (7.0)
Sale of available-for-sale debt securities............. -- 0.2 1.2
Purchases of available-for-sale debt securities........ (0.4) -- (0.2)
Proceeds from subsidiary redemption of Series A pre-
ferred stock.......................................... -- -- 100.0
----- ----- ------
Net cash (used for) provided by investing activities. (4.9) (4.8) 94.0
----- ----- ------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders......................... (7.1) (7.1) (9.2)
Treasury stock purchased, at cost...................... -- (11.1) (3.9)
Treasury shares reissued............................... 0.2 -- --
Redemption of Series A preferred stock................. -- -- (100.0)
----- ----- ------
Net cash used for financing activities............... (6.9) (18.2) (113.1)
----- ----- ------
Net decrease in cash and cash equivalents.............. (2.1) (4.2) (3.8)
Cash and cash equivalents at beginning of the period... 5.1 9.3 13.1
----- ----- ------
Cash and cash equivalents at end of the period......... $ 3.0 $ 5.1 $ 9.3
===== ===== ======
</TABLE>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto in this Form 10-K.
59
<PAGE>
SCHEDULE III
CITIZENS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
RESERVE FOR
DEFERRED LOSSES AND
POLICY LOSS NET NET
ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT
EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2)
----------- ----------- ----------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Private passenger auto-
mobile................. $20.0 $ 652.8 $178.4 $454.5
Homeowners.............. 12.1 38.6 67.2 113.8
Other personal lines.... 1.4 3.1 9.2 15.0
----- -------- ------ ------ ------
Total personal lines.. 33.5 694.5 254.8 583.3
----- -------- ------ ------ ------
Commercial automobile... 6.5 92.9 34.7 75.3
Commercial multiple per-
il..................... 7.9 127.1 35.2 69.2
Workers' compensation... 4.5 260.1 36.5 104.5
Other commercial lines.. 2.4 31.5 17.3 23.0
----- -------- ------ ------ ------
Total commercial
lines................ 21.3 511.6 123.7 272.0
----- -------- ------ ------ ------
Totals.............. $54.8 $1,206.1 $378.5 $855.3 $101.8
===== ======== ====== ====== ====== ===
</TABLE>
<TABLE>
<CAPTION>
LOSSES AND LOSS POLICY OTHER NET
ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS
EXPENSES EXPENSES EXPENSES(3) WRITTEN
--------------- ----------- ------------ --------
<S> <C> <C> <C> <C>
Private passenger
automobile......... $328.8 $ 86.2 $33.7 $453.7
Homeowners.......... 104.6 23.1 8.4 120.0
Other personal
lines.............. 7.8 2.8 1.1 15.5
------ ------ ----- ------
Total personal
lines............ 441.2 112.1 43.2 589.2
------ ------ ----- ------
Commercial automo-
bile............... 63.1 16.4 5.6 76.5
Commercial multiple
peril.............. 71.4 17.8 5.1 74.6
Workers' compensa-
tion............... 47.7 14.0 7.7 98.5
Other commercial
lines.............. 15.3 4.6 1.8 24.9
------ ------ ----- ------
Total commercial
lines............ 197.5 52.8 20.2 274.5
------ ------ ----- ------
Totals.......... $638.7 $164.9 $63.4 $863.7
====== ====== ===== ======
</TABLE>
- --------
(1) As of December 31, 1997
(2) Total invested assets which generate investment income are not recorded or
allocated by line of business; therefore, net investment income is stated
in total.
(3) Excludes policyholders' dividends of $6.6.
60
<PAGE>
SCHEDULE III
(CONTINUED)
CITIZENS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
RESERVE FOR
DEFERRED LOSSES AND
POLICY LOSS NET NET
ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT
EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2)
----------- ----------- ----------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Private passenger auto-
mobile................. $ 19.8 $ 582.7 $ 170.3 $ 436.1
Homeowners.............. 11.4 53.6 60.9 104.4
Other personal lines.... 1.3 2.3 8.5 14.1
------ --------- ------- ------- ------
Total personal lines.. 32.5 638.6 239.7 554.6
------ --------- ------- ------- ------
Commercial automobile... 6.8 106.5 33.7 67.6
Commercial multiple per-
il..................... 7.3 143.7 31.5 59.1
Workers' compensation... 5.3 320.4 42.7 130.7
Other commercial lines.. 2.4 29.3 14.7 23.5
------ --------- ------- ------- ------
Total commercial
lines................ 21.8 599.9 122.6 280.9
------ --------- ------- ------- ------
Totals.............. $ 54.3 $ 1,238.5 $ 362.3 $ 835.5 $ 88.9
====== ========= ======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
LOSSES AND LOSS POLICY OTHER NET
ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS
EXPENSES EXPENSES EXPENSES(3) WRITTEN
--------------- ----------- ------------ --------
<S> <C> <C> <C> <C>
Private passenger automo-
bile....................... $299.0 $ 87.5 $33.1 $433.8
Homeowners.................. 97.3 22.2 8.0 107.7
Other personal lines........ 7.8 2.8 1.7 14.5
------ ------ ----- ------
Total personal lines...... 404.1 112.5 42.8 556.0
------ ------ ----- ------
Commercial automobile....... 53.8 14.6 4.9 70.4
Commercial multiple peril... 56.8 14.3 7.4 63.3
Workers' compensation....... 73.4 17.4 7.1 125.0
Other commercial lines...... 16.3 5.3 2.2 23.5
------ ------ ----- ------
Total commercial lines.... 200.3 51.6 21.6 282.2
------ ------ ----- ------
Totals.................. $604.4 $164.1 $64.4 $838.2
====== ====== ===== ======
</TABLE>
- --------
(1) As of December 31, 1996.
(2) Total invested assets which generate investment income are not recorded or
allocated by line of business; therefore, net investment income is stated
in total.
(3) Excludes policyholders' dividends of $7.2.
