FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: to ____________
Commission file number: 1-13754
ALLMERICA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3263626
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
440 Lincoln Street, Worcester, Massachusetts 01653
(Address of principal executive offices)
(Zip Code)
(508) 855-1000
(Registrant's telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
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 [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's classes
of common stock as of the latest practicable date: 59,968,471 shares of
common stock outstanding, as of November 1, 1997.
39
Total Number of Pages Included in This Document
Exhibit Index is on Page 38
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Statements of Shareholders' Equity 4
Consolidated Balance Sheets 5
Consolidated Statements of Cash Flows 6
Notes to Interim Consolidated Financial Statements 7 - 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13 - 35
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 37
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions, except
per share data) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
REVENUES
Premiums $585.6 $557.1 $1,726.7 $1,658.4
Universal life and
investment product policy
fees 61.4 49.9 174.8 144.9
Net investment income 164.5 173.9 498.5 501.8
Net realized investment
gains (losses) 14.7 (0.6) 56.7 53.3
Other income 29.5 26.9 86.4 79.8
-------- -------- -------- --------
Total revenues 855.7 807.2 2,543.1 2,438.2
-------- -------- -------- --------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims,losses
and loss adjustment expenses 515.1 474.6 1,516.1 1,457.3
Policy acquisition expenses 117.3 113.1 353.9 348.8
Loss from cession of
disability income business 0.0 0.0 53.9 0.0
Other operating expenses 133.2 130.4 398.9 377.9
-------- -------- -------- --------
Total benefits, losses and
expenses 765.6 718.1 2,322.8 2,184.0
-------- -------- -------- --------
Income before federal income
taxes 90.1 89.1 220.3 254.2
-------- -------- -------- --------
Federal income tax expense
(benefit)
Current 33.8 32.7 66.2 77.0
Deferred (9.8) (11.5) (13.2) (19.0)
-------- -------- -------- --------
Total federal income
tax expense 24.0 21.2 53.0 58.0
-------- -------- -------- --------
Income before minority interest 66.1 67.9 167.3 196.2
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.1) 0.0 (10.5) 0.0
Equity in earnings (1.3) (21.2) (42.5) (59.6)
-------- -------- -------- --------
(5.4) (21.2) (53.0) (59.6)
-------- -------- -------- --------
Net income $ 60.7 $ 46.7 $ 114.3 $ 136.6
======== ======== ======== ========
PER SHARE DATA
Net income $ 1.04 $ 0.93 $ 2.16 $ 2.72
======== ======== ======== ========
Dividends declared to
shareholders $ 0.05 $ 0.05 $ 0.15 $ 0.15
======== ======== ======== ========
Weighted average shares
outstanding 58.4 50.1 53.0 50.1
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 3
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions) 1997 1996
<S> <C> <C>
PREFERRED STOCK
Balance at beginning and end of period 0.0 0.0
-------- --------
COMMON STOCK
Balance at beginning of period 0.5 0.5
Issuance of common stock 0.1 0.0
-------- --------
Balance at end of period 0.6 0.5
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,382.5 1,382.5
Issuance of common stock 375.9 0.0
Issuance costs of mandatorily
redeemable preferred securities
of a subsidiary trust holding solely
junior subordinated debentures of
the Company (3.7) 0.0
-------- --------
Balance at end of period 1,754.7 1,382.5
-------- --------
RETAINED EARNINGS
Balance at beginning of period 210.1 38.2
Net income 114.3 136.6
Dividends to shareholders (8.1) (7.5)
-------- --------
Balance at end of period 316.3 167.3
-------- --------
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 131.6 153.0
Net appreciation (depreciation) on
available-for-sale securities 130.6 (139.2)
(Provision) benefit for deferred federal
income taxes (46.4) 48.7
Minority interest (24.0) 20.2
-------- --------
Balance at end of period 191.8 82.7
-------- --------
Total shareholders' equity $ 2,263.4 $ 1,633.0
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 4
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
(In millions, except per share data) 1997 1996
<S> <C> <C>
ASSETS
Investments:
Fixed maturities-at fair value
(amortized cost of $7,089.8 and
$7,305.5) $ 7,363.4 $ 7,487.8
Equity securities-at fair value
(cost of $284.7 and $328.2) 475.6 473.6
Mortgage loans 564.7 650.1
Real estate 72.5 120.7
Policy loans 139.3 132.4
Other long-term investments 125.6 128.8
--------- ---------
Total investments 8,741.1 8,993.4
--------- ---------
Cash and cash equivalents 163.3 178.5
Accrued investment income 141.2 149.0
Deferred policy acquisition costs 881.2 822.7
Reinsurance receivable on paid and
unpaid losses, benefits and
unearned premiums 828.9 875.6
Deferred federal income taxes 27.0 93.2
Premiums, accounts and notes
receivable, net 548.4 533.0
Other assets 596.9 307.5
Closed Block assets 805.6 811.8
Separate account assets 9,233.6 6,233.0
--------- ---------
Total assets $21,967.2 $18,997.7
========== ==========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,591.3 $ 2,613.7
Outstanding claims, losses and
loss adjustment expenses 2,844.7 2,944.1
Unearned premiums 869.7 822.5
Contractholder deposit funds and
other policy liabilities 1,724.7 2,060.4
--------- ---------
Total policy liabilities and
accruals 8,030.4 8,440.7
--------- ---------
Expenses and taxes payable 680.9 622.3
Reinsurance premiums payable 45.6 31.4
Short-term debt 189.3 38.4
Deferred federal income taxes 0.0 34.7
Long-term debt 202.1 202.2
Closed Block liabilities 881.3 892.1
Separate account liabilities 9,228.0 6,227.2
--------- ---------
Total liabilities 19,257.6 16,489.0
--------- ---------
Minority interest:
Mandatorily redeemable preferred
securities of a subsidiary trust
holding solely junior subordinated
debentures of the Company 300.0 0.0
Common stock 146.2 784.0
--------- ---------
Total minority interest 446.2 784.0
--------- ---------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 20.0
million shares authorized, none issued 0.0 0.0
Common stock, $0.01 par value, 300.0
million shares authorized, 60.0 million
and 50.1 million shares issued and
outstanding, respectively 0.6 0.5
Additional paid-in capital 1,754.7 1,382.5
Unrealized appreciation on
investments, net 191.8 131.6
Retained earnings 316.3 210.1
--------- ---------
Total shareholders' equity 2,263.4 1,724.7
--------- ---------
Total liabilities and shareholders'
equity $21,967.2 $18,997.7
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 5
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions)
<S> 1997 1996
<C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $114.3 $136.6
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Minority interest 42.5 59.6
Net realized gains (57.8) (53.5)
Net amortization and depreciation 20.5 34.3
Deferred federal income taxes (13.3) (18.9)
Change in deferred acquisition costs (70.2) (55.7)
Change in premiums and notes
receivable, net of reinsurance
payable (0.9) (20.4)
Change in accrued investment income 7.2 6.3
Change in policy liabilities and
accruals, net (86.1) (31.3)
Change in reinsurance receivable 46.8 30.2
Change in expenses and taxes payable 52.6 8.3
Separate account activity, net 0.2 5.6
Other, net (9.0) 44.1
-------- --------
Net cash provided by
operating activities 46.8 145.2
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities
of available-for-sale fixed
maturities 2,065.3 3,083.5
Proceeds from disposals of equity
securities 126.6 218.3
Proceeds from disposals of other
investments 96.0 60.3
Proceeds from mortgages matured or
collected 157.4 122.9
Purchase of available-for-sale fixed
maturities (2,054.3) (3,282.8)
Purchase of equity securities (45.8) (81.1)
Purchase of other investments (94.3) (91.1)
Capital expenditures (5.4) (8.0)
Purchase of minority interest in
Allmerica P&C (425.6) 0.0
Other investing activities, net 1.2 2.6
--------- ---------
Net cash (used in) provided by
investing activities (178.9) 24.6
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 173.8 241.6
Withdrawals from contractholder
deposit funds (501.2) (790.4)
Change in short-term debt 150.8 294.9
Net proceeds from issuance of
mandatorily redeemable preferred
securities of a subsidiary trust
holding solely junior subordinated
debentures of the Company 296.3 0.0
Proceeds from issuance of common stock 2.6 0.0
Dividends paid to shareholders (8.1) (10.4)
Subsidiary treasury stock purchased,
at cost 0.0 (42.0)
--------- ---------
Net cash provided by (used in)
financing activities 114.2 (306.3)
--------- ---------
Net change in cash and cash equivalents (17.9) (136.5)
Net change in cash held in the Closed
Block 2.7 11.2
Cash and cash equivalents, beginning of
period 178.5 289.5
--------- ---------
Cash and cash equivalents, end of
period $ 163.3 $ 164.2
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 6
<PAGE>
ALLMERICA FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Allmerica
Financial Corporation ("AFC" or the "Company") have been prepared in
accordance with generally accepted accounting principles for stock life
insurance companies for interim financial information and with the
requirements of Form 10-Q.
The interim consolidated financial statements of AFC include the accounts of
AFC, First Allmerica Financial Life Insurance Company ("FAFLIC"), its wholly-
owned life insurance subsidiary, Allmerica Financial Life Insurance and
Annuity Company ("AFLIAC"), non-insurance subsidiaries (principally brokerage
and investment advisory subsidiaries), and Allmerica Property & Casualty
Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance holding
company). The Closed Block assets and liabilities at September 30, 1997 and
December 31, 1996 are presented in the consolidated financial statements as
single line items. Results of operations for the Closed Block for the nine
month and three month periods ended September 30, 1997 and September 30, 1996
are included in other income in the consolidated financial statements. All
significant intercompany accounts and transactions have been eliminated.
The financial statements reflect minority interst in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The financial statements also reflect
minority interest in Citizens Corporation (an 82.5%-owned non-insurance
holding company subsidiary of Hanover) and its wholly-owned subsidiary,
Citizens Insurance Company of America ("Citizens").
The accompanying interim consolidated financial statements reflect, in the
opinion of the Company's management, all adjustments, consisting of only
normal and recurring adjustments, necessary for a fair presentation of the
financial position and results of operations. Certain reclassifications have
been made to the 1996 consolidated statements of income in order to conform
to the 1997 presentation. The results of operations for the nine months
ended and quarter ended September 30, 1997 are not necessarily indicative of
the results to be expected for the full year. These financial statements
should be read in conjunction with the Company's 1996 Annual Report to
Shareholders, as filed on Form 10-K with the Securities and Exchange
Commission.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" (FAS No. 130). FAS No. 130 established
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. Comprehensive income will thus
represent the sum of net income and other comprehensive income, although FAS
No. 130 does not require the use of the terms comprehensive income or other
comprehensive income. The accumulated balance of other comprehensive income
shall be displayed separately from retained earnings and additional paid-in
capital in the statement of financial position. This statement is effective
for fiscal years beginning after December 15, 1997. The Company anticipates
that the adoption of FAS 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"(FAS No. 131). FAS 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" (FAS
No. 14). FAS No. 131 requires that all public enterprises report financial
and descriptive information about its reportable operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that 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 is currently determining
the impact of the adoption of FAS No. 131.
Page 7
<PAGE>
2. Merger with Allmerica Property & Casualty Companies, Inc.
The merger of Allmerica P&C and a wholly-owned subsidiary of the Company was
consummated on July 16, 1997. Through the merger, the Company acquired all
of the outstanding common stock of Allmerica P&C that it did not already own
in exchange for cash of $425.6 million and approximately 9.7 million shares
of AFC stock valued at $372.5 million. Pursuant to the merger, each
outstanding share of Allmerica P&C Common Stock, other than those shares
owned by the Company or its subsidiaries, became a right to receive $17.60
in cash, without interest, and 0.4 shares of AFC Common Stock, resulting in
the issuance of approximately 9.7 million shares of AFC Common Stock. On
July 15, 1997, the Certificate of Incorporation of Allmerica P&C was amended
and restated to authorize a class B common stock of Allmerica P&C, $5.00 par
value. Each share of Allmerica P&C Common Stock owned by the Company or its
subsidiaries was exchanged for one share of Class B Common Stock immediately
prior to the consummation of the merger.
The merger has been accounted for as a purchase. Total consideration of
approximately $798.1 million has been allocated to the minority interest in
the assets and liabilities based on estimates of their fair values. The
minority interest acquired totaled $703.5 million. A total of $90.6
million representing the excess of the purchase price over the fair values
of the net assets acquired, net of deferred taxes, has been allocated to
goodwill and is being amortized over a 40-year period.
The Company's consolidated results of operations include minority interest
in Allmerica P&C prior to July 16, 1997. The pro forma information below
presents combined results of operations as if the merger and issuance of
Capital Securities had occurred at the beginning of 1996 and reflects
adjustments which include interest expense related to the assumed
financing of a portion of the cash consideration paid and amortization of
goodwill.
The following pro forma information is not necessarily indicative of the
consolidated results of operations of the combined Company had the merger
and issuance of Capital Securities occurred at the beginning of 1996, nor
is it necessarily indicative of future results.
