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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM: TO
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 IDENTIFICATION
INCORPORATION OR ORGANIZATION) NUMBER)
440 LINCOLN STREET, WORCESTER, 01653
MASSACHUSETTS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
Registrant's telephone number, including area code: (508) 855-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class of securities Name of Exchange on which Registered
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
7 5/8% SENIOR DEBENTURES DUE 2025 NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Based on the closing sales price of February 28, 1997 the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$1,873,782,581.
The number of shares outstanding of the registrant's common stock, $.01 par
value, was 50,134,651 shares outstanding as of February 28, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Allmerica Financial Corporation's Annual Report to Shareholders
for 1996 are incorporated by reference in Parts I, II, and IV.
Total number of pages, including cover page: 170
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PART I
ITEM I
BUSINESS
ORGANIZATION
Allmerica Financial Corporation ("AFC" or the "Company") is a non-insurance
holding company organized as a Delaware corporation in 1995 to hold all of the
outstanding shares of First Allmerica Financial Life Insurance Company
("FAFLIC").
The consolidated financial statements of AFC include the accounts of 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 59.5%-owned non-insurance holding
company).
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and
Plan of Merger (the "Merger Agreement") pursuant to which AFC will acquire all
of the outstanding Common Stock, $1.00 par value per share, of Allmerica P&C
that it does not already own for consideration consisting of $33.00 per share
of Common Stock, subject to adjustment, payable in cash and shares of common
stock, par value $0.01 per share, of AFC (the "AFC Common Stock"). In
addition, a shareholder of Allmerica P&C may elect to receive the
consideration in cash, without interest, or in shares of AFC Common Stock,
subject to proration as set forth in the Merger Agreement. The maximum number
of shares of AFC Common Stock to be issued in the Merger is approximately 9.67
million shares. The acquisition will be accomplished by merging a newly
created, wholly-owned subsidiary of AFC with and into Allmerica P&C (the
"Merger") resulting in Allmerica P&C becoming a wholly-owned subsidiary of
AFC. Also, immediately prior to the Merger, Allmerica P&C's Certificate of
Incorporation will be amended to authorize a new class of Common Stock, one
share of which will be exchanged for each share of Common Stock currently held
by SMA Financial Corp., a wholly-owned subsidiary of AFC. The consummation of
the Merger is subject to the satisfaction of various conditions, including the
approval of regulatory authorities.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300.0 million Series A 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 are intended to
fund a portion of the acquisition of the 24.2 million publicly held shares of
Allmerica P&C pursuant to the Merger Agreement.
FAFLIC was organized as a mutual life insurance company until October 16,
1995. FAFLIC converted to a stock life insurance company pursuant to a plan of
reorganization ("the Plan") effective October 16, 1995 and became a wholly
owned subsidiary of AFC. Pursuant to the plan of reorganization, the Company
issued 37.5 million shares of its common stock to eligible policyholders. The
Company also issued 12.6 million shares of its common stock at a price of
$21.00 per share in a public offering, resulting in net proceeds of $248.0
million, and issued Senior Debentures in the principal amount of $200.0
million which resulted in net proceeds of $197.2 million.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Management. Within these broad areas, the
Company operates principally in five operating segments. These segments are
Regional Property and Casualty; Corporate Risk Management Services ("CRMS");
Retail
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Financial Services ("RFS"); Institutional Services; and Allmerica Asset
Management ("AAM"). The Regional Property and Casualty segment consists of the
Company's 59.5% ownership of Allmerica P&C; however, all property and casualty
results presented include 100% of Allmerica P&C's pre-tax results of
operations, consistent with the presentation in the Company's consolidated
financial statements. The other segments are all owned and operated by FAFLIC
and its wholly owned subsidiaries. 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. These proceeds are invested primarily in fixed maturities at
December 31, 1996.
Information with respect to each of the Company's segments is included in
"Segment Results" on pages 35-45 in Management's Discussion and Analysis of
Financial Condition and Results of Operations and in Note 14 on page 71 of the
Notes to the Consolidated Financial Statements included in the 1996 Annual
Report to Shareholders, the applicable portions of which are incorporated
herein by reference.
DESCRIPTION OF BUSINESS BY SEGMENT
The Company offers financial products and services in two major areas,
operating principally in five segments as described above. Following is a
discussion of each segment.
RISK MANAGEMENT
REGIONAL PROPERTY AND CASUALTY
General
The Company's Regional Property and Casualty segment is composed of FAFLIC's
59.5% ownership of Allmerica P&C. The Company's interest in Allmerica P&C is
composed of Hanover and Hanover's 82.5%-owned subsidiary, Citizens. For the
year ended December 31, 1996, the Regional Property and Casualty segment
accounted for approximately $2,193.7 million, or 67.0%, of consolidated
revenues and approximately $197.7 million, or 59.6%, of consolidated income
before taxes. The Company primarily underwrites personal and commercial
property and casualty insurance through this segment, with Hanover's principal
operations located in the Northeast and Citizens' in Michigan. Both Hanover
and Citizens Insurance have an historically strong regional focus and both
place heavy emphasis on underwriting profitability and loss reserve adequacy.
As of December 31, 1995, according to A.M. Best, the Regional Property and
Casualty segment ranks as one of the 30 largest property and casualty
insurance groups in the United States based on net premiums written.
The Company strives to maintain a clear focus on the core disciplines of
underwriting, pricing, claims adjusting, marketing and sales. In particular,
the Regional Property and Casualty segment seeks to achieve and maintain
underwriting profitability in each of its five major product lines. The
Company's overall strategy is to improve profitability through operating
efficiencies and to pursue measured growth in profitable markets.
Hanover's average premium growth rate for the ten-year period ended December
31, 1996 was 3.2% compared to an industry average of 6.2% for the same period.
Hanover's average statutory combined ratio for the same ten-year period was
107.1, compared to an industry average of 108.2. Over the last ten years,
Citizens has consistently reported stronger growth in statutory net premiums
written than the property and casualty industry as a whole. Citizens' average
premium growth rate was 8.9% for the ten-year period ended December 31, 1996
and its average statutory combined ratio for the same period was 100.1.
(Industry estimates are based on data published by A.M. Best.)
The industry's profitability can be affected significantly by price
competition, volatile and unpredictable developments such as extreme weather
conditions and natural disasters, legal developments affecting insurer
liability and the size of jury awards, fluctuations in interest rates and
other factors that may affect investment returns and other general economic
conditions and trends, such as inflationary pressures that may affect the
adequacy of reserves.
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Lines of Business
Hanover and Citizens both underwrite personal and commercial property and
casualty insurance coverage. The personal segment principally includes
personal automobile and homeowners' coverage. The commercial segment
principally includes workers' compensation, commercial automobile and
commercial multiple peril coverage.
Personal automobile coverage insures individuals against losses incurred
from personal bodily injury, bodily injury to third parties, property damage
to an insured's vehicle, and property damage to other vehicles and other
property.
Homeowners coverage insures individuals for losses to their residences and
personal property, such as those caused by fire, wind, hail, water damage
(except for flooding), theft and vandalism, and against third party liability
claims.
Commercial automobile coverage insures businesses against losses incurred
from personal bodily injury, bodily injury to third parties, property damage
to an insured's vehicle, and property damage to other vehicles and other
property.
Workers' compensation coverage insures employers against employee medical
and indemnity claims resulting from injuries related to work. Workers'
compensation policies are often written in conjunction with other commercial
policies.
Commercial multiple peril coverage insures businesses against third party
liability from accidents occurring on their premises or arising out of their
operations, such as injuries sustained from products sold. It also insures
business property for damage, such as that caused by fire, wind, hail, water
damage (except for flooding), theft and vandalism.
Both Hanover and Citizens Insurance also offer a variety of other products,
such as inland marine, fire, and fidelity and surety insurance. The Company,
through the Regional Property and Casualty segment, provides self-insurance
administration services for individual and group risks and writes excess
reinsurance coverage for the self-insurance programs it administers through
its wholly-owned subsidiary, Citizens Management, Inc.
Hanover's Amgro, Inc. ("Amgro"), is an insurance premium finance company
which provides short-term installment loans to small and medium-sized
businesses that do not wish to prepay property and casualty insurance
premiums. In exchange for advancing full policy premiums to the insurance
carrier or its agent, the insured executes a promissory note with Amgro which
enables Amgro to cancel the insurance and receive the unearned premium in the
event of default in payment by the insured.
Customers, Marketing and Distribution
Through its property and casualty insurance subsidiaries, the Company is
licensed to sell property and casualty insurance in all fifty states in the
United States, as well as the District of Columbia and all provinces of Canada
except Prince Edward Island. Hanover's business is concentrated in the
Northeast, primarily Massachusetts, New York, New Jersey and Maine. Citizens'
business is predominantly in Michigan and has recently expanded into Indiana
and Ohio.
The Company markets property and casualty insurance products through
approximately 2,600 independent insurance agencies and seeks to establish
long-term relationships with larger, well-established agencies. In selecting
agencies for new appointments, the Company considers the following criteria: a
record of profitability and financial stability, an experienced and
professional staff, a marketing plan for future growth and a succession plan
for management. Once appointed, each agency's performance is carefully
monitored.
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Since the Company offers property and casualty insurance products
predominately through independent agents, fostering a close, supportive
relationship with each agency is critical to the continued growth of the
business. The Company, in the Regional Property and Casualty segment,
compensates agents based on profitability, in addition to regular commission.
This practice motivates its agents to write policies for customers with above-
average profit characteristics. By offering its independent agents a
consistent source of products demanded by the agents' customers, the Company
believes that an increasing number of its agents will rely on it as their
principal supplier of insurance products. Hanover has implemented a number of
programs designed to strengthen its relationship with its agencies. These
initiatives include the formation of a National Agency Advisory Council, which
is intended to provide agents a role in coordinating marketing efforts and
implementing Hanover strategies, as well as remaining committed to maintaining
the local market presence which provides agents access to experienced Company
personnel with expertise in the local markets. Citizens' position as a
preferred provider with many of its agencies is evidenced by its high average
premiums written per agency of over $1.2 million in 1996.
In 1995, Hanover began to exploit the benefits of worksite marketing as a
distribution channel for personal property and casualty lines. This worksite
distribution channel offers discounted insurance products that are
individually written to employees and members of organizations which have
established a marketing agreement with the Company. Management believes that
advantages of competitive pricing, effective consumer awareness campaigns at
sponsoring organizations, the convenience of payroll deducted premiums and
word of mouth advertising will contribute to the effectiveness of the worksite
distribution channel. Additionally, the Company expects to be well positioned
to integrate other insurance products offered by other subsidiaries of AFC in
order to maximize corporate worksite marketing relationships.
Citizens also develops and markets franchise programs that are tailored for
members of associations and organizations, including its Citizens Best program
for senior citizens.
The Company, in the Regional Property and Casualty segment, is not dependent
upon a single customer or a few customers, for which the loss of any one or
more would have an adverse effect upon the segment's insurance operations.
Hanover
Hanover accounted for approximately $1,062.8 million, or 56.0%, of the
Regional Property and Casualty segment's consolidated net premium earned in
1996. Hanover's products are marketed through independent agencies which
provide specialized knowledge of property and casualty products, local market
conditions and targeted customer characteristics.
Hanover seeks to pursue measured growth in existing markets through local
management operations that apply extensive knowledge of markets to offer
competitive products and services. Hanover also seeks to increase operating
efficiencies through centralized strategic planning, marketing and
administrative support functions and increased use of sophisticated risk
selection and operational technologies. During 1996, the Company began the
process of consolidating certain operations of Hanover and Citizens which is
intended to achieve process improvements and efficiencies in operations. These
operations include claims, finance, policy processing and administration
functions.
Hanover has substantially enhanced the level of automation of functions such
as risk selection, policy processing, customer service and claims settlement.
Over the past few years, Hanover introduced an automated risk selection
program for the private passenger automobile business which rates the
probability of future claims potential and increases the efficiency of the
underwriting process. Hanover also introduced a similar program for its
homeowners' business. Hanover is also expanding its use of agency-company
interface ("ACI") technology, which enables agents to electronically submit
personal lines policies for review and rating. In addition, Hanover has
established automated client centers for centralizing the back office
processing functions of most of its branches. The Company believes that these
investments in technology will, over time, create technological efficiencies
and provide capacity for enhanced service to customers.
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Although Hanover's strategic planning and certain of its administrative
functions are centralized in the home office, the Company is committed to
maintaining the local market presence afforded by Hanover's twelve branch
offices. These branches provide knowledge of local regulatory and competitive
conditions, and have developed close relationships with Hanover's independent
agents, who provide specialized knowledge of property and casualty products,
local market conditions and target market characteristics. Hanover believes
that the selection of attractive markets in which to pursue profitable growth
depends upon maintaining its local market presence to enhance underwriting
results and identify favorable markets.
Citizens
Citizens' insurance products are marketed in Michigan through approximately
3,800 licensed independent insurance agents, who are paid on a commission
basis, associated with approximately 525 insurance agencies. Citizens also
markets its products in Indiana and Ohio through approximately 1,700 licensed
independent insurance agents associated with approximately 200 insurance
agencies. In 1996, each agency representing Citizens wrote an average of
approximately $1.2 million of Company premiums. The three largest agencies
wrote approximately $19.3 million, $12.9 million, and $10.7 million of Company
premiums, respectively.
Citizens seeks to establish long-term relationships with larger, well-
established agencies. In selecting agencies for new appointments, Citizens
considers the following criteria: a record of profitability and financial
stability; an experienced and professional staff; a marketing plan for future
growth; and a perpetuation plan for successor management. Citizens believes
that by improving its relationship and stature with its most productive
agents, it will receive a greater share of its agent's higher quality
writings. To solidify its relationships with higher quality agencies and take
advantage of local knowledge of operating territories, Citizens maintains four
branch offices and twenty five claims offices located throughout Michigan, one
branch office and three claims offices in Indiana and one branch office in
Ohio.
Since Citizens offers its products only through independent insurance
agencies, its relationships with those agencies is critical to the continued
growth of its business. Accordingly, Citizens establishes strong relationships
with quality agencies by offering enhanced profit sharing arrangements,
recognition awards and internal support for agency operations. Citizens seeks
to become the preferred provider for quality insurance agents who Citizens
believes will provide it with customers with average or above-average profit
characteristics. Citizens has a comprehensive program to recognize and honor
those agents who excel, as measured by profitability and premium volume. By
offering its independent agents a consistent source of personal and commercial
property and casualty insurance products, Citizens believes that an increasing
number of its agents will rely on Citizens as their principal supplier of
insurance products.
Citizens has been successful in developing and marketing affinity franchise
programs in both the personal and commercial segments that are tailored for
members of associations and organizations in Indiana and Michigan. The
associations may choose to make Citizens' programs available to their members
based on an evaluation of Citizens' rates, service and regulation, but each
risk is individually underwritten and each customer is issued a separate
policy. Associations and organizations receive no payment for making Citizens'
franchise programs available to their members. As of December 31, 1996,
Citizens had approximately 110 affinity franchise programs in-force, 82 of
which were in personal lines and 28 of which were in commercial lines.
Agents are authorized to bind Citizens on risks. The agents are guided by
Citizens' written underwriting rules and practices. These rules and practices
set forth eligibility rules for various policies and coverages, unacceptable
risks, and maximum and minimum limits of liability. Violation of these rules
and practices is grounds for termination of the agency's contract to represent
Citizens.
Residual Markets and Pooling Arrangements
As a condition of its license to do business in various states, the Company
is required to participate in mandatory property and casualty shared market
mechanisms or pooling arrangements which provide various
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insurance coverages to individuals or other entities that otherwise are unable
to purchase such coverage voluntarily provided by private insurers. For
example, since most states compel the purchase of a minimal level of
automobile liability insurance, states have developed shared market mechanisms
to provide the required coverages and in many cases, optional coverages, to
those drivers who, because of their driving records or other factors, cannot
find insurers who will write them voluntarily. The Company's participation in
such shared markets or pooling mechanisms is generally in amounts related to
the amount of the Regional Property and Casualty segment's direct writings for
the type of coverage written by the specific pooling mechanism in the
applicable state. The Company, in the Regional Property and Casualty segment,
incurred an underwriting loss from participation in such mechanisms, mandatory
pools and underwriting associations of $0.2 million and $0.7 million in 1996
and 1995, and underwriting profit of $1.3 million in 1994 relating primarily
to coverages for personal and commercial automobile, personal and commercial
property, and workers' compensation.
Assigned Risk Plans
Assigned risk plans are the most common type of shared market mechanism.
Many states, including California, Illinois, New Jersey, New York, and Texas
operate assigned risk plans. The plan assigns applications from drivers who
are unable to obtain insurance in the voluntary market to insurers licensed in
the applicant's state. Each insurer is required to accept a specific
percentage of applications based on its market share of voluntary business in
the state. Once an application has been assigned to an insurer, the insurer
issues a policy under its own name and retains premiums and pays losses as if
the policy were voluntarily written.
Reinsurance Facilities and Pools
Reinsurance facilities are currently in operation in various states and
require an insurer to write all applications submitted by an agent. As a
result, an insurer could be writing policies for applicants with a higher risk
of loss than it would normally accept. The reinsurance facility allows the
insurer to cede this high risk business to the reinsurance facility, thus
sharing the underwriting experience with all other insurers in the state. If a
claim is paid on a policy issued in this market, the facility will reimburse
the insurer. Typically, reinsurance facilities operate at a deficit, which is
then recouped by levying assessments against the same insurers.
A type of reinsurance mechanism that exists in New Jersey, The New Jersey
Unsatisfied Claim and Judgment Fund ("NJUCJF"), covers no-fault first party
losses in excess of $0.3 million. All no-fault insurers in this state are
required to participate in the reinsurance mechanism. Insurers are reimbursed
for their covered losses in excess of the threshold. Funding for such
facilities comes from assessments against automobile insurers based upon their
proportionate market share of the state's no-fault insurance market. The
NJUCJF currently has an unfunded liability for future payment years. It
calculates assessments against insurers on the basis of a two-year cash flow
analysis.
Michigan's no-fault law requires insurers to provide unlimited medical
coverage to automobile accident victims. In response, the Michigan
Catastrophic Claims Association (MCCA) was established to spread the costs of
medical coverage to all insureds. The MCCA acts as a reinsurer for all
Michigan automobile insurers, reimbursing for amounts paid on personal
protection insurance losses in excess of $0.25 million. Participation is
required for all Michigan-licensed automobile and motorcycle insurers. The
MCCA assesses its member companies an annual premium on each of such member
company's policies covering automobile and motorcycles written in Michigan.
The assessment is passed on directly to policyholders. The Company, in the
Regional Property and Casualty segment, cedes a significant portion of its
private passenger automobile premiums to the MCCA. Ceded premiums earned to
MCCA in 1996, 1995, and 1994 were $50.5 million, $66.8 million and $80.0
million, respectively. Losses and LAE ceded to MCCA in 1996, 1995, and 1994
were ($52.9) million, $62.9 million and $24.2 million, respectively. In 1996,
the MCCA's favorable development on prior year reserves exceeded the losses
and LAE incurred during the year. The aggregate losses and LAE ceded to the
MCCA have no impact on the Regional Property and Casualty segment's statements
of income.
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At December 31, 1996 and 1995, the Company, in the Regional Property and
Casualty segment, had reinsurance recoverable on paid and unpaid losses of
$292.0 million and $355.0 million, respectively, from the MCCA. The amount
recoverable from the MCCA is a current estimate of future payments to be made
to the Company, in the Regional Property and Casualty segment, by the MCCA for
reimbursements of amounts for currently pending personal protection insurance
(PIP) claims and PIP claims incurred but not yet reported. The Regional
Property and Casualty segment bills the MCCA on a quarterly basis and all
amounts have been paid when due. Because PIP claims, whose payments will be
reimbursed by the MCCA, involve amounts to be paid over many years, actual
amounts to be owed to the Company, in the Regional Property and Casualty
segment, by the MCCA in the future are subject to change based on claims paid.
The Regional Property and Casualty segment bills the MCCA based upon amounts
actually paid by the Regional Property and Casualty segment to policyholders,
however, there can be no assurance that the Company will recover the full
amount of reinsurance payments owed to it by the MCCA. As of June 30, 1996 and
1995, the MCCA estimated surplus of $1.7 billion and $666.2 million,
respectively, compared to an estimated deficit of $22.0 million, as of
December 31, 1994. Management believes that in the current regulatory climate,
the Company, in the Regional Property and Casualty segment, is unlikely to
incur any material loss or become unable to pay claims as a result of
nonpayment of amounts owed to it by the MCCA because (i) the MCCA is currently
in a surplus position, (ii) the payment obligations of the MCCA are extended
over many years, resulting in relatively small current payment obligations in
terms of MCCA total assets, (iii) all amounts owed to the Company by the MCCA
have been paid when due, and (iv) the MCCA is supported by assessments
permitted by statute.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool ("MWCRP"), which is administered by
The National Council on Compensation Insurance ("NCCI"). The Company was
involved in legal proceedings regarding the MWCRP's deficit which through a
legislative settlement issued on June 23, 1995, provided for an initial
funding of $220.0 million of which the insurance carriers were responsible for
$65.0 million. Hanover paid its allocation of $4.2 million in December 1995.
Some of the smaller carriers appealed this decision. See "Legal Proceedings"
on page 28 of this Form 10-K which is incorporated herein by reference.
As a servicing carrier in Massachusetts, the Company cedes a significant
portion of its private passenger and commercial automobile premiums to the
Massachusetts Commonwealth Automobile Reinsurers ("CAR"). Net premiums earned
and losses and loss adjustment expenses ceded to CAR in 1996, 1995 and 1994
were $38.0 million and $21.8 million, $49.1 million and $33.7 million, and
$50.0 million and $29.8 million, respectively. At December 31, 1996, CAR and
the MCCA were the only two reinsurers which represented 10% or more of the
Regional Property and Casualty segment's reinsurance business.
Reference is made to Note 16 on pages 72 and 73 and Note 20 on page 75 of
the Notes to Consolidated Financial Statements of the 1996 Annual Report to
Shareholders, the applicable portions of which are incorporated herein by
reference.
Joint Underwriting Associations
A joint underwriting association ("JUA") is similar to a reinsurance pool.
Generally, a JUA allows an insurer to share with other insurers the
underwriting experience of drivers that reflect a higher risk of loss than the
insurer would normally accept. Under a JUA, a limited number of insurers are
designated as "servicing carriers." The servicing carrier is responsible for
collecting premiums and paying claims for the policies issued in the JUA, and
such insurers receive a fee for these administrative services. The
underwriting results of the servicing carrier are then shared with all
insurers in the state. Like reinsurance facilities, JUA's typically operate at
a deficit, and fund that deficit by levying assessments on insurers.
The New Jersey legislature passed automobile insurance reform legislation
that eliminated the New Jersey JUA ("NJJUA") and imposed taxes and assessments
on the insurance industry to fund a portion of the NJJUA deficit. The deficit
resulted primarily from the inadequate rate level of the NJJUA and the
contraction of the
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voluntary auto market, which increased the number of risks requiring insurance
through the NJJUA. The reform legislation also established a Market Transition
Facility ("MTF") to manage business from the NJJUA that is not transferred to
the voluntary market. During 1994, the Company, in the Regional Property and
Casualty segment, released a reserve of $7.0 million as a result of the
resolution of the funding of the New Jersey Market Transition Facility
deficit. Legislation passed in New Jersey during the third quarter of 1994
substantially relieved insurers of responsibility for funding the deficit.
Other Mechanisms
The principal shared market mechanisms for property insurance are the Fair
Access to Insurance Requirements Plans ("FAIR Plans"), the formation of which
was required by the federal government as a condition to an insurer's ability
to obtain federal riot reinsurance coverage following the riots and civil
disorder that occurred during the 1960's. These plans, created as mechanisms
similar to automobile assigned risk plans, were designed to increase the
availability of property insurance in urban areas. The federal government
reinsures those insurers participating in FAIR Plans against excess losses
sustained from riots and civil disorders. The individual state FAIR Plans are
created pursuant to statute or regulation. The property shares market
mechanisms provide basic fire insurance and extended coverage protection for
dwellings and certain commercial properties that could not be insured in the
voluntary market. A few states also include a basic homeowners form of
coverage in their shared market mechanism.
With respect to commercial automobile coverage, another pooling mechanism, a
Commercial Auto Insurance Plan ("CAIP"), uses a limited number of servicing
carriers to handle assignments from other insurers. The CAIP servicing carrier
is paid a fee by the insurer who otherwise would be assigned the
responsibility of handling the commercial automobile policy and paying claims.
Approximately 40 states have CAIP mechanisms, including California,
Connecticut, Illinois, New Hampshire, New Jersey, New York and Rhode Island.
Competition
The property and casualty industry is highly competitive among national
agency companies, direct writers, and regional and local insurers on the bases
of both price and service. Many of these companies are larger and have greater
financial and technical resources than Hanover and Citizens. National agency
companies sell insurance through independent agents and usually concentrate on
commercial lines of property and casualty insurance. Direct writers dominate
the personal lines of property and casualty insurance and operate on a
national, regional or single state basis. Regional and local companies sell
through independent agents in one or several states in the same region and
compete in both personal and commercial lines. In addition, because both
companies market through independent agents, Hanover and Citizens compete with
other independent agency companies for business in each of the agencies
representing them.
Hanover faces competition in personal lines primarily from direct writers
and regional and local companies. In its commercial lines, Hanover faces
competition primarily from national agency companies and regional and local
companies. Due to the number of companies in Hanover's principal property and
casualty insurance marketplace, there is no single dominant competitor in any
of Hanover's markets. Management believes that its emphasis on maintaining a
local presence in its markets, coupled with investments in operating and
client technologies, will enable Hanover to compete effectively.
During the past two years, the competitive environment in Massachusetts has
increased substantially. Approximately 39% of Hanover's personal automobile
business is currently written in this state. In 1995 and 1996, Massachusetts
personal automobile rates decreased 4.5% and 6.2%, respectively, as mandated
by the Massachusetts Division of Insurance. In 1995, the Massachusetts
Division of Insurance began to allow sponsoring organizations to receive
discounts on their auto insurance. Today, Hanover currently offers more than
70 group programs throughout the state, including the second largest group
plan in the state with approximately 347,000 eligible members. On February 24,
1997, Hanover submitted its request to the Massachusetts Division of Insurance
to offer a 10% discount on automobile insurance for its safest drivers. If
approved, qualified
9
<PAGE>
Hanover policyholders would reduce their insurance premiums by as much as 20%
by combining "safe driver" and "group" discounts. Management has implemented
these discounts in an effort to retain the Regional Property and Casualty
segment's market share in Massachusetts. These discounts, together with
mandated rate decreases, may unfavorably impact premium growth.
In Michigan, Citizens competes in personal segments with a number of direct
writers and regional and local companies, several of which are larger than
Citizens. National agency companies have not been important factors in
Michigan in the personal segments of property and casualty insurance because
of their tendency to emphasize commercial segments and because Michigan's
insurance regulatory environment would require such companies to develop and
implement special incentive programs designed to encourage agents to identify
and sell insurance to individuals with lower risk profiles consistent with the
constraints of Michigan law. However, in February 1996, an amendment to the
Essential Insurance Act became effective in Michigan. This amendment
eliminates personal automobile and homeowners insurance territorial rating
restrictions and limits merit ratings for automobile policies. The Company
cannot predict the effect of this new legislation, but believes this law may
encourage national companies to return or enter into the state in commercial
and personal lines.
Citizens also faces competition from the two largest direct writers in
Michigan, Auto Club Michigan Group and State Farm Group companies, in the
personal automobile line. In the homeowners line, Citizens' principal
competition in Michigan is also from direct writers, including State Farm
Group. Citizens is the second leading writer in Michigan in its three primary
commercial lines combined: commercial automobile, workers' compensation, and
commercial multiple peril. Citizens faces competition principally from
national agency companies, and regional and local companies, many of which
have financial resources substantially greater than those of Citizens.
The industry has been in a downturn over the past several years due
primarily to price competition. Premium rate levels are related to the
availability of insurance coverage, which varies according to the level of
excess capacity in the industry. The current commercial lines market is
extremely competitive due to a continuing soft market in which capacity is
high and prices are low. Because of the commitment at both Hanover and
Citizens to focus on underwriting profitability and a refusal to write
business at inadequate prices, this highly competitive commercial lines market
has impacted the Regional Property and Casualty segment's growth in commercial
lines. In Michigan, Citizens workers' compensation line is the largest
commercial line in terms of premiums written. Over the past few years,
competition has caused Citizens to reduce rates four times; 8.5%, 7.0%, 6.4%
and 8.7% effective May 1, 1995, December 1, 1995, June 1, 1996, and March 1,
1997 respectively. Management believes that competition for premiums in the
Regional Property and Casualty segment's markets may continue to have an
adverse impact on rates and profitability.
Since there is no one dominant competitor in any of the markets in which the
Regional Property and Casualty segment competes, management believes there is
opportunity for future growth.
Underwriting
Pricing
The manner in which the Company prices products takes into consideration the
expected frequency and severity of losses, the costs of providing the
necessary coverage (including the cost of administering policy benefits, sales
and other administrative and overhead costs) and a margin for profit.
The Company, in the Regional Property and Casualty segment, seeks to achieve
an underwriting profit in each of its product lines regardless of market
conditions. This strategy seeks to achieve consistent profitability with
substantial growth in net premiums written during hard markets and more modest
growth during soft markets. The Company concentrates on its established major
product lines, and accordingly, does not typically pursue the development of
products with relatively unpredictable risk profiles. In addition, the Company
utilizes its extensive knowledge of local markets, including knowledge of
regulatory requirements, to achieve superior
10
<PAGE>
underwriting results. Hanover and Citizens rely on information provided by
their local agents and Hanover also relies on the knowledge of its staff in
the local branch offices. As a regional company with significant market share,
Citizens can apply its extensive knowledge and experience in making
underwriting and rate setting decisions.
Claims
The Company employs experienced claims adjusters, appraisers, medical
specialists, managers and attorneys in order to manage its claims. The
Company, in the Regional Property and Casualty segment, has field claims
offices strategically located throughout its operating territories. All claims
office staff members work closely with the agents to settle claims rapidly and
cost-effectively.
Claims office adjusting staff are supported by general adjusters on large
property losses, automobile and heavy equipment damage appraisers on
automobile material damage losses and medical specialists whose principal
concentration is in workers' compensation and no-fault automobile injury
cases. In addition, the claims offices are supported by staff attorneys who
specialize in litigation defense and claim settlements. The Regional Property
and Casualty segment also has special units which investigate suspected
insurance fraud and abuse.