61
<PAGE>
SCHEDULE III
(CONTINUED)
CITIZENS CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
RESERVE FOR
DEFERRED LOSSES AND
POLICY LOSS NET NET
ACQUISITION ADJUSTMENT UNEARNED PREMIUMS INVESTMENT
EXPENSES(1) EXPENSES(1) PREMIUMS(1) EARNED INCOME(2)
----------- ----------- ----------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Private passenger auto-
mobile................. $20.5 $ 653.9 $128.5 $424.4
Homeowners.............. 10.9 50.2 73.8 98.7
Other personal lines.... 1.3 3.5 9.4 13.1
----- -------- ------ ------ ------
Total personal lines.. 32.7 707.6 211.7 536.2
----- -------- ------ ------ ------
Commercial automobile... 5.7 121.1 35.6 59.8
Commercial multiple per-
il..................... 5.6 119.1 34.6 54.0
Workers' compensation... 5.9 323.6 56.4 148.3
Other commercial lines.. 2.3 20.2 13.1 19.5
----- -------- ------ ------ ------
Total commercial
lines................ 19.5 584.0 139.7 281.6
----- -------- ------ ------ ------
Totals.............. $52.2 $1,291.6 $351.4 $817.8 $ 78.8
===== ======== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
LOSSES AND LOSS POLICY OTHER NET
ADJUSTMENT ACQUISITION UNDERWRITING PREMIUMS
EXPENSES EXPENSES EXPENSES(3) WRITTEN
--------------- ----------- ------------ --------
<S> <C> <C> <C> <C>
Private passenger automo-
bile....................... $326.1 $ 86.8 $30.7 $425.5
Homeowners.................. 80.0 18.8 8.8 102.2
Other personal lines........ 7.5 2.5 1.6 13.8
------ ------ ----- ------
Total personal lines...... 413.6 108.1 41.1 541.5
------ ------ ----- ------
Commercial automobile....... 51.3 13.1 4.7 64.0
Commercial multiple peril... 39.9 10.9 8.3 58.4
Workers' compensation....... 63.8 23.7 2.8 147.2
Other commercial lines...... 9.7 3.8 3.0 22.6
------ ------ ----- ------
Total commercial lines.... 164.7 51.5 18.8 292.2
------ ------ ----- ------
Totals.................. $578.3 $159.6 $59.9 $833.7
====== ====== ===== ======
</TABLE>
- --------
(1) As of December 31, 1995.
(2) Total invested assets which generate investment income are not recorded or
allocated by line of business; therefore, net investment income is stated
in total.
(3) Excludes policyholders' dividends of $6.6.
62
<PAGE>
SCHEDULE IV
CITIZENS CORPORATION
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
DIRECT OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- ---------- ------ ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1997:
Property and liability insur-
ance premiums earned......... $1,022.6 $ 181.3 $ 14.0 $855.3 1.6%
======== ======= ====== ====== ===
1996:
Property and liability insur-
ance premiums earned......... $1,019.6 $ 201.1 $ 17.0 $835.5 2.0%
======== ======= ====== ====== ===
1995:
Property and liability insur-
ance premiums earned......... $1,003.7 $ 206.3 $ 20.4 $817.8 2.5%
======== ======= ====== ====== ===
</TABLE>
63
<PAGE>
SCHEDULE V
CITIZENS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
DEDUCTIONS
FROM
ADDITIONS PREMIUM
BALANCE AT CHARGED TO BALANCES TO BALANCE AT
BEGINNING OF COSTS AND ALLOWANCE END OF
PERIOD EXPENSES ACCOUNT PERIOD
------------ ---------- ----------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
1997:
Allowance for doubtful ac-
counts........................ $0.9 $1.2 $1.2 $0.9
==== ==== ==== ====
1996:
Allowance for doubtful ac-
counts........................ $0.8 $1.8 $1.7 $0.9
==== ==== ==== ====
1995:
Allowance for doubtful ac-
counts........................ $0.7 $1.9 $1.8 $0.8
==== ==== ==== ====
</TABLE>
64
<PAGE>
SCHEDULE VI
CITIZENS CORPORATION
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY/CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
DISCOUNT,
IF ANY,
DEFERRED DEDUCTED
POLICY RESERVE FOR FROM NET NET
ACQUISITION LOSSES AND PREVIOUS UNEARNED PREMIUMS INVESTMENT
AFFILIATION WITH REGISTRANT EXPENSES LAE(2) COLUMN(1) PREMIUMS EARNED INCOME
- --------------------------- ----------- ----------- --------- -------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
1997
Citizens Insurance
Group.................. $54.8 $1,206.1 $ -- $378.5 $855.3 $101.8
===== ======== ===== ====== ====== ======
1996
Citizens Insurance
Group.................. $54.3 $1,238.5 $ -- $362.3 $835.5 $ 88.9
===== ======== ===== ====== ====== ======
1995
Citizens Insurance
Group.................. $52.2 $1,291.6 $ -- $351.4 $817.8 $ 77.7
===== ======== ===== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AMORTIZATION
LOSSES AND LAE OF DEFERRED
----------------- POLICY PAID NET
CURRENT PRIOR ACQUISITION LOSSES PREMIUMS
YEAR YEAR.... EXPENSES AND LAE WRITTEN
-------- -------- ------------ ------- --------
<S> <C> <C> <C> <C> <C>
1997
Citizens Insurance Group...... $ 708.2 $ (69.5) $164.9 $663.3 $863.7
======== ======== ====== ====== ======
1996
Citizens Insurance Group...... $ 662.8 $ (58.4) $164.1 $605.0 838.2
======== ======== ====== ====== ======
1995
Citizens Insurance Group...... $ 625.3 $ (47.0) $159.6 $545.5 $833.7
======== ======== ====== ====== ======
</TABLE>
- --------
(1) The Company does not employ any discounting techniques.
(2) Reserves for losses and LAE are shown gross of $458.6 million, $466.4
million and $518.9 million of reinsurance recoverable on unpaid losses in
1997, 1996 and 1995, respectively. Unearned premiums are shown gross of
prepaid premiums of $70.4 million, $62.8 million and $54.5 million in 1997,
1996 and 1995, respectively.