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions)
<S> 1997 1996
<C> <C>
Revenue $2,521.6 $2,406.0
========= =========
Net realized capital gains included
in revenue $ 43.2 $ 34.3
========= =========
Income before taxes and minority
interest $ 196.4 $ 221.9
Income taxes (45.1) (47.2)
Minority Interest:
Distributions on mandatorily
redeemable preferred securities of
a subsidiary trust holding solely
junior subordinated debentures of
the Company (12.0) (12.0)
Equity in earnings (10.9) (11.0)
--------- ---------
Net income $ 128.4 $ 151.7
========= =========
Net income per common share $ 2.14 $ 2.54
========= =========
Weighted average shares outstanding 60.0 59.8
========= =========
</TABLE>
3. Significant Transactions
In June 1997, the Company entered into a credit agreement with The Chase
Manhattan Bank ("Chase") providing for a $225 million revolving line of
credit that expires on December 15, 1997. Borrowings under the line of
credit are unsecured and bear interest at a rate per annum equal to, at the
Company's option, Chase's base rate or the eurodollar rate plus an
applicable margin. The credit agreement requires the Company to comply with
certain financial ratios. As of September 30, 1997, the Company had
borrowed $140.0 million under the line of credit provided by this credit
agreement.
Page 8
<PAGE>
In July 1997, Hanover reached an agreement with Travelers Property Casualty
to facilitate Travelers' writing of certain Hanover Insurance policies, as
they expire, in Alabama, California, Kansas, Mississippi, Missouri, and
Texas. In these six states, Hanover has approximately 250 agents
generating approximately $90 million in premium annually. Hanover intends
to cease writing personal and commercial policies in these states except for
employer and association-sponsored group property and casualty business,
surety bonds and specialty program commercial policies. The plan is
conditioned upon the appropriate regulatory approval in each state.
On April 14, 1997, the Company entered into an agreement in principle to
transfer the Company's individual disability income under a 100% coinsurance
agreement to Metropolitan Life Insurance Company. The coinsurance agreement
became effective October 1, 1997. The transaction has resulted in the
recognition of a $53.9 million pre-tax loss in the first quarter of 1997.
On February 3, 1997, AFC Capital Trust (the "Trust"), a wholly-owned
subsidiary business trust of AFC, issued $300.0 million Series A Capital
Securities ("Capital Securities"), which pay cumulative dividends at a rate
of 8.207% semiannually commencing August 15, 1997. The Trust exists for the
sole purpose of issuing the Capital Securities and investing the proceeds
thereof in an equivalent amount of 8.207% Junior Subordinated Deferrable
Interest Debentures due 2027 of AFC (the "Subordinated Debentures"). Through
certain guarantees, the Subordinated Debentures and the terms of related
agreements, AFC has irrevocably and unconditionally guaranteed the
obligations of the Trust under the Capital Securities. Net proceeds from
the offering of approximately $296.3 million funded a portion of the
acquisition of the 24.2 million publicly held shares of Allmerica P&C
pursuant to the merger on July 16, 1997. On August 7, 1997, AFC and the
Trust exchanged the Series A Capital Securities for a like amount of
Series B Capital Securities and related guarantees which are registered under
the Securities Act of 1933 as required under the terms of the initial
transaction. During the nine months ended September 30, 1997, $12.3 million
in distributions was paid on the Capital Securities.
4. Federal Income Taxes
Federal income tax expense for the periods ended September 30, 1997 and
1996, has been computed using estimated effective tax rates. These rates
are revised, if necessary, at the end of each successive interim period to
reflect the current estimates of the annual effective tax rates.
Page 9
<PAGE>
5. Closed Block
Included in other income in the Consolidated Statements of Income in the
third quarter and first nine months of 1997 and 1996 is a net pre-tax
contribution from the Closed Block of $2.3 million and $8.3 million, and
$1.9 million and $7.9 million, respectively. Summarized financial
information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
1997 1996
(In millions) <C> <C>
<S>
ASSETS
Fixed maturities-at fair
value (amortized cost of
$414.4 and $397.2) $ 421.0 $ 403.9
Mortgage loans 101.5 114.5
Policy loans 223.2 230.2
Cash and cash equivalents 21.3 24.1
Accrued investment income 15.0 14.3
Deferred policy acquisition costs 18.8 21.1
Other assets 4.8 3.7
-------- --------
Total assets $ 805.6 $ 811.8
======== ========
LIABILITIES
Policy liabilities and accruals $ 875.7 $ 883.4
Other liabilities 5.6 8.7
-------- --------
Total liabilities $ 881.3 $ 892.1
======== ========
</TABLE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
(In millions) <C> <C> <C> <C>
<S>
REVENUES
Premiums $ 9.3 $ 10.4 $ 48.3 $ 50.9
Net investment income 13.1 13.3 39.8 39.4
Net realized investment
gains (losses) 0.1 (0.2) 1.1 0.2
-------- -------- -------- --------
Total revenues 22.5 23.5 89.2 90.5
-------- -------- -------- --------
BENEFITS AND EXPENSES
Policy benefits 19.3 20.7 78.4 79.8
Policy acquisition
expenses 0.7 0.7 2.1 2.3
Other operating expenses 0.2 0.2 0.4 0.5
-------- -------- -------- --------
Total benefits and
expenses 20.2 21.6 80.9 82.6
-------- -------- -------- --------
Contribution from the
Closed Block $ 2.3 $ 1.9 $ 8.3 $ 7.9
======== ======== ======== ========
</TABLE>
Many expenses related to Closed Block operations are charged to operations
outside the Closed Block; accordingly, the contribution from the Closed Block
does not represent the actual profitability of the Closed Block operations.
Operating costs and expenses outside of the Closed Block are, therefore,
disproportionate to the business outside the Closed Block.
6. Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Management. Within these broad areas,
the Company conducts business principally in five operating segments.
The Risk Management group includes two segments: Regional Property and
Casualty and Corporate Risk Management Services. The Regional Property
and Casualty segment includes property and casualty insurance products,
such as automobile insurance, homeowners insurance, commercial multiple-peril
insurance, and workers' compensation insurance. These products are offered
by Allmerica P&C through its operating subsidiaries, Hanover and Citizens.
Substantially all of the Regional Property and Casualty segment's earnings
are generated in Michigan and the Northeast (Connecticut, Massachusetts,
New York, New Jersey, New Hampshire, Rhode Island, Vermont and Maine). The
Corporate Risk Management Services segment includes group life and health
insurance products and services which assist employers in administering
employee benefit programs and in managing the related risks.
Page 10
<PAGE>
The Retirement and Asset Management group includes three segments: Retail
Financial Services, Institutional Services and Allmerica Asset Management.
The Retail Financial Services segment includes variable annuities, variable
universal life, and traditional insurance products distributed via retail
channels to individuals across the country. The Institutional Services
segment primarily includes group retirement products such as 401(k) plans,
tax-sheltered annuities and GIC contracts which are distributed to
institutions across the country via worksite marketing and other
arrangements. Allmerica Asset Management is a Registered Investment Advisor
which provides investment advisory services, primarily to affiliates, and to
other institutions, such as insurance companies and pension plans.
In addition to the five operating segments, the Company also has a Corporate
segment, which consists primarily of Senior Debentures and a portion of the
net proceeds from the Company's initial public offering and issuance of
Capital Securities.
Summarized below is financial information with respect to business segments
for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
(In millions) <C> <C> <C> <C>
<S>
Revenues:
Risk Management
Regional Property
and Casualty $ 572.2 $ 540.2 $1,702.0 $1,638.1
Corporate Risk
Management Services 100.1 90.7 294.2 267.1
-------- -------- -------- --------
Subtotal 672.3 630.9 1,996.2 1,905.2
-------- -------- -------- --------
Retirement and Asset Management
Retail Financial
Services 119.9 112.2 353.5 332.7
Institutional Services 60.5 64.6 183.1 201.7
Allmerica Asset
Management 2.1 1.7 6.4 6.2
-------- -------- -------- --------
Subtotal 182.5 178.5 543.0 540.6
-------- -------- -------- --------
Corporate 3.1 0.5 11.4 1.8
Eliminations (2.2) (2.7) (7.5) (9.4)
-------- -------- -------- --------
Total $ 855.7 $ 807.2 $2,543.1 $2,438.2
======== ======== ======== ========
Income (loss) from continuing operations before income taxes:
Risk Management
Regional Property
and Casualty $ 41.1 $ 57.8 $ 150.9 $ 162.4
Corporate Risk
Management Services 6.7 3.7 12.9 11.2
-------- -------- -------- --------
Subtotal 47.8 61.5 163.8 173.6
-------- -------- -------- --------
Retirement and Asset Management
Retail Financial
Services 27.2 18.9 15.2 54.0
Institutional Services 16.8 12.7 44.1 38.3
Allmerica Asset
Management 0.5 0.0 1.1 0.5
-------- -------- -------- --------
Subtotal 44.5 31.6 60.4 92.8
-------- -------- -------- --------
Corporate (2.2) (4.0) (3.9) (12.2)
-------- -------- -------- --------
Total $ 90.1 $ 89.1 $ 220.3 $ 254.2
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
1997 1996
(In millions) <C> <C>
<S>
Identifiable assets:
Risk Management
Regional Property and Casualty $ 5,921.1 $ 5,703.9
Corporate Risk Management Services 562.5 506.0
---------- ----------
Subtotal 6,483.6 6,209.9
---------- ----------
Retirement and Asset Management
Retail Financial Services 11,454.0 8,873.5
Institutional Services 3,998.8 3,879.0
Allmerica Asset Management 4.3 2.4
---------- ----------
Subtotal 15,457.1 12,754.9
---------- ----------
Corporate 26.5 32.9
---------- ----------
Total $21,967.2 $18,997.7
========== ==========
</TABLE>
Page 11
<PAGE>
7. Earnings Per Share
Earnings per share are based on the weighted average number of common shares
and common share equivalents. The weighted average number of shares of
common stock and equivalents was 58.4 million and 50.1 million for the third
quarters ended September 30, 1997 and 1996, respectively, and 53.0 million
and 50.1 million for the nine month periods ended September 30, 1997 and
1996, respectively.
Recently the FASB issued Statement of Financial Accounting Standards No. 128,
Earnings Per Share, which supersedes APB Opinion No. 15, Earnings Per Share.
This standard replaces the primary EPS requirements with a basic EPS
computation and requires a dual presentation of basic and diluted EPS for
those companies with complex capital structures. The Company intends to
adopt the standards of Statement No. 128 for financial statements issued
after December 15, 1997. The impact of this statement is expected to be
immaterial on the Company's EPS calculation.
8. Commitments and Contingencies
In late July 1997, a lawsuit was instituted in Louisiana against AFC and
certain of its subsidiaries by individual plaintiffs alleging fraud, unfair
or deceptive acts, breach of contract, misrepresentation and related claims
in the sale of life insurance policies. In October 1997, plaintiffs
voluntarily dismissed the Lousiana suit and refiled the action in Federal
District Court in Worcester, Massachusetts. The plaintiffs seek to be
certified as a class. The case is in early stages of discovery and the
company is evaluating the claims. Although the Company believes it has
meritorious defenses to plaintiffs' claims, there can be no assurance that
the claims will be resolved on a basis which is satisfactory to the Company.
Page 12
<PAGE>
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations and
financial condition of the Company should be read in conjunction with the
interim Consolidated Financial Statements and related footnotes included
elsewhere herein.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
subsidiaries ("AFC" or "the Company") include the accounts of AFC, First
Allmerica Financial Life Insurance Company ("FAFLIC") its wholly-owned life
insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company
("AFLIAC"), Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C",
a wholly-owned non-insurance company), The Hanover Insurance Company
("Hanover", a wholly-owned subsidiary of Allmerica P&C), Citizens Corporation
("Citizens", an 82.5%-owned subsidiary of Hanover), Citizens Insurance
Company of America (a wholly-owned subsidiary of Citizens) and certain other
insurance and non-insurance subsidiaries.
The results of operations reflect minority interest in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The results of operations also reflect
minority interest in Citizens Corporation (an 82.5%-owned non-insurance
holding company subsidiary of Hanover) and its wholly-owned subsidiary,
Citizens Insurance Company of America ("Citizens").
CLOSED BLOCK
On completion of its demutualization, FAFLIC established a Closed Block for
the payment of future benefits, policyholders' dividends and certain expenses
and taxes relating to certain classes of policies. FAFLIC allocated to the
Closed Block an amount of assets expected to produce cash flows which,
together with anticipated revenues from the Closed Block business, are
reasonably expected to be sufficient to support the Closed Block business.
The Closed Block includes only those revenues, benefit payments, dividends
and premium taxes considered in funding the Closed Block and excludes many
costs and expenses associated with operating the Closed Block and
administering the policies included therein. Since many expenses related
to the Closed Block were excluded from the calculation of the Closed Block
contribution, the contribution from the Closed Block does not represent the
actual profitability of the Closed Block. As a result of such exclusion,
operating costs and expenses outside the Closed Block are disproportionate
to the business outside the Closed Block.
The contribution from the Closed Block is included in 'Other income' in the
interim Consolidated Financial Statements. The pre-tax contribution from
the Closed Block was $2.3 million and $8.3 million for the quarter ended and
nine months ended September 30, 1997, respectively and $1.9 million and $7.9
million for the quarter ended and nine months ended September 30, 1996,
respectively.