Hanover utilizes advanced claims processing technology to allow smaller and
more routine claims to be processed at centralized locations. Hanover expects
that approximately 70% of its personal lines claims will be processed at these
locations in the future, thereby increasing efficiency and reducing operating
costs.
Citizens has instituted a program under which participating agents have
settlement authority for small property loss claims. Based upon program
experience, the Regional Property and Casualty segment believes that this
program contributes to low loss adjustment expense ("LAE") experience and to
its higher customer satisfaction ratings by permitting the early and direct
settlement of such small claims. Approximately 26.6% and 28.1% of the number
of total paid claims reported to Citizens in the years ended December 31, 1996
and 1995, respectively, were settled under this program.
Hanover and Citizens have also begun using the managed care expertise of the
Allmerica Financial's Corporate Risk Management Services ("CRMS") segment in
the analysis of the provision of medical services in the management of
workers' compensation and medical claims on its automobile policies. Hanover
and Citizens believe that their use of this capability reduces costs and
serves their customers more efficiently.
Property and casualty insurers are subject to claims arising out of
catastrophes which may have a significant impact on their results of
operations and financial condition. The Company, in the Regional Property and
Casualty segment, may experience catastrophe losses in the future which could
have a material adverse impact on the Company. Catastrophes can be caused by
various events including hurricanes, earthquakes, tornadoes, wind, hail, fires
and explosions, and the incidence and severity of catastrophes are inherently
unpredictable. Although catastrophes can cause losses in a variety of property
and casualty lines, homeowners and business property insurance have in the
past generated the vast majority of catastrophe-related claims.
Reserve for Unpaid Losses and Loss Adjustment Expenses
Reference is made to "Reserve for Losses and Loss Adjustment Expenses" on
pages 40, 41 and 42 of Management's Discussion and Analysis of Financial
Condition and Results of Operations of the 1996 Annual Report to Shareholders,
which is incorporated herein by reference.
The Company's actuaries, in the Regional Property and Casualty segment,
review the reserves each quarter and certify the reserves annually as required
for statutory filings.
11
<PAGE>
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 Regional Property and Casualty segment
and the industry, (iv) the relatively short-term nature of most policies and
(v) internal estimates of required reserves, management believes that adequate
provision has been made for loss reserves. However, establishment of
appropriate reserves is an inherently uncertain process and there can be no
certainty that current established reserves will prove adequate in light of
subsequent actual experience. A significant change to the estimated reserves
could have a material impact on the results of operations.
Significant periods of time often elapse between the occurrence of an
insured loss, the reporting of the loss to the Company and the Company's
payment of that loss. To recognize liabilities for unpaid losses, the Company
establishes reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported losses and LAE.
The Company, in the Regional Property and Casualty segment, does not use
discounting techniques in establishing reserves for losses and LAE, nor has it
participated in any loss portfolio transfers or other similar transactions.
The following table reconciles reserves determined in accordance with
accounting principles and practices prescribed or permitted by insurance
statutory authorities ("Statutory Reserve") to reserves determined in
accordance with generally accepted accounting principles ("GAAP Reserve") at
December 31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Statutory reserve for losses and LAE............. $2,113.2 $2,123.0 $2,093.6
GAAP adjustments:
Reinsurance recoverable on unpaid losses....... 626.9 763.5 712.4
Other(*)....................................... 4.0 9.5 15.7
======== ======== ========
GAAP reserve for losses and LAE.................. $2,744.1 $2,896.0 $2,821.7
======== ======== ========
</TABLE>
- --------
(*) Primarily other statutory liabilities reclassified as loss adjustment
expense reserves for GAAP reporting.
12
<PAGE>
Analysis of Losses and Loss Adjustment Expenses Reserve Development
The following table sets forth the development of net reserves for unpaid
losses and LAE from 1986 through 1996 for the Company.
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------
(IN MILLIONS) YEAR ENDED DECEMBER 31,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserve for
losses and
LAE(1)......... $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9 $1,772.4 $1,550.6 $1,326.3 $1,150.9 $1,008.0 $ 793.0
Cumulative
amount paid as
of(2):
One year later.. -- 627.6 614.3 566.9 564.3 569.0 561.5 521.1 465.3 384.3 319.6
Two years
later.......... -- -- 940.7 884.4 862.7 888.0 874.5 820.2 725.3 616.4 509.9
Three years
later.......... -- -- -- 1,078.1 1,068.4 1,077.1 1,074.3 1,009.3 901.5 764.5 643.6
Four years
later.......... -- -- -- -- 1,184.1 1,207.1 1,186.4 1,130.1 1,009.7 862.1 722.3
Five years
later.......... -- -- -- -- -- 1,279.4 1,265.4 1,192.7 1,078.8 926.0 780.8
Six years
later.......... -- -- -- -- -- -- 1,314.2 1,240.9 1,116.2 969.7 817.3
Seven years
later.......... -- -- -- -- -- -- -- 1,271.4 1,147.4 993.5 844.5
Eight years
later.......... -- -- -- -- -- -- -- -- 1,170.4 1,016.5 860.5
Nine years
later.......... -- -- -- -- -- -- -- -- -- 1,034.6 878.1
Ten years
later.......... -- -- -- -- -- -- -- -- -- -- 892.9
Net reserve re-
estimated as
of(3):
End of year..... 2,117.2 2,132.5 2,109.3 2,019.6 1,936.9 1,772.4 1,550.6 1,326.3 1,150.9 1,008.0 793.0
One year later.. -- 1,991.1 1,971.7 1,891.5 1,868.1 1,755.0 1,601.5 1,412.4 1,220.4 1,058.3 865.0
Two years
later.......... -- -- 1,859.4 1,767.4 1,762.8 1,717.7 1,601.9 1,449.0 1,262.0 1,096.4 904.4
Three years
later.......... -- -- -- 1,691.5 1,703.3 1,670.8 1,614.3 1,471.7 1,290.2 1,125.3 937.0
Four years
later.......... -- -- -- -- 1,658.9 1,654.1 1,597.6 1,484.7 1,312.3 1,155.1 963.5
Five years
later.......... -- -- -- -- -- 1,634.6 1,594.3 1,482.3 1,322.1 1,175.2 983.3
Six years
later.......... -- -- -- -- -- -- 1,588.7 1,486.9 1,328.6 1,188.5 999.5
Seven years
later.......... -- -- -- -- -- -- -- 1,488.4 1,340.7 1,201.2 1,009.5
Eight years
later.......... -- -- -- -- -- -- -- -- 1,403.7 1,215.4 1,025.0
Nine years
later.......... -- -- -- -- -- -- -- -- -- 1,226.8 1,039.6
Ten years
later.......... -- -- -- -- -- -- -- -- -- -- 1,056.1
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------
(Deficiency)
Redundancy,
net(4,5,6)..... $ -- $ 141.4 $ 249.9 $ 328.1 $ 278.0 $ 137.8 $ (38.1) $ (162.1) $ (252.8) $ (218.8) $(263.1)
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== =======
</TABLE>
- --------
(1) Sets forth the estimated net liability for unpaid losses and LAE recorded
at the balance sheet date for each of the indicated years; represents the
estimated amount of net losses and LAE for claims arising in the current
and all prior years that are unpaid at the balance sheet date, including
incurred but not reported ("IBNR") reserves.
(2) Cumulative loss and LAE payments made in succeeding years for losses
incurred prior to the balance sheet date.
(3) Re-estimated amount of the previously recorded liability based on
experience for each succeeding year; increased or decreased as payments
are made and more information becomes known about the severity of
remaining unpaid claims.
(4) In 1987, Hanover adopted a new actuarial-based reserve methodology
designed to result in a more accurate reflection of underwriting trends
and a more appropriate basis for assessing current reserve adequacy. The
new method is based on groupings of claims using the period in which the
accident occurred rather than loss experience in the financial reporting
period. This method tracks the development of claims from a given accident
period and provides management with continuous updates of losses incurred.
Management believes that this change to actuarial reserving methodologies
has resulted in improved reserve adequacy.
(5) Cumulative deficiency or redundancy at December 31, 1996 of the net
reserve amounts shown on the top line of the corresponding column. A
redundancy in reserves means the reserves established in prior years
exceeded actual losses and LAE or were reevaluated at less than the
original reserved amount. A deficiency in reserves means the reserves
established in prior years were less than actual losses and LAE or were
reevaluated at more than the original reserved amount.
(6) The following table sets forth the development of gross reserve for unpaid
losses and LAE from 1992 through 1996 for the Company:
13
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Reserve for losses and LAE:
Gross liability................ $2,744.1 $2,896.0 $2,821.7 $2,717.3 $2,598.9
Reinsurance recoverable........ 626.9 763.5 712.4 697.7 662.0
-------- -------- -------- -------- --------
Net liability................ $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9
======== ======== ======== ======== ========
One year later:
Gross re-estimated liability... $2,587.8 $2,593.5 $2,500.5 $2,460.5
Re-estimated recoverable....... 596.7 621.8 609.0 592.4
-------- -------- -------- --------
Net re-estimated liability... $1,991.1 $1,971.7 $1,891.5 $1,868.1
======== ======== ======== ========
Two years later:
Gross re-estimated liability... $2,339.2 $2,333.3 $2,341.9
Re-estimated recoverable....... 479.8 565.9 579.1
-------- -------- --------
Net re-estimated liability... $1,859.4 $1,767.4 $1,762.8
======== ======== ========
Three years later:
Gross re-estimated liability... $2,145.5 $2,257.3
Re-estimated recoverable....... 454.0 554.0
-------- --------
Net re-estimated liability... $1,691.5 $1,703.3
======== ========
Four years later:
Gross re-estimated liability... $2,168.2
Re-estimated recoverable....... 509.3
--------
Net re-estimated liability... $1,658.9
========
</TABLE>
Reinsurance
The Company, in the Regional Property and Casualty segment, maintains a
reinsurance program designed to protect against large or unusual losses and
LAE activity. This includes both excess of loss reinsurance and catastrophe
reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from
significant aggregate losses arising from a single event such as windstorm,
hail, hurricane, tornado, riot or other extraordinary events. The Company
determines the appropriate amount of reinsurance based on the Company's
evaluation of the risks accepted and analysis prepared by consultants and
reinsurers and on market conditions including the availability and pricing of
reinsurance. The Company, in the Regional Property and Casualty segment, has
reinsurance for casualty business. Under the 1996 casualty program, the
reinsurers are responsible for 100% of the amount of each loss in excess of
$1.0 million per occurrence up to $30.5 million for general liability and
workers' compensation. Additionally, this reinsurance covers workers'
compensation losses in excess of $30.5 million to $60.5 million per
occurrence. Under the Company's 1996 catastrophe reinsurance program, in the
Regional Property and Casualty segment, Hanover and Citizens retain the first
$25.0 million of loss per occurrence, all amounts in excess of $180.0 million
per occurrence and 10% of all aggregate loss amounts in excess of $25.0
million up to $180.0 million. In addition, Citizens retains 5% of losses in
excess of $10.0 million, up to $25.0 million. In 1996, Citizens purchased
aggregate catastrophe coverage which reinsures 90% of $5.0 million for
aggregated catastrophe losses in excess of $5.0 million which individually
exceed $1.0 million. Under this aggregate catastrophe coverage, Citizens is
expected to recover $4.5 million. In the years ended December 31, 1996, 1995
and 1994, the Company, in the Regional Property and Casualty segment, did not
exceed the minimum catastrophe levels, either individually or in the
aggregate, to obtain recovery under its reinsurance agreements, except as
described above.
Effective January 1, 1997, the Company, in the Regional Property and
Casualty segment, modified its reinsurance program. The 1997 modifications
include the purchase of additional casualty reinsurance and higher
14
<PAGE>
retention under the Company's catastrophe reinsurance program. Under the 1997
casualty reinsurance program, the Company added a layer which reinsured 100%
of each loss in excess of $.5 million up to $1.0 million per occurrence. Under
the 1997 catastrophe reinsurance program, Hanover and Citizens retain the
first $25.0 million of loss per occurrence and all amounts in excess of $180.0
million per occurrence, 55% of all aggregate loss amounts in excess of $25.0
million up to $45.0 million, and 10% of all aggregate loss amounts in excess
of $45.0 million up to $180.0 million. In addition, Citizens retains 5% of
losses in excess of $10.0 million, up to $25.0 million.
The Company, in the Regional Property and Casualty segment, cedes to
reinsurers a portion of its risk and pays a fee based upon premiums received
on all policies subject to such reinsurance. Reinsurance contracts do not
relieve the Company from its obligations to policyholders. Failure of
reinsurers to honor their obligations could result in losses to the Company.
The Company determines the appropriate amount of reinsurance based on
evaluation of the risks accepted and analyses prepared by consultants and
reinsurers and on market conditions (including the availability and pricing of
reinsurance). The Company also believes that the terms of its reinsurance
contracts are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limit and retention,
arbitration and occurrence. Based on its review of its reinsurers' financial
statements and reputations in the reinsurance marketplace, the Company
believes that its reinsurers are financially sound.
The Company, in the Regional Property and Casualty segment, is subject to
concentration of risk with respect to reinsurance ceded to various residual
market mechanisms. As a condition to the ability to conduct certain business
in various states, the Company is required to participate in various residual
market mechanisms and pooling arrangements which provide various insurance
coverages to individuals or other entities that are otherwise unable to
purchase such coverage voluntarily provided by private insurers. These market
mechanisms and pooling arrangements include the Massachusetts Commonwealth
Automobile Reinsurers ("CAR"), the Maine Workers' Compensation Residual Market
Pool ("MWCRP") and the Michigan Catastrophic Claims Association ("MCCA").
At December 31, 1996, the MCCA and CAR were the only two reinsurers which
represented 10% or more of the Regional Property and Casualty segment's
reinsurance business. As a servicing carrier in Massachusetts, the Company
cedes a significant portion of its private passenger and commercial automobile
premiums to CAR. Net premiums earned and losses and loss adjustment expenses
ceded to CAR for the years ended December 31, 1996, 1995 and 1994 were $38.0
million and $21.8 million, $49.1 million and $33.7 million, and $50.0 million
and $29.8 million, respectively.
From 1988 through 1992, the Company, in the Regional Property and Casualty
segment, was a servicing carrier in Maine, and ceded a significant portion of
its workers' compensation premiums to the Maine Workers' Compensation Residual
Market Pool, which is administered by The National Council on Compensation
Insurance ("NCCI"). The Company was involved in legal proceedings regarding
the MWCRP's deficit which through a legislative settlement issued on June 23,
1995, provided for an initial funding of $220.0 million of which the insurance
carriers were responsible for $65.0 million. Hanover paid its allocation of
$4.2 million in December 1995. Some of the smaller carriers appealed this
decision. The Company's right to recover reinsurance balances for claims
properly paid is not at issue in any such proceedings. The Company expects to
collect its reinsurance balance; however, funding of the cash flow needs of
the MWCRP may in the future be affected by issues related to certain
litigation, the outcome of which the Company cannot predict. See "Legal
Proceedings" on page 28 of this Form 10-K which is incorporated herein by
reference.
The Company ceded to MCCA premiums earned and losses and loss adjustment
expenses in 1996, 1995 and 1994 of $50.5 million and $(52.9) million, $66.8
million and $62.9 million, and $80.0 million and $24.2 million, respectively.
Because the MCCA is supported by assessments permitted by statute and all
amounts billed by the Company to CAR, MWCRP and MCCA have been paid when due,
the Company believes that it has no significant exposure to uncollectible
reinsurance balances.
The reserve for losses and loss adjustment expenses at December 31, 1996 and
1995 is shown gross of recoverable on unpaid losses of $626.9 million and
$763.5 million, respectively. The significant decrease in the reinsurance
recoverable on unpaid losses is primarily attributable to an overall decrease
in reinsurance activity at both Hanover and Citizens. The decrease at Hanover
is specifically related to a decrease in ceded losses on its
15
<PAGE>
servicing carrier business. The decrease at Citizens in 1996 is due to the
MCCA's favorable development on prior year reserves exceeding the losses and
LAE incurred during the current year. The aggregate losses and LAE ceded have
no impact on the Company's consolidated statements of income. Losses and LAE
ceded were $2.2 million, $229.1 million and $160.4 million in 1996, 1995 and
1994, respectively. Ceded premiums earned were $232.6 million, $296.2 million
and $291.9 million in 1996, 1995 and 1994, respectively.
Reference is made to "Reinsurance" in Note 16 on pages 72 and 73 of the
Notes to Consolidated Financial Statements of the 1996 Annual Report to
Shareholders, which is incorporated herein by reference.
Reference is also made to "Reinsurance Facilities" on page 7 of this Form
10-K which is incorporated herein by reference.
CORPORATE RISK MANAGEMENT SERVICES
General
The Corporate Risk Management Services segment provides managed care medical
group insurance products and administrative services as well as other group
insurance coverages, such as group life, dental and disability products, to
corporate employers. As of December 31, 1996, this segment insured and/or
provided administrative services to the employee benefit plans of over 2,700
employers covering 619,435 employee lives. For the year ended December 31,
1996, this segment accounted for approximately $361.5 million, or 11.0%, of
consolidated revenues and $20.7 million, or 6.2%, of consolidated income
before taxes.
The Company's strategy emphasizes risk sharing arrangements rather than
traditional indemnity medical insurance products. The Company's risk sharing
arrangements consist of providing stop-loss indemnity insurance coverage for
self-insured employers with 100 to 5,000 employees together with managed care
and administrative services for coverage provided by the employer and the
Company. This risk sharing approach enables the Company to provide more
managed care, administrative and other services with less exposure to losses
than traditional indemnity medical insurance. In addition, by emphasizing risk
sharing arrangements, the segment has demonstrated more stable profitability
by decreasing its exposure to unpredictable increases in health care costs.
As a result of this strategy, revenues from risk sharing arrangements and
administrative service only contracts have increased $24.1 million, or 23.0%,
from $104.2 million in 1994 to $128.3 million in 1996. Traditional indemnity
medical product revenues decreased $19.7 million, or 32.7%, from 1994 to 1996.
The Company is also leveraging the CRMS segment's managed care and claims
management expertise to capitalize on emerging opportunities with its Regional
Property and Casualty segment affiliates. New legislation in many states will
permit the cost containment approaches that have been used to manage employee
medical and disability costs to be applied to control workers' compensation
and the medical component of automobile insurance. In response, the Company
has collaborated with its affiliated Regional Property and Casualty segment's
claims operations to apply CRMS' expertise in medical management and claims
processing to the Company's workers' compensation business and the medical
component of its automobile insurance business. Claims examiners ensure that
appropriate medical care is provided to insureds and that bills from health
care providers are reasonable. This integrated managed care and claims
adjudication system can now manage medical claims covered by workers'
compensation, automobile insurance or a health benefit plan. The Company
believes that its capability of providing 24-hour managed care to effectively
manage claims for both casualty and employee benefit products is a competitive
advantage.
The Company is also emphasizing the CRMS segment's group life, dental and
disability products. These lines of coverage have historically provided more
stable profitability for the Company than medical coverages, by decreasing the
Company's exposure to unpredictable increases in healthcare costs and the
underlying risks which are assumed by employers. In order to enhance sales of
these products, each has been redesigned to be available as part of a full
service package or on a stand-alone basis.
Health Care Regulation and Reform
There continue to be a number of legislative and regulatory proposals
introduced at the federal and state level to reform the current health care
system. At the federal level, recent proposals have focused on benefits,
confidentiality and Medicare reform. State legislation adopted over the past
few years generally limits the flexibility of insurers with respect to rating
and underwriting practices for employer groups with less than 50 employees, or
in some states, less than 100 employees. In addition, several states have
enacted so-called "any
16
<PAGE>
willing provider" laws and managed care reform legislation which may decrease
the demand for managed care programs. While future legislative activity is
unknown, it is probable that limitations on insurers that market health
insurance to small employers will increase. It is also possible that many
states will increase the size of the employers considered a protected class
and will expand reforms to include the non-group market. However, the
Company's rating and underwriting practices are consistent with the objectives
of small group reform. For example, the Company does not experience rate small
cases, nor does it refuse coverage to newly eligible individuals within small
employer groups because of medical histories. Because of its emphasis on
managed care, management believes that it will continue to be able to operate
effectively in the event of small group reform, even if specific states expand
the existing limitations.
The Company believes that the proposed federal and state level health care
reforms would, if enacted, substantially expand access to and mandate the
amounts of health care coverage while limiting or eliminating insurers'
underwriting flexibility and restrict the level of profitability of health
insurers and managed care providers. The Company cannot predict whether any of
the current proposals will be enacted and what particular impact such
proposals may have on the Company's employee benefit services business.
Products
The following table summarizes premiums by product line for the CRMS segment
for the years ended December 31.
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Health
Medical
Fully insured...................................... $ 40.6 $ 44.6 $ 60.3
Risk sharing....................................... 83.2 83.0 77.1
Dental
Fully insured...................................... 21.3 13.1 11.3
Risk sharing....................................... 2.7 2.8 2.8
Short-term disability
Fully insured...................................... 6.5 5.5 4.1
Risk sharing....................................... 0.5 0.5 0.6
Long-term disability
Fully insured...................................... 8.5 9.0 7.6
Reinsurance assumed (1)................................ 57.5 44.9 43.4
Other (2)
Fully insured...................................... 8.3 8.1 8.1
Risk sharing....................................... 18.1 13.3 9.0
------ ------ ------
Total health........................................... 247.2 224.8 224.3
Accidental death & dismemberment....................... 5.0 4.5 3.8
Other reinsurance assumed.............................. 0.4 1.1 1.9
Life................................................... 50.3 42.3 38.0
------ ------ ------
Total CRMS premiums.................................... $302.9 $272.7 $268.0
====== ====== ======
ASO (3)................................................ $ 23.8 $ 18.7 $ 14.7
====== ====== ======
Total premiums and premium equivalents................. $884.3 $786.1 $727.7
====== ====== ======
</TABLE>
- --------
(1) Represents special risk arrangements whereby the Company assumes a limited
amount of risk by participating in a pool administered by a third party.
Such arrangements provide insurance coverage to companies for certain high
limit and excess loss risks.
(2) Represents premiums primarily related to customized products sold to
customers providing for stop-loss coverage and/or administrative services.
(3) Administrative services only ("ASO") fees are included in other income in
the financial information contained elsewhere herein.
17
<PAGE>
Risk Sharing Arrangements
The Company participates in risk sharing arrangements primarily for medical,
dental and short-term disability coverage. In accordance with its strategy to
emphasize risk sharing arrangements with its customers, the Company offers
several funding options that allow employers to share in the risk of their
plan. ASO plans provide employers with a self-funded arrangement in which the
Company provides claims administration and other services selected by the
employer. The Company also provides specific and aggregate stop-loss insurance
coverage for its ASO plans.
Other Group Coverage
The Company's group life, accidental death and dismemberment ("AD&D"),
disability and dental products are offered in conjunction with medical
insurance coverages or as stand alone products. The Company offers features in
its group life insurance which include fixed or variable pricing, or
traditional and supplemental contributory group term life insurance.
Accidental death and dismemberment insurance may be included with group term
life insurance to pay additional amounts for losses due to an accident. The
Company offers weekly disability income insurance to cover employees for loss
of wages during a short period of disability, long term disability insurance
either with weekly coverage or on a stand-alone basis and dental insurance for
preventive and diagnostic services, routine restorative services and major
restorative services.
Special Risk Arrangements
The Company also provides other special risk arrangements, often taking a
limited share of the risk through reinsurance pools (administered through
Third Party Administrators ("TPAs") or managing general underwriters), to
spread risk and limit exposure in each arrangement. These programs provide a
variety of insurance coverages, including high limit AD&D, high limit
disability income, excess loss medical reinsurance for self-funded plans,
aviation, organ transplant, occupational accident and travel accident.
Traditional Products
The Company offers full indemnity products for medical, surgical and
hospital expense coverage resulting from illness or injury. Many options are
available for deductible amounts and coinsurance levels.
Marketing
The Company sells its CRMS segment's products and services primarily through
approximately 50 sales representatives employed by the Company. These
representatives assist independent producers (for example, agents, brokers and
consultants who represent the purchasers of the Company's products) in the
marketing of these products, and provide assistance with plan design issues
and ongoing service.
The Company continues to expand its distribution channels primarily to
enhance the growth of its non-medical insurance coverages. The Company is
focusing on three distribution channels. First, the Company is capitalizing on
its special risk arrangements with TPAs to promote sales of group life and
disability coverages. Second, the Company continues to form strategic
alliances with Health Maintenance Organizations ("HMOs") and other managed
care entities to distribute group life, disability and dental plans. Third,
the Company is building cross-marketing programs with other segments to
capitalize on divisional distribution systems and products already in place.
The Company has also established regional offices to market non-medical
products through these new distribution channels and added three offices in
1996. The Company plans to open additional regional offices in the future.
Reinsurance
The Company purchases reinsurance for the CRMS segment's group life
insurance, accidental death and dismemberment, group health, stop-loss and
occupational accident coverages. The Company retains a maximum
18
<PAGE>
exposure of $500,000 on life policies and $250,000 on AD&D policies. The
Company also has reinsurance arrangements to further limit the Company's
liability with respect to policies for certain employers and groups. Although
reinsurance does not legally discharge the ceding insurer from its primary
liability for the full amount of policies reinsured, it does make the assuming
insurer liable to the ceding unsurer to the extent of the reinsurance ceded.
The Company maintains a gross reserve for reinsured liabilities.
The Company participates in a catastrophic reinsurance pool for this segment
for coverage against catastrophic life losses from the same event. Under the
pool arrangement, the Company shares in approximately 1.5% of the pool's
losses. The Company purchases reinsurance which limits the Company's share of
annual pool claim losses to $500,000.
With respect to this segment's group health policies, the Company purchases
specific stop-loss coverage for individual major medical claims over $350,000
once such excess claims exceed a minimum aggregate limit of $5.8 million. The
Company also purchases catastrophic coverage for three or more claims arising
from the same event. Under this coverage the Company is reimbursed for medical
and long term disability claims paid in excess of $500,000 in total as a
result of the event. The Company purchases reinsurance protection for long
term disability payments, covering a specific percent, generally approximately
50%, of each long term disability policy, with a few exceptions, and purchases
reinsurance for organ transplants.
The Company reinsures 90% of the risk associated with its specific and
aggregate stop-loss insurance policies issued as part of risk sharing
arrangements. This reinsurance is ceded to a group of ten reinsurers,
including FAFLIC, who share in the risk assumed. Stop-loss coverage provided
under Competitive Funding Option plans is not included in this reinsurance
coverage. The Company also reinsures 100% of the risk associated with its
occupational accident policies. This risk is ceded to a reinsurance pool
consisting of twelve reinsurers, including FAFLIC, who share in the risk
assumed. As a member in this reinsurance pool, FAFLIC assumes 12.5% of the
overall risk.
For the year ended December 31, 1996, the Company ceded approximately $74.5
million of premiums associated with its aggregate stop-loss policies and
approximately $8.0 million of premiums for the remaining direct insurance
coverages. As of December 31, 1996, the Company had no material amounts due
from reinsurers.
Competition
The Company competes with many insurance companies and other entities in
selling its CRMS products. Competition exists for employer groups, for the
employees who are the ultimate consumers of the Company's products sold
through the CRMS segment and for the independent producers who represent
purchasers of the Company's products. Additionally, most currently insured
employer groups receive annual rate adjustments, and employers may seek
competitive quotations from several sources prior to renewal.
The Company competes primarily with national and regional health insurance
companies and other managed care providers. Many of the Company's competitors
have greater capital resources, local market presence and greater name
recognition than the Company. The Company also competes with Blue Cross and
Blue Shield plans, which in some markets have dominant market share. Most Blue
Cross and Blue Shield plans are non-profit enterprises that do not necessarily
pursue profitability to the same extent as for-profit competitors do. The
Company also competes with HMOs, some of which are non-profit enterprises. In
addition, in its risk sharing and administrative service businesses, the
Company also competes with TPAs.
The Company believes, based upon its knowledge of the market, that in the
current environment, the principal competitive factors in the sale of managed
care medical products are price, breadth of managed care network arrangements,
name recognition, technology and management information systems, distribution
systems, quality of customer service, product line flexibility and variety,
and financial stability. As a result, the Company believes that its managed
care expertise, access to managed care networks, commitment to claims
management
19
<PAGE>
and customer service, and its advanced claims management and information
systems enable it to compete effectively in these markets. Although the
Company cannot predict the effect of current federal and state health care
reform proposals, the Company believes that such reform measures may increase
competition in the sale of health care products by limiting the ability of the
Company's customers to purchase health care coverage from a wide variety of
health care providers and insurers, by mandating participation by insurers in
regional health care alliances or pools and by limiting rating and
underwriting practices.
ASSET MANAGEMENT
RETAIL FINANCIAL SERVICES
General
The Retail Financial Services segment includes the individual financial
products businesses of FAFLIC and its wholly owned subsidiary AFLIAC, as well
as the Company's registered investment advisor and broker-dealer affiliates.
Through this segment, the Company is a leading provider of investment-oriented
life insurance and annuities to upper income individuals and small businesses
throughout the United States. These products are marketed through the
Company's career agency force of 576 agents and on a wholesale basis to
financial planners and broker/dealers. For the year ended December 31, 1996,
the Retail Financial Services segment accounted for $450.9 million, or 13.8%,
of consolidated revenues and $76.2 million, or 23.0%, of consolidated income
before taxes.
The Company offers a diverse line of products tailored to its customer
market, including variable universal life, variable annuities, universal life
and retirement plan funding products. The main components of the Company's
current strategy in this segment are to: (i) emphasize investment-oriented
insurance products, particularly variable annuities and variable universal
life insurance, (ii) improve the productivity of the career agency
distribution system, (iii) implement a targeted marketing approach emphasizing
value-added service, (iv) leverage the Company's technological resources to
support marketing and client service initiatives and (v) continue to develop
new distribution systems.
The Company is seeking to improve the productivity of its career agents, the
Company's primary distribution system in this segment. Virtually all of the
Company's career agents are registered broker-dealer representatives, licensed
to sell all of the Company's investment products as well as its insurance
products. The Company has implemented a performance-based compensation system
which rewards agents and agencies based upon sales of products which provide
greater profits for the Company. The Company has also instituted higher
performance standards for agency retention, and requires that such standards
be achieved earlier, in order to elevate the productivity of its agent sales
force.