65
<PAGE>
EXHIBIT 10.4
CITIZENS CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME TAX AGREEMENT
This agreement is entered into effective for the tax year ending December
31, 1997 between Allmerica Financial Corporation (the "Parent"), Allmerica,
Inc., Allmerica Funding Corp., First Allmerica Financial Life Insurance Company,
Allmerica Services Corporation, Logan Wells Water Company, Inc., SMA Financial
Corp., Allmerica Property & Casualty Companies, Inc., Sterling Risk Management
Services, Inc., Allmerica Trust Company, N.A., Somerset Square, Inc., Allmerica
Financial Life Insurance and Annuity Company, Allmerica Institutional Services,
Inc., Allmerica Investments, Inc., Allmerica Asset Management, Inc., Allmerica
Financial Services Insurance Agency, Inc., Linder Skokie Real Estate
Corporation, Allmerica Investment Management Company, Inc., Allmerica Benefits,
Inc., APC Funding Corp., The Hanover Insurance Company, Allmerica Financial
Insurance Brokers, Inc., Citizens Insurance Company of Illinois, Allmerica
Financial Benefit Insurance Company, Allmerica Plus Insurance Agency, Inc., The
Hanover American Insurance Company, Hanover Texas Insurance Management Company,
Inc., Hanover Lloyd's Insurance Company, Citizens Corporation, Massachusetts Bay
Insurance Company, Allmerica Financial Alliance Insurance Company, AMGRO, Inc.,
Citizens Insurance Company of Ohio, Citizens Insurance Company of America,
Citizens Insurance Company of Midwest, Lloyds Credit Corporation and Citizens
Management Inc.
WHEREAS, as of the date of this agreement, the parties hereto are members
of an affiliated group ("Affiliated Group") as defined in Section 1504(a) of the
Internal Revenue Code, and
WHEREAS, such Affiliated Group is required to file consolidated federal
income tax returns, and
WHEREAS, it is the intent and desire of the parties hereto that a method be
established for allocating the consolidated tax liability for the Affiliated
Group among its members, for reimbursing the Parent for payment of such
liability, and for compensating any party for use of its losses or credits.
NOW, THEREFORE, in consideration of the mutual covenants herein contained
the parties agree as follows:
(1) A U.S. consolidated income tax return shall be filed by the Parent for
each taxable period in respect of which the Affiliated Group is required or
permitted to file a consolidated tax return.
(2) (a) The consolidated tax liability shall be allocated among the
members of the Affiliated Group in the ratio that each member's regular separate
return tax liability for the year bears to the sum of the regular separate
return tax liabilities of all the members.
(b) For each taxable period, each member of the Affiliated Group shall
compute its separate tax liability in a manner consistent with the provisions of
Regulation Section 1.1552-1(a)(2)(ii).
(c) If, in any consolidated return year, there is an excess of
consolidated tentative minimum tax over consolidated regular tax liability, each
member whose separate return tentative minimum tax exceeds its separate return
regular tax shall pay the share of such consolidated excess that its separate
return excess of tentative minimum tax over regular tax bears to the total of
such excesses of all the members which have such excesses.
(3) For each tax year during which a Subsidiary is included in a
consolidated federal income tax return with the Parent, the Subsidiary will pay
to the Parent an amount equal to the federal income tax at the current year's
statutory rate applied to the Subsidiary's separate taxable income, adjusted for
all tax credits. Such tax shall be determined without regard to separate
company limitations. If the amount of the consolidated tax is greater than the
sum of the individual Subsidiary's tax amounts, the difference will be allocated
to the Parent.
68
<PAGE>
Any tax losses or credits utilized by the profit member(s) of the
Affiliated Group shall be reimbursed to a loss member(s) of the Affiliated Group
when such loss member(s) on a separate return basis could use the loss or
credits incurred in a prior year.
(4) If for any taxable period whereby a profit member of the Affiliated
Group becomes a loss member in the subsequent tax period, and that loss cannot
be absorbed in the current tax period, and which could on a separate return
basis have been carried back to offset taxable income in a prior year, then
those loss members which received a benefit pursuant to paragraph (3) from that
profit member shall refund to that member the applicable portion of the tax
payment.
(5) Payment of the consolidated tax liability for the taxable period shall
include the payment of estimated tax installments due for each taxable period,
and each subsidiary shall pay to the Parent its share of each payment within a
reasonable time of receiving notice of such payment from the Parent or, to the
extent required by Regulatory authorities, within 30 days after filing the
consolidated tax return. Any overpayment of estimated tax should be refunded to
the Subsidiary within a reasonable time following the filing of the consolidated
return. All settlements shall be made in cash or securities eligible as
investments pursuant to the insurance code of the Subsidiary's state of
domicile.
(6) If the consolidated tax liability is adjusted for any taxable period
whether by means of an amended return, claim for refund or after a tax audit by
the Internal Revenue Service, the liability of each member shall be recomputed
to give effect to such adjustments. In the case of a refund the Parent shall
make payment to each member for its share of the refund plus interest,
determined in the same manner as above, within a reasonable period after the
refund is received by the Parent or, to the extent required by Regulatory
authorities, within 30 days after receipt of the refund. In the case of an
increase in tax liability, each member shall pay to the Parent its allocable
share of such increased tax liability plus interest. It is agreed that the
Parent is hereby authorized in its sole discretion to make final settlement of
any proposed underpayment or overpayment of tax with representatives of the
United States Government on the basis that the Parent deems most beneficial to
the Affiliated Group.
(7) Nothing in this agreement shall authorize any practice by the Parent or
by any Subsidiary which is in conflict with regulations promulgated by the
Internal Revenue Service; further, nothing in this agreement shall affect any
elections which have been made under those regulations, or which might be made
in the future.
(8) It is agreed that if any Subsidiary should for any reason cease to be
included as a member of the Affiliated Group, final settlement of accounts
between that Subsidiary and the Affiliated Group shall be made according to this
agreement within a reasonable time following the filing of the consolidated
return for the last year the Subsidiary was a member of the Affiliated Group
except for adjustments pursuant to paragraph (6) above. Except as may be
required by law, to the extent there is any loss or credit attributable to such
Subsidiary which is unutilized by such Subsidiary, such Subsidiary hereby waives
any right to be compensated for such unused loss or credit to the extent such
loss or credit remains after such Subsidiary has left the Affiliated Group. To
the extent such Subsidiary generates any loss or credit after leaving the
Affiliated Group, which loss or credit can be carried back and utilized by the
Affiliated Group, such Subsidiary hereby waives any right to be compensated for
such loss or credit.
(9) The parties hereto specifically recognize that from time to time other
companies may become members of the Parent Affiliated Group and hereby agree
that such new members must become parties to this agreement. Such new members
should execute the master copy of this agreement (or a counterpart thereto,
which shall be deemed to be the original agreement) and it will not be necessary
for all the other members to sign the agreement, but it will be effective as if
the old members had signed the agreement.