Page 13
<PAGE>
FAFLIC's conversion to a stock life insurance company, which was completed
October 16, 1995, and the establishment of the Closed Block have affected
the presentation of the Company's interim Consolidated Financial Statements.
For comparability with prior periods, the following table presents the
results of operations of the Closed Block combined with the results of
operations outside the Closed Block for all periods presented. Management's
discussion and analysis addresses the results of operations as combined
unless otherwise noted.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
(In millions) <C> <C> <C> <C>
<S>
REVENUES
Premiums $ 595.0 $ 567.6 $1,775.1 $1,709.3
Universal life and investment
product policy fees 61.4 49.9 174.8 144.9
Net investment income 177.6 187.2 538.3 541.2
Net realized investment
gains (losses) 14.8 (0.8) 57.8 53.5
Other income 27.2 25.0 78.1 71.9
-------- -------- -------- --------
Total revenues 876.0 828.9 2,624.1 2,520.8
-------- -------- -------- --------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims,
losses and loss adjustment
expenses 534.5 495.3 1,594.6 1,537.1
Policy acquisition expenses 118.0 113.9 356.0 351.1
Loss from cession of
disability income business 0.0 0.0 53.9 0.0
Other operating expenses 133.4 130.6 399.3 378.4
-------- -------- -------- --------
Total benefits, losses
and expenses 785.9 739.8 2,403.8 2,266.6
-------- -------- -------- --------
Income before federal income
taxes 90.1 89.1 220.3 254.2
-------- -------- -------- --------
Federal income tax expense (benefit)
Current 33.8 32.7 66.2 77.0
Deferred (9.8) (11.5) (13.2) (19.0)
-------- -------- -------- --------
Total federal income tax
expense 24.0 21.2 53.0 58.0
-------- -------- -------- --------
Income before minority interest 66.1 67.9 167.3 196.2
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.1) 0.0 (10.5) 0.0
Equity in earnings (1.3) (21.2) (42.5) (59.6)
-------- -------- -------- --------
(5.4) (21.2) (53.0) (59.6)
-------- -------- -------- --------
Net income $ 60.7 $ 46.7 $ 114.3 $ 136.6
======== ======== ======== ========
</TABLE>
Page 14
<PAGE>
Results of Operations
Consolidated Overview
Quarter Ended September 30, 1997 Compared to Quarter Ended September 30, 1996
The Company's consolidated net income for the third quarter increased $14.0
million, or 30.0%, to $60.7 million, compared to the same period in 1996.
Net income includes certain items which management believes are not
indicative of overall operating trends.
The following table reflects consolidated net income adjusted for these
items, all net of taxes and minority interest as applicable.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
September 30,
(In millions) 1997 1996
<S> <C> <C>
Net income $ 60.7 $ 46.7
Adjustments:
Net realized investment gains (10.1) (1.6)
Restructuring costs 1.8 0.0
Differential earnings tax adjustment 0.0 (2.4)
------- -------
Adjusted net income $ 52.4 $ 42.7
======= =======
</TABLE>
The Company's adjusted net income increased $9.7 million, or 22.7%, to
$52.4 million in the third quarter of 1997. This increase is primarily
attributable to pre-tax increases of $7.4 million in the Retail Financial
Services segment, $3.9 million in the Corporate Risk Management segment
and $3.1 million in the Institutional Services segment, partially offset
by pre-tax decreases of $6.9 million and $4.5 million in the Regional
Property and Casualty and Corporate segments, respectively. The increase
in the Retail Financial Services segment was primarily due to growth in
variable products' fee income. The increase in the Corporate Risk
Management segment was primarily due to growth in fully insured group
dental, stop loss and ASO product lines and to reductions in overall
employee costs. Additionally, the Institutional Services segment increase
was due to increased net GIC margins and growth in group variable life and
telemarketing income. The decrease in the Regional Property and Casualty
segment is primarily attributable to an increase in the underwriting loss
of $24.6 million, partially offset by a reduction in the amount of income
attributed to minority interest of $21.5 million due to the recent merger
with Allmerica P&C. The decrease in the Corporate segment's adjusted
net income principally resulted from distributions on the mandatorily
redeemable preferred securities of a subsidiary trust ("Capital
Securities") issued February 3, 1997.
Premium revenue increased $27.4 million, or 4.8%, to $595.0 million in the
third quarter of 1997. Net premiums earned in the Regional Property and
Casualty segment increased $20.7 million, or 4.4%, to $493.4 million
primarily due to increased policies in force in the personal automobile
line at Hanover and homeowners' lines at Hanover and Citizens.
Additionally, Citizens' personal lines' net premiums earned increased due
to an increase in personal automobile and homeowners' rates. These
increases were partially offset by rate decreases in the workers'
compensation lines at both Hanover and Citizens. Premiums in the Corporate
Risk Management Services segment increased $9.2 million, or 12.2%, to $84.9
million due to increases in reinsurance, fully insured group dental, stop
loss and fully insured group medical product lines totaling $7.9 million.
Universal life and investment product policy fees increased $11.5 million,
or 23.1%, to $61.4 million during the third quarter of 1997. This increase
is primarily attributable to a $10.6 million increase in fees generated by
the Retail Financial Services segment due to additional deposits and
appreciation on variable products' account balances.
Net investment income decreased $9.6 million, or 5.1%, to $177.6 million
during the third quarter of 1997. This decrease resulted primarily from
decreases in the Institutional Services and Retail Financial Services
segments, partially offset by an increase in the Corporate segment. The
$6.9 million decrease in the Institutional Services segment resulted
primarily from a reduction in invested assets due to declining Guaranteed
Investment Contracts ("GICs") deposits. Net investment income in the Retail
Financial Services segment decreased $5.1 million, or 7.8%, to $60.5 million
primarily due to a reduction in average fixed maturities invested, partially
offset by increased portfolio yields. Net investment income in the Corporate
segment increased $2.6 million due to the temporary investment of proceeds
from the issuance of Capital Securities in the first quarter of 1997.
Page 15
<PAGE>
Net realized gains (losses) on investments increased $15.6 million to $14.8
million in the third quarter of 1997. The increase is primarily due to
increased net realized gains of $14.5 million in the Regional Property and
Casualty segment, reflecting increased sales of equity securities by both
Hanover and Citizens.
Other income increased $2.2 million, or 8.8%, to $27.2 million in the third
quarter of 1997. Other income from the Retail Financial Services segment
increased $2.5 million, or 32.9%, to $10.1 million due to increased
investment management fee income resulting from increased assets under
management. Other income in the Institutional Services segment increased
$0.8 million, or 25.0%, to $4.0 million primarily from increased
telemarketing income. Additionally, other income increased $0.9 million, or
9.8%, to $10.0 million in the Corporate Risk Management Services segment
due to growth in ASO and contracts fees. These increases were partially
offset by a decrease in Hanover's other income. Hanover's third quarter
1996 other income included $2.8 million from an arbitrated settlement from
a voluntary pool.
Policy benefits, claims, losses and loss adjustment expenses increased
$39.2 million, or 7.9% to $534.5 million during the third quarter of 1997.
This increase is primarily attributable to a $39.0 million, or 11.6%
increase in losses and loss adjustment expenses ("LAE") in the Company's
Regional Property and Casualty segment as a result of an increase in
current year claims severity in the personal automobile line at Hanover,
as well as less favorable current year claims experience in Citizens'
commercial multiple peril and commercial automobile lines. Also
contributing to this decline is less favorable prior year claims experience
in the personal automobile and commercial multiple peril lines at Hanover
and in the personal automobile line at Citizens, and a $5.0 million
increase in catastrophe losses. Additionally, an increase of $6.8 million,
or 13.0% in the Corporate Risk Management Services segment is primarily
related to product growth and the 1997 assumption of a block of affinity
group business. These increases were partially offset by decreased policy
benefits of $7.4 million, or 19.5% in the Institutional Services segment
primarily attributable to the continuing decline of GICs during 1997.
Other operating expenses increased $2.8 million, or 2.1%, to $133.4 million
in the third quarter of 1997 compared to the same period in 1996 primarily
due to increased expenses in the Regional Property and Casualty segment
primarily reflecting growth in net premiums earned, partially offset by
decreases in contingent commissions at Hanover and employee related expenses
at Citizens. In addition, Hanover's third quarter 1996 operating expenses
reflected decreased assessment expenses resulting from reapportionment of
an involuntary pool.
Federal income tax expense increased $2.8 million in the third quarter of
1997, while the effective tax rate increased from 23.8% to 26.6% in the
same period. For the life insurance subsidiaries, a rate increase from
28.4% to 36.8% resulted primarily from the absence of a differential
earnings adjustment in 1997 compared to a $2.4 million differential
earnings benefit in 1996. The effective tax rates for the Regional
Property and Casualty subsidiaries were 14.5% and 21.3% during the third
quarter of 1997 and 1996, respectively. This rate decrease reflects an
increase in the proportion of tax-exempt interest on bonds to pre-tax
income anticipated for the year.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended
September 30, 1996
The Company's consolidated net income for the nine months ended September
30, 1997 decreased $22.3 million, or 16.4%, to $114.3 million, compared
to the same period in 1996. Net income includes certain items which
management believes are not indicative of overall operating trends.
The following table reflects consolidated net income adjusted for these
items, all net of taxes and minority interest as applicable.
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions) 1997 1996
<S> <C> <C>
Net income $114.3 $136.6
Adjustments:
Net realized investment gains (26.8) (23.9)
Contingency payment from sale
of mutual fund processing business 0.0 (3.1)
Restructuring costs 2.8 0.0
Loss from cession of disability
income business 35.0 0.0
Differential earnings tax adjustment 0.0 (8.3)
------- -------
Adjusted net income $125.3 $101.3
======= =======
</TABLE>
Page 16
<PAGE>
The increase in adjusted net income of $24.0 million, or 23.7%, to $125.3
million is primarily attributable to pre-tax increases of $18.8 million in
the Retail Financial Services segment, $6.9 million in the Institutional
Services segment and $5.7 million in the Regional Property and Casualty
segment, partially offset by an increased loss of $8.5 million in the
Corporate segment. The Retail Financial Services segment increased
primarily due to growth in variable products' fee income. The Institutional
Services segment increased primarily from increased net GIC margins and
growth in telemarketing income. The increase in the Regional Property and
Casualty segment is primarily due to an increase in net investment income
of $18.1 million, a reduction in the amount of income attributable to the
minority interest of $15.1 million (due to the recent merger with Allmerica
P&C), partially offset by an increase in the underwriting loss of $24.5
million. These increases were partially offset by a decline in the
Corporate segment's adjusted net income primarily resulting from
distributions of $16.2 million on the Capital Securities issued February 3,
1997.
Premium revenue increased $65.8 million, or 3.9%, to $1,775.1 million
during the first nine months of 1997. Property and casualty net premiums
earned increased $46.9 million, or 3.4%, to $1,454.4 million due to an
increase in policies in force in the personal automobile lines at Hanover
and homeowners' line at Hanover and Citizens, rate increases in the
personal automobile and homeowners' lines at Citizens, and the accounting
effects of restructuring a reinsurance contract in the personal automobile
line at Hanover. These increases were partially offset by rate decreases
in the workers' compensation lines at both Hanover and Citizens. Premiums
in the Corporate Risk Management Services segment increased $23.3 million,
or 10.4%, to $247.9 million due to increases of $25.5 million in
reinsurance, fully insured group dental and stop loss product lines,
partially offset by decreases in risk sharing and fully insured group
medical product lines.
Universal life and investment product policy fees increased $29.9 million,
or 20.7%, to $174.8 million during the first nine months of 1997. This
was primarily the result of additional deposits and appreciation on
variable products' account balances within the Retail Financial Services
segment.
Net investment income decreased $2.9 million, or 0.5%, to $538.3 million
during the first nine months of 1997. This slight decrease primarily
reflects increases of $18.1 million and $8.9 million in the Regional
Property and Casualty and Corporate segments, respectively, partially
offset by a $25.0 million decrease in the Institutional segment. The
increase in the Regional Property and Casualty segment is the result of
an increase in average invested assets and a portfolio shift to higher
yielding debt securities, including longer duration and non-investment grade
securities. The Corporate segment's growth in investment income was derived
from the temporary investment of proceeds from the issuance of Capital
Securities in February 1997. The decrease in the Institutional segment
resulted primarily from a reduction in invested assets due to declining GIC
deposits.
Net realized gains on investments increased $4.3 million, or 8.0%, to $57.8
million for the nine months ended September 30, 1997. This increase is
primarily attributable to an increase of $3.7 million in the Institutional
Services segment resulting from increased sales of real estate properties,
and an increase of $2.9 million in the Regional Property and Casualty
segment reflecting increased sales of equity securities by both Hanover and
Citizens. These increases were partially offset by a $2.1 million decrease
in the Retail Financial Services segment.
Other income increased $6.2 million, or 8.6%, to $78.1 million in the first
nine months of 1997. Other income from the Retail Financial Services
segment increased $5.9 million, or 27.9%, to $27.1 million due to
increased investment management fee income resulting from increased assets
under management. Other income in the Institutional Services segment
increased $3.5 million, or 38.1%, to $12.7 million primarily from
increased telemarketing income. Additionally, other income increased
$3.4 million, or 13.0%, to $29.7 million in the Corporate Risk Management
Services segment due to growth in ASO and contracts fees. These increases
were partially offset by a decrease in Hanover's other income, which in
1996 included an arbitrated settlement from a voluntary pool.