In addition to its agency distribution system, the Company has established
several alternative distribution channels which have made significant
contributions to the overall growth of variable product sales in this segment.
Products sold through these channels include Allmerica Select life and annuity
products, which are distributed through independent broker-dealers and
financial planners, as well as annuity products sold through alliances with
mutual fund partners such as Delaware Group ("Delaware"), Pioneer Group
("Pioneer") and Zurich Kemper Investments ("Kemper"). The contribution of
these alternative distribution channels has grown from 34.3% of statutory
annuity premiums and deposits in 1994 to 46.5% in 1996. The Company's strategy
is to pursue additional alternative distribution channels and to seek to
increase sales under existing distribution channels.
The Company has developed a number of new marketing and client service
initiatives in order to encourage sales of its products and improve customer
satisfaction. As part of its focus on the sale of investment-oriented
insurance products, the Company has emphasized a financial planning approach
utilizing face-to-face presentations and seminar programs to address different
client needs. In order to identify a favorable prospective
20
<PAGE>
client base, the Company has developed a system utilizing advanced demographic
screening and telemarketing techniques. The Company also regularly delivers
seminars focused on retirement planning to these prospective clients. During
1996, the Company delivered approximately 300 seminars nationally with an
average of more than 60 attendees.
The Company has also utilized its technological resources to support its
marketing and client service initiatives in this segment. The Company has
developed automated portfolio rebalancing capabilities and graphical quarterly
report statements which are used to establish and monitor the desired mix of
investments by individual contract and policyholder.
According to 1996 A.M Best's Policy Reports, the Company is among the twenty
largest writers of individual variable annuity contracts and of individual
variable universal life insurance policies in the United States in 1995, based
on statutory separate account premiums and deposits. Sales of variable
products represented approximately 89.7%, 84.1% and 80.1% of this segment's
statutory premiums and deposits in 1996, 1995 and 1994, respectively. From
1994 to 1996, income before taxes from this segment improved $62.0 million,
from $14.2 million to $76.2 million. Statutory premiums and deposits, a common
industry benchmark for sales achievement, totalled $1,616.9 million, $1,060.8
million and $1,063.3 million in 1996, 1995 and 1994, respectively.
Products
The following table reflects premiums and deposits on a statutory accounting
practices ("SAP") basis, including universal life and investment-oriented
contract deposits, for the segment's major product lines for the years ended
December 31. For 1996 and 1995, Closed Block premiums and deposits have been
combined on a line-by-line basis with premiums and deposits outside the Closed
Block for comparability purposes. Receipts from various products are treated
differently under GAAP and SAP. Under GAAP, universal life, variable universal
life and annuity deposits are not included in revenues but are recorded
directly to policyholder account balances.
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Statutory Premiums and Deposits
Variable universal life........................ $ 117.2 $ 90.4 $ 86.2
Separate account annuities..................... 1,160.9 647.8 564.6
General account annuities...................... 147.9 128.8 173.5
Retirement investment account annuities........ 24.5 25.6 27.1
Universal life................................. 71.6 77.2 93.0
Traditional life............................... 61.9 59.1 86.8
Individual health.............................. 32.9 31.9 32.0
Other.......................................... -- -- 0.1
-------- -------- --------
Total premiums and deposits.................. $1,616.9 $1,060.8 $1,063.3
======== ======== ========
</TABLE>
While the Company continues to offer certain traditional insurance products,
its current focus for new business in this segment is on the sale of variable
products.
Variable Products
The Company's variable products offered through this segment include
variable universal life insurance and variable annuities. The Company's
variable universal life insurance products combine the flexible terms of the
Company's universal life insurance policy with separate account investment
opportunities. The Company also offers a variable joint life product through
this segment. The Company's variable annuities offer the investment
opportunities of the Company's separate accounts and provide a vehicle for
tax-deferred savings. These products are sold pursuant to registration
statements under the Securities Act or exemptions from registration
thereunder.
21
<PAGE>
The Company seeks to achieve product distinction with respect to its
variable products on the basis of quality and diversity of the separate
account investment options underlying these products. The Company's variable
universal life and annuity products offer a variety of account investment
options with choices ranging from money market funds to international equity
funds. The number of these investment options has increased, from 33 in 1994
to 60 in 1996, including those underlying the products sold through
alternative distribution channels. For management of these separate accounts,
the Company supplements its in-house expertise in managing fixed income assets
with the equity management expertise of well-known mutual fund advisors, such
as Fidelity Investments, as well as other independent management firms who
specialize in the management of institutional assets. Additionally, the
Company utilizes the services of an experienced investment consultant to the
pension industry to assist it in the selection of these institutional managers
and in the ongoing monitoring of their performance.
Traditional Products
Historically, the Company's primary insurance products offered in this
segment were traditional life insurance products, including whole life,
universal life and term life insurance, as well as fixed annuities, disability
income policies and retirement plan funding products. Upon completion of the
Company's demutualization in October 1995, a Closed Block of all existing
traditional participating life and annuity policies was established for the
payment of future benefits, policyholders' dividends and certain expenses and
taxes relating to these policies. As a result of the Company's conversion to a
stock life insurance company, participating policies are no longer offered.
The Company ceased offering term life insurance in March 1995 and ceased
offering its single premium fixed annuity product in the fourth quarter of
1995. In addition, the Company ceased offering its disability income products
in January, 1996.
The Company's universal life insurance product is an interest-sensitive
product which offers flexibility in arranging the amount of insurance
coverage, the premium level and the premium payment period. The Company also
offers joint life products through this segment designed to meet estate
planning needs. These products offer flexible premiums and benefits and cover
two lives, with benefits paid at the first or second death, depending on the
policy. In addition, the Company offers a funding vehicle for pension plans of
small to medium-sized employers which provides both general account and
separate account investment options.
Distribution
The Company's primary distribution channel for this segment is its national
career agency sales force of 576 agents, housed in 24 general agencies located
in or adjacent to most of the major metropolitan centers in the United States.
Virtually all of these agents are licensed both as insurance agents and
securities broker-dealers by the National Association of Securities Dealers
("NASD"), qualifying them to sell the full range of the Company's products.
The Company has focused on improving the productivity and reducing the cost of
its career agency system through performance-based compensation, higher
performance standards for agency retention and agency training programs. As
part of this strategy, the Company has decreased the number of agents from 800
at the end of 1994 to 576 at December 31, 1996. The Company also regularly
conducts comprehensive financial planning seminars and face-to-face
presentations to address different investment objectives of clients.
The Company has established several alternative distribution channels for
this segment's products utilizing independent broker-dealers and financial
planners. Through these distribution channels, the Company has obtained access
to over 260 distribution firms employing over 40,000 sales personnel. In
addition, establishment of these channels has enabled the Company to offer a
broader range of investment options through alliances with Delaware, Pioneer
and Kemper mutual funds. During 1996, total statutory premiums and deposits
from sales of variable annuities through these channels totalled $619.8
million, compared to $262.8 million in 1994.
22
<PAGE>
Underwriting
Life insurance underwriting involves a determination of the type and amount
of risk which an insurer is willing to accept and the price charged to do so.
The Company's insurance underwriting standards for this segment attempt to
produce mortality results consistent with the assumptions used in product
pricing. Underwriting also determines the amount and type of reinsurance
levels appropriate for a particular risk profile and thereby allows
competitive risk selection. Underwriting rules and guidelines are based on the
mortality experience of the Company, as well as of the insurance industry and
the general population. The Company also uses a variety of medical tests to
evaluate certain policy applications, based on the size of the policy, the age
of the applicant and other factors.
The Company's product specifications are designed to prevent anti-selection.
Mortality assumptions are thoroughly communicated and monitored. The
underwriting department tracks the profitability indicators of business by
each general agent, including the mix of business, percentage of substandard
and declined cases and placement ratio. Ongoing internal underwriting audits,
conducted at multiple levels, monitor consistency of underwriting requirements
and philosophy. Routine independent underwriting audits conducted by its
reinsurers have supported the Company's underwriting policies and procedures.
Insurance Reserves
The Company has established liabilities for policyholders' account balances
and future policy benefits in the consolidated balance sheets included in the
1996 Annual Report to Shareholders, the applicable portions of which are
incorporated herein by reference, to meet obligations on various policies and
contracts. Policyholders' account balances for universal life and investment-
type policies are equal to cumulative account balances: deposits plus credited
interest, less expense and mortality charges and withdrawals. Future policy
benefits for traditional products are computed on the basis of assumed
investment yields, mortality, persistency, morbidity and expenses (including a
margin for adverse deviation), which are established at the time of issuance
of a policy and generally vary by product, year of issue and policy duration.
Reinsurance
Consistent with the general practice in the life insurance industry, the
Company has reinsured portions of the coverage provided by this segment's
insurance products with other insurance companies. Insurance is ceded
principally to reduce net liability on individual risks, to provide protection
against large losses and to obtain a greater diversification of risk. Although
reinsurance does not legally discharge the ceding insurer from its primary
liability for the full amount of policies reinsured, it does make the
reinsurers liable to the insurer to the extent of the reinsurance ceded. The
Company maintains a gross reserve for reinsurance liabilities. The Company
ceded approximately 2.8% of this segment's total statutory life insurance
premiums in 1996.
With respect to life policies of the Retail Financial Services segment, the
Company has reinsurance agreements in place, established on an annual term,
for both automatic and facultative reinsurance. Under automatic reinsurance,
the reinsurer is automatically bound for up to three times the Company's
retention, which currently is $2 million per life, with certain restrictions
that determine the binding authority with the various reinsurers.
For life policies greater than $8 million, the Company obtains facultative
reinsurance. Prior to issuing facultative reinsurance, the facultative
reinsurer reviews all of the underwriting information relating to the policies
and reinsures on a policy by policy basis. Depending on the nature of the risk
and the size of the policy, the facultative reinsurance could be provided by
one company or several. The Company sometimes facultatively reinsures certain
policies under $2 million which do not satisfy the Company's underwriting
guidelines.
The Company seeks to enter into reinsurance treaties with highly rated
reinsurers. In 1996, the two largest reinsurers for life insurance in this
segment, Connecticut General and St. Louis Re, represented 55.3% of this
segment's life reinsurance ceded based upon statutory premium in that year.
All of the reinsurers utilized by this
23
<PAGE>
segment have received an A.M. Best rating of "A- (Excellent)" or better
(Best's Insurance Reports 1996 edition). The Company believes that it has
established appropriate reinsurance coverage for this segment based upon its
net retained insured liabilities compared to its surplus. Based on its review
of its reinsurers' financial positions and reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially sound.
In 1995, the Company entered into two 100% coinsurance agreements. One was
with Protective Life Insurance Company to reinsure its yearly renewable term
business. The other was with American Heritage Life Insurance Company to
reinsure its non-qualified payroll universal life business.
The Company also obtains catastrophe reinsurance for life insurance in this
segment through a catastrophe accident pool. The maximum pool reinsurance
available per company is $50 million and the maximum pool reinsurance
available for a single event is $125 million. Any amounts in excess of these
limits are the responsibility of the company suffering the loss. Each
participant in the pool pays a premium based on the share of claims paid by
the pool. The Company's share of pool losses is approximately 2.5%. There have
been three claims for which the Company's share was approximately $80,000
since the Company entered the pool on January 1, 1989. The pool is
administered by Lincoln National, and approximately 125 companies currently
participate.
For its disability income coverages, the company purchases reinsurance for
100% of coverage over a specified retention, generally between $1,000 and
$5,000 per month, per policy. This coverage is provided by Lincoln National,
Mercantile and General Life Reassurance Company of America, and North American
Reassurance Company, depending on the dates policies are or were issued. In
1995, the Company entered into a 100% coinsurance agreement with Protective
Life Insurance Company for the Company's yearly renewable term life insurance.
Competition
There is strong competition among insurance companies seeking clients for
the types of insurance, annuities and investment products sold by the Company
in this segment. As of December 31, 1996, there were over 1,700 companies that
offer life insurance in the United States, most of which offer one or more
products similar to those offered by the Company. In some cases these products
are offered through similar marketing techniques. In addition, the Company may
face additional competition from banks and other financial institutions should
current regulatory restrictions on the sale of insurance and securities by
these institutions be repealed.
The Company believes that, based upon its extensive experience in the
market, the principal competitive factors affecting the sale of its life
insurance and related investment products are price, financial strength and
claims-paying ratings, size and strength of agency force, range of product
lines, product quality, reputation and name recognition, value-added service
and, with respect to variable insurance and annuity products, investment
management performance of the underlying separate accounts. Accordingly,
management believes that the Company's strong financial strength and claims-
paying ratings, the quality and diversity of the separate accounts underlying
its investment-based products, the NASD licensing of approximately ninety-five
percent (95%) of its agents and its reputation in the insurance industry
enable it to compete effectively in the markets in which it operates.
INSTITUTIONAL SERVICES
General
The Company has historically offered plan design, investment and participant
recordkeeping services to defined benefit and defined contribution retirement
plans of corporate employers and sold GICs and annuities to corporate
retirement plans. The Company conducts its operations in this segment through
FAFLIC and its subsidiaries. For the year ended December 31, 1996, this
segment accounted for approximately $266.7 million, or 8.1%, of consolidated
revenues, and income before taxes of $52.8 million, or 15.9%, of consolidated
income before taxes.
24
<PAGE>
The Company provides consulting and investment services to defined benefit
and defined contribution retirement plans of corporate employers, as well as
the sale of group annuities to corporate pension plans. The Company also
offers participant recordkeeping and administrative services to defined
benefit retirement plans. The Company provides administration and
recordkeeping for approximately 553 qualified pension and profit sharing plans
which have assets totaling $2.5 billion and cover approximately 105,000
participants. To address the decrease in the market for defined benefit plans
sponsored by employers, the Company has focused on increasing sales to defined
contribution plans, targeting plans with 25 to 1,500 participants. Based upon
internal studies, management believes the size of this market provides the
greatest opportunity in this line of business. In addition, the Company
provides investment only plan services to approximately 210 plans with
aggregate assets under management of $1.1 billion.
Since late 1995, the Company has offered its products for sale directly at
the worksite through trained and licensed sales representatives. By using
education and personalized consulting to increase employee purchases, the
Company seeks to lower acquisition costs and increase employee participation
levels.
In March 1995, the Company entered into an agreement with TSSG, a subsidiary
of First Data Corporation, pursuant to which the Company sold its mutual fund
processing business and agreed not to engage in this business for four years
after closing. In 1996, the Company received a non-recurring $4.8 million
contingent payment related to this sale.
Products and Services
Retirement Plan Products and Services
Through the Institutional Services segment, the Company offers defined
contribution and defined benefit retirement plan investment options, as well
as compliance support, asset allocation services and actuarial benefit
calculations. The Company also offers full service recordkeeping for defined
benefit retirement plans. Participants in defined contribution plans serviced
by the Company have the option to invest their contributions to the plan in
the Company's general account or choose from one of the Company's separate
account investment options. The Company targets plans covering 25 to 1,500
employees. The Company also offers annuity products to retiring participants
in serviced defined benefit plans and to fund terminating benefit plans.
Historically, the Company offered two types of Guaranteed Investment
Contracts, or GICs. One is the traditional GIC; the other is the synthetic
GIC. The traditional GIC provides a fixed guaranteed interest rate and fixed
maturity for each contract. Some of the traditional GICs provide for a
specific lump sum deposit and no withdrawals prior to maturity. Other
traditional GICs allow for window deposits and/or benefit-sensitive
withdrawals prior to maturity, for which the Company builds an additional risk
charge into the guaranteed interest rate. The synthetic GIC is similar to the
traditional GIC, except that the underlying investments are generally held and
managed by a third party, in accordance with specific investment guidelines,
and the Company periodically resets the guaranteed interest rate for in-force
funds, based on the actual investment experience of the funds.
In 1996, total traditional GIC sales were less than $10.0 million, and total
synthetic GIC sales were less than $20.0 million. These amounts are immaterial
to the Company's operating income. The low volume of new GIC business reflects
the reduced focus on these products since the reduction of the Company's
financial strength ratings in 1995. Management believes that due to the
reduced ratings, it is currently not economical for the Company to compete in
this market.
Other Services
The Company also offers telemarketing services through this segment which
utilize experienced telemarketing management and program execution. The
Company offers these services to retail and financial clients.
25
<PAGE>
Distribution
The Company distributes retirement products through a dedicated salesforce
that sells directly to customers and through intermediaries. In addition to
the Home Office, the Company maintains seven regional sales and service
offices located in strategic financial markets.
Competition
The principal competitive factors in the Company's retirement services
provided to defined benefit and defined contribution customers are price, fund
performance, and the ability to provide high quality service. Competition
comes from other insurance companies, mutual fund companies and banks. The
sector of the retirement services market in which the Company most often
competes is the market for small to medium plans that desire a full spectrum
of investment and recordkeeping services. In March 1995, the recordkeeping
function was outsourced to a third party administrator.
INVESTMENT PORTFOLIO
General
At December 31, 1996, the Company managed $9.9 billion of investment assets,
including $772.7 million of investment assets in the Closed Block. These
investments are generally of high quality and broadly diversified across asset
classes and individual investment risks. The major categories of investment
assets are: fixed maturities, which includes both investment grade and below
investment grade public and private debt securities; equity securities;
mortgage loans, principally on commercial properties; real estate, which
consists primarily of investments in commercial properties; policy loans and
other long-term investments. The remainder of the investment assets is
comprised of cash and cash equivalents.
Management has an integrated approach to developing an investment strategy
for the Company that maximizes income, while incorporating overall asset
allocation, business segment objectives, and asset/liability management
tailored to specific insurance or investment product requirements. The
Company's integrated approach and the execution of the investment strategy is
founded upon a value orientation. The Company's investment professionals seek
to identify undervalued securities in the markets through extensive
fundamental research and credit analysis. Management believes this research-
driven, value orientation is a key to achieving the overall investment
objectives of producing superior rates of return, preserving capital, and
meeting the financial goals of the Company's business segments.
The appropriate asset allocation for the Company (the selection of broad
investment categories such as fixed maturities, equity securities, mortgages
and real estate) is determined by management initially through a process that
focuses overall on the types of businesses in each segment that the Company
engages in and the level of surplus (net worth) required to support these
businesses. Next, at the segment level, asset classes are selected to produce
cash flows and have maturities which match product requirements.
At the segment level, the Company has developed an asset/liability
management approach tailored to specific insurance, investment product, and
income objectives. The investment assets of the Company are then managed in
over 33 portfolio segments consistent with specific products or groups of
products having similar liability characteristics. As part of this approach,
management develops investment guidelines for each portfolio consistent with
the return objectives, risk tolerance, liquidity, time horizon, tax and
regulatory requirements of the related product or business segment. Specific
investments frequently meet the requirements of, and are acquired by, more
than one investment portfolio (or investment segment of the general account of
FAFLIC or AFLIAC, with each investment segment holding a pro rata interest in
such investments and the cash flows therefrom). Management has a general
policy of diversifying investments both within and across all portfolios. The
Company monitors the credit quality of its investments and its exposure to
individual borrowers, industries, sectors, and, in the case of mortgages and
real estate, property types and geographic locations. In 1996, management made
further investments in fixed maturities with lower credit quality and longer
durations, as well as incremental investments in limited partnerships, to meet
income objectives. All investments are subject to diversification requirements
under insurance laws.
26
<PAGE>
Consistent with this management approach, portfolio managers maintain close
working relationships with the managers of related product lines within the
Regional Property and Casualty, Corporate Risk Management Services, Retail
Financial Services, Institutional Services, and Allmerica Asset Management
segments. Changes in the outlook for investment markets or the returns
generated by portfolio holdings are reflected as appropriate on a timely basis
in the pricing of the Company's products and services.
RATING AGENCIES
Insurance companies are rated by rating agencies to provide both industry
and participants and insurance consumers meaningful information on specific
insurance companies. Higher ratings generally indicate financial stability and
a stronger ability to pay claims.
Hanover received an A.M. Best financial condition rating of A (Excellent) in
1996. Citizens has received an A.M. Best financial condition rating of A+
(Superior) in each year since 1968. FAFLIC and AFLIAC received A.M. Best
financial condition ratings of A (Excellent) in 1996 (Best's Insurance
Reports, 1996 edition).
FAFLIC was given a Duff & Phelps claims-paying ability rating of AA (Very
High) in September 1996 (Duff & Phelps Credit Rating Company, September 1996).
FAFLIC and AFLIAC were given Moody's financial strength ratings of A1 (Good)
in September 1996 (Moody's Investment Credit Reports, September 1996).
In September 1996, FAFLIC and AFLIAC received S&P claims-paying ability
ratings of A+ (Good). Hanover, together with its subsidiaries, including
Citizens Insurance, was given an AA- (Excellent) S&P claims-paying ability
rating (Standard & Poor's Insurance Rating Analysis, September, 1996).
Management believes that its strong ratings are important factors in
marketing the products of its insurance companies to its agents and customers,
since rating information is broadly disseminated and generally used throughout
the industry. Insurance company ratings are assigned to an insurer based upon
factors relevant to policyholders and are not directed toward protection of
investors. Such ratings are neither a rating of securities nor a
recommendation to buy, hold or sell any security.
EMPLOYEES
The Company has approximately 6,800 employees located throughout the
country. Management believes relations with employees and agents are good.
ITEM 2
PROPERTIES
The Company's headquarters are located at 440 Lincoln Street, Worcester,
Massachusetts and consist primarily of approximately 727,000 square feet of
office and conference space owned in fee and include the headquarters of
Hanover.
Citizens Insurance owns its home office, located at 645 W. Grand River,
Howell, Michigan, which is approximately 119,000 square feet. Citizens also
owns a three-building complex located at 808 North Highlander Way, Howell,
Michigan, with 155,000 square feet, where various business operations are
conducted.
The Company leases office space for its sales force throughout the United
States. The leased property houses agency offices and group insurance sales
offices. Hanover also leases offices throughout the country for its field
employees.
The Company believes that its facilities are adequate for its present needs
in all material respects.
27
<PAGE>
ITEM 3
LEGAL PROCEEDINGS
Reference is made to Note 20 on page 75 of the Notes to Consolidated
Financial Statements of the 1996 Annual Report to Shareholders, the applicable
portions of which are incorporated herein by reference.
MAINE WORKERS COMPENSATION RESIDUAL MARKET POOL
On June 23, 1995, the governor of Maine approved a legislative settlement
for the Maine Workers' Compensation Residual Market Pool deficit for the Years
1988 through 1992. The settlement provides for an initial funding of $220.0
million toward the deficit. The insurance carriers were liable for $65.0
million and employers would contribute $110.0 million payable through
surcharges on premiums over the course of the next ten years. The major
insurers are responsible for 90% of the $65.0 million. Hanover's allocated
share of the settlement is approximately $4.2 million, which was paid in
December 1995. The remainder of the deficit of $45.0 million will be paid by
the Maine Guaranty Fund, payable in quarterly contributions over ten years. A
group of smaller carriers filed litigation to appeal the settlement. The
Company believes that adequate reserves have been established for any
additional liability.
ALLMERICA P&C AND AFC MERGER
Shortly after AFC publicly disclosed its proposal regarding the Merger,
three separate stockholders of Allmerica P&C, Leslie Susser, Harbor Finance
Partners and William A. Kass, IRA-Simplified Employee Pension, filed lawsuits
in the Delaware Chancery Court against AFC, Allmerica P&C and the directors of
Allmerica P&C and the directors of AFC who are also on the board of directors
of Allmerica P&C (the "Delaware Actions"). An additional lawsuit challenging
the Merger was filed by another stockholder of Allmerica P&C, Daniel Bruno, in
the Worcester County (Massachusetts) Superior Court (the "Massachusetts
Action" and , together with the Delaware Actions, the "Actions"). The named
plaintiff in each of the Actions purports to maintain each individual action
as a class action on behalf of the public stockholders of Allmerica P&C
(excluding AFC, Allmerica P&C and the other defendants and any person, firm,
trust, corporation or any other entity related to or affiliated with any of
the defendants) (the "Public Stockholders"). In each of the Actions, the
plaintiff alleged that under the terms of the proposed Merger AFC would
acquire the Allmerica P&C Common Stock at a price that is substantially below
the fair price of such stock and that certain officers and/or directors of AFC
and/or Allmerica P&C breached fiduciary duties owed to Allmerica P&C and the
Public Stockholders in connection with the proposed Merger. The plaintiffs
sought injunctive relief prohibiting AFC from completing the Merger or, in the
alternative, compensatory damages. On February 19, 1997, the parties to the
Delaware Actions executed a Memorandum of Understanding (the "MOU")
memorializing an agreement-in-principle to settle the Delaware Actions. Under
the terms of the MOU, the parties to the Delaware Action have agreed to use
their best efforts to execute and present to the Delaware Chancery Court on or
before April 30, 1997, a formal Stipulation of Settlement. In the event that
the Delaware Chancery Court approves the proposed settlement, it is
anticipated that the Delaware Actions will be dismissed with prejudice as to
the individual plaintiffs and the class of Public Stockholders. In connection
with the MOU, AFC and Allmerica P&C have agreed that they will not oppose an
application to the court by plaintiffs' counsel for an aggregate award of
attorneys' fees and expenses in an amount not to exceed $995,000.00.
SALES PRACTICES
A number of civil jury verdicts have been returned against life and health
insurers in the jurisdictions in which the Company does business involving the
insurers' sales practices, alleged agent misconduct, failure to properly
supervise agents, and other matters. Some of the lawsuits have resulted in the
award of substantial judgments against the insurer, including material amounts
of punitive damages. In some states, juries have substantial discretion in
awarding punitive damages in these circumstances. The Company and its
subsidiaries, like other life and health insurers, from time to time are
involved in such litigation. Although the outcome of any litigation cannot be
predicted with certainty, to date, no such lawsuit has resulted in the award
of any material amount of damages against the Company.
28
<PAGE>
In December 1996, the Company received notice from the Securities and
Exchange Commission (the "Commission") that it would be conducting a limited
inspection concerning the Company's marketing and sales practices associated
with variable insurance products. The Commission requested that certain
information be provided to it by the Company, which the Company promptly
complied with. No litigation has been instituted, nor has the Commission
initiated any further action with respect to this matter.
OTHER
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the opinion of management, based
on the advice of legal counsel, the ultimate resolution of these proceedings
will not have a material effect on the Company's consolidated financial
statements.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth
quarter of the fiscal year covered by this Annual Report on Form 10-K.
29
<PAGE>
PART II
ITEM 5
MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED SHAREHOLDER MATTERS
Reference is made to the "Shareholder Information" on page 78 of the 1996
Annual Report to Shareholders, the applicable portions of which are
incorporated herein by reference, which displays (i) the principal market for
the common stock of AFC, (ii) the frequency and amount of dividends paid
thereon during such period, and (iii) the approximate number of holders of
common shares as of February 28, 1997.
Dividends by the Company are funded from dividends paid to the Company from
FAFLIC, which are subject to restrictions imposed by state insurance laws and
regulations with respect to dividends paid to the Company. Reference is made
to "Liquidity and Capital Resources" on pages 48-49 of Management's Discussion
and Analysis of Financial Condition and Results of Operations and to Note 13
on page 70 of the Notes to Consolidated Financial Statements of the 1996
Annual Report to Shareholders, the applicable portions of which are
incorporated herein by reference.
The payment of future dividends, if any, on the Company's Common Stock will
be a business decision made by the Board of Directors from time to time based
upon the results of operations and financial condition of the Company and such
other factors as the Board of Directors considers relevant.
ITEM 6
SELECTED FINANCIAL DATA
Reference is made to the "Five Year Summary of Selected Financial
Highlights" on page 31 of the 1996 Annual Report to Shareholders, which is
incorporated herein by reference.
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 32-49 of the 1996 Annual Report
to Shareholders, which is incorporated herein by reference.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements on pages 51-54
and the accompanying Notes to Consolidated Financial Statements on pages 55-76
of the 1996 Annual Report to Shareholders which meet the requirements of
Regulation S-X, and which include a summary of quarterly results of
consolidated operations (see Note 22 of Notes to Consolidated Financial
Statements--page 76), which is incorporated herein by reference.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
30
<PAGE>
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS OF THE REGISTRANT
Set forth below is biographical information concerning the directors of the
Company.
MICHAEL P. ANGELINI, 54
Director since February 1995
Chairman, Audit Committee
Mr. Angelini has been a Director of AFC since February 1995, of FAFLIC from
August 1984 to April 1996, and of Allmerica P&C since August 1992. He served
as a Director of Hanover from December 1991 through December 1992. Mr.
Angelini is a partner at the law firm of Bowditch & Dewey, with which he has
been associated since 1968, and is a Director of Flagship Bank & Trust
Company.
DAVID A. BARRETT, 69
Director since February 1995
Audit Committee
Mr. Barrett has been a Director of AFC since February 1995, of FAFLIC from
March 1976 to April 1996, of Allmerica P&C since August 1992 and of Hanover
from December 1991 to December 1992. Mr. Barrett was executive director of
Worcester Memorial Hospital, Inc. from 1968 until January 1983, and served as
President and Chief Executive Officer of that organization until October 1988.
Mr. Barrett served as President and Chief Executive Officer of Medical Center
of Central Mass., Inc. from October 1988 to April 1992, and currently is a
consultant to that organization, now known as Memorial Health Care.
GAIL L. HARRISON, 49
Director since February 1995
Ms. Harrison has been a Director of AFC since February 1995, of FAFLIC from
March 1986 to April 1996, of Allmerica P&C since August 1992, and of Hanover
from December 1991 to December 1992. Since February 1981, Ms. Harrison has
been affiliated with The Wexler Group (formerly Wexler, Reynolds, Harrison &
Shule, Inc.), a government relations consulting firm.
ROBERT P. HENDERSON, 65
Director since September 1996
Mr. Henderson has been a Director of AFC since September 1996. Mr. Henderson
has been the Chairman of Greylock Management Corporation, a venture capital
firm, since 1983. Mr. Henderson is also a Director of Cabot Corporation and
Filenes Basement, a Trustee of the Museum of Fine Arts in Boston,
Massachusetts, and a Member of Corporation of the New England Deaconess
Hospital. Mr. Henderson is a former Chairman of the Federal Reserve Bank of
Boston.
J. TERRENCE MURRAY, 57
Director since February 1995
Mr. Murray has been a Director of AFC since February 1995 and of FAFLIC from
January 1992 to April 1996. Mr. Murray is the Chairman, President and Chief
Executive Officer of Fleet Financial Group, Inc., a bank holding company,
where he has been employed since July 1962. Mr. Murray is also a Director of
A.T. Cross Co., a writing instrument company, and CVS Corporation, a drugstore
chain.