(10) The Parent shall be liable for, and indemnify and hold each member
harmless (subject to set off for any unpaid amounts due Parent from such member,
net of any unpaid amounts Parent owes such member, under this agreement)
against, any and all federal income tax for periods in which it is included in
the consolidated federal income tax return with Parent, including any
amounts for which such members may be held severally liable under Section
1.150 2-6 of the Treasury Regulations.
69
<PAGE>
(11) Miscellaneous
-------------
(a) Injunctions. The parties acknowledge that irreparable damage would
-----------
occur in the event that any of the provisions of this agreement were not
performed in accordance with its specific terms or were otherwise breached. The
parties hereto shall be entitled to an injunction or injunctions to prevent
breaches of the provisions of this agreement and to enforce specifically the
terms and provisions hereof in any court having jurisdiction, such remedy being
in addition to any other remedy to which they may be entitled at law or equity.
(b) Assignment. Except by operation of law or in connection with the sale
----------
of all or substantially all the assets of a party hereto, this agreement shall
not be assignable, in whole or in part, directly or indirectly, by any party
hereto without the written consent of the other parties; and any attempt to
assign any rights or obligations arising under this agreement without such
consent shall be void; provided, however, that the provisions of this agreement
-------- -------
shall be binding upon, inure to the benefit of and be enforceable by the parties
hereto and their respective successors and permitted assigns, but no assignment
shall relieve any party's obligations hereunder without the written consent of
the other parties.
(c) Further Assurances. Subject to the provisions hereof, the parties
------------------
hereto shall make, execute, acknowledge and deliver such other instruments and
documents, and take all such other actions, as may be reasonably required in
order to effectuate the purposes of this agreement and to consummate the
transactions contemplated hereby. Subject to the provisions hereof, each of the
parties shall, in connection with entering into this agreement, performing its
obligations hereunder and taking any and all actions relating hereto, comply
with all applicable laws, regulations, order and decrees obtain all required
consents and approvals and make all required filings with any governmental
agency, other regulatory or administrative agency, commission or similar
authority and promptly provide the other parties with all such information as
they may reasonably request in order to be able to comply with the provisions of
this paragraph.
(d) Parties in Interest. Except as herein otherwise specifically provided,
-------------------
nothing in this agreement expressed or implied is intended to confer any right
or benefit upon any person, firm or corporation other than the parties and their
respective successors and permitted assigns.
(e) Waivers, Etc. No failure or delay on the part of the parties in
------------
exercising any power or right hereunder shall operate as a waiver hereof, nor
shall any single or partial exercise of any such right or power, or any
abandonment or discontinuance of steps to enforce such a right or power,
preclude any other or further exercise thereof or the exercise of any other
right or power. No modification or waiver of any provision of this agreement
nor consent to any departure by the parties therefrom shall in any event be
effective unless the same shall be in writing, and then such waiver or consent
shall be effective only in the specific instance and for the purpose for which
given.
(f) Set off. All payments to be made by any party under this agreement
-------
shall, except to the extent otherwise specifically provided herein, be made
without set off, counterclaim or withholding, all of which are expressly waived.
(g) Change of Law. Any alteration, modification, addition, deletion, or
-------------
other change in the consolidated income tax return provisions of the Code or the
Treasury Regulations shall automatically be applicable to this agreement. If,
due to any change in applicable law or regulations interpretation hereof by any
court of law or other governing body having jurisdiction subsequent to the date
of this agreement, performance of any provision of this agreement or any
transaction contemplated thereby shall become impracticable or impossible, the
parties hereto shall use their best efforts to find and employ an alternative
means to achieve the same or substantially the same result as that contemplated
by such provision.
70
<PAGE>
(h) Prior Tax-Sharing Agreements: Amendment of this Agreement. This
---------------------------------------------------------
Agreement constitutes the entire agreement between the parties and shall
supersede any other tax-sharing or tax-allocation agreement or arrangement
(whether written or oral) in effect between the parties hereto prior to the
effective date hereof with respect to the matters expressly dealt with herein,
but shall not affect the currently outstanding intercompany accounts, if any, in
respect of taxes between the members. This agreement may not be altered,
changed, modified, or terminated orally; any modifications or revision of this
agreement shall be accomplished only through a writing clearly denominated as an
amendment to this agreement signed by the parties hereto.
(I) Confidentiality. Subject to any contrary requirement of law or
---------------
regulations and the right of each party to enforce its rights hereunder in any
legal action, each party agrees that it shall keep strictly confidential, and
shall cause its employees and agents to keep strictly confidential any
information which it or any of its agents or employees may acquire pursuant to,
or in the course of performing its obligations under, any provision of this
agreement; provided, however, that such obligation to maintain confidentiality
-------- -------
shall not apply to information which (1) at the time of disclosure was in the
public domain not as a result of acts by the receiving party or (2) was in the
possession of the receiving party at the time of disclosure.
(j) Headings. Descriptive headings are for convenience only and shall not
--------
control or affect the meaning or construction of any provision of this
agreement.
(k) Counterparts. For the convenience of the parties, any number of
------------
counterparts of this agreement may be executed by the parties hereto, and each
such executed counterpart shall be, and shall be deemed to be, an original
instrument.
(l) Governing Law. This agreement shall be governed by and construed and
-------------
enforced in accordance with the laws of the Commonwealth of Massachusetts
applicable to contracts made and to be performed therein.
(m) Records and Workpapers. Each party will retain all returns, schedules
----------------------
and workpapers, and all material records and other documents relating thereto,
until (I) parent notifies such party that such returns and other documents may
be destroyed after such returns and other documents are offered to Parent, and
(ii) the expiration of the statute of limitations (including extensions) of the
taxable years to which such returns and other documents relate or there has been
a Final Determination of all tax for such years, and (iii) there has been a
final settlement of all payments which may be required under this agreement for
such years.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement effective
for the tax year ending December 31, 1997 by their duly authorized officers this
28th day of February, 1998.
71
<PAGE>
EXHIBIT 10.22
CITIZENS CORPORATION AND SUBSIDIARIES
INTERCOMPANY REINSURANCE AGREEMENT
(HEREINAFTER REFERRED TO AS THE "AGREEMENT")
BETWEEN
CITIZENS INSURANCE COMPANY OF AMERICA
(HEREINAFTER REFERRED TO AS THE "REINSURER")
AND
CITIZENS INSURANCE COMPANY OF THE MIDWEST
(HEREINAFTER REFERRED TO AS THE "REINSURED")
ARTICLE I
COMMENCEMENT AND CANCELLATION
- ------------ --- ------------
This Agreement shall be effective at 12:01 a.m., standard time at the address of
the Reinsured, on January 1, 1995, with respect to losses occurring on or after
that date, and remain inforce for an indefinite period but may be terminated by
either party by giving ninety (90) days written notice.