Policy benefits, claims, losses and loss adjustment expenses increased
$57.5 million, or 3.7% to $1,594.6 million during the first nine months of
1997. This increase is primarily attributable to a $61.4 million, or 6.0%
increase in losses and LAE in the Company's Regional Property and Casualty
segment primarily resulting from an increase in current year claims
severity in the personal automobile line at Hanover, a decrease in
favorable development on prior year reserves in Hanover's personal
automobile, homeowners and commercial multiple peril lines, as well as
less favorable current year claims experience in Citizens' commercial
multiple peril line. These factors were partially offset by a $32.6
million decrease in catastrophe losses, primarily at Hanover.
Additionally, a $20.1 million, or 12.8% increase in the Corporate Risk
Management Services segment was due to related growth in premiums,
increased policy benefits due to the 1997 assumption of a block of
affinity group business, and increased group life claims due to
unfavorable claims experience. These increases were partially offset by
decreased policy benefits of $25.5 million, or 20.7% in the Institutional
Services segment primarily resulting from the continuing decline of GICs
during 1997.
Page 17
<PAGE>
Other operating expenses increased $20.9 million, or 5.5%, to $399.3 million
in the first nine months of 1997. This increase is primarily attributable
to increased expenses of $18.9 million in the Regional Property and Casualty
segment primarily reflecting growth in net premiums earned in the segment,
and increased technology expenses at Citizens partially offset by a decrease
in contingent commissions at Hanover. In addition, Hanover's operating
expenses for the nine months ended September 30, 1996 reflected decreased
assessment expenses resulting from the reapportionment of an involuntary
pool. Expenses in the Corporate Risk Management Services segment increased
by $4.7 million due to premium taxes and commissions related to growth in
premiums and ASO fees. Additionally, other operating expenses increased in
the Retail Financial Services and Institutional Services segments due to
product growth in each segment.
Federal income tax expense decreased $5.0 million in the first nine months
of 1997, while the effective tax rate increased from 22.8% to 24.1% for the
nine months ended September 30, 1996 and 1997, respectively. For the life
insurance subsidiaries, the effective tax rate increased from 27.9% in 1996
to 39.2% in 1997. Excluding the effect of an $18.9 million tax benefit
related to the agreement to cede the individual disability income business,
the 1997 effective tax rate for the FAFLIC/AFLIAC consolidated group was
37.3%. This increase resulted primarily from the absence of a differential
earnings adjustment in 1997 compared to a $8.3 million differential earnings
benefit in 1996. The effective tax rates for the Regional Property and
Casualty subsidiaries were 17.1% and 20.0% during the first nine months of
1997 and 1996, respectively.
Segment Results
The following is management's discussion and analysis of the Company's
results of operations by business segment. The Company offers financial
products and services in two major areas: Risk Management and Retirement
and Asset Management. Within these broad areas, the Company conducts
business principally in five operating segments. These segments are
Regional Property and Casualty; Corporate Risk Management Services;
Retail Financial Services; Institutional Services; and Allmerica Asset
Management. The segment results are presented before taxes and minority
interest.
In addition to the five operating segments, the Company also has a Corporate
segment, which consists primarily of Senior Debentures and a portion of the
net proceeds from the Company's initial public offering and issuance of
Capital Securities.
Risk Management
Regional Property and Casualty
The following table summarizes the results of operations for the Regional
Property and Casualty segment.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
(In millions) <C> <C> <C> <C>
<S>
Revenues
Net premiums earned $ 493.4 $ 472.7 $1,454.4 $1,407.5
Net investment income 62.8 63.0 189.7 171.6
Net realized gains (losses) 12.9 (1.6) 48.8 45.9
Other income 3.1 6.1 9.1 13.1
-------- -------- -------- --------
Total revenues 572.2 540.2 1,702.0 1,638.1
Losses and LAE (1) 374.4 335.4 1,087.0 1,025.6
Policy acquisition and other
operating expenses 156.7 147.0 464.1 450.1
-------- -------- -------- --------
Income before taxes $ 41.1 $ 57.8 $ 150.9 $ 162.4
======== ======== ======== ========
<FN>
<FN1>
(1) Includes policyholders' dividends of $2.8 million, $3.7 million, $6.9
million and $8.7 million for the quarters ended September 30, 1997 and 1996
and the nine months ended September 30, 1997 and 1996, respectively.
</FN>
</TABLE>
Page 18
<PAGE>
Quarter Ended September 30, 1997 Compared to Quarter Ended September 30,1996
INCOME BEFORE TAXES
Income before taxes decreased $16.7 million, or 28.9%, to $41.1 million in
the third quarter of 1997, compared to income before taxes of $57.8 million
for the same period in 1996. Net realized gains on investments before taxes
were $12.9 million during the third quarter of 1997 compared to losses of
$1.6 million during the third quarter of 1996, reflecting increased sales
of equity securities by both Hanover and Citizens. Excluding realized gains
and losses and restructuring charges, income before taxes decreased $28.4
million, to $31.0 million in the third quarter of 1997 versus $59.4 million
during the comparable period of 1996. This decrease is primarily
attributable to a $24.6 million increase in the underwriting loss. The
decline in underwriting results is primarily attributable to an increase in
current year claims severity in the personal automobile line at Hanover, as
well as less favorable current year claims experience in Citizens'
commercial multiple peril and commercial automobile lines. Also
contributing to this decline is less favorable prior year claims experience
in the personal automobile and commercial multiple peril lines at Hanover
and in the personal automobile line at Citizens, lower net premiums earned
in the Citizens' workers' compensation line, and a $5.0 million increase in
catastrophe losses. Net investment income decreased $0.2 million, or 0.3%,
to $62.8 million in the third quarter of 1997 as a result of a decrease in
partnership income of $5.7 million offset by additional income from an
increase in average invested assets and the Company's portfolio shift to
higher yielding debt securities, including longer duration and non-investment
grade securities. Net income during the three month period ended September
30, 1996 was also favorably impacted by a $5.7 million arbitrated settlement
from a voluntary pool and a $4.0 million reapportionment of an involuntary
pool.
LINES OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 61.7% and 61.4% of total net
premiums earned in the third quarter of 1997 and 1996, respectively.
<TABLE>
<CAPTION>
Hanover Citizens Consolidated
For the Quarters Ended 1997 1996 1997 1996 1997 1996
September 30 (In millions)<C> <C> <C> <C> <C> <C>
<S>
Net premiums earned $158.8 $149.4 $145.7 $141.0 $304.5 $290.4
Losses and loss
adjustment expenses 128.9 107.6 113.9 95.6 242.8 203.2
Policy acquisition and
other underwriting
expenses 54.3 46.8 37.3 38.5 91.6 85.3
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $(24.4) $ (5.0) $ (5.5) $ 6.9 $(29.9) $ 1.9
======= ======= ======= ======= ======= =======
</TABLE>
Revenues
Personal lines' net premiums earned increased $14.1 million, or 4.9%, to
$304.5 million during the third quarter of 1997, compared to $290.4 million
in the third quarter of 1996. Hanover's personal lines net premiums earned
increased $9.4 million, or 6.3%, to $158.8 million during the third quarter
of 1997. A 7.1% increase in policies in force in the personal automobile
line as well as a 2.2% increase in policies in force in the homeowners line
since September 30, 1996, contributed to the increase in net premiums earned.
These increases were partially offset by the effect of a mandated 6.2%
decrease in Massachusetts personal automobile rates on January 1, 1997. In
March 1997, the Massachusetts Division of Insurance approved Hanover's plan
to offer a safe driver's discount of 10% on automobile insurance premiums.
Management believes these rate decreases may unfavorably impact premium
growth in Massachusetts. Approximately 35% of Hanover's personal automobile
business is currently written in Massachusetts.
Page 19
<PAGE>
Citizens' personal lines net premiums earned increased $4.7 million, or
3.3%, to $145.7 million during the third quarter of 1997, compared to $141.0
million during the third quarter of 1996. This increase is primarily
attributable to rate increases in personal automobile and homeowners lines
and a 3.2% increase in policies in force in the homeowners line, partially
offset by a 0.5% decrease in policies in force in the personal automobile
line since September 30, 1996, attributable to continued strong competition
in Michigan.
Underwriting results
The personal lines' underwriting results declined $31.8 million, to a loss of
$29.9 million in the third quarter of 1997. Hanover's underwriting results
declined $19.4 million to a loss of $24.4 million, while Citizens'
underwriting results declined $12.4 million to a loss of $5.5 million.
The decline in Hanover's underwriting results is primarily attributable to an
increase in current year claim severity in the personal automobile line and
to a reduction in favorable claim experience on prior year reserves in this
line, partially offset by a $3.8 million decrease in catastrophes losses.
The decline in Citizens' underwriting results is primarily due to an increase
in catastrophe losses of $9.2 million, primarily in the homeowners line, and
less favorable claim activity in prior accident years in the personal
automobile line.
Policy acquisition and other underwriting expenses in the personal lines
increased $6.3 million, or 7.4%, to $91.6 million in the third quarter of
1997, primarily reflecting growth in net premiums earned. In addition,
Hanover's third quarter 1996 policy acquisition and other underwriting
expenses reflected decreased commission and assessment expenses resulting
from the reapportionment of an involuntary pool and an increase in
deferrable costs attributable to premiums assumed in a reinsurance contract.
These changes were partially offset by a decrease in contingent commissions
at Hanover and a reduction in employee related expenses at Citizens.
Commercial Segment
The commercial lines of business represented 38.3% and 38.6% of total net
premiums earned in the third quarter of 1997 and 1996, respectively.
<TABLE>
<CAPTION>
Hanover Citizens Consolidated
For the Quarters Ended 1997 1996 1997 1996 1997 1996
September 30 (In millions)<C> <C> <C> <C> <C> <C>
<S>
Net premiums earned $120.0 $112.5 $ 68.9 $ 69.8 $188.9 $182.3
Losses and loss
adjustment expenses 70.9 83.5 57.3 45.0 128.2 128.5
Policy acquisition and
other underwriting
expenses 41.3 40.3 18.2 18.6 59.5 58.9
Policyholders' dividends 1.5 1.7 1.3 2.0 2.8 3.7
------- ------- ------- ------- ------- -------
Underwriting profit (loss)$ 6.3 $(13.0) $ (7.9) $ 4.2 $ (1.6) $ (8.8)
======= ======= ======= ======= ======= =======
</TABLE>
Page 20
<PAGE>
Revenues
Commercial lines' net premiums earned increased $6.6 million, or 3.6%, to
$188.9 million during the third quarter of 1997, compared to $182.3 million
in the third quarter of 1996. Hanover's commercial lines net premiums earned
increased $7.5 million, or 6.7%, to $120.0 million during the third quarter
of 1997. This increase is primarily attributable to a $2.8 million increase
in assumed premiums in Hanover's reinsurance division, as well as a 2.2%
increase in policies in force in Hanover's commercial multiple peril line,
since September 30, 1996. These increases were partially offset by average
rate decreases of approximately 10.9% since January 1, 1997, in the
workers' compensation line. Citizens' commercial lines net premiums earned
decreased $0.9 million, or 1.3%, to $68.9 million in the third quarter of
1997. This decrease is primarily attributable to rate decreases in the
workers' compensation line, resulting from continued competitive conditions
in Michigan, partially offset by growth in the commercial multiple peril
and commercial automobile lines. Rates in the workers' compensation line
were decreased 6.4% and 8.7% effective June 1, 1996 and March 1, 1997,
respectively. Management believes competitive conditions in the workers'
compensation line may impact future growth in net premiums earned.
Underwriting results
The commercial lines' underwriting results improved $7.2 million, or 81.8%,
to a loss of $1.6 million in the second quarter of 1997. Hanover's
underwriting results improved $19.3 million, to a profit of $6.3 million,
while Citizens' underwriting results declined $12.1 million, to a loss of
$7.9 million in the third quarter of 1997.
The improvement in Hanover's commercial segment underwriting results is
primarily attributable to more favorable current year claim experience in
the commercial multiple peril line, an increase in favorable claim activity
in prior accident years in the workers' compensation and commercial
automobile lines, as well as a decrease in catastrophe losses of $4.1
million, partially offset by less favorable claim activity in prior accident
years in the commercial multiple peril line. The decline in Citizens'
commercial lines' underwriting results is primarily attributable to lower
net premiums earned in the workers' compensation line, an increase in
catastrophe losses of $3.7 million, primarily in the commercial multiple
peril line, and increased current year claim severity in the commercial
automobile and commercial multiple peril lines.
Policy acquisition and other underwriting expenses in the commercial segment
increased $0.6 million, or 1.0%, to $59.5 million in the third quarter of
1997, primarily reflecting growth in net premiums earned, partially offset
by a decrease in contingent commissions at Hanover and a reduction in
employee related expenses at Citizens.