31
<PAGE>
ROBERT J. MURRAY, 55
Director since May 1996
Mr. Murray has been a Director of AFC since May 1996. He has been Chairman,
President and Chief Executive Officer of New England Business Service, Inc.
("NEBS"), a supplier of business forms, since December 1995 and has served on
the Board of Directors of NEBS since 1991. Prior to joining NEBS, Mr. Murray
was employed by The Gillette Company, Inc. ("Gillette"), a manufacturing
company, beginning in 1961. He served as a Corporate Vice President of
Gillette beginning in 1987 and as the Executive Vice President of Gillette's
North Atlantic Group from January 1991 to December 1995. Mr. Murray is also a
Director of North American Mortgage Company, LoJack Corporation and Fleet
National Bank, as well as a Trustee of Boston College.
JOHN F. O'BRIEN, 53
Director, Chief Executive Officer and President of the Company since February
1995
Mr. O'Brien has been a Director, Chief Executive Officer and President of
AFC since February 1995. He has also served as a Director, Chief Executive
Officer and President of FAFLIC since August 1989. In addition to his
positions with AFC and FAFLIC, Mr. O'Brien has served as a Director, President
and Chief Executive Officer of Allmerica P&C since August 1992, and has been a
Director of Hanover since September 1989, Citizens Insurance since March 1992
and Citizens, for which he also serves as Chief Executive Officer, since
December 1992. Mr. O'Brien is also a trustee or director and executive officer
of Allmerica Investment Trust, Allmerica Securities Trust, and Allmerica
Funds. Additionally, Mr. O'Brien is a director and/or holds offices at various
other non-public FAFLIC affiliates including SMA Financial Corp. and AFLIAC.
Mr. O'Brien also currently serves as a Director of The TJX Companies, Inc., an
off-price family apparel retailer, ABIOMED, Inc., a medical device company,
Cabot Corporation, a diversified specialty chemicals and materials and energy
company, The Life Insurance Association of Massachusetts, and The American
Council of Life Insurance. He also currently serves as a member of the
executive committee of the Mass Capital Resource Company, a Massachusetts
investment partnership. Prior to joining FAFLIC, Mr. O'Brien served as an
officer of FMR Corp., the parent company of various financial services
companies in the Fidelity Group and a director and/or an executive officer at
various other of FMR Corp.'s affiliates.
JOHN L. SPRAGUE, 66
Director since February 1995
Audit Committee
Mr. Sprague has been a Director of AFC since February 1995 and of FAFLIC
from September 1972 to April 1996. Mr. Sprague has been President of John L.
Sprague Associates, Inc., a consulting company for technology companies, since
January 1988. He served as President and Chief Executive Officer of Sprague
Electric Company, a semiconductor company, from December 1980 to January 1988.
Mr. Sprague is also a Director of Aerovox Corp., a manufacturing company,
Sipex Corporation and California MicroDevices Corporation, an electronic
components manufacturer.
ROBERT G. STACHLER, 67
Director since February 1995
Compensation Committee
Mr. Stachler has been a Director of AFC since February 1995, of FAFLIC from
March 1978 to April 1996, of Allmerica P&C since August 1992, and of Hanover
from April 1990 to December 1992. Mr. Stachler has been a partner at the law
firm of Taft, Stettinius & Hollister since 1964.
32
<PAGE>
HERBERT M. VARNUM, 59
Director since February 1995
Compensation Committee
Mr. Varnum has been a Director of AFC since February 1995, of FAFLIC from
March 1979 to April 1996, of Allmerica P&C since August 1992, and of Hanover
from December 1991 through December 1992. Mr. Varnum was employed by Quabaug
Corporation, a manufacturing company, beginning in 1960 and served as
President and Chief Executive Officer from 1982 to 1989, and as Chairman and
Chief Executive Officer from January 1990 until his retirement in June 1995.
RICHARD M. WALL, 68
Director since February 1995
Compensation Committee
Mr. Wall has been a Director of AFC since February 1995, of FAFLIC from
March 1986 to April 1996, of Allmerica P&C since August 1992, and of Hanover
from December 1991 through December 1992. Mr. Wall has been General Counsel
and assistant to the Chairman and Chief Executive Officer of FLEXcon Company,
Inc., a plastics manufacturing company, since November 1985.
EXECUTIVE OFFICERS OF THE REGISTRANT
JOHN F. O'BRIEN, 53
Director, Chief Executive Officer and President of the Company since February
1995
See biography under "Directors of the Registrant" above.
BRUCE C. ANDERSON, 53
Vice President of the Company since February 1995
Mr. Anderson has been Vice President of AFC since February 1995 and Vice
President of Allmerica P&C and Citizens since March 1997. Mr. Anderson has
been employed by FAFLIC since 1967 and has been Vice President of FAFLIC since
October 1984.
RICHARD J. BAKER, 65
Vice President and Secretary of the Company since February 1995
Mr. Baker has been Vice President and Secretary of AFC since February 1995,
Vice President and Assistant Secretary of FAFLIC since 1973 and April 1996,
respectively, and has been employed by FAFLIC since 1959. He has served as
Assistant Secretary of Allmerica P&C since October 1992, Vice President and
Secretary of Allmerica P&C since May 1995, and as Vice President and Secretary
of Citizens since September 1993 and January 1993, respectively. Mr. Baker has
also served as Vice President of AFLIAC since January 1982 and as Director
from June 1993 to April 1996. In addition, Mr. Baker is a director and/or
executive officer at various other non-public affiliates.
JOHN P. KAVANAUGH, 42
Vice President and Chief Investment Officer of the Company since 1996
Mr. Kavanaugh has been Vice President and Chief Investment Officer of AFC
since September 1996, has been employed by FAFLIC since 1983, and has been
Vice President of FAFLIC since December 1991 and Vice President of AFLIAC
since January 1992. Mr. Kavanaugh has also served as Director and Chief
Investment Officer of FAFLIC, Hanover, Citizens Insurance and AFLIAC since
August 1996, and Vice President and Chief Investment Officer of Allmerica P&C
and Citizens since September 1996. Mr. Kavanaugh is also a director and/or
executive officer at various other non-public affiliates.
33
<PAGE>
JOHN F. KELLY, 58
Vice President and General Counsel of the Company since February 1995
Mr. Kelly has been Vice President, General Counsel and Assistant Secretary
of AFC since February 1995, has been employed by FAFLIC since July 1968, and
has been Senior Vice President and General Counsel of FAFLIC since February
1986. In addition to his positions with AFC and FAFLIC, Mr. Kelly has been
Vice President and General Counsel of Allmerica P&C since August 1992,
Assistant Secretary of Allmerica P&C since May 1995, Assistant Secretary of
Citizens since December 1992, and Vice President, General Counsel and
Assistant Secretary of Citizens since September 1993. Mr. Kelly was Secretary
of Allmerica P&C from August 1992 to May 1995. Mr. Kelly has been a Director
of AFLIAC since October 1982 and is a director and/or executive officer at
various other non-public affiliates.
J. BARRY MAY, 49
Vice President of the Company since February 1997
Mr. May has been Vice President of AFC since February 1997, Vice President
of Allmerica P&C and President of Hanover since September 1996 and Vice
President of Citizens since March 1997. He has been a Director of Hanover and
Citizens Insurance since September 1996. Mr. May served as Vice President of
Hanover from May 1995 to September 1996, as Regional Vice President from
February 1993 to May 1995 and as a General Manager of Hanover from June 1989
to May 1995. Mr. May has been employed by Hanover since 1985.
JAMES R. MCAULIFFE, 52
Vice President of the Company since February 1995
Mr. McAuliffe has been Vice President of AFC from February 1995 through
December 1995 and since February 1997, Vice President of Allmerica P&C since
August 1992, a Director of Allmerica P&C from August 1992 through December
1994, a Director and Vice President of Citizens since December 1992, and a
Director of AFLIAC from April 1987 through May 1995 and since May 1996. Mr.
McAuliffe has been President of Citizens Insurance since December 1994. Mr.
McAuliffe has been employed by FAFLIC since 1968, and served as Vice President
and Chief Investment Officer of FAFLIC from November 1986 through December
1994. Mr. McAuliffe also served as Vice President and Chief Investment Officer
of Allmerica P&C from August 1992 through December 1994, and Vice President
and Chief Investment Officer of AFLIAC from December 1986 through May 1995.
Additionally, Mr. McAuliffe is a director and/or executive officer at various
other non-public affiliates.
EDWARD J. PARRY, III, 37
Vice President and Treasurer of the Company since February 1995
Chief Financial Officer of the Company since December 1996
Mr. Parry has been Chief Financial Officer of AFC since December 1996. He
has also been Vice President and Treasurer of AFC since February 1995. He has
served as Chief Financial Officer of FAFLIC, AFLIAC, Allmerica P&C, Hanover,
Citizens and Citizens Insurance since December 1996 and as Vice President and
Treasurer of FAFLIC, AFLIAC, Allmerica P&C and Hanover since February 1993 and
of Citizens since September 1993 and December 1992, respectively. Mr. Parry is
also a director and/or executive officer at various other non-public
affiliates. Prior to joining FAFLIC in July 1992, Mr. Parry was employed by
the accounting firm of Price Waterhouse from July 1987 through July 1992.
RICHARD M. REILLY, 58
Vice President of the Company since February 1997
Mr. Reilly has been Vice President of AFC and FAFLIC since February 1997 and
November 1990, respectively, and Vice President of Allmerica P&C and Citizens
since March 1997. He has also been a Director and Vice President of AFLIAC
since November 1990 and President and Chief Executive Officer of AFLIAC since
August 1995. Mr. Reilly was Vice President of AFC from February 1995 through
December 1995.
34
<PAGE>
Additionally, Mr. Reilly has been the President of Allmerica Investment Trust,
Allmerica Funds, and Allmerica Securities Trust, each a registered investment
company, since February 1991, April 1991 and February 1991, respectively. Mr.
Reilly is also a director and/or holds an executive office at various other
non-public affiliates. Prior to his affiliation with FAFLIC, he was executive
officer of Fidelity Management and Research Company from 1969 to 1987 and
Oppenheimer Capital from 1987 to 1990.
LARRY C. RENFRO, 46
Vice President of the Company since February 1997
Mr. Renfro has been a Vice President of AFC and FAFLIC since February 1997
and April 1990, respectively, and Vice President of Allmerica P&C and Citizens
since March 1997. He has served as Director, President and Chief Executive
Officer of 440 Financial Group of Worcester, Inc. (a former subsidiary of
FAFLIC) from May 1990 to March 1995. Mr. Renfro has also served as Vice
President of Allmerica P&C from October 1992 through December 1995 and as Vice
President of AFC from February 1995 through December 1995. From August 1989
through March 1990, Mr. Renfro was an Executive Vice President at State Street
Bank & Trust Company. From March 1988 through July 1989, Mr. Renfro served as
President and Chief Executive Officer of Boston Financial Data Services,
Incorporated, a subsidiary of State Street Bank & Trust Company. From April
1981 through March 1988, Mr. Renfro held various executive offices at Fidelity
Investments, including Managing Director of Fidelity Management & Research
Company. Mr. Renfro is currently a Director of LoJack Corporation, a
manufacturer of anti-theft systems.
ERIC A. SIMONSEN, 51
Vice President of the Company since February 1995
Mr. Simonsen has been Vice President of AFC since February 1995. He has been
a Director and Vice President of APY since August 1992, of Citizens since
December 1992 and of AFLIAC since September 1990. He has served as Vice
President and as a Director of FAFLIC since September 1990 and April 1996,
respectively. Mr. Simonsen has been President of Allmerica Service Company,
Inc. since December 1996. Mr. Simonsen was Chief Financial Officer of AFC from
February 1995 to December 1996, of FAFLIC and AFLIAC from September 1990 to
December 1996, of Allmerica P&C from August 1992 to December 1996 and of
Citizens from December 1992 to December 1996. Mr. Simonsen is also a director
and/or executive officer at various other non-public affiliates. From April
1987 to September 1990, Mr. Simonsen served as a Principal and Chief Financial
Officer of The Lincoln Group, Inc., a privately owned group of manufacturing
companies.
PHILLIP E. SOULE, 47
Vice President of the Company since February 1997
Mr. Soule has been Vice President of AFC, Citizens, and FAFLIC since
February 1997, March 1997 and February 1987, respectively, and of Allmerica
P&C since September 1996. He was Vice President of AFC from February 1995
through December 1995. Mr. Soule has been employed by FAFLIC since 1972 in
various capacities.
35
<PAGE>
ITEM 11
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all plan and non-plan compensation awarded
to, earned by, or paid to the Chief Executive Officer of AFC, and the four
other most highly compensated executive officers of AFC (collectively, the
"Named Executive Officers"). Because AFC is a holding company, it does not pay
any compensation to its executive officers. The Named Executive Officers,
unless otherwise indicated, receive compensation in their capacities as
executive officers of FAFLIC, which is then reimbursed, in accordance with
AFC's policy and intercompany service agreements, by its various subsidiaries
for services rendered to such subsidiaries.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
---------------------------- ------------
OTHER
ANNUAL LTIP ALL OTHER
COMPEN- PAY- COMPEN-
NAME AND BONUS SATION OUTS SATION
PRINCIPAL POSITION YEAR SALARY ($) ($)(1) ($)(2) ($)(3) ($)(4)
------------------ ---- ---------- --------- ------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
John F. O'Brien....... 1996 850,000 1,816,000 109,422 500,000 120,227
President and Chief 1995 775,000 775,000 109,422 250,000 120,227
Executive Officer 1994 725,000 400,000 132,922 0 161,402
Larry C. Renfro....... 1996 370,000 667,609 11,275 160,000 4,500
Vice President 1995 340,000 390,150 17,070 200,000 0
1994 340,000 95,000 10,250 240,000 21,420
Eric A. Simonsen...... 1996 370,000 406,436 12,215 160,000 4,500
Vice President 1995 305,000 99,430 18,492 210,000 4,500
1994 305,000 81,282 -- 260,000 19,215
Phillip E. Soule...... 1996 295,000 254,991 6,577 120,000 4,500
Vice President 1995 265,000 85,993 9,958 120,000 4,500
1994 245,000 91,508 3,208 140,000 15,435
Richard M. Reilly..... 1996 270,000 256,893 7,517 120,000 4,500
Vice President 1995 210,000 58,380 8,463 130,000 4,500
1994 210,000 74,760 -- 130,000 13,230
</TABLE>
- --------
(1) Amounts shown for 1996 include the following special bonus payments,
discussed in more detail in the Compensation Committee Report, which
payments are intended by the Company to facilitate the purchase of AFC
common stock by the executive officers in 1997: $1,000,000 for Mr.
O'Brien, $150,000 for Mr. Renfro, $250,000 for Mr. Simonsen, $150,000 for
Mr. Soule and $150,000 for Mr. Reilly. All other amounts shown are bonuses
earned pursuant to FAFLIC's Incentive Compensation Plan, except with
respect to the amounts reported for Mr. Renfro in 1996 and 1995, which
also include payments of $335,384 and $255,000, respectively, in
connection with the sale of FAFLIC's mutual fund servicing business,
discussed below.
(2) The amounts shown reflect the payment of taxes in the amount of $109,422
in 1996, $109,422 in 1995 and $109,850 in 1994 in connection with the
payment by FAFLIC of a life insurance premium on behalf of Mr. O'Brien.
All other amounts shown include interest earned on long-term incentive
compensation paid, or deferred at the election of the Named Executive
Officer, in the respective year. No Named Executive Officer received any
perquisites or other personal benefits from any source for his services to
FAFLIC or any subsidiary with an aggregate value exceeding the lesser of
$50,000 or 10% of cash compensation.
(3) Amounts shown include installment payments vesting and received by the
Named Executive Officers in the respective year pursuant to awards which
were earned in 1992, 1993, 1995 and 1996 under FAFLIC's Long-Term
Performance Unit Plan (the "Long-Term Performance Plan"). No such cash
amounts were earned in 1994 by the Named Executive Officers in respect of
units granted under the Long-Term Performance Plan with values
determinable based on FAFLIC's surplus level at the end of 1994.
36
<PAGE>
(4) Amounts shown include $4,500 paid to each of the Named Executive Officers
by FAFLIC during 1996 in the form of employer contributions to each Named
Executive Officer's 401(k) and related post-retirement accounts pursuant
to FAFLIC's 401(k) Matched Savings Plan ("Matched Savings Plan") (in
effect beginning in 1995) (except amounts contributed on behalf of Messrs.
O'Brien and Reilly in 1996, which are attributable to the Executive Non-
Qualified Retirement Plan) as well as pursuant to FAFLIC's Excess Benefit
Retirement Plan ("Excess Benefit Plan") as described more fully below. The
amount shown for Mr. O'Brien in 1996 also reflects the payment by FAFLIC
of a life insurance premium of $115,727.
OPTION GRANTS
The Company maintains a long-term stock incentive plan pursuant to which
stock options covering shares of the Company's Common Stock may be granted to
key employees.
In 1996, the Company did not grant any options to the Named Executive
Officers.
LONG-TERM INCENTIVE AWARDS
Neither the Company nor FAFLIC made any awards to Named Executive Officers
under the Long-Term Performance Plan in 1996.
EMPLOYMENT AGREEMENTS AND NON-SOLICITATION AGREEMENTS
In connection with the sale of FAFLIC's mutual fund servicing business to
The Shareholder Services Group, Inc. ("TSSG") and related transactions in
March 1995, and in consideration of the agreement by Mr. Renfro not to engage
in this business for four years, AFC agreed to pay Mr. Renfro (i) a one-time
bonus payment of $350,000 in 1995 ($95,000 of which represents a payment under
FAFLIC's Incentive Compensation Plan in respect of his 1994 performance), and
(ii) annual contingent payments based upon the prospective performance of the
businesses sold or assigned in the TSSG transactions for four years with
certain guaranteed minimum payments up to a maximum aggregate amount for four
years of $3.7 million. The agreement also provides that, in the event Mr.
Renfro is terminated without cause, he will receive $25,000 per month until
March 31, 1998 plus $600,000 (less any contingent payments made under (ii)
above). In the event of any such termination without cause, the agreement
provides that Mr. Renfro would be subject to confidentiality and non-
competition restrictions during the payment period.
As of December 31, 1996, substantially all of the Company's executive
officers had entered into non-solicitation agreements ("Non-Solicitation
Agreements") with the Company. The Non-Solicitation Agreements provide that,
during employment and for a period of two years after termination, the
executive officer will not recruit or solicit, attempt to induce, or assist or
encourage others to recruit or solicit, any employee, agent or broker of the
Company to terminate employment with the Company. The Non-Solicitation
Agreements prohibit the executive officers from soliciting the business or
patronage of any policyholders or existing or prospective clients, customers
or accounts of the Company that were contacted, solicited or served while the
executive officer was employed by the Company. Finally, the Non-Solicitation
Agreements provide that all proprietary information relating to the Company's
business and all software, works of authorship and other developments created
during employment by the Company are the sole property of the Company.
EMPLOYMENT CONTINUITY PLAN
In December 1996 the AFC Board of Directors voted to adopt the Allmerica
Financial Corporation Employment Continuity Plan (the "Employment Continuity
Plan"). The purposes of the Employment Continuity Plan are (i) to secure
senior management's objectivity and ensure focus on behalf of shareholder
interest in the event of actions or occurrences that could lead to a Change of
Control, and (ii) to ensure, in the event of a Change in Control resulting in
payment under the Employment Continuity Plan, that senior management does not
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<PAGE>
compete in the business of the Company, solicit Company employees or disclose
any confidential or propriety information of the Company. The Employment
Continuity Plan is administered by the AFC Board of Directors. All of the
Named Executive Officers were named as participants in the Employment
Continuity Plan at its adoption.
In the event of a Change in Control (defined below) of the Company and
subsequent involuntary termination of a participant within a two year period
after the Change in Control, or voluntary termination of the participant in
the 13th month after a Change in Control, the Employment Continuity Plan
authorizes the payment of specified benefits to eligible participants. These
include a lump-sum cash payment equal to a Multiplier (defined below) times a
participant's base salary, average bonus for the preceding three years, and
the amount that would be credited under a cash balance pension plan sponsored
by the Company or its affiliates. The Multiplier is three (3) for the Chief
Executive Office and two (2) for all other participants. Additionally, the
Employment Continuity Plan provides for continued coverage under the health
and welfare benefit plans sponsored by the Company and its affiliates, the
lump-sum actuarial equivalent for grandfathered benefits earned under the
retirement plan for "transition group" employees for the number of years
commensurate with the Multiplier, 75% of a participant's maximum bonus
potential pro-rated for service performed in the year of termination, and
outplacement services. The Chief Executive Officer is also entitled to a
gross-up payment when the Change in Control payment or other benefit under the
plan is subject to the excise tax imposed by section 4999 of the Internal
Revenue Code.
For purposes of the Employment Continuity Plan, a Change in Control is
defined as follows: (i) a change in the composition of the Board of Directors
such that the Incumbent Directors (as defined in the Employment Continuity
Plan) at the beginning of any consecutive twenty-four month period cease to
constitute a majority of the Board; (ii) any person or group is or becomes the
beneficial owner of 35% or more of the Company's voting stock outstanding;
(iii) a merger or consolidation of the Company or any affiliate that requires
shareholder approval, unless the shareholders immediately prior to the merger
or consolidation own more than 50% of the total voting stock of the successor
corporation or a majority of the board of directors of the successor
corporation were Incumbent Directors immediately prior to the merger or
consolidation; or (iv) the approval by shareholders of a plan of liquidation
or dissolution of the Company or the sale of all or substantially all of the
Company's assets.
In the event of a Change of Control, for all stock awards and stock options
granted to a participant pursuant to the Company's Long-Term Stock Incentive
Plan that do not otherwise vest immediately after the Change of Control, the
participant will be paid a lump sum amount equal to (i) the fair market value
of all stock awards as of the date of the Change of Control (excluding stock
options) and (ii) with respect to stock options, the excess of the fair market
value of the Company's common stock as of the date of the Change of Control
over the stock option exercise price.
The payment of benefits under the Employment Continuity Plan is contingent
upon the Company's receipt of a signed waiver and release from the participant
that release certain claims the participant may have and precludes the
participant from competing with the Company for a period of two years.
PENSION BENEFITS
FAFLIC, Hanover and Citizens each maintain a tax-qualified, non-contributory
defined benefit retirement plan ("Pension Plan") for the benefit of eligible
employees.
Until December 31, 1994, annual benefits under the Pension Plan were based
primarily upon each employee's years of service and compensation during the
highest five consecutive plan years of employment or the last 60 months if
greater. Such benefits under the Pension Plan were frozen as of December 31,
1994 for most participants, with the exception of certain grandfathered
employees, including Mr. Soule. These benefits will be paid to participants as
a monthly annuity at age 65 unless a participant terminates with 15 or more
years of service in which case monthly benefits may commence anytime after the
participant's 55th birthday. Effective as of January 1, 1995, the Pension Plan
was converted into a cash balance plan, such that benefits are no longer
determined primarily by final average compensation and years of service.
Instead, annually each employee
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<PAGE>
accrues a benefit that is equal to a percentage of the employee's salary,
similar to a defined contribution plan arrangement. Amounts contributed by the
employer to an employee are allocated to a memorandum account as to which the
employee is permitted to make investment elections from among choices provided
by the employer. Upon termination of employment of a participant, the amount
in the participant's memorandum account as of such date is eligible for
distribution. If the amount in the participant's memorandum account plus the
present value of the benefit frozen under the Pension Plan as of December 31,
1994 is less than $3,500, all benefits are distributed immediately in a lump
sum.
The estimated annual benefits payable under the Pension Plan upon retirement
at normal retirement age for each of the Named Executive Officers is as
follows: Mr. O'Brien: $428,138; Mr. Renfro: $258,033;
Mr. Simonsen: $151,262; Mr. Soule: $491,745; Mr. Reilly: $53,640. Such figures
include amounts that have accrued under the Pension Plan as in effect on
December 31, 1994, including, $355,841 for Mr. Soule. With respect to benefits
attributable to the cash balance component of the Pension Plan, it was assumed
that each individual's salary and bonus for the years until retirement were as
shown in the Summary Compensation Table; that employer allocations were made
to the Pension Plan at a rate of 7% of eligible compensation (7% is the actual
amount accrued in 1996, although the plan only guarantees an accrual rate of
0.5%); and that investment earnings accrued to each participant's memorandum
account under the Pension Plan at a rate of 6% per year.
The estimated annual benefits under the Pension Plan shown for each of the
Named Executive Officers are not reduced to reflect the limitations imposed by
Federal tax laws, which place upper limits on the benefits which may be
provided to any individual by tax-qualified pension plans. FAFLIC, Hanover and
Citizens Insurance each have adopted an Excess Benefit Plan, an unfunded, non-
qualified plan, which provides that it will pay directly the difference
between the retirement benefit normally calculated under the Pension Plan and
the maximum amount which may be paid from the Pension Plan consistent with
Federal tax law. In addition, certain employees of FAFLIC and its subsidiaries
may participate, in the discretion of the Board of Directors, in either an
unfunded, Non-Qualified Executive Retirement Plan or an unfunded, Non-
Qualified Executive Deferred Compensation Plan. Under the Non-Qualified
Executive Retirement Plan, participating employees may (i) elect to defer
compensation in an amount not to exceed the annual dollar limitation set forth
in the Internal Revenue Code in respect of defined contribution plans, (ii)
elect to defer additional compensation in an amount not to exceed 12.5% of the
participant's annual salary, (iii) receive and defer the amount, if any, that
the participant would have received as a matching employer's contribution
under his employer's 401(k) Matched Savings Plan, and (iv) receive and defer
the amount, if any, that the participant would have been credited under his
employer's Cash Balance and Excess Benefit Plans had the participant
participated in such plan during the year. Under the Non-Qualified Executive
Deferred Compensation Plan, certain other employees may elect to defer up to
12.5% of their annual salaries. In both cases, AFC shall from time to time
designate one or more investments in which each participant's accounts shall
be deemed to be invested for the purpose of determining the participant's
gains and income on such account. Participation in the Non-Qualified Executive
Retirement Plan is in lieu of participation in the corresponding qualified
retirement and/or pension plans of FAFLIC, Hanover or Citizens.
COMPENSATION COMMITTEE REPORT
General. The Compensation Committee ("Committee") of the Board of Directors
is comprised of the Directors whose names appear at the end of this report,
none of whom is an employee of AFC or of any affiliate or subsidiary of AFC.
Among other duties, the Committee has oversight responsibility with respect to
compensation matters involving Directors and executive officers of AFC. As a
holding company, AFC has no employees of its own and does not pay any
compensation to its officers. Officers who are employees of FAFLIC, Hanover or
Citizens Insurance are compensated directly by their respective employers. In
addition, a portion of the salaries and other compensation paid by FAFLIC to
its employees, who provide services to Hanover or Citizens Insurance, is
allocated to such companies. This report reflects the compensation philosophy
of AFC, FAFLIC, Hanover and Citizens Insurance as endorsed by the Committee.
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<PAGE>
Compensation Philosophy. The Executive Compensation Program is designed to
support the following objectives:
.to attract and retain individuals key to the future success of AFC and its
subsidiaries;
.to align the interests of executives with those of shareholders;
.to motivate and reward the profitable growth of AFC;
.to ensure that AFC has competitive opportunities for key personnel.
The key elements of the Executive Compensation Program consist of base
salary, annual incentive compensation and long-term incentive compensation. A
general description of each element and the review taken by the Committee for
the 1996 fiscal period is presented in the following material.
Base Salary. The chief goals of AFC and its subsidiaries are to improve
market focus in order to identify profitable opportunities that capitalize on
competitive strengths; to provide quality, value-added services that are
flexible and responsive to customer needs; to capitalize on growth
opportunities in targeted markets with innovative, market-driven products and
services that can be distributed broadly and cost-effectively; and to build
financial strength with effective business strategies that generate superior
financial performance and deliver solid returns on capital. In furtherance of
these goals, annual base salaries of the Named Executive Officers and other
key executives are set at levels considered to be competitive with amounts
paid to executive officers with comparable qualifications, experience and
responsibilities at competing companies, based on published surveys and proxy
information, which include base salary, total cash compensation data, and
other SEC required salary disclosures.
Annual Incentive Compensation. Annual incentive compensation for employees
of FAFLIC, Hanover and Citizens Insurance is tied to the achievement of
significant financial performance goals.
FAFLIC, Hanover and Citizens Insurance maintain a consolidated incentive
plan which provides supplementary cash compensation as an incentive to key
employees who, through exceptional performance, contribute materially to the
success of the companies. For 1996, the incentive plan had two components: (a)
the corporate and business unit return on equity; and (b) the successful
completion of individual performance goals. Awards under the incentive plan
may range from 0% to 100% of a participant's base salary.
Long-Term Compensation. FAFLIC maintains a Long-Term Performance Unit Plan
("Long-Term Performance Plan"). The Boards of both Hanover and Citizens
Insurance have ratified the participation of certain of their officers in the
Long-Term Performance Plan.
The objectives of the Long-Term Performance Plan include providing
incentives to attract and retain top executives and achieving significant
long-term financial results for FAFLIC and its subsidiaries. Criteria
considered in determining participation in the Long-Term Performance Plan
include the direct and measurable impact the executive has on longer-term
financial results, the influence the individual has on strategic direction and
the degree of risk inherent in the individual's business decisions. Previously
awarded units are payable dependent upon specific increases in capital,
surplus and equity position determined at of the end of a three-year plan
cycle and payments are made subject to a subsequent three-year vesting cycle.
The last three-year plan cycle under the Long-Term Performance Plan began in
1995. Therefore, no Named Executive Officers were awarded Long-Term
Performance Plan units in 1996, although certain awards made in 1995 will
continue to vest through 1999. Commencing in 1997, long-term incentive
compensation awards will be made to the Named Executive Officers pursuant to
AFC's Long-Term Stock Incentive Plan.