Upon cancellation of this Agreement and unless otherwise mutually agreed, the
liability of the Reinsurer with respect to policies in effect at the time and
date of cancellation, shall continue until the expiration or cancellation or
next anniversary date of each such policy of the Reinsured, whichever comes
first.
ARTICLE II
BUSINESS COVERED
- -------- -------
This Agreement applies to new and renewal insurance contracts (Covered
Contracts) issued by the Reinsured, which are effective on and after the
commencement date of this Agreement.
ARTICLE III
RETENTION AND LIMITS
- --------------------
The Reinsured hereby obligates itself to cede to the Reinsurer and the Reinsurer
obligates itself to accept cessions of reinsurance of 80% of the Reinsured's Net
Retained Liability for Covered Contracts inforce at the effective date hereof or
renewed on or after that date.
The Reinsured shall retain net for its own account the remaining 20% of its Net
Retained Liability.
For the purposes of this Agreement, Net Retained Liability is defined as the
insurance liabilities exceeding recoveries from any other reinsurance contract.
ARTICLE IV
LIABILITY OF THE REINSURER
- --------------------------
The liability of the Reinsurer with respect to each session hereunder shall
commence simultaneuosly with that of the Reinsured subject to the terms,
conditions and limitations hereinafter set forth.
72
<PAGE>
ARTICLE V
LOSS AND LOSS ADJUSTMENT EXPENSE
- --------------------------------
The Reinsured at its full, sole discretion shall adjust, settle or compromise
all claims or losses.
Any loss settlement made by the Reinsured, whether under the strict conditions
of the policy or by way of compromise, shall be unconditionally binding upon the
Reinsurer in proportion to its participation hereunder.
The Reinsurer shall bear its proportionate share of all expenses incurred by the
Reinsured in the investigation, adjustment, appraisal or defense of all claims
under policies reinsured hereunder and shall receive its proportionate share of
any recoveries of such expenses.
If there are any recoveries, salvages or reimbursements subsequent to a loss
settlement, and if the expenses incurred in obtaining salvage or other
recoveries are less than the amount recovered, the amount recovered shall first
be applied to the reimbursement of the expense of recovery, and the remaining
expense shall be borne by the Reinsured and the Reinsurer in proportion to the
liability of each party for the loss before such recovery has been obtained.
All salvages, recoveries and payments recovered or received subsequent to a loss
settlement under this Agreement shall be applied as if recovered and received
prior to the said settlement; and all necessary adjustments shall be made by the
parties hereto.
ARTICLE VI
OTHER EXPENSES
- --------------
The Reinsurer shall bear its proportionate share of all acquisition,
underwriting, investment and general expenses of the Reinsured.
ARTICLE VII
COMMISSIONS
- -----------
The Reinsurer shall receive, from the Reinsured, its proportionate share of
ceding commissions or contingent commissions from any other reinsurance
contracts covering the insurance policies issued by the Reinsured.
ARTICLE VIII
ORIGINAL CONDITIONS
- -------------------
All amounts ceded hereunder shall be subject to the same rates, clauses,
conditions, waivers, and to the same modifications and alterations as the
respective policies of the Reinsured. The Reinsurer shall be receive from the
Reinsured its proportionate share of gross premiums less commission expense
hereon received by the Reinsured, prior to disbursement of any dividends, but
after deduction of premiums, if any, ceded by the Reinsured for any other
reinsurance contract.
ARTICLE IX
INSOLVENCY
- ----------
In the event of the insolvency of the Reinsured, this reinsurance shall be
payable directly to the Reinsured, or to its liquidator, receiver, conservator
or statutory successor on the basis of the liability of the Reinsured without
diminution because of the insolvency or because the liquidator, receiver,
conservator or statutory successor has failed to pay all or a portion of any
claim. However, as a condition precedent to any such payment the liquidator,
receiver, conservator or statutory successor shall give written notice to the
Reinsurer of the pendency of a claim against the Reinsured indicating the
covered contract reinsured which claim would involve a possible liability on the
part of the Reinsurer within a reasonable time after such claim is filed in the
conservation of liquidation proceeding
73
<PAGE>
or in the receivership, and that during the pendency of such claim, the
Reinsurer may investigate such claim and interpose, at its own expense, in the
proceeding where such claim is to be adjudicated any defense that it may deem
available to the Reinsured or its liquidator, receiver, conservator or statutory
successor. The expense thus incurred by the Reinsurer shall be chargeable
subject to the approval of the court against the Reinsured as part of the
expense of conservation or liquidation to the extent of a prorata share of the
benefit which may accrue to the Reinsured solely as a result of the defense
undertaken by the Reinsurer.
ARTICLE X
ARBITRATION
- -----------
Any controversy of claim arising out of or relating to this Agreement, or breach
thereof, shall be settled by arbitration in accordance with the Rules of the
American Arbitration Association, and judgement upon the award may be entered in
any court having jurisdiction thereof.
ARTICLE XI
TAXES
- -----
The Reinsured shall be liable for all taxes on premium ceded to the Reinsurer
under this agreement. If the Reinsurer is obligated to pay any taxes on such
premium, the Reinsured shall reimburse the Reinsurer; however, the Reinsured
shall not be required to pay taxes twice on the same premium.
ARTICLE XII
ERRORS AND OMISSIONS
- --------------------
Any inadvertant error or omission shall not invalidate the liability of the
Reinsurer, provided that the error or omission is rectified promptly upon
discovery.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by the duly authorized officers.