INVESTMENT RESULTS
Net investment income before taxes decreased $0.2 million, to $62.8 million
in the third quarter of 1997 compared to $63.0 million in the comparable
quarter of 1996. The decrease is the result of a $5.7 million decline in
income from limited partnership investments from $6.9 million in the third
quarter of 1996 to $1.2 million in the third quarter of 1997. This decrease
is significantly offset by an increase in average invested assets and the
Company's portfolio shift to higher yielding debt securities, including
longer duration and non-investment grade securities. The average pre-tax
yield on debt securities was 6.8% and 6.6% for the quarters ended September
30, 1997 and 1996, respectively. Average invested assets increased $224.6
million, or 5.8%, to $4,077.0 million for the three months ended September
30, 1997 compared to $3,852.4 million for the comparable period of 1996.
Net realized gains on investments before taxes were $12.9 million during the
third quarter of 1997 compared to losses of $1.6 million during the third
quarter of 1996, reflecting increased sales of equity securities by both
Hanover and Citizens.
Page 21
<PAGE>
Nine months ended September 30, 1997 and 1996
INCOME BEFORE TAXES
Income before taxes decreased $11.5 million, or 7.1%, to $150.9 million in
the nine months ended September 30, 1997, compared to income before taxes of
$162.4 million for the same period in 1996. Net realized gains were $48.8
million during the nine months ended September 30, 1997, versus $45.9
million during the comparable period of 1996, reflecting increased sales of
equity securities by both Hanover and Citizens. Excluding realized gains
and losses and restructuring charges, both net of taxes and minority
interest, income before taxes decreased $9.4 million, to $107.1 million in
the nine months ended September 30, 1997, versus $116.5 million during the
comparable period of 1996. This decrease is attributable to a $24.5
million increase in the underwriting loss partially offset by an increase
in net investment income of $18.1 million. The decline in underwriting
results is primarily attributable to an increase in current year claims
severity in the personal automobile line at Hanover, a decrease in
favorable development on prior year reserves in Hanover's personal
automobile, homeowners and commercial multiple peril lines, lower net
premiums earned in Citizens' workers' compensation line, as well as
less favorable current year claims experience in Citizens' commercial
multiple peril line. These factors were partially offset by a $32.6
million decrease in catastrophe losses, primarily at Hanover. The growth
in net investment income resulted primarily from an increase in average
invested assets and the Company's portfolio shift to higher yielding debt
securities, including longer duration and non-investment grade securities.
Net income during the nine month period ended September 30, 1996 was also
favorably impacted by a $5.7 million arbitrated settlement from a
voluntary pool.
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 61.8% and 60.8% of total net
premiums earned in the nine months ended September 30, 1997 and 1996,
respectively.
<TABLE>
<CAPTION>
Hanover Citizens Consolidated
For the Nine Months
Ended 1997 1996 1997 1996 1997 1996
September 30 (In <C> <C> <C> <C> <C> <C>
millions)
<S>
Net premiums earned $ 466.7 $442.2 $ 432.7 $ 413.3 $ 899.4 $ 855.5
Losses and loss
adjustment expenses 362.8 321.2 335.6 305.6 698.4 626.8
Policy acquisition and
other underwriting
expenses 152.7 146.1 114.5 112.7 267.2 258.8
------- ------- ------- ------- ------- -------
Underwriting loss $(48.8)$(25.1) $(17.4) $(5.0) $(66.2) $(30.1)
======= ======= ======= ======= ======= =======
</TABLE>
Revenues
Personal lines' net premiums earned increased $43.9 million, or 5.1%, to
$899.4 million during the nine months ended September 30, 1997, compared to
$855.5 million in the same period of 1996. Hanover's personal lines net
premiums earned increased $24.5 million, or 5.5%, to $466.7 million during
the nine months ended September 30, 1997. This increase is primarily
attributable to a 7.1% increase in policies in force in the personal
automobile line as well as a 2.2% increase in policies in force in the
homeowners line, since September 30, 1996, and to an increase in the
personal automobile line associated with the accounting effects of
restructuring a reinsurance contract which increased both net premiums
earned and losses and LAE by approximately $6.7 million. These increases
were partially offset by the effect of a mandated 6.2% decrease in
Massachusetts personal automobile rates on January 1, 1997.
Page 22
<PAGE>
Citizens' personal lines net premiums earned increased $19.4 million, or
4.7%, to $432.7 million in the nine months ended September 30, 1997. This
increase is primarily attributable to rate increases in the personal
automobile and homeowners lines, a 3.2% increase in policies in force in
the homeowners line, and a decrease in premiums ceded to MCCA. The non-
recurring decrease in premiums ceded to MCCA was a result of a lower
surcharge effective January 1, 1997 for personal automobile policies
written. These factors were partially offset by a 0.5% decrease in
policies in force in the personal automobile line since September 30, 1996,
attributable to continued strong competition in Michigan.
Underwriting Results
The personal lines' underwriting loss for the nine months ended
September 30, 1997 increased $36.1 million, to a loss of $66.2 million.
Hanover's underwriting loss increased $23.7 million, to a loss of $48.8
million. Citizens' underwriting loss increased $12.4 million, to a loss of
$17.4 million.
The decline in Hanover's underwriting results is primarily attributable to a
$21.9 million reduction in favorable development on prior year reserves in
the personal automobile line, as well as an increase in current year claim
severity in this line. These increases were partially offset by a $19.1
million decrease in catastrophe losses in the homeowners line, from $24.3
million during the nine months ended September 30, 1996, to $5.2 million in
1997. The decline in Citizens' underwriting results is primarily due to
less favorable claims activity in prior accident years in the personal
automobile line. Additionally, Citizens experienced an increase in claim
severity in the homeowners line for the current accident year, primarily
in the first quarter.
Policy acquisition and other underwriting expenses in the personal segment
increased $8.4 million, or 3.2%, to $267.2 million in the nine months ended
September 30, 1997, reflecting the growth in net premiums earned. In
addition, Hanover's policy acquisition and other underwriting expenses for
the nine months ended September 30, 1996 reflected decreased commission and
assessment expenses resulting from the reapportionment of an involuntary
pool and an increase in deferrable costs attributable to premiums assumed
in a reinsurance contract. These changes were partially offset by a
decrease in contingent commissions at Hanover.
Commercial Segment
The commercial lines of business represented 38.2% and 39.2% of total net
premiums earned in the nine months ended September 30, 1997 and 1996,
respectively.
<TABLE>
<CAPTION>
Hanover Citizens Consolidated
For the Nine Months
Ended 1997 1996 1997 1996 1997 1996
September 30 (In <C> <C> <C> <C> <C> <C>
millions)
<S>
Net premiums earned $353.1 $338.9 $201.9 $213.1 $555.0 $552.0
Losses and loss
adjustment expenses 227.5 238.3 151.4 151.8 378.9 390.1
Policy acquisition and
other underwriting
expenses 132.6 128.4 53.5 53.3 186.1 181.7
Policyholders'
dividends 2.2 3.1 4.7 5.6 6.9 8.7
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $(9.2) $(30.9) $(7.7) $ 2.4 $(16.9) $(28.5)
======= ======= ======= ======= ======= =======
</TABLE>
Page 23
<PAGE>
Revenues
Commercial lines' net premiums earned increased $3.0 million, or 0.5%, to
$555.0 million in the nine months ended September 30, 1997, compared to
$552.0 in the same period in 1996. Hanover's commercial lines net premiums
earned increased $14.2 million, or 4.2%, to $353.1 million during the nine
months ended September 30, 1997. This increase is primarily attributable
to a $7.0 million increase in assumed premiums in Hanover's reinsurance
division, as well as an 8.9% and 2.2% increase in policies in force in
Hanover's commercial automobile and commercial multiple peril lines,
respectively, since September 30, 1996. These increases were partially
offset by average rate decreases of 10.9%, since January 1, 1997, in
Hanover's workers' compensation line. Citizens' commercial lines net
premiums earned decreased $11.2 million, or 5.3%, to $201.9 million in
the nine months ended September 30, 1997 from $213.1 million for the nine
months ended September 30, 1996. This decrease is attributable to rate
decreases in workers' compensation, resulting from continued competitive
conditions in Michigan, partially offset by growth in the commercial
multiple peril and commercial automobile lines. Rates in the workers'
compensation line were decreased 6.4% and 8.7% effective June 1, 1996
and March 1, 1997, respectively.
Underwriting Results
The commercial lines' underwriting loss decreased $11.6 million, or 40.7% to
a loss of $16.9 million for the nine months ended September 30, 1997.
Hanover's underwriting results improved $21.7 million, to a loss of $9.2
million while Citizens' underwriting results declined $10.1 million to a
loss of $7.7 million in the nine months ended September 30, 1997.
The improvement in Hanover's underwriting results reflects an increase in
favorable development on prior accident years in workers' compensation and
commercial automobile lines as well as a decrease in catastrophe losses of
$12.9 million, primarily in the commercial multiple peril line. These
factors were partially offset by an increase in current year claims
frequency and severity in the commercial automobile line. The decline in
Citizens' underwriting results is primarily attributable to lower net
premiums earned in the workers' compensation line and increased current
year claim severity in the commercial multiple peril line, partially
offset by an increase in favorable development of prior year claims in the
workers' compensation line.
Policy acquisition and other underwriting expenses in the commercial segment
increased $4.4 million, or 2.4%, to $186.1 million in the nine months ended
September 30, 1997, reflecting the growth in net premiums earned and
increased technology expenses at Citizens, partially offset by a decrease
in contingent commissions at Hanover.
INVESTMENT RESULTS
Net investment income before taxes increased $18.1 million, or 10.5%, to
$189.7 million during the nine months ended September 30, 1997 compared to
$171.6 million in the comparable period of 1996. The increase is primarily
the result of an increase in average invested assets and the Company's
portfolio shift to higher yielding debt securities, including longer
duration and non-investment grade securities. The average pre-tax yield
on debt securities was 6.8% and 6.4% for the nine months ended September 30,
1997 and 1996, respectively. Average invested assets increased $157.7
million, or 4.1%, to $4,048.7 million at September 30, 1997 compared to
$3,891.0 million at September 30, 1996.
Net realized gains on investments before taxes were $48.8 million and $45.9
million for the nine months ended September 30, 1997 and 1996, respectively.
The increase in net realized gains reflects increased sales of equity
securities by both Hanover and Citizens. In both periods, net realized
investment gains resulted primarily from the sale of appreciated equity
securities, due to the Company's strategy of shifting to a higher
proportion of debt securities.
Reserve for Losses and Loss Adjustment Expenses
The Regional Property and Casualty segment maintains reserves to provide
for its estimated ultimate liability for losses and loss adjustment expenses
with respect to reported and unreported claims incurred as of the end of
each accounting period. These reserves are estimates, involving actuarial
projections at a given point in time, of what management expects the
ultimate settlement and administration of claims will cost based on facts
and circumstances then known, predictions of future events, estimates of
future trends in claim severity and judicial theories of liability and
other factors. The inherent uncertainty of estimating insurance reserves
is greater for certain types of property and casualty insurance lines,
particularly workers' compensation and other liability lines, where a
longer period of time may elapse before a definitive determination of
ultimate liability may be made, where the technological, judicial and
political climates involving these types of claims are changing.
Page 24
<PAGE>
The Regional Property and Casualty segment regularly updates its reserve
estimates as new information becomes available and further events occur which
may impact the resolution of unsettled claims. Changes in prior reserve
estimates are reflected in results of operations in the year such changes are
determined to be needed and recorded. The table below provides a
reconciliation of the beginning and ending reserve for unpaid losses and LAE
as follows:
<TABLE>
<CAPTION>
For the nine months ended September 30,
(In millions) 1997 1996
<S> <C> <C>
Reserve for losses and LAE, beginning
of period $2,744.1 $2,896.0
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events of the
current year 1,156.5 1,097.2
Decrease in provision for insured
events of prior years (76.4) (80.3)
-------- --------
Total incurred losses and LAE 1,080.1 1,016.9
-------- --------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to
insured events of current year 536.9 512.3
Losses and LAE attributable to
insured events of prior years 592.8 504.7
-------- --------
Total payments 1,129.7 1,017.0
Change in reinsurance recoverable on
unpaid losses (54.1) (35.6)
Other (1) (7.4) 0.0
-------- --------
Reserve for losses and LAE, end of
period $2,633.0 $2,860.3
======== ========
<FN>
<FN1>
(1) Includes purchase accounting adjustments.
</FN>
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $76.4 million and $80.3 million
for the nine months ended September 30, 1997 and 1996, respectively. The
decrease in favorable development on prior years' loss reserves of $3.9
million results from a $15.7 million decrease in favorable development at
Hanover to $38.6 million, partially offset by an $11.8 million increase in
favorable development at Citizens to $37.8 million. The favorable reserve
development in both years at Citizens primarily reflects the initiatives
taken by Citizens to manage medical costs in the personal automobile and
workers' compensation lines, as well as the impact of the Michigan Supreme
Court ruling on workers' compensation indemnity payments, which decreases
the maximum amount to be paid for indemnity cases on all existing and
future claims. The decrease in Citizens' reserves for all prior accident
years was $2.2 million, and $11.7 million, for the three months ended
September 30, 1997 and 1996, respectively. Hanover's decreased favorable
development is primarily attributable to decreased favorable development
in the personal automobile, homeowners and commercial multiple peril lines.
The decrease in Hanover's reserves for all prior accident years was $13.2
million and $12.9 million for the three months ended September 30, 1997 and
1996, respectively. The Company believes reduced favorable reserve
development may continue to impact future earnings.