AFC, Allmerica P&C and Citizens Corporation each have in place Long Term
Stock Incentive Plans (the "Stock Plans"). The objectives of each of the Stock
Plans include providing incentives for participants to make substantial
contributions to the company's long-term business growth, enhancing the
company's ability to attract and retain executive officers and other key
employees, rewarding participants for their contributions to the success of
the company, and aligning the interests of executive officers and other key
employees with those of
40
<PAGE>
the company's stockholders. Up to 2,350,000 shares are available for awards
under the AFC plan, up to 1,000,000 shares are available for awards under
Allmerica P&C's plan and up to 200,000 shares are available for awards under
Citizens Corporation's plan. In connection with its conversion from a mutual
life insurance company to a stock life insurance company in October 1995,
State Mutual Life Assurance Company of America, FAFLIC's predecessor, agreed
with the Commissioner of Insurance of the Commonwealth of Massachusetts, in
the Plan of Reorganization dated February 28, 1995 (the "Plan of
Reorganization"), that certain executive officers of FAFLIC and AFC would not
be permitted to acquire AFC stock, and would not be eligible to participate in
any stock-based compensation plan, until one year after the demutualization
was completed. As a result, during 1996 no stock-based awards were made to the
ineligible executive officers, which included the Named Executive Officers.
Factors to be considered in determining the grant of options under the
respective stock plans include the contribution of each executive to the long-
term performance of AFC, Allmerica P&C or Citizens Corporation, respectively,
and the importance of such executive's responsibilities within the
organization.
Special Cash Bonus. In evaluating the total compensation of the Named
Executive Officers and certain other executive officers of FAFLIC and Hanover,
the Compensation Committee also considered the importance of individual stock
ownership of executive officers to the future performance of the Company. Due
to the restrictions imposed by the Plan of Reorganization prohibiting the
Named Executive Officers and certain other executive officers of AFC and
FAFLIC from acquiring AFC stock or participating in AFC's Stock Plan until
October 1996, the Compensation Committee approved a special cash bonus payment
to these executives with the intent that the bonus be used to purchase an
equal amount of AFC Common Stock. As an incentive to encourage such purchases,
for each share of AFC Common Stock purchased with such bonus funds, certain of
the Named Executive Officers will be awarded one share of restricted stock
pursuant to the AFC Stock Plan.
Compensation of the Chief Executive Officer. John F. O'Brien, President and
Chief Executive Officer of AFC, serves as President and Chief Executive
Officer of FAFLIC, and as Chairman of the Board of Hanover and of Citizens
Insurance.
In approving the 1996 compensation package for Mr. O'Brien, the Compensation
Committee compared Mr. O'Brien's compensation against the comparative base
salaries, annual and long-term incentives and other compensation of chief
executives of a peer group of companies. The peer goup companies included (i)
insurance companies identified as having distribution systems,
products/product mix and/or markets similar to FAFLIC and its subsidiaries;
(ii) a subset of insurance companies that were identified by scope of
financial activity (such as assets, revenue, and net written premium); and
(iii) a subset of financial service companies that provide for a
stratification of salary data based on similarity in the nature and scope of
business activities. The Compensation Committee assumes (a) that such
independent variables are meaningful in determining CEO compensation, and (b)
that a correlation exists between pay and such variables. However, the
approach does not consider variances in the business strategies and goals of
each company, the relative competitive positions of the companies, and the
personal characteristics and accomplishments of the individual executives.
Therefore, the review of Mr. O'Brien's compensation by the Compensation
Committee also included an assessment of the performance of FAFLIC and its
subsidiaries in terms of profitability and growth in the various business
lines, as well as an evaluation of the capital positions of the companies, the
implementation of significant cost controls and other strategic initiatives.
In comparison to the peer group of companies, Mr. O'Brien's base salary was
near the median, while the potential for incentive compensation, as a
percentage of base salary, was below the median.
Mr. O'Brien's 1996 incentive compensation performance measures included a
corporate goal based upon GAAP Consolidated Net Income Return on Equity of
AFC, business unit Return on Equity, focus goals relating to earnings per
share, revenue, AFC's stock price and individual performance goals. Individual
performance goals included significant improvement in earnings and capital;
development of alternate distribution systems; initiatives to improve
technology; and continued development and implementation of a strategic plan
for the Company. Achievement of individual performance goals and other
initiatives undertaken by Mr. O'Brien in 1996 resulted in performance that
exceeded expectations.
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The Compensation Committee carefully reviewed Mr. O'Brien's personal
achievements against his 1996 goals and based on its evaluation, the Committee
approved Mr. O'Brien's annual incentive compensation award of 96% of his base
salary, out of a maximum potential of 100% of base salary. In addition, the
Committee approved a special bonus award to Mr. O'Brien in the amount of
$1,000,000, based on the reasons discussed in the paragraph entitled "Special
Cash Bonus" above.
The Committee believes that the executive compensation policies of AFC and
its subsidiaries are appropriate both to attract and retain corporate officers
and other key employees of outstanding abilities and to motivate them to
perform to the full extent of their abilities.
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of the
Internal Revenue Code, enacted in 1993, generally disallows a tax deduction to
public companies for compensation over $1 million paid to the corporation's
Chief Executive Officer and its four other most highly compensated executive
officers. Qualifying performance-based compensation will not be subject to the
deduction limit if certain requirements are met. In 1996, the compensation
paid to the Chief Executive Officer exceeded the limit imposed by Section
162(m). The Committee monitors the impact of Section 162(m) in order to
balance the benefits of favorable tax treatment with a need to apply prudent
judgment in carrying out AFC's compensation philosophy, recognizing that under
certain circumstances it may be appropriate to exceed the deduction limit.
Members of the Compensation Committee:
Herbert M. Varnum, Chair
Robert G. Stachler
Richard M. Wall
DIRECTOR COMPENSATION
Non-employee Directors of AFC who are not also directors of APY receive an
annual retainer of $20,000. Non-employee Directors of AFC who are also
directors of APY receive an aggregate retainer of $30,000. In addition, non-
employee Directors of AFC receive $1,500 per meeting of the Board of Directors
and $1,000 for each meeting of a committee thereof that they attend. Mr.
O'Brien, the only Employee Director, is not paid any fees or additional
compensation for service as a member of the Board of Directors or any of its
committees. All Directors are reimbursed for reasonable travel and other
expenses of attending meetings of the Board of Directors and committees of the
Board of Directors.
As of the date of the annual meeting in 1997, Non-employee Directors of AFC
will receive an annual retainer of 1,400 shares of AFC stock payable on the
first business day following the annual meeting. Chairpersons of committees
will receive a $4,000 annual retainer. In addition, Non-employee Directors of
AFC will receive $1,500 per meeting of the Board of Directors and $1,000 for
each meeting of a committee thereof that they attend.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires executive
officers and Directors, and persons who beneficially own more than ten percent
(10%) of the Common Stock, to file initial reports of ownership and reports of
changes in ownership with the Securities and Exchange Commission (the "SEC")
and the New York Stock Exchange (the "NYSE"). Such persons are required by SEC
regulations to provide to AFC copies of all their Section 16(a) filings. Based
solely on a review of the forms furnished to AFC and written representations
from AFC's executive officers and Directors, AFC believes that during 1996
there was full compliance with all Section 16(a) filing requirements.
CERTAIN BUSINESS RELATIONSHIPS
The Company's subsidiaries or affiliates have, from time to time, retained
the services of Bowditch & Dewey, LLP, a law firm in which Mr. Angelini, a
Director of the Company, is a partner.
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COMMON STOCK PERFORMANCE CHART
The following graph compares the performance of the Company's Common Stock
since its initial public offering on October 11, 1995 with the performance of
the S&P 500 Index and with the performance of an industry peer group comprised
of a composite of two published indices--the S&P Property-Casualty Insurance
Index and the S&P Life Insurance Index. Returns of the latter two indices have
been weighted according to their respective aggregate market capitalization at
the beginning of each period shown on the graph. The graph plots the changes
in the value of an initial $100 investment over the indicated time periods,
assuming reinvestment of all dividends.
COMPARISON OF 14 MONTH CUMULATIVE TOTAL RETURN *
AMONG ALLMERICA FINANCIAL CORPORATION,
THE S&P 500 INDEX AND A PEER GROUP
[GRAPH APPEARS HERE]
- --------
* $100 invested on 10/11/95 in stock or index--including reinvestment of
dividends. Fiscal year ending December 31.
The insurance composite is a market value weighted composite of the S&P
Property-Casualty Insurance and the S&P Life Insurance indices. The components
of the insurance composite have been weighted in accordance with the
respective aggregate market capitalization of the companies in each index as
of the date of Allmerica Financial Corporation's public offering and at the
beginning of each period shown on the graph, as indicated below:
<TABLE>
<CAPTION>
10/11/95 12/95 3/96 6/96 9/96 12/96
-------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
S&P Property-Casualty.......... 62.09% 62.73% 61.13% 60.78% 59.62% 61.47%
S&P Life....................... 37.91% 37.27% 38.87% 39.22% 40.38% 38.53%
------ ------ ------ ------ ------ ------
Total.......................... 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
The Compensation Committee Report and Stock Price Performance Graph above
shall not be deemed incorporated by reference by any general statement
incorporating by reference this Annual Report on Form 10-K into any filing
under the Securities Act of 1933 or the Securities Exchange Act of 1934,
except to the extent that AFC specifically incorporates this information by
reference, and shall not otherwise be deemed filed under such acts.
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ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of Common Stock of AFC,
APY and Citizens Corporation owned as of March 17, 1997 by (i) each Director
of AFC, (ii) the named executive officers in the Summary Compensation Table
appearing later in this Proxy Statement, (iii) all officers and directors of
AFC as a group and (iv) each person who is known by AFC to be the beneficial
owner of more than five percent of the Common Stock as of such date. This
information has been furnished by the persons listed in the table.
<TABLE>
<CAPTION>
NUMBER OF SHARES OF NUMBER OF SHARES OF NUMBER OF SHARES OF
NAME OF COMMON STOCK OF COMMON STOCK OF COMMON STOCK OF
BENEFICIAL OWNER AFC* APY* CITIZENS*
---------------- ------------------- ------------------- -------------------
<S> <C> <C> <C>
Michael P. Angelini..... 54 3,000 --
David A. Barrett........ 285 600 1,000(1)
Gail L. Harrison........ 82 450 --
Robert P. Henderson..... -- -- --
J. Terrence Murray...... 69 -- --
Robert J. Murray........ -- -- --
John F. O'Brien......... 270(2) 16,000 1,000
Richard M. Reilly....... 98(3) -- --
Larry C. Renfro......... 88(4) -- --
Eric A. Simonsen........ 146(5) 9,000(6) 3,000(7)
Phillip E. Soule........ 652(8) 300 100
John L. Sprague......... 220 -- --
Robert G. Stachler...... 171 -- --
Herbert M. Varnum....... 76 600 --
Richard M. Wall......... 180 -- --
Directors and executive
officers as a group (22
persons)............... 21,674(9) 40,400 12,500
Holder of Greater Than Five Percent of Common Stock
10.43% of shares of AFC Common
FMR Corp................ 5,233,970(10) Stock outstanding
82 Devonshire Street
Boston MA 02109
</TABLE>
- --------
* With the exception of FMR Corp.'s holdings of AFC Common Stock, each of the
amounts represents less than 1% of the outstanding shares of Common Stock
as of March 22, 1996. As to shares beneficially owned, each person has sole
voting and investment power, except as indicated in other footnotes to this
table.
(1) Shares owned by Mr. Barrett's spouse. Mr. Barrett disclaims beneficial
ownership with respect to such shares.
(2) Includes 198 shares held for the benefit of Mr. O'Brien by the trustees
of the First Allmerica Financial Life Insurance Company's Employees'
401(k) Matched Savings Plan (the "FAFLIC Plan").
(3) Shares held for the benefit of Mr. Reilly by the trustees of the FAFLIC
Plan.
(4) Shares held for the benefit of Mr. Renfro by the trustees of the FAFLIC
Plan.
(5) Shares held for the benefit of Mr. Simonsen by the trustees of the FAFLIC
Plan.
(6) Includes an aggregate of 3,000 shares of Common Stock of APY held in
trusts for the benefit of Mr. Simonsen's children. Mr. Simonsen is
trustee of the trusts and he disclaims beneficial ownership of the shares
held in the trusts.
(7) Includes an aggregate of 1,000 shares of Common Stock of Citizens held in
trusts for the benefit of Mr. Simonsen's children. Mr. Simonsen is
trustee of the trusts and he disclaims beneficial ownership of the shares
held in the trusts.
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<PAGE>
(8) Includes 596 shares held for the benefit of Mr. Soule by the trustees of
the FAFLIC Plan.
(9) Includes 18,683 shares held by the trustees of the FAFLIC Plan. See notes
2-5 and 8 above.
(10) Based on a Schedule 13G dated February 14, 1997 filed by FMR Corp., which
has sole dispositive power overall 5,226,920 shares and sole voting power
over 289,820 shares.
As of March 17, 1997, there were no persons other than FMR Corp. known to
AFC to be the beneficial owners of more than 5% of the outstanding shares of
Common Stock.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
AFC's subsidiary, FAFLIC, currently provides various centralized
administrative and management services, operating support and office space to
Allmerica P&C and its subsidiaries, as well as to other FAFLIC subsidiaries.
Effective in 1970, Allmerica P&C's predecessor entered into an agreement with
FAFLIC pursuant to which FAFLIC agreed to provide services to Allmerica P&C in
accordance with FAFLIC's cost allocation policy. FAFLIC's cost allocation
policy is based on state insurance law requirements that all cost allocations
be on a fair and reasonable basis between entities and product lines within
FAFLIC's holding company structure and also are designed to meet regulations
imposed by taxing authorities. Services provided by FAFLIC include investment
services, portfolio management, and a certain amount of accounting, financial,
legal and administrative services, operations relating to servicing and
underwriting of policies and information and data systems. FAFLIC's cost
allocation and distribution policies are subject to review by various state
and federal regulatory agencies. AFC intends to continue to provide such
services on the same cost allocation basis to Allmerica P&C and its
subsidiaries immediately following the Merger Transactions.
Administrative charges (excluding rental charges) incurred by FAFLIC and
charged to Allmerica P&C were $58.0 million, $50.8 million and $63.1 million
for the years ended December 31, 1996, 1995 and 1994, respectively. Allmerica
P&C leases its principal office from FAFLIC, with which it shares most of the
facility. The annual rental charge was $1.3 million for each of the years
ended December 31, 1996, 1995 and 1994. The rent is triple net, with rent
based on cost using a fluctuating interest rate. FAFLIC believes that such
terms are no less favorable to Allmerica P&C than if the property was leased
to a non-affiliate.
In April 1996, Ms. Harrison and Messrs. Angelini, Barrett, J.T. Murray,
Sprague, Stachler, Varnum and Wall resigned their positions as Directors of
FAFLIC, the Company's operating subsidiary, in connection with the Company's
restructuring following the demutualization of FAFLIC's predecessor, State
Mutual Life Assurance Company of America. FAFLIC's subsequent Board of
Directors, consisting of insiders, terminated a FAFLIC policy that provided
FAFLIC's directors with periodic cash payments upon retirement from the FAFLIC
Board based on years of service with that company. Accrued benefits under the
terminated policy, which will be paid to the former FAFLIC directors in one
lump sum in 1997, had the following values as of December 17, 1996: $33,074
for Mr. Angelini; $166,851 for Mr. Barrett; $23,910 for Ms. Harrison; $18,417
for Mr. J.T. Murray; $137,745 for Mr. Sprague; $126,798 for Mr. Stachler;
$72,913 for Mr. Varnum; and $76,229 for Mr. Wall. Until the amounts above are
disbursed, the funds are accruing interest at the rate of 7% per annum.
45
<PAGE>
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
The consolidated financial statements and accompanying notes thereto on
pages 51 through 76 of the 1996 Annual Report to Shareholders have been
incorporated herein by reference in their entirety.
<TABLE>
<CAPTION>
ANNUAL
REPORT
PAGE(S)
--------
<S> <C>
Report of Independent Accountants................................. 50
Consolidated Statements of Income for the years ended December 31,
1996, 1995 and 1994.............................................. 51
Consolidated Balance Sheets as of December 31, 1996 and 1995...... 52
Consolidated Statements of Shareholders' Equity for the years
ended
December 31, 1996, 1995 and 1994................................. 53
Consolidated Statements of Cash Flows for the years ended December
31, 1996, 1995 and 1994.......................................... 54
Notes to Consolidated Financial Statements........................ 55-76
</TABLE>
(A)(2) FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE NO. IN
SCHEDULE THIS REPORT
-------- -----------
<C> <S> <C>
Report of Independent Accountants on Financial
Statement Schedules.................................... 51
Summary of Investments--Other than Investments in
I Related Parties........................................ 52
II Condensed Financial Information of Registrant.......... 53-55
III Supplementary Insurance Information.................... 56-58
IV Reinsurance............................................ 59
V Valuation and Qualifying Accounts...................... 60
VI Supplemental Information concerning Property/Casualty
Insurance Operations................................... 61
</TABLE>
(A)(3) EXHIBIT INDEX
Exhibits filed as part of this Form 10-K are as follows:
<TABLE>
<C> <S>
2.1 Plan of Reorganization.+
2.2 Stock and Asset Purchase Agreement by an among State Mutual Life
Assurance Company of America, 440 Financial Group of Worcester, Inc., and
The Shareholder Services Group, Inc. dated as of March 9, 1995.+
2.3 Agreement and Plan of Merger, dated as of February 19, 1997, among AFC,
Allmerica Property and Casualty Companies, Inc. and APY Acquisition,
Inc.++++
3.1 Certificate of Incorporation of AFC.+
3.2 By-Laws of AFC.+
4 Specimen Certificate of Common Stock.+
4.1 Form of Indenture relating to the Debentures between the Registrant and
State Street Bank & Trust Company, as trustee.++
4.2 Form of Global Debenture.++
4.3 Amended and Restated Declaration of Trust of AFC Capital Trust I dated
February 3, 1997.+++++
4.4 Indenture dated February 3, 1997 relating to the Junior Subordinated
Debentures of AFC.+++++
</TABLE>
46
<PAGE>
<TABLE>
<C> <S>
4.5 Series A Capital Securities Guarantee Agreement dated February 3,
1997.+++++
4.6 Common Securities Guarantee Agreement dated February 3, 1997.+++++
4.7 Registration Rights Agreement dated February 3, 1997.+++++
10.1 Consolidated Income Tax Agreement between Allmerica Financial
Corporation and certain subsidiaries dated January 1, 1996.+++
10.2 Consolidated Service Agreement between State Mutual Life Assurance
Company of America and its subsidiaries, dated September 30, 1993.+
10.2.1 Addendum to the Consolidated Service Agreement between State Mutual
Life Assurance Company of America and its subsidiaries, dated October
9, 1995.+++
10.2.2 Addendum to the Consolidated Service Agreement between State Mutual
Life Assurance Company of America and its subsidiaries, dated November
30, 1995.+++
10.3 Administrative Services Agreement between State Mutual Life Assurance
Company of America and The Hanover Insurance Company, dated July 19,
1989.+
10.4 First Allmerica Financial Life Insurance Company Employees' 401(k)
Matched Savings Plan incorporated by reference to Exhibit 10.1 to the
Allmerica Financial Corporation Registration Statement on Form 8-K (No.
333-576) and incorporated herein by reference originally filed with the
Commission on January 24, 1996.
10.5 State Mutual Life Assurance Company of America Excess Benefit
Retirement Plan.+
10.6 State Mutual Life Assurance Company of America Supplemental Executive
Retirement Plan.+
10.7 State Mutual Incentive Compensation Plan.+
10.8 State Mutual Companies Long-Term Performance Unit Plan.+
10.9 Indenture of Lease between State Mutual Life Assurance Company of
America and the Hanover Insurance Company dated July 3, 1984 and
corrected First Amendment to Indenture of Lease dated December 20,
1993.+
10.11 Lease dated November 1993 by and between Connecticut General Life
Insurance Company and State Mutual Life Assurance Company of America,
including amendments thereto, relating to property in Marlborough,
Massachusetts.+
10.12 Lease dated March 23, 1993 by and between Aetna Life Insurance Company
and State Mutual Life Assurance Company of America, including
amendments thereto, relating to property in Atlanta, Georgia.+
10.13 Stockholder Services Agreement dated as of January 1, 1992 between
Private Healthcare Systems, Inc. and Group Healthcare Network, Inc., a
wholly-owned subsidiary of State Mutual Life Assurance Company of
America.+
10.14 Lease dated January 26, 1995 by and between Citizens Insurance and
Upper Peninsula Commission for Area Progress, Inc., including
amendments thereto, relating to property in Escanaba, Michigan.+
10.15 Compensation Agreement between State Mutual Life Assurance of America
and Larry E. Renfro.+
10.16 Trust Indenture for the State Mutual Life Assurance Company of America
Employees' 401(k) Matched Savings Plan between State Mutual Life
Assurance Company of America and Bank of Boston/Worcester.+
10.17 State Mutual Life Assurance Company of America Non-Qualified Executive
Retirement Plan.+
10.18 State Mutual Life Assurance Company of America Non-Qualified Executive
Deferred Compensation Plan.+
10.19 The Allmerica Financial Cash Balance Pension Plan incorporated by
reference to Exhibit 10.19 to the Allmerica Financial Corporation
September 30, 1995 report on Form 10-Q and incorporated herein by
reference.
10.20 The Allmerica Financial Corporation Employment Continuity Plan
10.21 Form of Non-Solicitation Agreement executed by substantially all of the
executive officers of AFC.
11 Statement regarding computation of per share earnings.
13 Annual Report to Shareholders for 1996.
21 Subsidiaries of AFC.
23 Consent of Price Waterhouse LLP.
24 Power of Attorney.
</TABLE>
47
<PAGE>
<TABLE>
<C> <S>
27 Financial Data Schedule.
99.1 Internal Revenue Service Ruling dated April 15, 1995.+
99.2 Important Factors Regarding Forward Looking Statements.
</TABLE>
- --------
+ Incorporated herein by reference to the correspondingly numbered exhibit
contained in the Registrant's Registration Statement on Form S-1 (No.
33-91766) originally filed with the Commission on May 1, 1995.
++ Incorporated herein by reference to the correspondingly numbered exhibit
contained in the Registrant's Registration Statement on Form S-1 (No.
33-96764) originally filed with the Commission on September 11, 1995.
+++ Incorporated herein by reference to the correspondingly numbered exhibit
contained in the Registrant's 1995 Annual Report on Form 10-K originally
filed with the Commission on March 28, 1996.
++++ Incorporated by herein by reference to Exhibit I of the Current Report
of the Registrant (Commission File No. 1-13754) filed February 20, 1997.
+++++ Incorporated herein by reference to Exhibits 2, 3, 4, 5 and 6,
respectively, contained in the Registrant's Current Report on Form 8-K
filed on February 5, 1997.
(B) REPORTS ON FORM 8-K
On December 18, 1996, a report on Form 8-K was filed reporting under item 5,
Other Events, the announcement by the Registrant that AFC's Board of Directors
had made a proposal to the Board of Directors of Allmerica P&C to acquire the
shares of Common Stock of Allmerica P&C that AFC and its subsidiaries do not
already own.
On February 5, 1997, a report on Form 8-K was filed reporting under item 5,
Other Events, the announcement of the sale of $300 million of Capital
Securities issued by AFC Capital Trust I.
On February 20, 1997, a report on Form 8-K was filed reporting under item 5,
Other Events, the announcement that the Company and Allmerica P&C entered into
an Agreement and Plan of Merger.
48
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES AND
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
Date: March 18, 1997 /s/ John F. O'Brien
By: _________________________________
JOHN F. O'BRIEN,
CHAIRMAN OF THE BOARD,
CHIEF EXECUTIVE OFFICER AND
PRESIDENT
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
Date: March 18, 1997
/s/ John F. O'Brien
By: _________________________________
JOHN F. O'BRIEN,
CHAIRMAN OF THE BOARD,
CHIEF EXECUTIVE OFFICER AND
PRESIDENT
Date: March 18, 1997
/s/ Edward J. Parry, III
By: _________________________________
EDWARD J. PARRY III,
VICE PRESIDENT, CHIEF FINANCIAL
OFFICER AND PRINCIPAL ACCOUNTING
OFFICER
Date: March 18, 1997
*
By: _________________________________
MICHAEL P. ANGELINI,
DIRECTOR
Date: March 18, 1997
By: _________________________________
DAVID A. BARRETT,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
GAIL L. HARRISON,
DIRECTOR
Date: March 18, 1997
By: _________________________________
ROBERT P. HENDERSON,
DIRECTOR
49
<PAGE>
Date: March 18, 1997
*
By: _________________________________
J. TERRENCE MURRAY,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
ROBERT J. MURRAY,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
JOHN L. SPRAGUE,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
ROBERT G. STACHLER,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
HERBERT M. VARNUM,
DIRECTOR
Date: March 18, 1997
*
By: _________________________________
RICHARD M. WALL,
DIRECTOR
/s/ John F. O'Brien
*By: ________________________________
JOHN F. O'BRIEN,
ATTORNEY-IN-FACT
50
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULES
To the Board of Directors of
Allmerica Financial Corporation
Our audits of the consolidated financial statements referred to in our
report dated February 3, 1997, except as to Notes 1 and 2, which are as of
February 19, 1997, appearing in the Allmerica Financial Corporation 1996
Annual Report to Shareholders (which report and consolidated financial
statements are incorporated by reference in this Annual Report on Form 10-K)
also included an audit of the Financial Statement Schedules listed in Item
14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules
present fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
As discussed in the accompanying notes to the consolidated financial
statements, the Company changed its method of accounting for investments (Note
1) and postemployment benefits (Note 11) in 1994.
/s/ Price Waterhouse LLP
_____________________________________
Price Waterhouse LLP
Boston, Massachusetts
February 3, 1997, except as to Notes
1 and 2, which are as of February
19, 1997
51
<PAGE>
SCHEDULE I
ALLMERICA FINANCIAL CORPORATION
SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
IN THE BALANCE
TYPE OF INVESTMENT COST (1) VALUE SHEET
- ------------------ -------- ------- --------------
(IN MILLIONS)
<S> <C> <C> <C>
Fixed maturities:
Bonds:
United States Government and government
agencies and authorities.................. $ 520.8 $ 530.7 $ 530.7
States, municipalities and political subdi-
visions................................... 2,228.8 2,269.6 2,269.6
Foreign governments........................ 108.8 116.2 116.2
Public utilities........................... 495.7 508.3 508.3
Convertibles and bonds with warrants at-
tached.................................... 1.1 1.3 1.3
All other corporate bonds.................. 3,844.8 3,952.8 3,952.8
Redeemable preferred stocks.................. 105.5 108.9 108.9
-------- ------- --------
Total fixed maturities..................... 7,305.5 7,487.8 7,487.8
-------- ------- --------
Equity securities:
Common stocks:
Public utilities........................... 4.9 5.5 5.5
Banks, trust and insurance companies....... 30.6 55.1 55.1
Industrial, miscellaneous and all other.... 281.4 401.5 401.5
Nonredeemable preferred stocks............... 11.3 11.5 11.5
-------- ------- --------
Total equity securities.................... 328.2 473.6 473.6
-------- ------- --------
Mortgage loans on real estate.................. 650.1 XXXXXX 650.1
Real estate (2)................................ 120.7 XXXXXX 120.7
Policy loans................................... 132.4 XXXXXX 132.4
Other long-term investments.................... 128.8 XXXXXX 128.8
-------- --------
Total investments.......................... $8,665.7 XXXXXX $8,993.4
======== ========
</TABLE>
- --------
(1) Original cost of equity securities and, as to fixed maturities, original
cost reduced by repayments and adjusted for amortization of premiums and
accretion of discounts.
(2) Includes $106.6 million of real estate acquired through foreclosure.
52
<PAGE>
SCHEDULE II
ALLMERICA FINANCIAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ -----
(IN MILLIONS)
<S> <C> <C> <C>
Revenues
Net investment income................................. $ 2.7 $ 0.4 $ --
Net realized investment losses........................ (0.9) -- --
------ ------ -----
Total revenues...................................... 1.8 0.4 38.0
------ ------ -----
Expenses
Interest expense...................................... 15.3 3.2 --
Operating expenses.................................... 3.3 0.3 --
------ ------ -----
Total expenses...................................... 18.6 3.5 --
------ ------ -----
Net income before federal income taxes and equity in net
income of unconsolidated subsidiaries.................. (16.8) (3.1) 38.0
Federal income tax benefit.............................. 5.9 -- --
Equity in net income of unconsolidated subsidiaries
prior to demutualization............................... -- 93.2 38.0
Equity in net income of unconsolidated subsidiaries
subsequent to demutualization.......................... 192.8 43.8 --
------ ------ -----
Net income.............................................. $181.9 $133.9 $38.0
====== ====== =====
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial statements and notes thereto. Allmerica Financial
Corporation ("AFC") was incorporated under Delaware law on January 12, 1995,
for the purpose of becoming the parent holding company of First Allmerica
Financial Insurance Company ("FAFLIC"). Accordingly, the financial information
reflects the equity in the financial position and results of operations of
FAFLIC for the periods prior to the date of demutualization as if AFC had been
the parent of FAFLIC at that time.
53
<PAGE>
SCHEDULE II
(CONTINUED)
ALLMERICA FINANCIAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1995
------------- -------------
(IN MILLIONS, EXCEPT SHARE
AND PER SHARE DATA)
<S> <C> <C>
ASSETS
Fixed maturities-at fair value (amortized cost of
$26.4).......................................... $ 26.2 $ --
Equity securities-at fair value (amortized cost
of $0.4)........................................ 0.6 --
Cash............................................. 2.5 52.9
Investment in unconsolidated subsidiaries........ 1,896.3 1,724.2
Accrued investment income........................ 0.4 0.2
Other assets..................................... 5.2 2.3
------------- -------------
Total assets................................... $1,931.2 $1,779.6
============= =============
LIABILITIES
Expenses and taxes payable....................... $ 1.1 $ 0.2
Deferred income taxes............................ 0.1 --
Dividends payable................................ 2.5 2.5
Interest payable................................. 3.3 3.2
Long-term debt................................... 199.5 199.5
------------- -------------
Total liabilities.............................. 206.5 205.4
------------- -------------
Shareholders' Equity
Preferred stock, par value $0.01 per share, 20.0
million shares authorized, none issued.......... -- --
Common stock, par value $0.01 per share, 300.0
million shares authorized, 50.1 million shares
issued and outstanding at December 31, 1996 and
December 31, 1995............................... 0.5 0.5
Additional paid-in-capital....................... 1,382.5 1,382.5
Unrealized appreciation on investments, net...... 131.6 153.0
Retained earnings................................ 210.1 38.2
------------- -------------
Total shareholders' equity..................... 1,724.7 1,574.2
------------- -------------
Total liabilities and shareholders' equity..... $1,931.2 $1,779.6
============= =============
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial statements and notes thereto. Allmerica Financial
Corporation ("AFC") was incorporated under Delaware law on January 12, 1995,
for the purpose of becoming the parent holding company of First Allmerica
Financial Insurance Company ("FAFLIC"). Accordingly, the financial information
reflects the equity in the financial position and results of operations of
FAFLIC for the periods prior to the date of demutualization as if AFC had been
the parent of FAFLIC at that time.