In Howell, Michigan, this 18th day of April, 1995
CITIZENS INSURANCE COMPANY OF AMERICA
Name /s/ Joseph O. Marker
Title Assistant Vice President
In Indianapolis, Indiana this 20th day of April, 1995
CITIZENS INSURANCE COMPANY OF THE MIDWEST
Name /s/ William Schramm
Title Vice President
74
<PAGE>
EXHIBIT 10.23
CITIZENS CORPORATION AND SUBSIDIARIES
CONSOLIDATED SERVICE AGREEMENT
AGREEMENT effective January 1, 1998, between ALLMERICA FINANCIAL CORPORATION
("Parent") and AAM GROWTH & INCOME FUND L.L.C., AAM HIGH YIELD FUND, L.L.C.,
AAM EQUITY FUND, AFC CAPITAL TRUST I, ALLMERICA ASSET MANAGEMENT, INC.,
ALLMERICA BENEFITS, INC., ALLMERICA EQUITY INDEX POOL, ALLMERICA FINANCIAL
ALLIANCE INSURANCE COMPANY, ALLMERICA FINANCIAL BENEFIT INSURANCE COMPANY,
ALLMERICA FINANCIAL INSURANCE BROKERS, INC., ALLMERICA FINANCIAL LIFE INSURANCE
AND ANNUITY COMPANY, ALLMERICA FINANCIAL SERVICES INSURANCE AGENCY, INC.,
ALLMERICA FUNDING CORP., ALLMERICA FUNDS, ALLMERICA, INC., ALLMERICA
INSTITUTIONAL SERVICES, INC., ALLMERICA INVESTMENT MANAGEMENT COMPANY, INC.,
ALLMERICA INVESTMENTS, INC., ALLMERICA INVESTMENT TRUST, ALLMERICA PLUS
INSURANCE AGENCY, INC., ALLMERICA PROPERTY & CASUALTY COMPANIES, INC., ALLMERICA
SECURITIES TRUST, ALLMERICA SERVICES CORPORATION, ALLMERICA TRUST COMPANY, N.A.,
AMGRO, INC., APC FUNDING CORP., CITIZENS CORPORATION, CITIZENS INSURANCE COMPANY
OF AMERICA, CITIZENS INSURANCE COMPANY OF ILLINOIS, CITIZENS INSURANCE COMPANY
OF THE MIDWEST, CITIZENS INSURANCE COMPANY OF OHIO, CITIZENS MANAGEMENT INC.,
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY, GREENDALE SPECIAL PLACEMENTS
FUND, THE HANOVER AMERICAN INSURANCE COMPANY, THE HANOVER INSURANCE COMPANY,
HANOVER TEXAS INSURANCE MANAGEMENT COMPANY, INC., HANOVER LLOYD'S INSURANCE
COMPANY, LOGAN WELLS WATER COMPANY, INC., LLOYDS CREDIT CORP., MASSACHUSETTS BAY
INSURANCE COMPANY, SMA FINANCIAL CORP., SOMERSET SQUARE, INC., STERLING RISK
MANAGEMENT SERVICES, INC. The above listed companies known collectively as
"Affiliated Group".
WHEREAS, the Cost Distribution Policy adopted by the Affiliated Group on June
15, 1993 and amended as of October 21, 1997, for implementation in calendar year
1998 ("Policy"), and as supplemented by the Cost Distribution Policy
Implementation Manual, as may be created or amended by Parent's management from
time to time to conform to State or Federal law, regulation or requirement or
for other sound reason "Implementation Manual") has been determined to be an
appropriate method of achieving fair distribution of servicing costs between the
Affiliated Group.
NOW, THEREFORE, the Affiliated Group hereby agree as follows:
1. Each Company hereby agrees to provide any other Company in the Affiliated
Group with such services as it may require for its operations. The Policy
and Implementation Manual shall be the basis for allocating cost for various
services between each Company. The Policy and Implementation Manual will
become a part of this Agreement.
2. The servicing company agrees to provide each serviced company with a
quarterly report covering the items of service performed on behalf of
serviced company.
3. This Agreement may be canceled in whole upon 60 days written notice by any
party delivered to the other members of the Affiliated Group, or in part by
any party giving the other 60 days written notice that certain services will
no longer be performed by the servicing company or will no longer be
purchased by the serviced company. This Agreement will automatically be
canceled with respect to a company that leaves the Affiliated Group.
4. The parties to the Agreement acknowledge that First Allmerica Financial Life
Insurance Company ("FAFLIC") shall be the single employer within the
Affiliated Group and that all employment costs shall be
75
<PAGE>
paid by FAFLIC. Each member of the Affiliated Group shall then be charged by
FAFLIC for services performed by employees of FAFLIC on behalf of such
affiliate. Employees of FAFLIC shall not be directly compensated by an
affiliate under this Agreement.
5. The parties hereto specifically recognize that from time to time other
companies may become members of the Affiliated Group and hereby agree that
such new members must become parties to this Agreement. Such new members
should execute the master copy of this Agreement (or a counterpart thereto,
which shall be deemed to be the original agreement) and it will not be
necessary for all the other members to sign the agreement, but it will be
effective as if the old members had signed the agreement.
6. For the convenience of the parties, any number of counterparts of this
Agreement may be executed by the parties hereto, and each such executed
counterpart shall be, and shall be deemed to be, an original instrument.
7. This Agreement supersedes all previous agreements or understandings of any
nature whatsoever regarding the subject matter of this Agreement.
8. This Agreement shall be governed by and construed and enforced in accordance
with the laws of the Commonwealth of Massachusetts.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement by their
duly authorized officers as of the 1st day of January, 1998.
ALLMERICA FINANCIAL
CORPORATION
By: /s/ Richard J. Baker
----------------------
Richard J. Baker
Secretary
AAM GROWTH & INCOME FUND L.L.C.
By: Allmerica Asset Management, Investment Manager
By: /s/ Henry L. Ferguson III
-------------------------
Henry L. Ferguson III
Clerk
AAM HIGH YIELD FUND, L.L.C.
By: First Allmerica Financial Life Insurance Company, Member
By: Citizens Insurance Company of America, Member
By: The Hanover Insurance Company, Member
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Assistant Secretary/Secretary/Clerk
AAM EQUITY FUND
By: Allmerica Asset Management, Inc., Trustee
By: /s/ Henry L. Ferguson III
--------------------------
Henry L. Ferguson III
Clerk
76
<PAGE>
AFC CAPITAL TRUST I
By: /s/ John P. Kavanaugh
----------------------
John P. Kavanaugh
Administrative Trustee
ALLMERICA ASSET
MANAGEMENT, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA BENEFITS, INC.