The Regional Property and Casualty segment regularly reviews its reserving
techniques, its overall reserving position and its reinsurance. Based on
(i) review of historical data, legislative enactments, judicial decisions,
legal developments in impositions of damages, changes in political
attitudes and trends in general economic conditions, (ii) review of per
claim information, (iii) historical loss experience of the Company and the
industry, (iv) the relatively short-term nature of most policies, and (v)
internal estimates of required reserves, management believes that adequate
provision has been made for loss reserves. However, establishment of
appropriate reserves is an inherently uncertain process and there can be
no certainty that current established reserves will prove adequate in
light of subsequent actual experience. A significant change to the
estimated reserves could have a material impact on the results of
operations.
Page 25
<PAGE>
Corporate Risk Management Services
The following table summarizes the results of operations for the Corporate
Risk Management Services ("CRMS") segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Premiums and premium equivalents
Premiums $ 84.9 $ 75.7 $247.9 $224.6
Premium equivalents 150.3 145.9 448.5 432.4
------- ------- ------- -------
Total premiums and premium
equivalents $235.2 $221.6 $696.4 $657.0
======= ======= ======= =======
Revenues
Premiums $ 84.9 $ 75.7 $247.9 $224.6
Net investment income 5.9 5.8 17.2 16.0
Net realized (losses) gains (0.7) 0.1 (0.6) 0.2
Other income 10.0 9.1 29.7 26.3
------- ------- ------- -------
Total revenues 100.1 90.7 294.2 267.1
Policy benefits, claims and
losses 59.3 52.5 178.1 158.0
Policy acquisition expenses 0.8 0.8 2.5 2.3
Other operating expenses 33.3 33.7 100.7 95.6
------- ------- ------- -------
Income before taxes $ 6.7 $ 3.7 $ 12.9 $ 11.2
======= ======= ======= =======
</TABLE>
Quarter Ended September 30, 1997 Compared to Quarter Ended September 30,
1996
Income before taxes increased $3.0 million, or 81.1%, to $6.7 million in
the third quarter of 1997. This increase was primarily due to growth in
premiums and fees in the Company's fully insured group dental, stop loss
and ASO product lines, reductions in overall employee costs due to cost
containment efforts initiated in 1996, as well as favorable long term
disability claims experience. These increases were partially offset by
additional policy benefits, premium taxes, and commissions resulting from
the growth in premiums and ASO fees.
Premiums increased $9.2 million, or 12.2%, to $84.9 million in the third
quarter of 1997 primarily due to increases in reinsurance, fully insured
group dental, stop loss, and fully insured group medical product lines.
The assumption of a block of affinity group business in the beginning of
1997, accounted for $4.6 million of the $9.2 million increase in premiums
during the quarter.
Other income increased $0.9 million, or 9.9%, to $10.0 million in the third
quarter of 1997 due to growth in ASO and contract fees.
Policy benefits, claims and losses increased $6.8 million, or 13.0%, to
$59.3 million in the third quarter of 1997. This increase is principally
attributable to the increased premiums. The 1997 assumption of a block
of affinity group business accounted for $3.3 million of the growth-related
increase in policy benefits during the quarter.
Other operating expenses decreased $0.4 million, or 1.2%, to $33.3 million
in the third quarter of 1997 primarily due to a decrease in overall employee
costs of $2.9 million offset by an increase of $1.3 million in premium taxes
and commissions resulting from the growth in premiums and ASO fees, in
addition to an increase of $1.2 million relating to the affinity group
business.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Income before taxes increased $1.7 million, or 15.2%, to $12.9 million in the
first nine months of 1997 compared to the same period in 1996. During the
first quarter of 1996, CRMS released reserves of $1.2 million related to a
litigation settlement. Excluding this item, income before taxes increased
$2.9 million, or 25.9%. This increase was primarily due to growth of the
Company's fully insured group dental, stop loss, and ASO product lines,
reductions in overall employee costs, and to favorable long-term disability
claims experience.
Page 26
<PAGE>
Premiums increased $23.3 million, or 10.4%, to $247.9 million in the first
nine months of 1997 primarily due to increases in reinsurance, fully insured
group dental, and stop loss product lines totaling $25.5 million. The
aforementioned assumption of a block of affinity group business resulted
in a $13.6 million increase in reinsurance premiums during 1997. These
increases were partially offset by decreases in risk sharing and fully
insured group medical product lines of $2.4 million. The decline in risk
sharing premiums primarily reflects the Company's emphasis on stop loss
coverage and ASO arrangements.
Net investment income increased $1.2 million, or 7.5%, to $17.2 million in
the first nine months of 1997 due to increased yields on invested assets.
This increase primarily reflects the Company's continued shift to higher
yielding, longer duration investments.
Other income increased $3.4 million, or 12.9%, to $29.7 million in the first
nine months of 1997 due to growth in ASO and contract fees.
Policy benefits, claims and losses increased $20.1 million, or 12.7%, to
$178.1 million in the first nine months of 1997 compared to the same period
in 1996. Excluding the aforementioned reserve release in 1996, policy
benefits, claims and losses increased $18.9 million, or 12.0%. This
increase is primarily due to the 1997 assumption of a block of affinity
group business which contributed $9.4 million in policy benefits during the
year. Additionally, group life claims increased $4.9 million in 1997 due to
unfavorable claims experience particularly in the first quarter of the year
combined with unusually favorable claims experience in the first quarter of
1996. Increased benefits due to growth in the fully insured group dental
and reinsurance product lines were partially offset by decreased benefits
due to cancellations in the fully insured medical product line.
Other operating expenses increased $5.1 million, or 5.3%, to $100.7 million
for the nine months ended September 30, 1997 primarily due to increases of
$5.0 million in premium taxes and commissions resulting from the growth in
premiums and ASO fees, in addition to an increase of $4.3 million relating
to the affinity group business, partially offset by a $4.1 million decrease
in overall employee costs.
Retirement and Asset Management
Retail Financial Services
The following table summarizes the results of operations for the Retail
Financial Services segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Revenues
Premiums $ 16.6 $ 19.2 $ 72.7 $ 77.2
Fees 56.5 45.9 158.8 132.8
Net investment income 60.5 65.6 182.6 188.8
Net realized losses (3.6) (4.5) (6.8) (4.7)
Other income 10.1 7.6 27.1 21.2
------- ------- ------- -------
Total revenues 140.1 133.8 434.4 415.3
Policy benefits, claims and losses 70.2 69.5 231.5 230.1
Policy acquisition expenses 12.8 13.7 43.0 42.7
Loss from cession of
disability income business 0.0 0.0 53.9 0.0
Other operating expenses 29.9 31.7 90.8 88.5
------- ------- ------- -------
Income before taxes $ 27.2 $ 18.9 $ 15.2 $ 54.0
======= ======= ======= =======
</TABLE>
Quarter Ended September 30, 1997 Compared to Quarter Ended September 30,
1996
Income before taxes increased $8.3 million, or 43.9%, to $27.2 million in
the third quarter of 1997. This increase is primarily attributable to
growth in variable products' fee income, partially offset by decreased net
investment income due to a reduction in average fixed maturities invested,
and lower premiums from traditional insurance products.
Premiums decreased $2.6 million, or 13.5%, to $16.6 million during the third
quarter of 1997. This decrease is due to the Company's continued shift in
focus from traditional life insurance products to variable life insurance
and annuity products.
Page 27
<PAGE>
Fee revenue increased $10.6 million, or 23.1%, to $56.5 million in the
third quarter of 1997 due to additional deposits and appreciation on
variable products' account balances. Fees from annuities increased $10.1
million, or 70.6%, to $24.4 million in the third quarter of 1997 compared
to the same period in 1996. Fees from variable universal life policies
increased $1.9 million, or 16.7%, to $13.3 million in the third quarter of
1997. These increases were partially offset by a continued decline in fees
from non-variable universal life of $1.4 million. The Company expects fees
from this product to continue to decrease as policies in force and related
contract values decline.
Net investment income decreased $5.1 million, or 7.8%, to $60.5 million in
the third quarter of 1997. This decrease is primarily due to a reduction
in average fixed maturities invested, partially offset by increased
portfolio yields. The reason for the reduction in average fixed maturities
invested is twofold. First, there has been a reduction in the Company's
general account, due to the ongoing shift in focus from traditional life
insurance products to variable life insurance and annuity products.
Additionally, during 1996, the Company temporarily increased its fixed
maturity holdings by utilizing short-term debt to finance additions to the
investment portfolio. This strategy has not been utilized in 1997. The
increased yields were achieved through a series of modest portfolio shifts,
beginning in the second quarter of 1996, to higher yielding debt securities,
including longer duration and non-investment grade securities.
Other income increased $2.5 million, or 32.9%, to $10.1 million in the third
quarter of 1997. This increase is primarily attributable to increased
investment management fee income resulting from increased assets under
management.
Other operating expenses include insurance taxes, licenses, fees, and
administrative expenses incurred to support sales and marketing of products
sold in this segment. The decrease of $1.8 million, or 5.7%, to $29.9
million for the quarter ended September 30, 1997 is primarily due to a
reduction in interest expense on short-term debt used to finance additions
to the investment portfolio in 1996. This was partially offset by an
increase in administrative expenses related to continued growth in the
variable product lines.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Income before taxes decreased $38.8 million, or 71.9%, to $15.2 million in
the first nine months of 1997. This decrease is attributable to a $53.9
million loss sustained in the first quarter of 1997 related to an agreement
to cede the individual disability income line of business. Excluding this
non-recurring charge, income before taxes increased $15.1 million, or 28.0%,
to $69.1 million in the first nine months of 1997. This increase is
primarily due to growth in variable products' fee income, partially offset
by lower premiums and net investment income.
Premiums decreased $4.5 million, or 5.8%, to $72.7 million during the first
nine months of 1997. This decrease reflects the Company's continued shift
in focus from traditional life insurance products to variable life
insurance and annuity products and the decision in the first half of 1996
to discontinue issuing new individual disability income policies.
Fee revenue increased $26.0 million, or 19.6%, to $158.8 million in the
first nine months of 1997 due to additional deposits and appreciation in
variable products' account balances. Fees from annuities increased $22.5
million, or 56.4%, to $62.4 million in the first nine months of 1997
compared to the same period in 1996. Fees from variable universal life
policies increased $7.0 million, or 22.0%, to $38.8 million in the first
nine months of 1997. These increases were partially offset by a continued
decline in fees from non-variable universal life of $3.5 million.
Net investment income decreased $6.2 million, or 3.3%, to $182.6 million in
the first nine months of 1997. This decrease is primarily due to the
aforementioned reduction in average fixed maturities invested, partially
offset by increased portfolio yields.
Other income increased $5.9 million, or 27.8%, to $27.1 million in the first
nine months of 1997. This increase is primarily attributable to increased
investment management fee income resulting from increased assets under
management.
The increase in other operating expenses of $2.3 million, or 2.6%, to $90.8
million for the nine months ended September 30, 1997 is primarily the result
of increased premium taxes and administrative expenses related to growth in
the variable product lines. Additionally, increases in sub-advisor fees and
brokerage commissions resulted from growth in investments under management.
These increases were partially offset by a reduction in interest expense on
short-term debt used to finance additions to the investment portfolio in
1996.
Page 28
<PAGE>
Interest Margins
The results of the Retail Financial Services segment depend, in part, on the
maintenance of profitable margins between investment results from investment
assets supporting universal life and general account annuity products and the
interest credited on those products. The following table sets forth interest
earned, interest credited and the related interest margin.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Net investment income $ 34.4 $ 36.6 $105.0 $110.0
Less: Interest credited 24.6 27.3 73.8 76.3
------- ------- ------- -------
Interest margins (1) $ 9.8 $ 9.3 $ 31.2 $ 33.7
======= ======= ======= =======
</TABLE>
(1) Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal life
and general account annuity policies.
Interest margins were relatively consistent in 1997 as compared to 1996.
Institutional Services
The following table summarizes the results of operations for the
Institutional Services segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Revenues
Fees, premiums, and
non-insurance income (1) $ 8.9 $ 7.1 $ 28.7 $ 26.0
Net investment income
GICs 20.1 23.5 63.1 78.7
Other 25.1 28.6 75.1 84.5
Net realized gains 6.4 5.4 16.2 12.5
------- ------- ------- -------
Total revenues 60.5 64.6 183.1 201.7
Policy benefits, claims and losses
Interest credited to GICs 15.0 20.3 49.2 71.0
Other 15.5 17.6 48.7 52.4
Policy acquisition expenses 0.6 0.7 1.9 2.1
Other operating expenses 12.6 13.3 39.2 37.9
------- ------- ------- -------
Income before taxes $ 16.8 $ 12.7 $ 44.1 $ 38.3
======= ======= ======= =======
<FN>
<FN1>
(1) Fees, premiums, and non-insurance income includes fees from retirement
services, institutional 401(K) recordkeeping services, and other
miscellaneous non-insurance related fees.
</FN>
</TABLE>
Quarter Ended September 30, 1997 compared to Quarter Ended September 30,
1996
Income before taxes increased $4.1 million, or 32.3%, to $16.8 million in
the third quarter of 1997. This increase was primarily attributable to an
increase in the net GIC margins of $1.9 million and increased realized
gains of $1.0 million. Also contributing to the increase was growth in
defined contribution separate account product and group variable life
product fees.