54
<PAGE>
SCHEDULE II (CONTINUED)
ALLMERICA FINANCIAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Cash flows from operating activities
Net income, including net income prior to
demutualization................................... $ 181.9 $ 133.9 $ 38.0
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed income of First Allmerica
Financial Life Insurance Company................. (192.8) (137.0) (38.0)
Net realized investment losses.................... 0.9 -- --
Change in accrued investment income............... (0.2) (0.2) --
Change in expenses and taxes payable.............. 0.9 0.2 --
Change in dividends payable....................... -- 2.5 --
Change in debt interest payable................... 0.1 3.2 --
Other, net........................................ (3.6) (2.5)
------- ------- ------
Net cash (used in) provided by operating
activities......................................... (12.8) 0.1 --
------- ------- ------
Cash flows from investing activities Capital
contributed to unconsolidated subsidiaries......... -- (392.4) --
Proceeds from disposals and maturities of
available-for- sale fixed maturities.............. 32.7 -- --
Purchase of available-for-sale fixed maturities.... (59.6) -- --
Purchase of equity securities...................... (0.7) -- --
------- ------- ------
Net cash used in investing activities............... (27.6) (392.4) --
------- ------- ------
Cash flow from financing activities Net proceeds
from issuance of common stock...................... -- 248.0 --
Net proceeds from issuance of debt securities...... -- 197.2 --
Dividends paid to shareholders..................... (10.0) -- --
------- ------- ------
Net cash (used in) provided by financing
activities......................................... (10.0) 445.2 --
------- ------- ------
Net change in cash and cash equivalents............. (50.4) 52.9 --
Cash and cash equivalents at beginning of the
period............................................. 52.9 -- --
------- ------- ------
Cash and cash equivalents at end of the period...... $ 2.5 $ 52.9 $ --
======= ======= ======
</TABLE>
The condensed financial information should be read in conjunction with the
consolidated financial statements and notes thereto. Allmerica Financial
Corporation ("AFC") was incorporated under Delaware law on January 12, 1995,
for the purpose of becoming the parent holding company of First Allmerica
Financial Insurance Company ("FAFLIC"). Accordingly, the financial information
reflects the equity in the financial position and results of operations of
FAFLIC for the periods prior to the date of demutualization as if AFC had been
the parent of FAFLIC at that time.
55
<PAGE>
SCHEDULE III
ALLMERICA FINANCIAL CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, 1996
<TABLE>
<CAPTION>
FUTURE
POLICY AMORTIZA-
BENEFITS, OTHER BENEFITS, TION OF
DEFERRED LOSSES, POLICY CLAIMS, DEFERRED
POLICY CLAIMS AND CLAIMS AND NET INVEST- LOSSES AND POLICY OTHER PREM-
ACQUISI- LOSS UNEARNED BENEFITS PREMIUM MENT SETTLEMENT ACQUISI- OPERATING IUMS
TION COSTS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES TION COSTS EXPENSES WRITTEN
---------- ---------- -------- ---------- -------- ----------- ---------- ---------- --------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
RISK MANAGEMENT
Regional Property
and Casualty.... $164.2 $2,744.1 $815.1 $12.8 $1,898.3 $235.4 $1,383.4 $422.6 $190.0 $1,914.4
Corporate Risk
Management
Services........ 2.9 299.0 4.7 11.1 302.9 21.7 211.3 3.1 126.4 --
RETIREMENT AND
ASSET MANAGEMENT
Retail Financial
Services........ 649.0 2,225.5 2.7 120.1 34.0 198.7 202.2 54.9 117.6 --
Institutional
Services........ 6.6 289.2 -- 1,916.4 1.1 214.0 160.1 2.9 50.9 --
Allmerica Asset
Management...... -- -- -- -- -- 0.1 -- -- 7.7 --
Corporate........ -- -- -- -- -- 2.7 -- -- 18.6 --
Eliminations..... -- -- -- -- -- -- -- -- (8.7) --
------ -------- ------ -------- -------- ------ -------- ------ ------ --------
Total........... $822.7 $5,557.8 $822.5 $2,060.4 $2,236.3 $672.6 $1,957.0 $483.5 $502.5 $1,914.4
====== ======== ====== ======== ======== ====== ======== ====== ====== ========
</TABLE>
56
<PAGE>
SCHEDULE III (CONTINUED)
ALLMERICA FINANCIAL CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, 1995
<TABLE>
<CAPTION>
FUTURE
POLICY AMORTIZA-
BENEFITS, OTHER BENEFITS, TION OF
DEFERRED LOSSES, POLICY CLAIMS, DEFERRED
POLICY CLAIMS AND CLAIMS AND NET INVEST- LOSSES AND POLICY OTHER PREM-
ACQUISI- LOSS UNEARNED BENEFITS PREMIUM MENT SETTLEMENT ACQUISI- OPERATING IUMS
TION COSTS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES TION COSTS EXPENSES WRITTEN
---------- ---------- -------- ---------- -------- ----------- ---------- ---------- --------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
RISK MANAGEMENT
Regional Property
and Casualty.... $157.5 $2,896.0 $797.3 $ 12.8 $1,863.2 $209.6 $1,300.3 $409.1 $179.4 $1,885.3
Corporate Risk
Management
Services........ 2.3 282.4 0.8 9.4 272.7 17.6 197.2 2.7 110.3 --
RETIREMENT AND
ASSET MANAGEMENT
Retail Financial
Services........ 569.4 2,248.2 2.8 148.7 86.6 216.3 295.0 55.3 101.2 --
Institutional
Services........ 6.5 294.0 -- 2,566.5 0.3 266.4 217.8 3.2 66.4 --
Allmerica Asset
Management...... -- -- -- -- -- 0.2 -- -- 2.1 --
Corporate........ -- -- -- -- -- 0.4 -- -- 3.5 --
Eliminations..... -- -- -- -- -- -- -- -- (4.4) --
------ -------- ------ -------- -------- ------ -------- ------ ------ --------
Total........... $735.7 $5,720.6 $800.9 $2,737.4 $2,222.8 $710.5 $2,010.3 $470.3 $458.5 $1,885.3
====== ======== ====== ======== ======== ====== ======== ====== ====== ========
</TABLE>
57
<PAGE>
SCHEDULE III (CONTINUED)
ALLMERICA FINANCIAL CORPORATION
SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, 1994
<TABLE>
<CAPTION>
FUTURE
POLICY AMORTIZA-
BENEFITS, OTHER BENEFITS, TION OF
DEFERRED LOSSES, POLICY CLAIMS, DEFERRED
POLICY CLAIMS AND CLAIMS AND NET INVEST- LOSSES AND POLICY OTHER PREM-
ACQUISI- LOSS UNEARNED BENEFITS PREMIUM MENT SETTLEMENT ACQUISI- OPERATING IUMS
TION COSTS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES TION COSTS EXPENSES WRITTEN
---------- ---------- -------- ---------- -------- ----------- ---------- ---------- --------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
RISK MANAGEMENT
Regional Property
and Casualty.... $155.0 $2,821.7 $793.2 $11.9 $1,791.3 $202.4 $1,315.5 $390.3 $185.9 $1,822.9
Corporate Risk
Management
Services........ 2.2 248.1 0.6 10.0 268.0 14.0 182.6 2.5 97.4 --
RETIREMENT AND
ASSET MANAGEMENT
Retail Financial
Services........ 637.5 3,037.2 2.8 260.5 121.6 223.9 300.8 79.5 113.4 --
Institutional
Services........ 8.1 300.9 -- 3,153.3 0.9 302.8 248.1 3.4 142.0 --
Allmerica Asset
Management...... -- -- -- -- -- -- -- -- 2.1 --
Eliminations..... -- -- -- -- -- -- -- -- (21.9) --
------ -------- ------ -------- -------- ------ -------- ------ ------ --------
Total........... $802.8 $6,407.9 $796.6 $3,435.7 $2,181.8 $743.1 $2,047.0 $475.7 $518.9 $1,822.9
====== ======== ====== ======== ======== ====== ======== ====== ====== ========
</TABLE>
58
<PAGE>
SCHEDULE IV
ALLMERICA FINANCIAL CORPORATION
REINSURANCE
DECEMBER 31,
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
--------- --------- ---------- --------- -----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1996
Life insurance in force... $41,943.1 $7,135.8 $559.2 $35,366.5 1.58%
========= ======== ====== ========= =====
Premiums:
Life insurance.......... $ 72.0 $ 18.1 $ 5.9 $ 59.8 9.85%
Accident and health
insurance.............. 317.1 120.8 81.9 278.2 29.41%
Property and casualty
insurance.............. 2,018.5 232.6 112.4 1,898.3 5.92%
--------- -------- ------ ---------
Total premiums............ $ 2,407.6 $ 371.5 $200.2 $ 2,236.3 8.78%
========= ======== ====== ========= =====
1995
Life insurance in force... $40,274.2 $8,003.1 $585.6 $32,856.7 1.78%
========= ======== ====== ========= =====
Premiums:
Life insurance.......... $ 131.4 $ 33.8 $ 1.8 $ 99.4 1.80%
Accident and health
insurance.............. 307.5 116.5 69.2 260.2 26.59%
Property and casualty
insurance.............. 2,021.7 296.2 137.7 1,863.2 7.39%
--------- -------- ------ ---------
Total premiums............ $ 2,460.6 $ 446.5 $208.7 $ 2,222.8 9.39%
========= ======== ====== ========= =====
1994
Life insurance in force... $41,812.5 $2,301.2 $649.1 $40,160.4 1.62%
Premiums:
Life insurance.......... $ 144.4 $ 9.5 $ 2.5 $ 137.4 1.80%
Accident and health
insurance.............. 302.8 101.5 51.8 253.1 20.47%
Property and casualty
insurance.............. 1,967.1 291.9 116.1 1,791.3 6.48%
--------- -------- ------ ---------
Total premiums............ $ 2,414.3 $ 402.9 $170.4 $ 2,181.8 7.81%
========= ======== ====== ========= =====
</TABLE>
59
<PAGE>
SCHEDULE V
ALLMERICA FINANCIAL CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31,
<TABLE>
<CAPTION>
ADDITIONS
---------------------
DEDUCTIONS
BALANCE AT CHARGED TO CHARGED TO FROM BALANCE AT
BEGINNING OF COSTS AND OTHER ALLOWANCE END OF
PERIOD EXPENSE ACCOUNTS ACCOUNT PERIOD
------------ ---------- ---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
1996
Mortgage loans.......... $33.8 $ 5.5 $-- $19.7 $19.6
Real estate............. 19.6 -- -- 4.7 14.9
Allowance for doubtful
accounts............... 4.6 6.8 -- 6.9 4.5
----- ----- ---- ----- -----
$58.0 $12.3 $-- $31.3 $39.0
===== ===== ==== ===== =====
1995
Mortgage loans.......... $47.2 $ 1.5 $-- $14.9 $33.8
Real estate............. 22.9 (0.6) -- 2.7 19.6
Allowance for doubtful
accounts............... 4.7 5.3 -- 5.4 4.6
----- ----- ---- ----- -----
$74.8 $ 6.2 $-- $23.0 $58.0
===== ===== ==== ===== =====
1994
Mortgage loans.......... $73.8 $14.6 $-- $41.2 $47.2
Real estate............. 21.0 3.2 -- 1.3 22.9
Allowance for doubtful
accounts............... 3.5 4.1 -- 2.9 4.7
----- ----- ---- ----- -----
$98.3 $21.9 $-- $45.4 $74.8
===== ===== ==== ===== =====
</TABLE>
60
<PAGE>
SCHEDULE VI
ALLMERICA FINANCIAL CORPORATION
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
DISCOUNT, IF
RESERVES FOR ANY,
DEFERRED LOSSES AND DEDUCTED
POLICY LOSS FROM NET NET
ACQUISITION ADJUSTMENT PREVIOUS UNEARNED PREMIUMS INVESTMENT
AFFILIATION WITH REGISTRANT COSTS EXPENSES(2) COLUMN(1) PREMIUMS(2) EARNED INCOME
--------------------------- ----------- ------------ ------------ ----------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Consolidated Property and
Casualty Subsidiaries
1996................... $164.2 $2,744.1 $-- $815.1 $1,898.3 $235.4
====== ======== ==== ====== ======== ======
1995................... $157.5 $2,896.0 $-- $797.3 $1,863.2 $209.6
====== ======== ==== ====== ======== ======
1994................... $155.0 $2,821.7 $-- $793.2 $1,791.3 $202.4
====== ======== ==== ====== ======== ======
</TABLE>
<TABLE>
<CAPTION>
LOSSES AND LOSS
ADJUSTMENT EXPENSES
------------------------
AMORTIZATION
OF DEFERRED PAID LOSSES
POLICY AND LOSS
ACQUISITION ADJUSTMENT NET PREMIUMS
CURRENT YEAR PRIOR YEARS EXPENSES EXPENSES WRITTEN
------------ ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
1996......... $1,513.3 $(141.4) $422.6 $1,387.2 $1,914.4
======== ======= ====== ======== ========
1995......... $1,427.3 $(137.6) $409.1 $1,266.5 $1,885.3
======== ======= ====== ======== ========
1994......... $1,434.8 $(128.1) $390.3 $1,217.1 $1,822.9
======== ======= ====== ======== ========
</TABLE>
- --------
(1) The Company does not employ any discounting techniques.
(2) Reserves for losses and loss adjustment expenses are shown gross of $626.9
million, $763.5 million and $712.5 million of reinsurance recoverable on
unpaid losses in 1996, 1995 and 1994, respectively. Unearned premiums are
shown gross of prepaid premiums of $45.5 million, $43.8 million and $61.9
million in 1996, 1995 and 1994, respectively.
61
<PAGE>
LOGO
AFC9610K
<PAGE>
EXHIBIT 10.20
THE ALLMERICA FINANCIAL CORPORATION
EMPLOYMENT CONTINUITY PLAN
ARTICLE 1
PURPOSE
1.1The purpose of the Plan is
(a) to keep top management employees focused on the interests of the
Company's shareholders and to secure their continued services in
addition to their undivided dedication and objectivity in the event of
any threat or occurrence of, or negotiation or other action that could
lead to the possibility of, a Change in Control; and
(b) to ensure top management employees do not, in the event of a Change in
Control resulting in the payment of benefits hereunder, (i) compete in
the businesses of the Company or any affiliate for a specified period,
(ii) solicit or assist in the solicitation of employees of the Company
or any affiliate for a specified period, or (iii) disclose any
confidential or proprietary information of the Company or any
affiliate.
ARTICLE 2
DEFINITIONS
The following capitalized terms used in the Plan have the respective
meanings set forth in this Article:
2.1 Actuarial Equivalent: The actuarial equivalent determined in accordance
with the methodology specified in the Retirement Plan(s).
2.2 Anticipatory Change in Control: (i) Any "person" including a "group" (as
such terms are used in Section 13(d) and 14(d)(2) of the 1934 Act, but
excluding the Company, its affiliates (including without limitation,
Allmerica Financial Corporation, Allmerica Property & Casualty Companies,
Inc., Citizens Corporation, or any newly organized or incorporated
affiliate), any employee benefit plan of the Company or any affiliate,
and an underwriter temporarily holding securities pursuant to an offering
of such securities) commences a tender offer for securities, which if
consummated, would result in such person owning 20% or more of the
combined voting power of the Company's then outstanding securities, (ii)
the Company enters into an agreement the consummation of which would
constitute a Change in Control, (iii) proxies for the election of
directors of the Company are solicited by anyone other than the Company,
(iv) any "person" including a "group" (as such terms are used in Section
13(d) and 14(d)(2) of the 1934 Act, but excluding the Company, its
affiliates (including without limitation, Allmerica Financial
Corporation, Allmerica Property & Casualty Companies, Inc., Citizens
Corporation, or any newly organized or incorporated affiliate), any
employee benefit plan of the Company or any affiliate, and an underwriter
temporarily holding securities pursuant to an offering of such
securities) is required to file a statement under Rule 13d-1(b)(2) of the
1934 Act, or (v) any other event occurs which is deemed to be an
Anticipatory Change in Control by the Committee.
2.3 Board: The Board of Directors of Allmerica Financial Corporation or any
successor entity thereto.
2.4 Cause: (i) The willful failure of a Participant to perform substantially
his or her duties with the Company or any affiliate (other than any such
failure resulting from the Participant's incapacity due to disability
within the meaning of the Company's long term disability plan as in
effect at the time such determination is made); (ii) the Participant's
conviction of, or plea of guilty or nolo contendere to, a felony; (iii)
the willful engaging by the Participant in illegal conduct or gross
misconduct which is demonstrably and materially injurious to the Company
or any affiliate; or (iv) the breach by the Participant of any written or
1
<PAGE>
unwritten noncompetition, nondisclosure or nonsolicitation agreement with
the Company or any affiliate, including but not limited to the agreements
provided under sections 5.2 and 6.5 hereof.
2.5 Cash Balance Plan: The Allmerica Financial Corporation Cash Balance
Retirement Plan, as from time to time amended.
2.6 Change in Control: (i) The members of the Board at the beginning of any
consecutive twenty-four (24) calendar month period (the "Incumbent
Directors") cease at any time during such period for any reason other
than due to death, Disability or Retirement (in the event of a member's
death, Disability or Retirement, such member shall be deemed to continue
as an Incumbent Director until such member's seat on the Board is filled)
to constitute at least a majority of the members of the Board, provided
that any director whose election or nomination for election by the
Company's stockholders was approved by a vote of at least a majority of
such Incumbent Directors shall be treated as an Incumbent Director; (ii)
any "person" including a "group" (as such terms are used in Section 13(d)
and 14(d)(2) of the 1934 Act, but excluding the Company, its affiliates
(including without limitation, Allmerica Financial Corporation, Allmerica
Property & Casualty Companies, Inc., Citizens Corporation, or any newly
organized or incorporated affiliate), any employee benefit plan of the
Company or any affiliate, and an underwriter temporarily holding
securities pursuant to an offering of such securities) is or becomes the
"beneficial owner" (as defined in Rule 13(d)(3) under the 1934 Act),
directly or indirectly, of securities of the Company representing 35% or
more of the combined voting power of the Company's then outstanding
securities; (iii) the consummation of a merger, consolidation, share
exchange or similar form of corporate transaction involving the Company
or any affiliate that requires the approval of the Company's stockholders
(excluding a corporate transaction involving solely the Company and its
affiliates, including without limitation, Allmerica Financial
Corporation, Allmerica Property & Casualty Companies, Inc., Citizens
Corporation, or any newly organized or incorporated affiliate) (a
"Business Combination"), unless the stockholders immediately prior to
such Business Combination own more than 50% of the total voting power of
the successor corporation resulting from such Business Combination or a
majority of the board of directors of the successor corporation were
Incumbent Directors immediately prior to such Business Combination; or
(iv) the stockholders of the Company approve a plan of complete
liquidation or dissolution of the Company or a sale of all or
substantially all of the Company's assets.
2.7 Code: The Internal Revenue Code of 1986, as amended from time to time.
2.8 Committee: The Board or such other persons designated by the Board.
2.9 Company: Allmerica Financial Corporation or any successor entity thereto,
including without limitation, the transferee of all or substantially all
of the stock or assets of the Company.
2.10 Coverage Period: The three-year period commencing on the date of
termination of employment with the Company and its affiliates for
Category 1 Participants; the two-year period commencing on the date of
termination of employment with the Company and its affiliates for
Category 2 Participants.
2.11 Disability: With respect to members of the Board, the inability to engage
in any substantial gainful activity by reason of a medically determinable
physical or mental impairment which can be expected to result in death or
which can be expected to last for a continuous period of not less than
twelve (12) months.
2.12 Early Retirement Age: Early retirement age as defined in the Retirement
Plan(s).
2.13 Effective Date: The date on which the Plan becomes effective as set forth
in section 3.1 hereof.
2.14 Excess Plan: Any nonqualified plan which provides supplementary
retirement benefits for participants in the Cash Balance Plan with
compensation in excess of the section 401(a)(17) and section 415 limits
of the Code, as from time to time amended.
2
<PAGE>
2.15 Executive Plan: The First Allmerica Financial Executive Plan, as from
time to time amended or The Hanover Executive Plan, as from time to time
amended.
2.16 Good Reason: Upon or subsequent to a Change in Control, without the
Participant's express written consent, (i) any change in the duties or
responsibilities of the Participant that are inconsistent in any material
and adverse respect with the Participant's duties or responsibilities
immediately prior to the Change in Control; provided, that no change in
the Participant's responsibilities that occurs as a result of the Company
no longer being a public company or becoming a subsidiary after the
Change in Control shall constitute Good Reason hereunder, (ii) a material
reduction in the Participant's rate of annual base salary and annual
target bonus opportunity (including any adverse change in the formula for
such annual bonus target but excluding the conversion of any cash bonus
arrangement into an equity incentive arrangement of commensurate value)
as in effect immediately prior to such Change in Control; (iii) a failure
to provide benefits which are substantially similar in the aggregate to
the benefits under any employee benefit plan, compensation plan, welfare
benefit plan or material fringe benefit plan in which the Participant is
participating immediately prior to the Change in Control (excluding any
across-the-board reduction in benefits effected with respect to all
executive employees of the Company after the Change in Control); (iv) any
requirement that the Participant relocate to an office more than 35 miles
from the facility where the Participant is located immediately prior to
the Change in Control; or (v) the failure of the Company to cause any
successor entity to the Company to assume all obligations under the Plan
as set forth in section 8.3 hereof.
2.17 Multiplier: Three (3) for Category 1 Participants; two (2) for Category 2
Participants.
2.18 Net After-Tax Benefit: The sum of (i) the total amount payable to the
Participant hereunder, plus (ii) all other payments and benefits which
the Participant receives or is entitled to receive from the Company that
would constitute "parachute payments" within the meaning of section 280G
of the Code, less (iii) the amount of federal, state and local income and
other taxes (including the excise tax under section 4999 of the Code)
payable with respect to the foregoing amounts calculated at the maximum
income tax rates applicable to such Participant for each year in which
the foregoing amounts shall be paid.
2.19 1934 Act: The Securities Exchange Act of 1934, as amended from time to
time.
2.20 Normal Retirement Age: Normal retirement age as defined in the Retirement
Plan(s).
2.21 Participant: Any individual specified on Appendix A attached hereto in
accordance with Article 4 hereof.
2.22 Plan: The Allmerica Financial Corporation Employment Continuity Plan, as
from time to time amended.
2.23 Protection Period: The period beginning with a Change in Control and
ending on the second anniversary thereof.
2.24 Rate of Reserves Increase: With respect to a period of plan months in a
Long-Term Performance Unit Plan cycle, the percentage rate equal to (i)
the consolidated combined contingency reserves at the end of the last
plan month in such period, minus the consolidated combined contingency
reserves at the beginning of the first plan month in such period, divided
by (ii)(A) the consolidated combined contingency reserves at the
beginning of such first plan month, times (B) the number of plan months
in such period.
2.24 Retirement: With respect to employees, separation from service with the
Company and its affiliates in accordance with a retirement plan
maintained by the Company (as in existence immediately prior to the
Change in Control) or in accordance with any retirement arrangement
established with respect to the Participant with the Participant's
consent; with respect to members of the Board, retirement pursuant to a
retirement policy then in effect for members of the Board.
3
<PAGE>
2.25 Retirement Plan(s): To the extent a Participant is eligible for
retirement benefits thereunder, the Cash Balance Plan, the Excess Plan
and the Executive Plan as applicable.
2.26 Stock Incentive Plans: Allmerica Financial Corporation Long-Term Stock
Incentive Plan, the 1994 Long Term Stock Incentive Plan of Citizens
Corporation, the Allmerica Property & Casualty Companies, Inc. 1995 Long-
Term Stock Incentive Plan and any successor(s) to such plans.
2.27 Transition Group: Participants who have attained an age as of December
31, 1994, which when added with two (2) times their service as of
December 31, 1994 under the Cash Balance Plan, equals or exceeds eighty-
five (85).
ARTICLE 3
PLAN TERM
3.1 Effective Date: The Plan shall be effective as of December 17, 1996.
3.2 Expiration: Except as provided in sections 3.3, 3.4 and 3.5 hereof, the
Plan shall terminate on the December 31st of the calendar year in which
the notice requirement of section 3.6 hereof has been satisfied.
3.3 Initial Term: In no event shall the Plan terminate prior to December 31,
1998.
3.4 Anticipatory Change in Control: In the event the Plan would otherwise
terminate pursuant to section 3.2 hereof during any one-year period
commencing upon an Anticipatory Change in Control, the Plan shall
terminate on the first anniversary of such Anticipatory Change in Control;
provided, however, in the event of a Change in Control during the one-year
period commencing upon such Anticipatory Change in Control, the Plan shall
terminate on the last day of the Protection Period.
3.5 Change in Control: In the event the Plan would otherwise terminate
pursuant to section 3.2 hereof during the Protection Period commencing
upon a Change in Control, the Plan shall terminate on the last day of the
Protection Period.
3.6 Notice: The notice requirement of this section shall be satisfied on the
September 30th coincident with or next following the date on which all
Participants have received written notice from the Committee of its desire
to terminate the Plan.
4
<PAGE>
ARTICLE 4
ELIGIBILITY
4.1 General: Any individual specified on Appendix A attached hereto shall be a
Participant eligible to receive benefits and payments hereunder.
Participants shall be designated as either "Category 1" or "Category 2" on
Appendix A and shall receive benefits and payments hereunder in accordance
with such designation.
4.2 Addition or Move: The Committee in its sole discretion may add the names
of additional employees of the Company or any affiliate to Appendix A or
move the name of a Participant from Category 2 to Category 1 at any time,
or subject to the provisions of section 4.3 hereof, move the name of a
Participant from Category 1 to Category 2. Each such employee shall be
eligible to receive benefits and payments hereunder in accordance with the
employee's designation on Appendix A.
4.3 Removal: Except as provided in sections 4.4, 4.5 and 4.6 hereof, the
Committee in its sole discretion may remove the name of any individual
specified on Appendix A or move the name of a Participant from Category 1
to Category 2 on the December 31st of the calendar year in which the
notice requirement of section 4.7 hereof has been satisfied. An individual
removed from Appendix A shall cease to be eligible to receive benefits and
payments hereunder and all rights thereto shall be without further force
or effect upon removal from Appendix A. An individual moved from Category
1 to Category 2 shall be eligible to receive benefits and payments
hereunder in accordance with such individual's designation on Appendix A.
Notwithstanding any provision in the Plan to the contrary, the Committee
may remove the name of any individual specified on Appendix A or move the
name of a Participant from Category 1 to Category 2 at any time with such
individual's written consent.
4.4 Initial Term: In no event shall the name of any Participant be removed
from Appendix A prior to December 31, 1998.
4.5 Anticipatory Change in Control: In the event of an Anticipatory Change in
Control, any name which would otherwise be removed from Appendix A
pursuant to section 4.3 hereof during the one-year period commencing upon
such Anticipatory Change in Control shall be removed on the first
anniversary of such Anticipatory Change in Control; provided, however, in
the event of a Change in Control during the one-year period commencing
upon such Anticipatory Change in Control, such name shall be removed from
Appendix A on the last day of the Protection Period.
4.6 Change in Control: In the event of a Change in Control, any name which
would otherwise be removed from Appendix A or moved from Category 1 to
Category 2 pursuant to section 4.3 hereof during the Protection Period
shall be so removed from Appendix A or moved from Category 1 to Category
2, as the case may be, on the last day of the Protection Period.
4.7 Notice: The notice requirement of this section shall be satisfied on the
September 30th coincident with or next following the date on which the
Participant has received written notice from the Committee of its desire
to remove such individual's name from the list of Participants on Appendix
A or to move such individual from Category 1 to Category 2, as the case
may be.
ARTICLE 5
CHANGE IN CONTROL PAYMENTS
5.1 General: In the event of a Change in Control, the Company shall pay to
each Participant within ten (10) days following such Change in Control, a
lump-sum cash amount equal to the sum of
(a) the fair market value (determined in accordance with the applicable
Stock Incentive Plans as of the date of the Change in Control) of
shares of common stock awarded to the Participant under the Stock
Incentive Plans which are not vested immediately after the Change in
Control; and
5
<PAGE>
(b) the excess of
(i) the fair market value (determined in accordance with the
applicable Stock Incentive Plans as of the date of the Change in
Control) of the shares of common stock designated to a stock
option (or stock appreciation right) granted to the Participant
under the Stock Incentive Plans and with respect to which, such
stock option (or stock appreciation right) is not exercisable
immediately after the Change in Control, over
(ii) the exercise price (or base price) for such shares.
5.2 Release: Notwithstanding the foregoing, no amount shall be payable under
section 5.1 hereof unless the Participant executes a Waiver and Release in
the form provided in Appendix B attached hereto or as otherwise amended by
the Company in accordance with section 8.5 hereof, and such agreement
becomes effective waiving and extinguishing any further rights or benefits
under the Stock Incentive Plans.
ARTICLE 6
PROTECTED TERMINATION BENEFITS AND PAYMENTS
6.1 General: Except as provided in section 6.2(b) hereof, in the event of a
Change in Control, the Company shall pay the benefits and payments
specified in sections 6.3 and 6.4 hereof if,
(a) the Company or any affiliate terminates a Participant's employment
with the Company and its affiliates without Cause during the
Protection Period,
(b) the Participant terminates employment with the Company and its
affiliates with Good Reason during the Protection Period, or
(c) the Participant terminates employment with the Company and its
affiliates for any reason at any time during the thirteenth calendar
month commencing after the Change in Control.
6.2 Retirement, Death or Disability:
(a) For purposes of section 6.1 hereof, any termination of employment by
reason of Retirement without Good Reason shall be deemed to be a
termination of employment by the Participant without Good Reason.
(b) Notwithstanding the foregoing, no benefits or payments shall be
payable to a Participant under this Article in the event the
Participant's employment is terminated by reason of death or such
Participant becomes eligible for disability benefits under the
Company's long-term disability plan.