By: /s/ Abigail M. Armstrong
------------------------
Abigail M. Armstrong
Secretary
ALLMERICA EQUITY INDEX POOL
By: Allmerica Asset Management, Inc. Trustee
By: /s/ Henry L. Ferguson III
-------------------------
Henry L. Ferguson III
Clerk
ALLMERICA FINANCIAL ALLIANCE
INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
--------------------------
William J. Cahill, Jr.
Secretary
ALLMERICA FINANCIAL BENEFIT
INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
ALLMERICA FINANCIAL INSURANCE
BROKERS, INC.
By: /s/ William J. Cahill, Jr.
--------------------------
William J. Cahill, Jr.
Clerk
ALLMERICA FINANCIAL LIFE
INSURANCE AND ANNUITY COMPANY
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary
77
<PAGE>
ALLMERICA FINANCIAL SERVICES
INSURANCE AGENCY, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA FUNDING CORP.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA FUNDS
By: /s/ George M. Boyd
------------------
George M. Boyd
Secretary
ALLMERICA, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA INSTITUTIONAL
SERVICES, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA INVESTMENT
MANAGEMENT COMPANY, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA INVESTMENTS, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA INVESTMENT TRUST
By: /s/ George M. Boyd
-------------------
George M. Boyd
Secretary
78
<PAGE>
ALLMERICA PLUS INSURANCE
AGENCY, INC.
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Clerk
ALLMERICA PROPERTY &
CASUALTY COMPANIES, INC.
By: /s/ Richard J. Baker
---------------------
Richard J. Baker
Secretary
ALLMERICA SECURITIES TRUST
By: /s/ George M. Boyd
-------------------
George M. Boyd
Secretary
ALLMERICA SERVICES CORPORATION
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
ALLMERICA TRUST COMPANY, N.A.
By: /s/ Charles F. Cronin
----------------------
Charles F. Cronin
Secretary
AMGRO, INC.
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Clerk
APC FUNDING CORP.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
CITIZENS CORPORATION
By: /s/ Richard J. Baker
---------------------
Richard J. Baker
Secretary
79
<PAGE>
CITIZENS INSURANCE COMPANY
OF AMERICA
By: /s/ Karen Livingston-Wilson
----------------------------
Karen E. Livingston-Wilson
Secretary
CITIZENS INSURANCE
COMPANY OF ILLINOIS
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
CITIZENS INSURANCE COMPANY
OF THE MIDWEST
By: /s/ Karen E. Livingston-Wilson
------------------------------
Karen E. Livingston-Wilson
Secretary
CITIZENS INSURANCE
COMPANY OF OHIO
By: /s/ Karen E. Livingston-Wilson
-------------------------------
Karen E. Livingston-Wilson
Secretary
CITIZENS MANAGEMENT INC.
By: /s/ Karen E. Livingston-Wilson
-------------------------------
Karen E. Livingston-Wilson
Secretary
FIRST ALLMERICA FINANCIAL
LIFE INSURANCE COMPANY
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary
GREENDALE SPECIAL
PLACEMENTS FUND
By: Allmerica Asset Management, Inc., Trustee
By: /s/ Henry L. Ferguson III
--------------------------
Henry L. Ferguson III
Clerk
80
<PAGE>
THE HANOVER AMERICAN
INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
THE HANOVER INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
HANOVER TEXAS INSURANCE
MANAGEMENT COMPANY, INC.
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
HANOVER TEXAS INSURANCE MANAGEMENT
COMPANY, INC. ATTORNEY-IN-FACT FOR
HANOVER LLOYD'S INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
LOGAN WELLS WATER
COMPANY, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
LLOYDS CREDIT CORP.
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Clerk
MASSACHUSETTS BAY
INSURANCE COMPANY
By: /s/ William J. Cahill, Jr.
---------------------------
William J. Cahill, Jr.
Secretary
SMA FINANCIAL CORP.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary/Clerk
81
<PAGE>
SOMERSET SQUARE, INC.
By: /s/ Henry L. Ferguson III
--------------------------
Henry L. Ferguson III
Secretary/Clerk
STERLING RISK MANAGEMENT
SERVICES, INC.
By: /s/ Abigail M. Armstrong
-------------------------
Abigail M. Armstrong
Secretary
82
<PAGE>
Allmerica Financial Corporation ("Parent")
AAM Growth & Income Fund L.L.C.
AAM High Yield Fund, L.L.C.
AAM Equity Fund
AFC CAPITAL TRUST I
Allmerica Asset Management, Inc.
Allmerica Benefits, Inc.
Allmerica Equity Index Pool
Allmerica Financial Alliance Insurance Company
Allmerica Financial Benefit Insurance Company
Allmerica Financial Insurance Brokers, Inc.
Allmerica Financial Life Insurance and Annuity Company
Allmerica Financial Services Insurance Agency, Inc.
Allmerica Funding Corp.
Allmerica Funds
Allmerica, Inc.
Allmerica Institutional Services, Inc.
Allmerica Investment Management Company, Inc.
Allmerica Investments, Inc.
Allmerica Investment Trust
Allmerica Plus Insurance Agency, Inc.
Allmerica Property & Casualty Companies, Inc.
Allmerica Securities Trust
Allmerica Services Corporation
Allmerica Trust Company, N.A.
AMGRO, Inc.
APC Funding Corp.
Citizens Corporation
Citizens Insurance Company of America
Citizens Insurance Company of Illinois
Citizens Insurance Company of the Midwest
Citizens Insurance Company of Ohio
Citizens Management Inc.
First Allmerica Financial Life Insurance Company
Greendale Special Placements Fund
The Hanover American Insurance Company
The Hanover Insurance Company
Hanover Texas Insurance Management Company, Inc.
Hanover Lloyd's Insurance Company
Logan Wells Water Company, Inc.
Lloyds Credit Corp.
Massachusetts Bay Insurance Company
SMA Financial Corp.
Somerset Square, Inc.
Sterling Risk Management Services, Inc.