Fees, premiums, and non-insurance income increased $1.8 million, or 25.4%,
to $8.9 million in the third quarter of 1997. This increase was primarily
due to growth in fees for the Company's group variable life and defined
contribution separate account product lines of $0.6 million and $0.4 million,
respectively. Telemarketing revenues also increased by $0.3 million.
Page 29
<PAGE>
Net investment income related to GICs and interest credited to GIC
contractholders have declined as a result of declining GIC deposits over
the past two years. In the third quarter of 1997, the interest margin on
GICs increased $1.9 million due to the combination of slightly higher
investment yields and lower average crediting rates on the remaining
contracts. Other net investment income decreased $3.5 million, or 12.2%,
to $25.1 million in the third quarter of 1997. This decrease resulted from
a decline in average invested assets due to cancellations of defined benefit
plans, as well as transfers of certain plan assets to the separate accounts.
Net realized gains increased $1.0 million, or 18.5%, to $6.4 million in the
third quarter of 1997 primarily as a result of sales of real estate during
the quarter.
Other policy benefits, claims and losses consist principally of interest
credited and benefits provided by the Company's defined contribution and
defined benefit plan products, including annuity benefits for certain
defined benefit plan participants electing that option. Other policy
benefits, claims and losses decreased $2.1 million, or 11.9%, to $15.5
million for the third quarter of 1997, primarily due to reductions in
interest credited to participants resulting from the aforementioned
cancellations, partially offset by less favorable mortality in the defined
benefit plan product line and increased policy benefits in the group
variable life product line.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Income before taxes increased $5.8 million, or 15.1%, to $44.1 million for
the nine months ended September 30, 1997 compared to the nine months ended
September 30, 1996. During the first half of 1996, Institutional Services
recognized a contingency payment for the sale of the mutual fund processing
business of $4.8 million. Excluding this item, income before taxes
increased $10.6 million, or 31.6%. This change was primarily attributable
to an increase in the net GIC margins of $6.2 million, increased realized
gains of $3.7 million, and growth in telemarketing and group variable life
product fee income of $1.1 million and $0.7 million, respectively.
Fees, premiums, and non-insurance income increased $2.7 million, or 10.4%,
to $28.7 million in the first nine months of 1997. Excluding the
aforementioned contingency payment, fees, premiums, and non-insurance income
increased $7.5 million, or 28.9%. This increase was primarily due to growth
in fees for the Company's group variable life and defined contribution
separate account product lines of $3.0 million and $0.9 million,
respectively. Telemarketing revenues also increased by $2.5 million
compared to 1996.
During the first nine months of 1997, the interest margin on GICs increased
$6.2 million due to the combination of slightly higher investment yields and
lower average crediting rates on the remaining contracts. Other net
investment income decreased $9.4 million, or 11.1%, to $75.1 million in
the first nine months of 1997. This decrease resulted from a decline in
average invested assets due to cancellations of defined benefit plans, as
well as transfers of certain plan assets to the separate accounts.
Net realized gains increased $3.7 million, or 29.6%, to $16.2 million in the
first nine months of 1997. This change resulted primarily from increased
sales of real estate properties.
Other policy benefits, claims and losses for defined benefit plans, defined
contribution plans, and the group variable life product declined from $52.4
million in 1996 to $48.7 million in 1997. This was primarily due to
reductions in the interest credited to participants resulting from the
aforementioned cancellations, partially offset by less favorable mortality
in the defined benefit plan product line and increased policy benefits in the
group variable life product line.
Page 30
<PAGE>
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica
Asset Management segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Fees and other income:
External $0.4 $0.2 $1.1 $0.7
Internal 1.7 1.5 5.3 5.5
----- ----- ----- -----
Total revenue 2.1 1.7 6.4 6.2
Other operating expenses 1.6 1.7 5.3 5.7
----- ----- ----- -----
Income before taxes $0.5 $0.0 $1.1 $0.5
===== ===== ===== =====
</TABLE>
Since 1994, the Company has provided investment advisory and sub-advisory
services, primarily to affiliates, through its registered investment
advisor, Allmerica Asset Management ("AAM"). In the second quarter of
1996, AAM finalized contracts with two related parties, FAFLIC and AFLIAC,
to provide investment advisory services at cost. The internal fees and
corresponding operating expenses related to these contracts totaled $0.7
million for the quarters ended September 30, 1997 and 1996 and $2.6 million
and $3.0 million for the nine months ended September 30, 1997 and 1996,
respectively.
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
Revenues
Investment and other
income $3.3 $0.7 $11.2 $2.2
Realized (losses) gains (0.2) (0.2) 0.2 (0.4)
----- ----- ----- -----
Total revenues 3.1 0.5 11.4 1.8
Other operating expenses 5.3 4.5 15.3 14.0
----- ----- ----- -----
Loss before taxes and
minority interest (2.2) (4.0) (3.9) (12.2)
Minority interest:
Distributions on
mandatorily redeemable
preferred securities of
a subsidiary trust holding
solely junior subordinated
debentures of the Company (6.3) 0.0 (16.2) 0.0
----- ----- ----- -----
Loss before taxes $(8.5) $(4.0) $(20.1) $(12.2)
===== ===== ===== =====
</TABLE>
This segment consists primarily of $26.3 million of cash, investments,
and other assets remaining from the $296.3 million in net proceeds from
the February 3, 1997 issuance of Capital Securities. Investment and other
income increased $2.6 million in the third quarter of 1997, and $9.0 million
in the first nine months of 1997, primarily due to the investment of the net
proceeds from these securities. These proceeds were invested in the short-
term investment portfolio, and used to finance, in part, the July 16 merger
with Allmerica P&C. For all periods presented, other operating expenses
principally reflect interest expense on the Company's 7 5/8% Senior
Debentures. Other operating expenses for the quarter and nine months ended
September 30, 1997 also reflect interest expense on the Company's short-term
revolving credit loan commencing August 15, 1997 and maturing December
15, 1997. Additionally, minority interest represents distributions on the
Capital Securities, which pay cumulative distributions at a rate of 8.207%
semiannually, commencing August 15, 1997.
Page 31
<PAGE>
Investment Portfolio
The Company had investment assets diversified across several asset classes,
as follows:
<TABLE>
<CAPTION>
September 30, 1997(1) December 31, 1996(1)
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
<S> <C> <C> <C> <C>
Fixed maturities (2) $7,784.4 80.5% $7,891.7 79.4%
Equity securities (2) 475.6 4.9 473.6 4.8
Mortgages 666.2 6.9 764.6 7.7
Policy loans 362.5 3.7 362.6 3.6
Real estate 72.5 0.8 120.7 1.2
Cash and cash equivalents 184.6 1.9 202.6 2.0
Other invested assets 125.6 1.3 128.8 1.3
------------------ --------------------
Total $9,671.4 100.0% $9,944.6 100.0%
================== ====================
<FN>
<FN1>
Includes Closed Block invested assets with a carrying value of $767.0
million and $772.7 million at September 30, 1997 and December 31, 1996,
respectively.
<FN2>
The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
</FN>
</TABLE>
Total investment assets decreased $273.2 million, or 2.7%, to $9.7 billion
during the first nine months of 1997. This decrease is primarily
attributable to the sales of fixed maturities and loan repayments on
outstanding mortgages. Fixed maturities decreased $107.3 million, or 1.4%
primarily due to sales made late in the third quarter in order to generate
cash needed to transfer assets relating to the Company's agreement to cede
its individual disability income business. Related transfers of
approximately $207 million were made in early October. The decrease in
fixed maturities due to sales was partially offset by strong appreciation
during the first nine months of 1997. Mortgages decreased $98.4 million,
or 12.9%, to $666.2 million due to loan repayments received during the
period. Additionally, real estate decreased $48.2 million, or 39.9%, to
$72.5 million during the first nine months of 1997 due to sales of
investment properties. The Company intends to sell its holdings in this
portfolio within the next several years. Cash and cash equivalents decreased
$18.0 million, or 8.9%, to $184.6 million. See "Liquidity and Capital
Resources".
The Company's fixed maturity portfolio is comprised of primarily
investment grade corporate securities, tax-exempt issues of state and
local governments, U.S. government and agency securities and other issues.
Based on ratings by the National Association of Insurance Commissioners,
investment grade securities comprised 80.8% and 84.8% of the Company's
total fixed maturity portfolio at September 30, 1997 and December 31,
1996,respectively. In 1996 and continuing in the first nine months of
1997, there was a modest shift to higher yielding debt securities,
including longer duration and non-investment grade securities. The average
yield on debt securities was 7.6% and 7.2% for the nine months ended
September 30, 1997 and 1996, respectively. Although management expects
that a substantial portion of new funds will be invested in investment
grade fixed maturities, the Company may invest a portion of new funds
in below investment grade fixed maturities or equity interests.
The following table illustrates asset valuation allowances and additions
to or deductions from such allowances for the periods indicated.
<TABLE>
<CAPTION>
Other
Invested
(Dollars in millions) Mortgages Real Estate Assets Total
<S> <C> <C> <C> <C>
Year Ended December 31, 1996
Beginning balance $33.8 $19.6 $ 3.7 $57.1
Provision 5.5 0.0 0.0 5.5
Write-offs (1) (19.7) (4.7) (3.7) (28.1)
------ ------ ------ ------
Ending balance $19.6 $14.9 $ 0.0 $34.5
Valuation allowance as a
percentage of carrying value
before reserves 2.5% 11.0% 0.0% 3.8%
Nine months ended September
30, 1997
Provision (benefits) 2.6 6.0 0.0 8.6
Write-offs (1) (1.3) (2.9) 0.0 (4.2)
------ ------ ------ ------
Ending balance $20.9 $18.0 $ 0.0 $38.9
Valuation allowance as a
percentage of carrying value
before reserves 3.0% 19.9% 0.0% 5.0%
<FN>
<FN1>
(1) Write-offs reflect asset sales, foreclosures and forgiveness of debt
upon restructurings.
</FN>
</TABLE>
Page 32
<PAGE>
Income Taxes
Prior to the merger of AFC and Allmerica P&C, AFC and its life insurance
subsidiaries (including certain noninsurance operations) filed a
consolidated United States federal income tax return separate from the
United States federal income tax return filed by Allmerica P&C. Entities
included within the AFC consolidated group were segregated into either a
life insurance or a non-life insurance company subgroup. The
consolidation of these subgroups is subject to certain statutory
restrictions on the percentage of eligible non-life tax losses that can
be applied to offset life company taxable income. Beginning with the
period ending December 31, 1997, AFC and Allmerica P&C will file a single
United States federal income tax return.
FAFLIC, as a mutual insurance company until October 1995, was required to
adjust its deduction for policyholder dividends by the differential
earnings amount under Section 809 of the Internal Revenue Code. This
amount was computed, for each tax year, by multiplying the average equity
base of the FAFLIC/AFLIAC consolidated group, as determined for tax
purposes, by the estimate of an excess of an imputed earnings rate over
the average mutual life insurance companies' earnings rate. The
differential earnings amount for each tax year was subsequently recomputed
when actual earnings rates were published by the IRS. As a stock company,
AFC, including its life insurance subsidiaries, is no longer required to
reduce its policyholder dividend deduction by the differential earnings
amount. The differential earnings adjustment in the third quarter and
first nine months of 1996 related to an adjustment for the 1994 tax year
based on the actual average mutual life insurance companies' earnings
estimated rate issued by the IRS in 1996.
Provision for federal income taxes before minority interest was $24.0
million during the third quarter of 1997 compared to $21.2 million during
the same period in 1996. These provisions resulted in consolidated
effective federal tax rates of 26.6% and 23.8%, respectively. The
effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 36.8% and 28.4% during the third quarter of 1997 and
1996, respectively. The effective tax rates for the Regional Property and
Casualty subsidiaries were 14.5% and 21.3% during the third quarter of
1997 and 1996, respectively. The increase in the rate for FAFLIC resulted
from the absence of a differential earnings adjustment in 1997 compared to
a $2.4 million differential earnings benefit in 1996. The decrease in the
rate for the Regional Property and Casualty subsidiaries reflects an
increase in the proportion of tax-exempt interest on bonds to pre-tax
income and lower underwriting income anticipated for the full year.
Provision for federal income taxes before minority interest was $53.0
million during the first nine months of 1997 compared to $58.0 million
during the same period in 1996. These provisions resulted in
consolidated effective federal tax rates of 24.1% and 22.8%, respectively.
The effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 39.2% and 27.9% during the first nine months of 1997 and
1996, respectively. Excluding the effect of an $18.9 million tax benefit
related to the agreement to cede the individual disability income business,
the 1997 effective tax rate for the FAFLIC/AFLIAC consolidated group was
37.3%. This increase resulted primarily from the absence of a differential
earnings adjustment in 1997 compared to an $8.3 million differential
earnings benefit in 1996. The effective tax rates for the Regional
Property and Casualty subsidiaries were 17.1% and 20.0% during the first
nine months of 1997 and 1996, 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, AFC's primary source of cash is dividends from its insurance
subsidiaries. However, dividend payments to AFC by its insurance
subsidiaries are subject to limitations imposed by state regulators, such
as the requirement that cash dividends be paid out of unreserved and
unrestricted earned surplus and restrictions on the payment of
"extraordinary" dividends, as defined.