6.3 Lump-Sum Benefits: In the event of a termination of employment specified
in section 6.1 hereof, the Company shall pay to each Participant within
thirty (30) days following such termination, a lump-sum cash amount equal
to the sum of
(a) the Multiplier times the sum of
(i) the greater of (A) the Participant's annual base salary in effect
on the date of termination of employment or (B) the Participant's
annual base salary for the calendar year immediately preceding the
year in which the Participant's employment is terminated; and
(ii) the average bonus paid to the Participant under the Short Term
Incentive Plan for the three (3) plan years preceding the year in
which the Participant's employment is terminated (if the
Participant was eligible for a bonus during only a portion of
such three-year period, the average of the annualized bonuses
paid to the Participant for the plan years in such three-year
period in which the Participant was eligible for a bonus);
(b) the product of (i) seventy-five (75) percent of the maximum bonus
potential under the Short Term Incentive Plan for the plan year in
which the Participant's employment is terminated, times (ii) a
fraction (less than one (1)), the numerator of which shall be the
number of days the Participant is
6
<PAGE>
employed by the Company or any affiliate during the plan year in which
the Participant's employment is terminated and the denominator of
which shall be 365;
(c) (i) to the extent not paid, the remaining balance of the total potential
awards under the Term Performance Unit Plan payable to the
Participant for plan cycles completed on or before the Change in
Control, and
(ii) with respect to each plan cycle ending after the Change in
Control, an amount equal to the product of (A) the total
potential award under the Long-Term Performance Unit Plan which
would be payable to the Participant upon completion of such plan
cycle, if the Rate of Reserves Increase for the plan cycle months
completed after the Change in Control were equal to the average
Rate of Reserves Increase experienced for the plan cycle months
completed on or prior to the Change in Control, times (B) a
fraction (less than one (1)), the numerator of which shall be the
number of full calendar months completed during the plan cycle
prior to the date of the Participant's termination of employment
and the denominator of which shall be thirty-six (36);
(d) the Multiplier times the amount which would be credited to the
Participant's account balance(s) under the Retirement Plan(s) in the
plan year in which the Participant's employment is terminated,
assuming the Participant's account balance(s) is credited in such year
with seven (7) percent of compensation as defined in the Retirement
Plan(s) at the greater of (A) the annualized rate of compensation in
effect on the date of termination of employment or (B) the
compensation for the plan year immediately preceding the year in which
the Participant's employment is terminated; and
(e) with respect to any member of the Transition Group, the excess of
(i) the Actuarial Equivalent of the final average pay benefit under
the Retirement Plan(s) at Normal Retirement Age assuming such
member were credited with two (2) additional years of service,
over
(ii) the Actuarial Equivalent of the actual final average pay benefit
under the Retirement Plan(s) at Normal Retirement Age;
6.4 Other Benefits: In the event of a termination of employment specified in
section 6.1 hereof, the Company shall
(a) continue for the Coverage Period to cover the Participant under those
employee benefit plans (including but not limited to life and
disability insurance coverage but excluding health plan coverage which
is otherwise provided for in sections 6.4(d) and 6.4(e) hereof) which
were applicable to the Participant immediately prior to the Change in
Control at the same benefit levels then in effect (or shall provide
their equivalent);
(b) provide outplacement services to the Participant at a cost of no more
than 17% of the greater of the Participant's annual base salary in
effect on the date of termination of employment or the Participant's
annual base salary for the calendar year immediately preceding the
year in which the Participant's employment is terminated, or at the
Participant's election, in lieu of such outplacement services, pay to
the Participant within thirty (30) days following such termination, a
lump-sum cash amount equal to $20,000;
(c) with respect to any member of the Transition Group who does not
satisfy the age and service requirements for early retirement benefits
without actuarial reduction under the Retirement Plan(s) upon
termination of employment but would satisfy such requirements if such
member were two (2) years older than such member actually is on the
date of such termination and such member were credited with two (2)
additional years of service,
provide supplemental payments hereunder at the same time and in
the same manner as the payments payable under the Retirement
Plan(s) to the Participant so that the Participant receives in
the aggregate the benefit (calculated using the Participant's
actual age and years
7
<PAGE>
of service) that would be payable if the Participant were
entitled to an early retirement benefit without actuarial
reduction under such Retirement Plan(s); and
(d) with respect to any Participant who is entitled to post-retirement
medical benefits under the post-retirement medical plan or arrangement
in effect immediately prior to the Change in Control or who would be
entitled to such benefits if such Participant were older than such
Participant actually is on the date of the Participant's termination
of employment by a number of years equal to the Multiplier and such
Participant were credited with a number of additional years of service
equal to the Multiplier,
(i) provide coverage for the Participant and the applicable dependents
under the group health plan maintained by the Company or any
affiliate at the same level of coverage in effect immediately
prior to the Change in Control for the eighteen-month period
commencing upon termination of employment, and
(ii) upon expiration of such eighteen-month period, provide the
Participant and applicable dependents with coverage under the
post-retirement medical plan or arrangement at a level
substantially similar to the level in effect immediately prior to
termination of employment, subject to retiree contributions at a
rate no greater than that in effect (as the same may be adjusted
from time to time) for all similarly situated retirees with
comparable age, health background and coverage (or shall provide
their equivalent);
(e) with respect to any Participant who is not eligible for the benefits
specified in section 6.4(d) hereof,
(i) provide coverage for the Participant and the applicable dependents
under the group health plan maintained by the Company or any
affiliate at the same level of coverage in effect immediately
prior to the Change in Control for the eighteen-month period
commencing upon termination of employment, and
(ii) upon expiration of such period and provided the Participant
submits evidence to the satisfaction of the Committee that he or
she is not eligible for comparable coverage as a participant or
dependent under a plan maintained by another employer, pay to the
Participant a lump-sum cash amount equal to the product of (A)
the number of calendar months remaining in the Coverage Period at
such time, times (B) 102% of the "applicable premium" (as defined
in section 4980B of the Code) payable for the group health plan
maintained by the Company or any affiliate for the benefit of the
Participant and applicable dependents at such time.
6.5 Release: Notwithstanding the foregoing, no amounts shall be payable under
sections 6.3 and 6.4 hereof unless the Participant executes a Waiver and
General Release, in the form provided in Appendix C attached hereto or as
otherwise amended by the Company in accordance with section 8.5 hereof,
and such agreement becomes effective.
ARTICLE 7
TAXATION OF BENEFITS AND PAYMENTS
7.1 Withholding Taxes: The Company may withhold from the Participant's
benefits and payments payable hereunder the amount which it determines is
necessary to satisfy its obligation to withhold federal, state and local
income taxes or other taxes or amounts required to be withheld.
7.2 Gross-Up Payment: In the event it shall be determined that any benefit or
payment payable hereunder to a Category 1 Participant would be subject to
the excise tax imposed by section 4999 of the Code, the Company shall pay
to the Participant (or to the Internal Revenue Service on behalf of the
Participant) in any taxable year for which the excise tax is payable an
additional payment (a "Gross-Up Payment") in an amount such that after
payment by the Participant of all taxes (including but not limited to
federal, state and local income taxes, excise taxes, and FICA taxes
including hospital insurance taxes) imposed on the
8
<PAGE>
Gross-Up Payment, the Participant retains (or has had paid to the Internal
Revenue Service on his or her behalf) an amount of the Gross-Up Payment
equal to the sum of
(a) the excise tax imposed by section 4999 of the Code, and
(b) the product of (i) any deductions disallowed because of the inclusion
of the Gross-Up Payment in the Participant's adjusted gross income,
times (ii) the highest applicable marginal rate of federal income
taxation for the calendar year in which the Gross-Up Payment is to be
made.
For purposes of determining the amount of the Gross-Up Payment, the
Participant shall be deemed to (a) pay federal, state and local income
taxes (for the residence where the Participant most recently filed a
return for such taxes) at the highest marginal rate of taxation for the
calendar year in which the Gross-Up Payment is to be made and (b) have
otherwise allowable deductions for federal income tax purposes at least
equal to the Gross-Up Payment.
7.3 Best Payment: In the event it shall be determined that any benefit or
payment payable hereunder to a Category 2 Participant would be subject to
the excise tax imposed by section 4999 of the Code, such benefits and
payments shall be reduced to the extent necessary so that no portion
thereof shall be subject to the excise tax, but only if by reason of such
reduction, the Net After-Tax Benefit without such reduction does not
exceed 110% of the Net After-tax Benefit with such reduction.
7.4 Determination of Excise Tax: All determinations of gross-up payments and
best payments that are required to be made under sections 7.2 and 7.3
hereof shall be made by Price Waterhouse LLP or such other public
accounting firm as may be retained by the Company. The determination by
such accounting firm shall be final and conclusive.
7.5 Claim by Internal Revenue Service: As soon as practicable, a Participant
shall notify the Company in writing of any claim by the Internal Revenue
Service that, if successful, would result in the imposition of the excise
tax under section 4999 of the Code. If the Company notifies the
Participant in writing that it desires to contest such claim, the
Participant shall cooperate in all reasonable ways with the Company in
such contest and the Company shall be entitled to participate in all
proceedings relating to such claim; provided, however, that the Company
shall bear and pay directly all costs and expenses (including additional
interest and penalties) incurred in connection with such contest and shall
indemnify and hold the Participant harmless, on an after-tax basis, for
any excise tax or income tax (including interest and penalties with
respect thereto) imposed as a result of such representation and payment of
costs and expenses. Without limitation on the foregoing, the Company shall
control all proceedings taken in connection with such contest and, at its
sole option, may pursue or forego any and all administrative appeals,
proceedings, hearings and conferences with the taxing authority in respect
of such claim and may, at its sole option, either direct the Participant
to pay the tax claimed and sue for a refund or contest the claim in any
permissible manner, and the Participant agrees to prosecute such contest
to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company
shall determine; provided, however, that if the Company directs the
Participant to pay such claim and sue for a refund, the Company shall
advance the amount of such payment to the Participant on an interest-free
basis, and shall indemnify and hold the Participant harmless, on an after-
tax basis, from any excise tax or income tax (including interest or
penalties with respect thereto) imposed with respect to such advance or
with respect to any imputed income with respect to such advance; and
provided, further, that if the Participant is required to extend the
statute of limitations to enable the Company to contest such claim, the
Participant may limit this extension solely to such contested amount. The
Company's control of the contest shall be limited to issues with respect
to the imposition of the excise tax under section 4999 of the Code and the
Participant shall be entitled to settle or contest, as the case may be,
any other issue raised by the Internal Revenue Service or any other taxing
authority.
9
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ARTICLE 8
MISCELLANEOUS
8.1 No Mitigation: No benefit or payment payable hereunder shall be subject to
offset including, but not limited to, amounts in respect of any claims
which the Company may have against the Participant, provided, however, the
amount payable hereunder to any Participant shall be reduced by any
amounts payable to such Participant from the Company or any affiliate
pursuant to any other severance plan or policy (including any employment
agreement) that first becomes effective after the Effective Date.
8.2 Legal Fees: The Company shall reimburse all costs and expenses, including
attorneys' fees, of the Participant in connection with any legal
proceedings relating to the Plan, any plan listed on Appendix D, or any
successor plans; provided, however, the Company shall not reimburse such
costs and expenses for the Participant if (a) prior to the initiation of
any proceedings by the Participant, such Participant fails to specify in
writing all claims relating to the Plan, any plan listed on Appendix D, or
any successor plans and to provide the Committee with thirty (30) days to
address such claims, or (b) the judge or other individual presiding over
the proceedings affirmatively finds that (i) the Participant initiated
such proceedings in bad faith, or (ii) the Participant violated the terms
of the Waiver and Release required under section 5.2 hereof or the Waiver
and General Release required under section 6.5 hereof.
8.3 Successors: If the Company shall be merged into or consolidated with
another entity, the provisions of this Plan shall be binding upon and
inure to the benefit of the entity surviving such merger or resulting from
such consolidation. The Company shall require any successor (whether
direct or indirect, by purchase, merger, consolidation or otherwise) to
all or substantially all of the business or assets of the Company to
expressly assume and agree to perform the duties set forth hereunder in
the same manner and to the same extent that the Company would be required
to perform if no such succession had taken place (including but not
limited to section 8.7 hereof).
8.4 Indemnification. In addition to such other rights of indemnification as
they may have as members of the Board or the Committee, the members of the
Board and the Committee shall be indemnified by the Company against all
costs and expenses reasonably incurred by them in connection with any
action, suit or proceeding to which they or any of them may be party by
reason of any action taken or failure to act under or in connection with
the Plan and against all amounts paid by them in settlement thereof
(provided such settlement is approved by independent legal counsel
selected by the Company) or paid by them in satisfaction of a judgment in
any such action, suit or proceeding, except a judgment based upon a
finding that such member was not acting in good faith on the reasonable
belief that he or she was acting in the best interests of the Company;
provided that upon the institution of any such action, suit or proceeding,
a Committee or Board member shall, in writing, give the Company notice
thereof and an opportunity, at its own expense, to handle and defend the
same before such Committee or Board member undertakes to handle and defend
it on such member's own behalf.
8.5 Amendments: The Board may at any time, or from time to time, amend the
Plan in whole or in part or amend it in such respects as the Board may
deem appropriate; provided, however, that no amendment to the Plan
(including the waiver and release agreements provided in sections 5.2 and
6.5 hereof) shall, without the affected Participant's written consent,
impair any rights or obligations hereunder except as provided in section
4.3 hereof.
8.6 Plan Expenses: Any expenses of administering the Plan shall be borne by
the Company.
8.7 Survival: Notwithstanding any provision in the Plan to the contrary, the
obligations hereunder to the Participants shall survive any termination of
the Plan and shall be binding upon the Company.
10
<PAGE>
8.8 Notice: All notices and other communications required or permitted
hereunder shall be in writing and shall be deemed to have been duly given
when actually delivered or three (3) days after deposit in the United
States mail, certified and return receipt requested, for delivery to
(a) the Committee at Allmerica Financial, 440 Lincoln Street, Worcester,
MA 01653; or
(b) the Participant at the last known address specified in the Company's
records.
8.9 Governing Law: The validity, construction and effect to the Plan and any
actions taken under or relating to the Plan shall be determined in
accordance with the laws of the State of Delaware.
11
<PAGE>
APPENDIX A
<TABLE>
<CAPTION>
CATEGORY 1 CATEGORY 2
---------- -------------------
<S> <C>
John F. O'Brien Bruce C. Anderson
John P. Kavanaugh
John F. Kelly
J. Barry May
James R. McAuliffe
Edward J. Parry III
Richard M. Reilly
Larry C. Renfro
Eric A. Simonsen
Phillip E. Soule
</TABLE>
12
<PAGE>
APPENDIX B
WAIVER AND RELEASE
In exchange for the benefits and payments offered to me by Allmerica
Financial Corporation as set forth in section 5.1 of The Allmerica Financial
Corporation Employment Continuity Plan (the "Plan"), I hereby release
Allmerica Financial Corporation and all of its past and/or present divisions,
affiliates, subsidiaries, officers, directors, stockholders, trustees,
employees, agents, representatives, administrators, attorneys, insurers,
fiduciaries, successors and assigns, in their individual and/or representative
capacities (the "Company") from any and all causes of action, suits,
agreements, promises, damages, disputes, controversies, contentions,
differences, judgments, claims and demands of any kind whatsoever which I or
my heirs, executors, administrators, successors and assigns ever had, now have
or may have against the Company, whether known or unknown to me, under the
Allmerica Financial Corporation Long-Term Stock Incentive Plan, the 1994 Long
Term Stock Incentive Plan of Citizens Corporation, the Allmerica Property &
Casualty Companies, Inc. 1995 Long-Term Stock Incentive Plan and any
successor(s) to such plans.
I represent that I have not filed, and will not hereafter file, any claim
against the Company relating to such plans.
I understand and agree that if
(i) I commence, continue, join in , or in any other manner attempt to
assert any claim released herein against the Company, or otherwise violate
the terms of this Waiver and Release;
(ii) without prior written consent from the Company, I disclose to any
other person or entity any non-public information concerning the Company's
financial data, strategic business plans, product development (or other
proprietary product data), customer lists, marketing plans and other
proprietary information, except for specific items which have become
publicly available information other than through a breach by me of my
fiduciary duties to the Company or which cannot reasonably be expected to
adversely affect the business of the Company, unless required to do so by a
court of competent jurisdiction or other governmental authority with
purported or apparent jurisdiction;
(iii) upon termination of employment, I directly or indirectly (whether
as owner, partner, consultant, employee or otherwise) engage in any major
business segment or any other business of the Company that produces (or is
projected to produce in any of the three succeeding fiscal years after the
date of termination of employment) over five (5) percent of the revenues of
the Company as of the date of termination of employment during the two-year
period commencing on the date of termination of employment;
(iv) upon termination of employment, I employ, solicit for employment, or
recommend for employment any officer of the Company during the two-year
period commencing on the date of termination of employment; or
(v) I violate the terms of any noncompetition and nonsolicitation
agreement between myself and the Company, the Company shall have the right
to the return of the benefits and payments paid to me by the Company under
section 5.1 of the Plan (together with interest thereon at the rate of six
(6) percent per annum from the date of receipt by me to the date of payment
by me). Notwithstanding the foregoing, in no event shall this Waiver and
Release be construed so as to preclude me from investing in any publicly or
privately held company, so long as my beneficial ownership of any class of
such company's securities does not exceed 1% of the outstanding securities
of such class.
I understand and agree that I shall notify the Company in writing, as soon
as practicable, of any claim by the Internal Revenue Service that, if
successful, would result in the imposition of the excise tax under section
4999 of the Code. I further understand and agree that if the Company notifies
me in writing that it desires to contest such claim, I shall cooperate in all
reasonable ways with the Company in accordance with the provisions of section
7.5 of the Plan.
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<PAGE>
IN WITNESS WHEREOF, the Company has caused this Waiver and Release to be
executed by a duly authorized officer of the Company and I have executed this
Waiver and Release as of the date set forth below.
_____________________________________
Name of Participant
_____________________________________
Signature
_____________________________________
Date
Allmerica Financial Corporation
By:__________________________________
_____________________________________
Title
_____________________________________
Date
14
<PAGE>
APPENDIX C
WAIVER AND GENERAL RELEASE
In exchange for the benefits and payments offered to me by Allmerica
Financial Corporation as set forth in The Allmerica Financial Corporation
Employment Continuity Plan (the "Plan"), I hereby release Allmerica Financial
Corporation and all of its past and/or present divisions, affiliates,
subsidiaries, officers, directors, stockholders, trustees, employees, agents,
representatives, administrators, attorneys, insurers, fiduciaries, successors
and assigns, in their individual and/or representative capacities (the
"Company") from any and all causes of action, suits, agreements, promises,
damages, disputes, controversies, contentions, differences, judgments, claims
and demands of any kind whatsoever which I or my heirs, executors,
administrators, successors and assigns ever had, now have or my have against
the Company, whether known or unknown to me,
(a) by reason of my employment and/or cessation of employment with the Company
or otherwise involving facts which occurred on or prior to the date that I
have signed this Release, including without limitation all claims under
Title VII of the Civil Rights Act of 1964, the Age Discrimination in
Employment Act of 1967, the Reconstruction Era Civil Rights Act, the Civil
Rights Act of 1991, the Fair Labor Standards Act, the Employee Retirement
Income Security Act, the Americans with Disabilities Act, the Family and
Medical Leave Act of 1993, and any and all other federal, state and local
laws, statutes, rules and regulations pertaining to employment, as well as
any and all claims under state contract or tort law; and
(b) under any employee benefit plan maintained by the Company (including but
not limited to the Allmerica Financial Corporation Long-Term Stock
Incentive Plan, the 1994 Long Term Stock Incentive Plan of Citizens
Corporation, the Allmerica Property & Casualty Companies, Inc. 1995 Long-
Term Stock Incentive Plan, the Short Term Incentive Plan, the Long-Term
Performance Unit Plan, and the successor(s) to such plans), other than any
claim relating to the benefits and payments described in the Plan or any
claim relating to the benefits and payments payable to me under the
Company's nonqualified retirement plans.
I represent that I have not filed, and will not hereafter file, any claim
against the Company relating to my employment and/or cessation of employment
with the Company, or otherwise specified above involving facts which occurred
on or prior to the date that I have signed this Waiver and General Release.
I understand and agree that if
(i) I commence, continue, join in, or in any other manner attempt to assert
any claim released herein against the Company, or otherwise violate the
terms of this Waiver and General Release,
(ii) without prior written consent from the Company, I disclose to any other
person or entity any non-public information concerning the Company's
financial data, strategic business plans, product development (or other
proprietary product data), customer lists, marketing plans and other
proprietary information, except for specific items which have become
publicly available information other than through a breach by me of my
fiduciary duties to the Company or which cannot reasonably be expected to
adversely affect the business of the Company, unless required to do so by
a court of competent jurisdiction or other governmental authority with
purported or apparent jurisdiction;
(iii) I directly or indirectly (whether as owner, partner, consultant,
employee or otherwise) engage in any major business segment or any other
business of the Company that produces (or is projected to produce in any
of the three succeeding fiscal years after the date of termination of
employment) over five (5) percent of the revenues of the Company as of
the date of termination of employment during the two-year period
commencing on the date of termination of employment;
(iv) I employ, solicit for employment, or recommend for employment any officer
of the Company during the two-year period commencing on the date of
termination of employment; or
(v) I violate the terms of any noncompetition and nonsolicitation agreement
between myself and the Company, the Company shall have the right to the
return of the benefits and payments paid to me by the Company
15
<PAGE>
under the Plan (together with interest thereon at the rate of six (6)
percent per annum from the date of receipt by me to the date of payment by
me). Notwithstanding the foregoing, in no event shall this Waiver and
General Release be construed so as to preclude me from investing in any
publicly or privately held company, so long as my beneficial ownership of
any class of such company's securities does not exceed 1% of the
outstanding securities of such class.
I understand and agree that I shall notify the Company in writing, as soon
as practicable, of any claim by the Internal Revenue Service that, if
successful, would result in the imposition of the excise tax under section
4999 of the Code. I further understand and agree that if the Company notifies
me in writing that it desires to contest such claim, I shall cooperate in all
reasonable ways with the Company in accordance with the provisions of section
7.5 of the Plan.
I have read this Waiver and General Release carefully, have been given at
least 21 days to consider all of its terms, have been advised to consult with
an attorney and any other advisors of my choice, and fully understand that by
signing below I am, to the extent provided herein, giving up any right which I
may have to sue or bring any other claims against the Company. I have not been
forced or pressured in any manner whatsoever to sign this Waiver and General
Release, and I agree to all of its terms voluntarily.
I understand that I have seven days from the date I have signed this Waiver
and General Release below to revoke this Waiver and General Release, that this
Waiver and General Release will not become effective until the 8th day
following the date that I have signed this Waiver and General Release, and
that the Company will have no obligation to pay me the benefits and payments
under the Plan as agreed unless this Waiver and General Release becomes
effective.
I further understand that this Waiver and General Release is the complete
and exclusive statement of its terms and any waiver prior to the date of my
signature below with respect to the Plan shall be without further force or
effect on the effective date of this Waiver and General Release.
IN WITNESS WHEREOF, the Company has caused this Waiver and General Release
to be executed by a duly authorized officer of the Company and I have executed
this Waiver and General Release as of the date set forth below.
________________________________________
Name of Participant
________________________________________
Signature
________________________________________
Date
Allmerica Financial Corporation
By:________________________________
___________________________________
Title
___________________________________
Date
16
<PAGE>
APPENDIX D
FIRST ALLMERICA
First Allmerica Financial Life Insurance Company Non-Qualified Executive
Deferred Compensation Plan
First Allmerica Financial Life Insurance Company Non-Qualified Executive
Retirement Plan
First Allmerica Financial Life Insurance Company Excess Benefit Retirement Plan
First Allmerica Financial Life Insurance Company Deferred Compensation
Agreements
HANOVER
The Hanover Insurance Company Non-Qualified Executive Deferred Compensation
Plan
The Hanover Insurance Company Non-Qualified Executive Retirement Plan
The Hanover Insurance Company Excess Benefit Retirement Plan
The Hanover Insurance Company Deferred Compensation Agreements
CITIZENS
Citizens Insurance Company of America Non-Qualified Executive Deferred
Compensation Plan
Citizens Insurance Company of America Non-Qualified Executive Retirement Plan
Citizens Insurance Company of America Excess Benefit Retirement Plan
Citizens Insurance Company of America Deferred Compensation Agreements
17
<PAGE>
EXHIBIT 10.21
NON-SOLICITATION AGREEMENT
This Agreement is made this day of , 1996, between ALLMERICA
FINANCIAL CORPORATION, a Delaware corporation (hereinafter referred to
collectively with its subsidiaries, as the "Company"), and (the
"Employee").
WHEREAS, Employee acknowledges that the Company could be significantly
harmed if the Employee solicits the Company's employees, agents, brokers, or
clients, or discloses any proprietary or confidential business information of
the Company.
NOW, THEREFORE, in consideration of the continued employment of the Employee
by the Company and the Employee being selected to be a participant in the
Company's Employment Continuity Plan and the receipt of a cash bonus payment
upon the execution of this Agreement, the Employee and the Company agree as
follows:
1.NON-SOLICITATION.
During the period that the Employee is employed by the Company and for a
period of two (2) years after the termination or expiration thereof, the
Employee will not directly or indirectly:
(a) recruit, solicit or induce, attempt to induce, or assist or encourage
a third party to solicit or recruit any employee(s), agent(s) or
broker(s) of the Company to terminate their employment with, or
otherwise cease their relationship with the Company; or
(b) solicit, divert or take away, attempt to divert or to take away, or
assist or encourage a third party to solicit or divert the business or
patronage of any of the policyholders, clients, customers or accounts
of the Company which were contacted, solicited or served while the
Employee was employed by the Company.
2.UNENFORCEABILITY.
(a) If any restriction set forth in Section 1 is found by any court of
competent jurisdiction to be unenforceable because it extends for too
long a period of time or over too great a range of activities or in
too broad a geographic area, it shall be interpreted to extend only
over the maximum period of time, range of activities or geographic
area as to which it may be enforceable.
(b) The restrictions contained in Section 1 are necessary for the
protection of the business and goodwill of the Company and are
considered by the Employee to be reasonable for such purpose. The
Employee agrees that any breach of Section 1 will cause the Company
substantial and irrevocable damage and therefore, in the event of any
such breach, in addition to such other remedies which may be
available, the Company shall have the right to seek specific
performance and injunctive relief.
3.PROPRIETARY INFORMATION AND DEVELOPMENTS.
3.1 Proprietary Information.
(a) Employee agrees that all information and know-how, whether or not in
writing, of a private, secret or confidential nature concerning the
Company's products, servicers, customers or business or financial
affairs (collectively, "Proprietary Information") is and shall be the
exclusive property of the Company. By way of illustration, but not
limitation, Proprietary Information may include products, processes,
methods, techniques, projects, plans, research data, financial data,
personnel data, computer programs, and policyholders, client, agent,
broker and supplier lists. Employee will
1
<PAGE>
not disclose any Proprietary Information to others outside the Company
or use the same for any unauthorized purposes without written approval
by a vice president of the Company, either during or after his/her
employment, unless and until such Proprietary Information has become
public knowledge without fault by the Employee.
(b) Employee agrees that all files, letters, memoranda, reports, records,
data or other written, photographic, or other tangible material
containing Proprietary Information, whether created by the Employee or
others, which shall come into his/her custody or possession, shall be
and are the exclusive property of the Company to be used by the
Employee only in the performance of his/her duties for the Company.
(c) Employee agrees that his/her obligation not to disclose or use
information, know-how and records of the types set forth in paragraphs
(a) and (b) above, also extends to such types of information, know-
how, records and tangible property of clients of the Company or
suppliers to the Company or other third parties who may have disclosed
or entrusted the same to the Company or to the Employee in the course
of the Company's business.
3.2 DEVELOPMENTS.
(a) Employee agrees that all inventions, improvements, discoveries,
methods, developments, software, and works of authorship, whether
patentable or not, which are created, made, conceived or reduced to
practice by the Employee or under his/her direction or jointly with
others during his/her employment by the Company, whether or not during
normal working hours or on the premises of the Company (all of which
are collectively referred to in this Agreement as "Developments")
shall be the sole property of the Company.
(b) Employee agrees to assign and does hereby assign to the Company (or
any person or entity designated by the Company) all his/her right,
title and interest in and to all Developments and all related patents,
patent applications, copyrights and copyright applications. However,
this Section 3(b) shall not apply to Developments which do not relate
to the present or planned business of the Company and which are made
and conceived by the Employee not during normal working hours, not on
the Company's premises and not using the Company's tools, devices,
equipment or Proprietary Information.
(c) Employee agrees to cooperate fully with the Company, both during and
after his/her employment with the Company, with respect to the
procurement, maintenance and enforcement of copyrights and patents
(both in the United States and foreign countries) relating to
Developments. Employee shall sign all papers, including, without
limitation, copyright applications, patent applications, declarations,
oaths, formal assignments, assignment of priority rights, and powers
of attorney, which the Company may deem are reasonably necessary or
desirable in order to protect its rights and interests in any
Development.
4.OTHER AGREEMENTS.
Employee hereby represents that he/she is not bound by the terms of any
agreement with any previous employer or other party to refrain from using
or disclosing any trade secret or confidential or proprietary information
in the course of his/her employment with the Company or to refrain from
competing, directly or indirectly, with the business of such previous
employer or any other party. Employee further represents that his/her
performance of all the terms of this Agreement and as an employee of the
Company does not and will not breach any agreement to keep in confidence
proprietary information, knowledge or data acquired by him/her in
confidence or in trust prior to his/her employment with the Company.
5.NOTICES.
All notices required or permitted under this Agreement shall be in
writing and shall be deemed effective upon personal delivery or upon
deposit in the United States Post Office, by registered or certified
2
<PAGE>
mail, postage prepaid, addressed to the other party at the address shown
below, or at such other address or addresses as either party shall
designate to the other in accordance with this Section.
The Company:Allmerica Financial Corporation
440 Lincoln Street
Worcester, MA 01653
Attention: Law Department
The Employee:Home Address as reflected on Company records.
6.PRONOUNS.
Whenever the context may require, any pronouns used in this Agreement
shall include the corresponding masculine, feminine or neuter forms, and
the singular forms of nouns and pronouns shall include the plural, and
vice versa.
7.ENTIRE AGREEMENT.