83
<PAGE>
EXHIBIT 11
CITIZENS CORPORATION AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER COMMON SHARE EARNINGS
FOR THE PERIODS ENDED DECEMBER 31, 1997 AND 1996
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
-------------- -------------
1997 1996 1997 1996
----- ----- ----- -----
<S> <C> <C> <C> <C>
Basic:
Average shares outstanding...................................................... 35.3 35.3 35.3 35.3
===== ===== ===== =====
Net income available to common shareholders..................................... $31.9 $22.4 $94.2 $84.1
===== ===== ===== =====
Per share amount................................................................ $0.90 $0.63 $2.67 $2.37
Diluted:
Average shares outstanding...................................................... 35.3 35.3 35.3 35.3
Net effect of dilutive stock options based on the treasury stock method
using average market price.................................................... _ _ _ _
----- ----- ----- -----
Totals...................................................................... 35.3 35.3 35.3 35.5
===== ===== ===== =====
Net income available to common shareholders....................................... $31.9 $22.4 $94.2 $84.1
===== ===== ===== =====
Per share amount.................................................................. $0.90 $0.63 $2.67 $2.37
</TABLE>
84
<PAGE>
EXHIBIT 21
CITIZENS CORPORATION
SUBSIDIARIES OF REGISTRANT
Citizens Insurance Company of America (Michigan)
Citizens Management Inc. (Michigan)
Citizens Insurance Company of Ohio (Ohio)
Citizens Insurance Company of the Midwest (Indiana)
85
<PAGE>
EXHIBIT 23
CITIZENS CORPORATION
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-97066) of Citizens Corporation of our report
dated February 3, 1998, which appears in this Annual Report on Form 10-K.
/s/ PRICE WATERHOUSE LLP
-------------------------------
Price Waterhouse LLP
Boston, Massachusetts
March 24, 1998
86
<PAGE>
EXHIBIT 24
CITIZENS CORPORATION
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 Citizens Corporation (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.
Dated January 29, 1998 By: /s/ John F. O'Brien
----------------------------------
John F. O'Brien
DIRECTOR, CHAIRMAN OF THE BOARD,
CEO and President
Dated January 29, 1998 /s/ Edward J. Parry, III
-----------------------------------
EDWARD J. PARRY, III
Vice President, Chief Financial Officer,
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Dated January 29, 1998 /s/ James A. Cotter, Jr.
--------------------------------
JAMES A. COTTER, JR.
Director
Dated January 29, 1998 /s/ Neal J. Curtin
------------------------------
NEAL J. CURTIN
Director
Dated January 29, 1998 /s/ Donna Scott Laskey
------------------------------
DONNA SCOTT LASKEY
Director
Dated January 29, 1998 /s/ J. Barry May
-----------------------------
J. BARRY MAY
Vice President and Director
Dated January 29, 1998 /s/ James R. McAuliffe
------------------------------
JAMES R. MCAULIFFE
VICE PRESIDENT AND DIRECTOR
Dated January 29, 1998 /s/ Eric A. Simonsen
------------------------------
ERIC A. SIMONSEN
Vice President and Director
87
<TABLE> <S> <C>
<PAGE>
<CAPTION>
<S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000,000
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 1522
<DEBT-CARRYING-VALUE> 1453
<DEBT-MARKET-VALUE> 1522
<EQUITIES> 183
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1722
<CASH> 47
<RECOVER-REINSURE> 16
<DEFERRED-ACQUISITION> 55
<TOTAL-ASSETS> 2605
<POLICY-LOSSES> 1206
<UNEARNED-PREMIUMS> 379
<POLICY-OTHER> 2
<POLICY-HOLDER-FUNDS> 5
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 873
<TOTAL-LIABILITY-AND-EQUITY> 2605
855
<INVESTMENT-INCOME> 102
<INVESTMENT-GAINS> 29
<OTHER-INCOME> 7
<BENEFITS> 639
<UNDERWRITING-AMORTIZATION> 151
<UNDERWRITING-OTHER> 84
<INCOME-PRETAX> 119
<INCOME-TAX> 25
<INCOME-CONTINUING> 94
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 94
<EPS-PRIMARY> 2.67
<EPS-DILUTED> 2.67
<RESERVE-OPEN> 1239
<PROVISION-CURRENT> 708
<PROVISION-PRIOR> (70)
<PAYMENTS-CURRENT> 383
<PAYMENTS-PRIOR> 280
<RESERVE-CLOSE> 1206
<CUMULATIVE-DEFICIENCY> (70)
</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 adverse 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-related losses in
the future which could have a material adverse impact on the Company.
Catastrophes and severe weather-related 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.
<PAGE>
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, 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 Commissioner ("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
rating agencies.
2
<PAGE>
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 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.
In 1997, A.M. Best decided to no longer rate Citizens independently from its
majority parent, The Hanover Insurance Company, but instead rated the two
separate companies as a group. Consequently, Citizens was assigned Best's "A
(Excellent)" rating. Management believes that its strong ratings are important
factors in marketing the products of its insurance companies to its agents and
customers, since rating information is broadly disseminated and generally used
throughout the industry. Insurance company ratings are assigned to an insurer
based upon factors relevant to policyholders and are not directed toward
protection of investors. Such ratings are neither a rating of securities nor a
recommendation to buy, hold or sell any security. Further downgrades may have a
material adverse effect on the Company's business and prospects.
STATE GUARANTY FUNDS, SHARED MARKETS MECHANISMS AND POOLING ARRANGEMENTS
All fifty states of the United Sates have insurance guaranty fund laws
requiring all property and casualty insurance companies doing business within
the state to participate in guaranty associations, 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.
3
<PAGE>
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
Based on a recent assessment, the Company determined that it will be required
to modify or replace significant portions of its software so that its computer
systems will properly utilize dates beyond December 31, 1999. The Company
presently believes that with modifications to existing software and conversions
to new software, the Year 2000 Issue can be resolved. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. The Company's total Year 2000 project cost and estimates to complete the
project include the estimated costs and time associated with the impact of a
third party's Year 2000 Issue, and are based on presently available information.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have material adverse effect on the Company. The
Company does not believe that it has material exposure to contingencies related
to the Year 2000 Issue for the products it has sold. Although the Company does
not believe that there is a material contingency associated with the Year 2000
project, there can be no assurance that exposure for material contingencies will
not arise.
The Company will utilize both internal and external resources to reprogram, or
replace, and test the software for Year 2000 modifications. The Company plans
to complete the mission critical elements of the Year 2000 project by December
31, 1998. The cost of the Year 2000 project will be expensed as incurred over
the next two years, and is being funded through a reallocation of resources from
discretionary projects. Therefore, the Year 2000 project is not expected to
result in significant incremental technology costs or to have material effect on
the results of operations.
The costs of the project and the date on which the Company plans to complete
the Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
4