Sources of cash for the Company's insurance subsidiaries are from premiums
and fees collected, investment income and maturing investments. Primary
cash outflows are paid benefits, claims losses and loss adjustment
expenses, policy acquisition expenses, other underwriting expenses and
investment purchases. Cash outflows related to benefits, claim losses and
loss adjustment expenses can be variable because of uncertainties
surrounding settlement dates for liabilities for unpaid losses and because
of the potential for large losses either individually or in the aggregate.
The Company periodically adjusts its investment policy to respond to
changes in short-term and long-term cash requirements.
Net cash provided by operating activities decreased from $145.2 million
for the first nine months of 1996 to $46.8 million during the same period
in 1997. This change resulted primarily from increased commissions and
other deferrable expenses related to the growth in the annuity and variable
universal life product lines of the Retail Financial Services segment and
an acceleration of claims payments in the Regional Property and Casualty
segment. In addition, 1996 cash provided by operating activities was
positively impacted by the receipt of an $11.1 million litigation
settlement in the Corporate Risk Management Services segment.
Page 33
<PAGE>
Net cash used in investing activities was $178.9 million during the first
nine months of 1997, as compared to $24.6 million provided by investing
activities during the same period in 1996. This decrease primarily
reflects the purchase of the minority interest of Allmerica P&C on July 16,
1997 for $425.6 million offset by fewer net purchases of fixed maturities
during 1997. In 1996, purchases of fixed maturities were unusually high
due to the investment of the remaining net proceeds of the Company's
initial public offering of stock and debt. Additionally, proceeds from
disposals and maturities were delayed in 1996 by financing new investment
purchases with repurchase agreements, thereby decreasing the cash provided
by investing activities during that period.
Net cash provided by financing activities was $114.2 million during the
first nine months of 1997, as compared to net cash used of $306.3 million
during the same period of 1996. In 1997, cash provided by financing
activities was positively impacted by the Company's receipt of proceeds
of $296.3 million from the issuance of Capital Securities. In addition,
cash payments, net of interest credited, on net withdrawals from GICs
decreased $221.4 million to $327.4 million in the first nine months of
1997 compared to the same period in 1996. These items were partially offset
by reduced proceeds from short-term debt financing of $144.1 million. During
1996, the Company increased its short-term debt in order to finance
additions to the investment portfolio and maximize investment earnings.
In June 1997, the Company entered into a credit agreement with The Chase
Manhattan Bank ("Chase") providing for a $225 million revolving line of
credit that expires on December 15, 1997. Borrowings under the line of
credit will be unsecured and will bear interest at a rate per annum equal
to, at the Company's option, Chase's base rate or the eurodollar rate plus
an applicable margin. The credit agreement requires the Company to comply
with certain financial ratios. As of September 30, 1997, the Company had
borrowed $140.0 million under the line of credit provided by this credit
agreement.
On February 3, 1997, AFC Capital Trust ("The Trust"), a wholly-owned
subsidiary business trust of AFC, issued $300 million Series A Capital
Securities, which pay cumulative distributions at a rate of 8.207%
semiannually commencing August 15, 1997. The Trust exists for the sole
purpose of issuing the Capital Securities and investing the proceeds
thereof in an equivalent amount of 8.207% Junior Subordinated Deferrable
Interest Debentures due 2027 of AFC (the "Subordinated Debentures").
Through certain guarantees, the Subordinated Debentures and the terms of
related agreements, AFC has irrevocably and unconditionally guaranteed the
obligations of the Trust under the Capital Securities. Net proceeds from
the offering of approximately $296.3 million funded a portion of the July
16, 1997 acquisition of the 24.2 million publicly held shares of Allmerica
P&C. On August 7, 1997, AFC and the Trust exchanged the Series A Capital
Securities for a like amount of Series B Capital Securities and related
guarantees which are registered under the Securities Act of 1933 as
required under the terms of the initial transaction.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C to meet its obligations to pay
interest on the Senior Debentures, Subordinated Debentures and dividends,
when and if declared by the Board of Directors, on the common stock.
Whether the Company will pay dividends in the future depends upon the costs
of administering a dividend program as compared to the benefits conferred,
and upon the earnings and financial condition of AFC.
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and long-term
cash requirements. The Company maintains a high degree of liquidity within
the investment portfolio in fixed maturity investments, common stock and
short-term investments. FAFLIC and Allmerica P&C have $100.0 million
and $40.0 million, respectively, under various committed short-term lines
of credit. At September 30, 1997, no amounts were outstanding and $80.0
million and $12.1 million were available for borrowing by FAFLIC and
Allmerica P&C, respectively. FAFLIC and Allmerica P&C had $20.0 million
and $28.0 million, respectively, of commercial paper borrowings
outstanding at September 30, 1997. In addition, FAFLIC and AFLIAC had no
repurchase agreements outstanding as of September 30, 1997, as compared to
$249.4 million outstanding at September 30, 1996. The repurchase
agreements in 1996 were used to delay sales of investments.
Recent Developments
On October 23, 1997, Standard & Poor's changed its claims-paying ability
ratings for FAFLIC and AFLIAC to AA- (Excellent) from A+ (Good).
In late July 1997, a lawsuit was instituted in Louisiana against AFC and
certain of its subsidiaries by individual plaintiffs alleging fraud,
unfair or deceptive acts, breach of contract, misrepresentation and
related claims in the sale of life insurance policies. In October 1997,
plaintiffs voluntarily dismissed the Louisiana suit and refiled the action
in Federal District Court in Worcester, Massachusetts. The plaintiffs seek
to be certified as a class. The case is in early stages of discovery and the
Company is evaluating the claims. Although the Company believes it has
meritorious defenses to the plaintiff's claims, there can be no assurance
that the claims will be resolved on a basis which is satisfactory to the
Company.
Page 34
<PAGE>
In July 1997, Hanover reached an agreement with Travelers Property Casualty
to facilitate Travelers' writing of certain Hanover Insurance policies,
as they expire, in Alabama, California, Kansas, Mississippi, Missouri, and
Texas. In these six states, Hanover has approximately 250 agents generating
approximately $90 million in premium annually. Hanover intends to cease
writing personal and commercial policies in these states except for
employer and association-sponsored group property and casualty business,
surety bonds and specialty program commercial policies. The plan is
conditioned upon the appropriate regulatory approval in each state.
The merger of Allmerica P&C and a wholly-owned subsidiary of the Company
was consummated on July 16, 1997. Through the merger, the Company acquired
all of the outstanding common stock of Allmerica P&C that it did not already
own in exchange for cash of $425.6 million and approximately 9.7 million
shares of AFC stock. Pursuant to the merger, each outstanding share of
Allmerica P&C Common Stock, other than those shares owned by the Company or
its subsidiaries, became a right to receive $17.60 in cash, without
interest, and 0.4 shares of AFC Common Stock, resulting in the issuance of
approximately 9.7 million shares of AFC Common Stock. On July 15, 1997,
the Certificate of Incorporation of Allmerica P&C was amended and restated
to authorize a class B common stock of Allmerica P&C, $5.00 par value.
Each share of Allmerica P&C Common Stock owned by the Company or its
subsidiaries was exchanged for one share of Class B Common Stock
immediately prior to the consummation of the merger.
The merger has been accounted for as a purchase. Total consideration of
approximately $798.1 million has been allocated to the minority interest
in the assets and liabilities based on estimates of their fair values.
The minority interest acquired totaled $703.5 million. A total of $90.6
million, representing the excess of the purchase price over the fair values
of the net assets acquired, net of deferred taxes, has been allocated to
goodwill and is being amortized over a 40-year period.
On April 14, 1997, the Company entered into an agreement in principle to
transfer the Company's individual disability income under a 100%
coinsurance agreement to Metropolitan Life Insurance Company. The
coinsurance agreement became effective October 1, 1997. The transaction
has resulted in the recognition of a $53.9 million pre-tax loss in the
first quarter of 1997.
Forward-Looking Statements
The Company wishes to caution readers that the following important
factors, among others, in some cases have affected and in the future
could affect, the Company's actual results and could cause the Company's
actual results for 1997 and beyond to differ materially from those
expressed in any forward-looking statements made by, or on behalf of,
the Company. When used in the MD&A discussion, the words "believes",
"anticipated", "expects" and similar expressions are intended to identify
forward looking statements. See "Important Factors Regarding
Forward-Looking Statements" filed as Exhibit 99-2 to the Company's
Annual Report on Form 10-K for the period ended December 31, 1996.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such
forward looking statements include among others, the following
possibilities: (i) adverse catastrophe experience and severe weather;
(ii) adverse loss development for events the Company insured in
prior years or adverse trends in mortality and morbidity; (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 or regulation, 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, liabilities related to tobacco products, 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 genetic
testing and other criteria; (xiii) adverse changes in the ratings obtained
from independent rating agencies, such as Moody's, Standard and Poors, A.M.
Best, and Duff & Phelps; (xiv) lower appreciation on and decline in value
of managed investments, resulting in reduced variable products, assets and
related fees; and (xv) claims relating to sales practices for insurance
products.
Page 35
<PAGE>
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX - 11 Statement regarding computation of per share earnings
EX - 27 Financial Data Schedule
(b) Reports on Form 8K
On July 9, 1997, a report on Form 8-K was filed reporting under
item 5, Other Events, information relating to the merger with
Allmerica P&C.
On July 11, 1997, a report on Form 8-K was filed reporting under
item 5, Other Events, the announcement that an estimated $10
million in pre-tax catastrophe losses impacted the third quarter
results of Citizens Corporation, a subsidiary of Allmerica
Financial Corporation.
On July 16, 1997, a report on Form 8-K was filed reporting under
item 5, Other Events, the announcement of the closing of the merger
(the "Merger") of Allmerica P&C and a wholly-owned subsidiary of
AFC. Through the transaction, AFC acquired the approximately 24.2
million shares of Allmerica P&C that it did not already own for
approximately $426 million in cash and 9.7 million shares
of AFC common stock.
Page 36
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
Registrant
Dated November 13, 1997
/s/ John F. O'Brien
John F. O'Brien
President and Chief Executive Officer
Dated November 13, 1997
/s/ Edward J. Parry III
Edward J. Parry III
Vice President, Chief Financial
Officer, and Treasurer
Page 37
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Exhibit Page
<C> <C> <C>
11 Statement regarding computation of per
share earnings 39
27 Financial Data Schedule -
</TABLE>
Page 38
<PAGE>
Exhibit 11
ALLMERICA FINANCIAL CORPORATION
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
For the Periods Ended September 30, 1997 and 1996
(in millions, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months
Quarter Ended Ended
September 30, September 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Primary:
Average shares outstanding 58.3 50.1 52.9 50.1
Net effect of dilutive stock
options based on the treasury
stock method using average
market price 0.1 0.0 0.1 0.0
----- ----- ----- -----
TOTALS 58.4 50.1 53.0 50.1
===== ===== ===== =====
Net income $60.7 $46.7 $114.3 $136.6
==== ===== ===== =====
Per share amount $1.04 $0.93 $2.16 $2.72
Fully diluted:
Average shares outstanding 58.3 50.1 52.9 50.1
Net effect of dilutive stock
options based on the treasury
stock method using the higher
of period end or average
market price 0.2 0.0 0.1 0.0
----- ----- ----- -----
TOTALS 58.5 50.1 53.0 50.1
===== ===== ===== =====
Net income $60.7 $46.7 $114.3 $136.6
===== ===== ===== =====
Per share amount $1.04 $0.93 $2.16 $2.72
</TABLE>
Page 39
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
interim consolidated balance sheet and income statement of Allmerica
Financial Corporation as of September 30, 1997 and for the period then ended,
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 7363
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 476
<MORTGAGE> 565
<REAL-ESTATE> 73
<TOTAL-INVEST> 8741
<CASH> 163
<RECOVER-REINSURE> 829
<DEFERRED-ACQUISITION> 881
<TOTAL-ASSETS> 21967
<POLICY-LOSSES> 2845
<UNEARNED-PREMIUMS> 870
<POLICY-OTHER> 1725
<POLICY-HOLDER-FUNDS> 2591
<NOTES-PAYABLE> 391
0
0
<COMMON> 1
<OTHER-SE> 2263
<TOTAL-LIABILITY-AND-EQUITY> 21967
1727
<INVESTMENT-INCOME> 499
<INVESTMENT-GAINS> 57
<OTHER-INCOME> 86
<BENEFITS> 1516
<UNDERWRITING-AMORTIZATION> 354
<UNDERWRITING-OTHER> 453
<INCOME-PRETAX> 220
<INCOME-TAX> 53
<INCOME-CONTINUING> 167
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 114
<EPS-PRIMARY> 2.16
<EPS-DILUTED> 2.16
<RESERVE-OPEN> 2744
<PROVISION-CURRENT> 1157
<PROVISION-PRIOR> (76)
<PAYMENTS-CURRENT> 537
<PAYMENTS-PRIOR> 593
<RESERVE-CLOSE> 2633
<CUMULATIVE-DEFICIENCY> (54)
</TABLE>