This Agreement constitutes the entire agreement between the parties and
supersedes all prior agreements and understandings, whether written or
oral, relating to the subject this of this Agreement.
8.AMENDMENT.
This Agreement may be amended or modified only by a written instrument
executed by both the Company and the Employee.
9.EMPLOYMENT CONTINUITY PLAN.
The Employee's selection to be a participant in the Company's Employment
Continuity Plan (the "Plan") does not mean that the Employee cannot be
removed as a Participant in the Plan. Participation in the Plan is in
accordance with the Plan's provisions and as determined by the Committee
(as defined in the Plan). Removal as a Participant in the Plan does not
affect your obligations under this Agreement.
10.GOVERNING LAW.
This Agreement shall be construed, interpreted and enforced in
accordance with the laws of the Commonwealth of Massachusetts.
11.SUCCESSORS AND ASSIGNS.
This Agreement shall be binding upon and inure to the benefit of both
parties and their respective successors and assigns, including any
corporation with which or into which the Company may be merged or which
may succeed to its assets or business, provided, however, that the
obligations of the Employee are personal and shall not be assigned by him.
12.MISCELLANEOUS.
12.1 No delay or omission by the Company in exercising any right under this
Agreement shall operate as a waiver of that or any other right. A waiver
or consent given by the Company on any one occasion shall be effective
only in that instance and shall not be construed as a bar or waiver of
any right on any other occasion.
12.2 The captions of the sections of this Agreement are for convenience of
reference only and in no way define, limit or affect the scope or
substance of any section of this Agreement.
3
<PAGE>
12.3 In case any provision of this Agreement shall be invalid, illegal or
otherwise unenforceable, the validity, legality and enforceability of the
remaining provisions shall in no way be affected or impaired thereby.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date and year set forth above.
ALLMERICA FINANCIAL CORPORATION
By: _________________________________
Bruce C. Anderson
Vice President
EMPLOYEE
_____________________________________
Printed Name: _______________________
4
<PAGE>
EXHIBIT 11
ALLMERICA FINANCIAL CORPORATION
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
FOR THE PERIOD ENDED DECEMBER 31, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1996 1996
--------------------- ------------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C>
PRIMARY:
Average shares
outstanding............ 50.1 50.1
Net effect of dilutive
stock options based on
the treasury stock
method using average
market price(1)........ -- --
----------------- ------------------
TOTALS................... 50.1 50.1
================= ==================
Net income.............. $ 45.3 $ 181.9
Per share amount........ $ 0.91 $ 3.63
FULLY DILUTED:
Average shares
outstanding............ 50.1 50.1
Net effect of dilutive
stock options based on
the treasury stock
method using the higher
of period end or
average market
price(2)............... -- --
----------------- ------------------
TOTALS................... 50.1 50.1
================= ==================
Net income.............. $ 45.3 $ 181.9
Per share amount........ $ 0.91 $ 3.63
</TABLE>
- --------
(1) The weighted average incremental options used to calculate primary earnings
per share were 20,947 and 2,482 for the quarter and year ended December 31,
1996, respectively.
(2) The weighted average incremental options used to calculate fully diluted
earnings per share were 24,898 and 8,773 for the quarter and year ended
December 31, 1996, respectively.
1
<PAGE>
Understanding what makes people secure is our business.
What is security?
1
<PAGE>
a bank?
[PHOTO OF PIGGY BANK APPEARS HERE]
2
<PAGE>
Most of us learned to save the same way. We put spare coins into a glass jar or
ceramic copy of a pink barnyard animal--a piggy bank. Eventually, when the
piggybank was full, we took what we had saved to a nearby savings institution.
That was where we first planted our money, expecting it to grow. And savings do
grow, but slowly. Very, very slowly. Over the years, savers have realized that
while a bank can keep funds secure, just opening an account may not maximize the
growth of their savings. Building financial security takes more. These days,
true security lies in building a solid base of diversified assets, with
promising growth potential. Variable annuity products give those who want their
savings to grow into a secure nest egg the ability to build security using fund
managers with years of experience in money management.
[PHOTO APPEARS HERE]
3
<PAGE>
A strong knot is tied securely and stays tied as long as you want it to.
However, trying to untie the knot can be frustrating-- sometimes seeming
impossible if it has been tied too tightly, or if its ends become frayed. A
financial plan can also be tied too tightly. If it's not flexible, no amount of
tugging at it is going to help. A successful financial plan must easily allow
for changes and new options as market conditions or personal circumstances
dictate. Providing for the future means taking into consideration that times
change and that the unexpected often does occur. One of the many benefits of
variable life insurance is that in addition to estate value protection, it has
the flexibility to address many of the financial needs that arise from time to
time.
[PHOTO APPEARS HERE]
4
<PAGE>
[PHOTO OF A ROPE TIED IN A KNOT APPEARS HERE]
a knot?
5
<PAGE>
[PHOTO OF A HOUSE APPEARS HERE]
a house?
6
<PAGE>
For many, a home represents basic security. Buying a home is very often the
single most significant investment we make in our lives. And we may depend on
that investment to provide comfort for today, and equity for retirement needs.
That may have once been a reasonable strategy, but times have changed. Owning a
home may not provide the financial assurance of satisfying as many concerns as
it once did. To gain more security, consumers have to invest more widely--beyond
their own backyard--in a well-diversified portfolio that is focused on growth.
Consumers also need to be sure that their home and families are protected from
risk of loss.
[PHOTO APPEARS HERE]
7
<PAGE>
Few things are more comfortable than an old shoe. It's soft and cozy, and feels
secure on your foot. Nothing feels better. Or so it seems. But the most
comfortable shoe can't always take you where you need to go. Comfortable shoes
don't always work at the office, a nice restaurant or a fancy party.
Comfortable, traditional methods of saving are like old shoes. They no longer
meet the security needs they were once supposed to fulfill. In fact, just having
a savings nest egg may give people a false sense of security. What seems the
most comfortable ways to save may not take investors where they want to go. New
styles of investing, like a new pair of shoes, are a smart choice to reach the
important destinations of a secure retirement and financial well-being.
[PHOTO APPEARS HERE]
8
<PAGE>
[PHOTO OF AN OLD SHOE APPEARS HERE]
an old shoe?
9
<PAGE>
a paycheck?
[PHOTO OF A PAYROLL CHECK APPEARS HERE]
10
<PAGE>
[PHOTO APPEARS HERE]
A paycheck is the ultimate foundation of financial security; it buys food,
shelter and comfort. But a paycheck is also often a key to the quality of
financial security after we stop working. Future financial security begins when
a part of each current paycheck is invested for the future. While millions of
Americans follow this philosophy, many don't. They need a partner to show them
the most effective way, providing them with convenient opportunities to make
choices at the worksite or through an agent or other financial advisor. A
paycheck by itself doesn't guarantee future financial security. If opportunities
aren't available or are limited, it can turn out to be just a piece of paper
with not enough numbers on it. But, for those who actively look for the best
ways to maximize their future, a paycheck can be stretched a long way toward
achieving financial goals.
11
<PAGE>
To Our Shareholders
[PHOTO OF PRESIDENT AND CHIEF EXECUTIVE OFFICER APPEARS HERE]
John F. O'Brien
The merger of Allmerica Financial with its property and casualty subsidiary is
an important step which will make Allmerica Financial a larger and more powerful
financial services group, with greater financial flexibility to fund growth
plans.
Allmerica Financial achieved record earnings in 1996. We also substantially
advanced three major initiatives to significantly increase our capital base,
position the company for leadership in worksite marketing, and restructure
operations for greater efficiency. Progress made by Allmerica Financial on these
initiatives includes:
. Initiating the pending merger with Allmerica Property & Casualty, which will
increase Allmerica Financial's ownership to 100 percent and increase
shareholders' equity by more than 20 percent
. Signing agreements with banks and businesses to provide worksite-sold products
in order to establish a solid base for growth through this attractive
marketing channel
. Shifting all processing operations into a Service Company, which allows us to
consolidate process improvement and expense reduction efforts
Record Earnings
1996 operating earnings were $2.75 per share, up 18.5 percent from $2.32
per share in 1995. Growth was achieved largely from our Retirement and Asset
Management segment, which nearly doubled pre-tax income in 1996. This strong
result more than offset a difficult catastrophe year for our property and
casualty operations. Net income of $3.63 per share was up 36 percent over the
prior year. With the proceeds from realized gains on the sale of part of our
equity portfolio, we invested in higher-yielding, fixed income securities to
enhance current income.
Shareholders' equity grew 9.6 percent in 1996. Including proceeds from
Allmerica Financial's initial public offering in October of 1995, shareholders'
equity increased 40 percent, to $1.7 billion in just over a year. With the
equity from the merger with Allmerica Property & Casualty in 1997, Allmerica
Financial's five-year growth in shareholders' equity will exceed 230 percent--
from $900 million in 1992, to approximately $2.1 billion.
By any financial measure, our capital base is dramatically stronger than it
has ever been. Our capital position affords assurance to policyholders and
shareholders alike that we can continue to provide quality service and products,
backed by solid asset liability management strategies. The merger also gives
Allmerica Financial greater financial flexibility and a more diverse earnings
base. It also gives investors ownership in a larger organization, whose stock
has greater liquidity than ever before.
These accomplishments--record earnings, a pending merger, worksite
agreements, and service company
12
<PAGE>
[BAR GRAPH APPEARS HERE]
Shareholders' Equity (In Millions)
96 - $1,725
95 - $1,574
94 - $992
93 - $1,051
initiatives--are the result of strategies developed several years ago to enhance
our product offerings, develop new distribution channels, and focus on
processing efficiencies required to compete in today's marketplace.
Merger With Allmerica P&C
Expense reduction and higher revenue growth are primary drivers of
acquisitions in any industry. With these goals in mind, in December of 1996, we
offered to buy all of the minority-held shares in Allmerica P&C. Terms were
reached in February and the transaction should close by the third quarter of
1997. This merger presents unique advantages. Allmerica Financial has managed
Allmerica P&C's operations for many years, as majority shareholder. The two
"home office" buildings are literally side-by-side. Because the operations of
both companies have been so close, the assimilation period typical to a merger
of unrelated parties simply does not exist for us. We gain a head start at
achieving advantages normally associated with combining business operations and
strategies.
Since we are so familiar with Allmerica P&C, we know that there are major
challenges ahead in the property and casualty industry. Competition in two of
our key states--Michigan and Massachusetts--eroded premium growth last year, and
rate pressures continue nationally as companies strive to maintain market share.
Investments in technology are absolutely necessary to give us the proper
information systems required to effectively service and maintain our market
share, and we must be diligent in identifying offsetting expense reductions.
We plan to address high expenses by sharpening our regional focus in order
to devote the most cost-effective resources to profitable markets. In 1997, we
will review our current markets to ensure that we can achieve required returns
in a reasonable time frame.
Key initiatives for our property and casualty segments are affinity group
and worksite marketing. Our Michigan-based company, Citizens Corporation, has
been a leader in affinity group marketing for a number of years. Currently,
nearly 50 percent of Citizens' premium comes from affinity groups such as the
Society of Automotive Engineers. During 1996, Citizens added several groups
including the University of Michigan Alumni Association, which has approximately
400,000 members. Hanover Insurance, which is regionally focused in the
Northeast, signed a group arrangement with BJ's Wholesale Club to market to its
347,000 Massachusetts members.
[BAR GRAPH APPEARS HERE]
Net Operating Income
Per Share*
96 - $2.75
95 - $2.32
94 - $1.80
93 - $2.38
* Per share data reflects outstanding shares of 50.1 million in all periods
presented.
Strong underwriting discipline and a regional focus have helped keep our
combined ratio below the industry average. Citizens leads this success,
with a combined ratio that has consecutively outperformed the industry average
for nearly two decades.
13
<PAGE>
[BAR GRAPH APPEARS HERE]
Total Assets (In billions)
96 - $19.0
95 - $17.8
94 - $15.9
93 - $15.4
Worksite Marketing
Property and casualty products are the lead offerings for our worksite
program, but our asset accumulation products are also an excellent fit for this
market. There is a growing consumer demand for investment-type products,
including variable annuities and variable universal life insurance. The need is
especially great for millions of baby boomers who realize they are not
financially prepared for retirement. The time-pressured consumer also needs
convenient product delivery. Worksite marketing affords that convenience.
Employees are accustomed to purchasing benefits at work, and it is equally
convenient for them to address other financial needs at their place of
employment.
Our Retirement and Asset Management products have demonstrated value and
solid appeal through our retail sales channel. Our variable products business
has grown rapidly over the past five years. In 1996, total variable product
assets increased nearly 45 percent, to $6.2 billion. Retail sales alone were up
nearly 70 percent, to $1.3 billion. Worksite relationships established this year
are expected to substantially contribute to continued growth in these product
lines.
[BAR GRAPH APPEARS HERE]
Total Revenues (In millions)
96 - $3,275
95 - $3,241
94 - $3,195
93 - $3,239
In 1996, we refocused the efforts of our Institutional Services segment,
making it responsible for coordinating the worksite marketing and cross-selling
efforts for both property and casualty insurance and variable products. This
strategy is an outgrowth of our long history of marketing to small businesses.
Across our asset accumulation, Corporate Risk Management Services, and
commercial property and casualty lines, Allmerica Financial serves thousands of
businesses with at least one product. Each of these clients represents a
satisfied relationship on which we can build.
Key to worksite selling is our knowledge of this market, and our ability to
assist current customers by expanding the relationship to include new product
offerings and services. In 1996, Institutional Services hired more than a dozen
experienced marketing professionals to sell core products for worksite
distribution. This effort generated worksite relationships with more than 60
companies--including many clients we already serve who agreed to add additional
Allmerica Financial product offerings. We also forged new relationships with
several banks, including Chase Manhattan, Fleet Financial and First of America.
With each bank, we are developing strategies for worksite sales to their
employees and potentially to their commercial customers as well.
14
<PAGE>
The investment we are making in our worksite distribution channel is a
viable remedy for a major problem facing our industry--cost-effective lead
generation. We have made substantial investments over the past five years in
sophisticated telephone marketing capabilities, policy automation, payroll
systems and claims management. As a result, we are confident that we will be
able to benefit from worksite sales as enrollments grow into a profitable
revenue stream.
The Service Company
In 1996, we significantly advanced our service strategies with the
expansion of Allmerica's Service Company. The concept of consolidating all
processing activities into a single service unit has been used successfully by
many leading companies in the banking, mutual fund and other service industries.
Allmerica Financial first implemented this concept in 1992, by combining all
corporate services, including human resources, legal, accounting and technology
into a single structure, and mandating process improvements. That effort proved
successful in improving service levels, leading us to enter the next phase. In
1996, we added to the Service Company all other processing activities, including
applications, endorsements, claims and many aspects of customer service.
The Service Company's role was expanded for two key reasons: to enable
distribution units to focus on sales, marketing and point-of-sale services; and
to consolidate all service improvement and expense control programs. The Service
Company will evaluate the cost and effectiveness of each core process impacting
a distribution unit, to ensure that we can satisfy operational needs at the
lowest possible cost.
Outlook
Allmerica Financial has enhanced its products, distribution strategies,
operating systems and corporate structure. Those efforts have produced
profitable results, and positioned Allmerica Financial to deliver even greater
returns. Our products are attractive, our worksite distribution strategy is off
and running, our earnings base is solid, and our Service Company is moving
rapidly to establish targets for cost-effective process improvement.
The transformation of Allmerica Financial into a competitive financial
services provider continues to be exciting and challenging. Both the pace and
scope of change in this industry continue to increase. We view change as a
positive and integral part of our commitment to deliver value to clients and
healthy growth to shareholders. Going forward, we intend to continue to achieve
profitable growth, and to ensure that shareholders' confidence in our strategies
is rewarded.
/s/ John F. O'Brien
John F. O'Brien
President and Chief Executive Officer
The mandate of our Service Company is to improve our business processes and
reduce operating costs.
[BAR GRAPH APPEARS HERE]
Net Income (In millions)
96 - $182
95 - $134
94 - $38
93 - $157
15
<PAGE>
Allmerica Financial At A Glance
Retirement and Asset Management
Competitive Position
RETAIL . Strong growth achieved through diversified distribution using
agency, broker/dealer and financial planner channels.
. Excellent variable product offerings employing a diverse group of
quality funds and investment managers generate a marketing
advantage.
. Products developed in partnership with leading mutual fund
families.
. Emphasis on investment-oriented insurance products which offer a
strong growth outlook.
. Sourced in traditional insurance products from leading providers.
INSTITUTIONAL
. Full service provider of employee retirement plan services to a
solid base of institutional clients.
. Telemarketing expertise to reach retail customers.
. Coordination of direct worksite sales of Allmerica Financial
products through trained and licensed sales representatives.
. Variable products provide a broad array of quality funds and
investment managers to the group market.
. Providing education and personalized servicing to clients through
worksite marketing.
ASSET
MANAGEMENT
. Successful long-term record in fixed income portfolio management.
. Strong fundamental research orientation.
. Comprehensive client service and support capability.
1997 Outlook
RETAIL . Continue strong growth and market share gains in variable
annuities and variable universal life insurance products.
. Cost effectively grow agency system.
. Develop additional "wrapper" arrangements and broaden existing
relationships by expanding product offerings.
. Manage profitability through focus on cost control.
. Emphasis on customer needs through further enhancements to
existing products.
INSTITUTIONAL
. Continued focus on cross-selling initiatives and worksite
marketing sales of Allmerica Financial products.
. Focus on the corporate special benefits market with group variable
life and other products.
. Partnering with banks for expanded worksite distribution.
. Manage profitability in traditional spread based business.
ASSET
MANAGEMENT
. Continue targeting institutional clients, including other
insurance companies and pension funds for investment management
services.
[BAR GRAPH APPEARS HERE]
Retail - Life & Annuity Sales
By Channel (In millions)
96 - $1,350
95 - $813
94 - $790
93 - $710
92 - $406
[BAR GRAPH APPEARS HERE]
Institutional Variable
Product Assets (In millions)
96 - $1,429
95 - $1,190
94 - $991
93 - $845
92 - $606
[BAR GRAPH APPEARS HERE]
Asset Management
Assets Managed
(In millions)
96 - $1,557
95 - $1,232
94 - $1,024
93 - $942
92 - $537
16
<PAGE>
Risk Management
Competitive Position
HANOVER . Regional property and casualty insurer with distribution through
a network of over 1,900 quality independent agencies.
. Strong local market expertise with Northeast concentration.
. Emerging employer-sponsored group business offers strong future
growth outlook and marketing advantage.
. Disciplined underwriter; small environmental exposure.
. Service capacity enhanced by on-line policy processing and
automated underwriting technology.
. Solid financial position; high degree of liquidity within well
managed investment portfolio.
CITIZENS . Leading Michigan property and casualty insurer, with nearly 10
percent market share.
. Disciplined underwriter; consistently outperforms industry.
. Regionally focused with Michigan concentration; expansion into
Indiana and Ohio.
. Company of choice through over 700 productive independent agencies.
. Successful affinity group marketing programs constitute nearly 50
percent of earned premiums.
. Solid reputation; ranked among top insurers in the nation for
claims service.
. Strong financial position; conservative investment and reserving
practices.
CORPORATE RISK MANAGEMENT
. Leading provider of Risk Sharing Employee Benefit programs to the
mid-sized employer.
. Managed Care plans offer one of the largest national Preferred
Provider organizations (PPO) serving over 200 markets.
. Products include a broad array of managed health and disability
plans along with all forms of non-medical insurance coverages.
. Capabilities include services for self-insured Workers'
Compensation programs which enable us to administer Workers'
Comp and Employee Benefit plans on a fully integrated "24-hour"
basis.
. Emerging leader in the Voluntary Employee Benefit marketplace with
group auto and homeowners as our lead product offerings.
1997 Outlook
HANOVER . Increase efficiencies by leveraging shared resources and new
technologies with Citizens and other Allmerica Financial marketing
units.
. Broaden distribution through expanding group business via
employer-sponsored worksite marketing.
. Maintain strong regional focus and disciplined underwriting
through local market knowledge and expertise.
. Growth in market share from continued worksite sales of personal
automobile and homeowners business.
. Technology enhancements to support further claims processing
automation.
CITIZENS . Maintain regional focus and disciplined underwriting.
. Increase efficiencies by leveraging shared resources and new
technologies with Hanover and other Allmerica Financial marketing
units.
. Develop new bank relationships and additional affinity and
employer group marketing programs, while increasing enrollment in
existing programs.
. Continue providing successful managed care solutions for medical
claims through Citizens Care program.
. Technology enhancements to support further claims processing
automation.
. Further penetration of Indiana and Ohio market share through strong
relationships with existing agents.
CORPORATE RISK MANAGEMENT
. Further develop our on-line information system to continue
providing employers' with administrative benefit plan processing
capabilities.
. Focus on expanding distribution through cross selling more
products to existing customers and building on existing third
party administrator relationships to sell non-medical products.
. Expand our sales growth of integrated Workers' Compensation and
Employee Benefit plans ("24-hour").
. Introduce Voluntary Life and Health products in conjunction with
group auto and homeowners business.
. Maintain our focus in the Alternative market for Workers' Comp
and Employee Benefit plans.
[BAR GRAPH APPEARS HERE]
Hanover
% of Agencies Using
Electronic Processing
---------------------
96 - 87%
95 - 80%
94 - 62%
93 - 30%
92 - 20%
[BAR GRAPH APPEARS HERE]
Citizens
Statutory Combined Ratio
------------------------
Citizens Industry
-------- --------
96 100.4 107.0
95 98.6 106.5
94 104.5 108.5
93 98.9 106.9
92 97.9 115.8
[BAR GRAPH APPEARS HERE]
Corporate Risk Management - Covered Lives (in thousands)
--------------------------------------------------------
96 - 620
95 - 547
94 - 497
93 - 387
92 - 325
17
<PAGE>
Retirement and Asset Management
The transformation of Allmerica Financial that began six years ago continues. We
are focused on two distinct business segments: Retirement and Asset Management,
and Risk Management. With a goal of improving growth and increasing profit
margins, we have altered our product mix, exited low-return businesses,
aggressively expanded our distribution channels and improved internal processing
systems and technology. Work on all of these strategies is ongoing, but we are
proceeding with great confidence in our mission of growth and increased
[PHOTO APPEARS HERE]
profitability. In the Retirement and Asset Management business, we are dedicated
to meeting the needs of baby boomers--to achieve financial security by managing
today's risks, and saving for tomorrow's retirement rewards. Many boomers
believe that Social Security will not be there for them come retirement, and
feel insecure because they don't quite know how to even begin saving enough to
be prepared. We have products that can help, which are broadly available through
convenient distribution channels.
It is good news that baby boomers have been improving their savings habits
in the last few years. That makes them more attuned than ever to our mix of
variable annuities and variable universal life products. Beginning six years
ago, we shifted our focus to these products, thereby emphasizing the areas of
our core competency. This has proven to be a sound decision from both a
marketing and financial perspective. While traditional insurance product sales
have essentially stagnated over this period, the variable product marketplace
has seen impressive growth.
In 1996, our Retirement and Asset Management segment produced a pre-tax
operating profit of $104.1 million, up from $54.6 million in 1995, and variable
assets under management exceed $6.2
Baby boomers are looking for ways to effectively save for retirement or to fund
their childrens' education. We offer smart choices with flexible, high-quality
variable annuities and variable life products--our fastest growing product
lines.
18
<PAGE>
Our variable annuity sales continue to outpace that of the industry.
In 1996, Allmerica ranked 15th in annual variable annuity sales among U.S.
companies, up from 19th in 1995.
[PHOTO APPEARS HERE]
billion, compared with $800 million just five years ago.
Not only is this business growing, it is also fundamentally a better
business. Variable products require less capital support than traditional
insurance because they are fee-based businesses rather than "spread" products.
This corporate transformation required discipline, and a willingness to
stop doing the same old things the same old way. We have sold off marginal
operations such as a mutual-fund processing unit in 1995, and reinvested the
proceeds in the variable products business. We have exited slow-growth, low-
profit businesses and will continue to do so, redeploying the assets into core
businesses that are more promising.
In some aspects, we have been slower to transform the company than we would
have liked. Allmerica Financial is a fine, solid company, but it cannot be
considered a great one until it operates more efficiently and reduces its costs
of doing business. These issues will be addressed in several ways, through the
newly expanded scope of our Service Company.
For example, in the property and casualty operations, our Service Company
oversees client centers in Worcester and in Howell, Michigan. These two
locations now encompass many administrative functions previously handled within
branches. Although investments at this point are ongoing, process consolidation
should result in future cost savings, and should also free branch management to
concentrate fully on strategic field marketing and underwriting. During 1997,
[BAR CHART APPEARS HERE]
Retail Variable
Product Assets
(in millions)
--------------------
96 - $4,804
95 - $3,159
94 - $1,975
93 - $1,373
92 - $ 666
19
<PAGE>
RETIREMENT AND ASSET MANAGEMENT CONTINUED
[PHOTO APPEARS HERE]
Distribution, distribution, distribution--our focus on broadening distribution
for asset management and risk products is key for future growth.
RETAIL VARIABLE PRODUCT SALES
[PIE CHART APPEARS HERE]
Agency 53%
Broker/Dealers & Other 47%
the Service Company will focus on production support initiatives necessary to
run our day-to-day operations, such as policy processing systems used by
independent agents.
Success In Multi-Channel Distribution
In our business, good products at competitive prices are not enough.
Increasingly, success is determined by distribution.
In recent years, Allmerica Financial has been a leader in creating new
distribution opportunities on both the retail and institutional side. Our Retail
Financial Services division once depended primarily on career agents, but no
longer. Agents are still important to us, and their sales volumes have shown
impressive growth. At the same time, we have developed many new methods for
reaching the expanding market for our products and services.
We now market products through broker-dealers, financial planners and a
growing number of private labeling arrangements. Last fall, Kemper began selling
our variable annuities as a wrapper around its mutual funds and is expected to
make a strong contribution to sales in 1997. New avenues of distribution now
account for close to 50 percent of our retail variable sales and have helped us
grow variable product sales at a pace far greater than the industry. When 1996
began, Allmerica Financial was ranked 19th in variable annuity sales by the
Variable Annuity Research and Data Service (VARDS), a major tracking and
reporting service. Our strong performance in 1996 now puts us in the number 15
spot. Retail variable sales rose 66 percent last year, from $802 million to $1.3
20
<PAGE>
billion. In 1997, we should approach $2 billion in variable sales. We expect
some of this growth to come from new third-party distribution agreements.
These marketing arrangements have two distinct advantages. First, they
allow us to reach a large number of potential clients without making major
marketing investments. Second, by partnering with these distributors, we
potentially gain access to their clients for additional product offerings.
Along with creating new distribution opportunities, career agents have been
more productive as well. In 1990, 1,400 agents generated $290 million in
variable sales. Today, our agent force consists of 700 agents who produced more
than $720 million in variable sales during 1996.
We continue to believe that an effectively managed agency force is a key to
successful growth. Accordingly, we completed a major revision of our general
agency structure, linking agents more closely to the company from both an
operational and compensation perspective. The revisions made to our agency
system enable us to grow that distribution channel on a basis that will
contribute significantly to the profitability of our company.
Worksite Marketing
One of the most promising growth areas in our business is worksite
distribution. Several forces are converging to make it particularly attractive.
Busy employees are finding it convenient to do more of their financial shopping
at work, when such opportunities are presented by employers as a benefit option.
Employees appreciate insurance offered in partnership with their employer,
especially since it comes with a discount and the convenience of payments made
via payroll deduction--ensuring that each paycheck is used to buy a little extra
security.
Worksite marketing has similar appeal to employers as it does employees. At
a time when many companies must do more with less, employers are eager to
[PHOTO APPEARS HERE]
Whether a consumer wants to buy variable insurance products from an agent, a
broker, or directly from a mutual fund, Allmerica offers the choice. Today, half
of our variable annuity sales are made by agents, and the remainder are made
through a regional broker or mutual fund provider.
21
<PAGE>
RETIREMENT AND ASSET MANAGEMENT CONTINUED
treat their employees well while keeping a tight rein on costs. This is one
reason the ability to offer a perceived benefit to employees--at no cost--is
very attractive to employers.
Allmerica Financial sells at the worksite in a variety of different ways.
In some cases, we will establish an on-site financial center for employees. It
would be similar to the full-service financial center we run for our employees
at our Worcester home office.
In a second format, we first make an institutional sale, for example, to
manage a company's 401(k) plan. Then we would begin a retail sales effort
directed at the companys' employees, with periodic on-site financial seminars,
but not necessarily a permanent presence.
A third format, which developed during 1996, also offers opportunity. We
have formed strategic partnerships with several banks to sell Allmerica
Financial, Hanover and Citizens products to their employees and to potentially
sell our insurance products to some of the banks' commercial customers.
We intend to collaborate with banks of all sizes, and those with which we
already have agreements represent a broad spectrum of U.S. banking. They include
community banks, such as Safety Fund National Bank of Fitchburg, MA, regional
banks, such as Fleet Financial, and the largest money center institution, Chase
Manhattan Bank. In 1997, we anticipate signing agreements with additional banks
and credit unions.
At Chase, we expect to begin selling our group P&C and group variable life
products. We will customize variable products so the investment choices include
funds Chase directly markets to its customers and employees. We have experience
in product customization to meet the needs of our marketing partners, and we
believe that our flexibility and speed in doing so are a
[PHOTO APPEARS HERE]
In today's fast-paced society, consumers are looking for convenience wherever
they can find it. We make our products available at the workplace, with easy
enrollment and time-saving payment options such as payroll deduction or
electronic funds transfer.
22
<PAGE>
[PHOTO APPEARS HERE]
Our experience and flexibility in product customization, to meet the needs of
our marketing partners, gives us a competitive advantage.
competitive strength. We believe this strength and our flexible approach are
qualities that help us win business when we go head-to-head with larger
competitors.
In all three worksite formats, our representatives can conduct seminars for
employees and offer financial counseling. Our products are highlighted in
communications with employees, via benefits communications, such as employee
newsletters, paycheck inserts and other similar means.
Worksite sales represent an enormous opportunity, and we expect it to
account for a substantial part of our business by the end of the decade.
Our Corporate Risk Management Services unit is also successfully using
third parties to broaden distribution. It has broadened alliances with plan
administrators and health maintenance organizations (HMO's) to help distribute
non-medical products, such as group life and disability, and dental insurance.
We are also using an old distribution approach in new ways. It is called
strategic cross-selling. Historically, it has often been true that when an
insurance company starts referring to cross-selling, or selling additional
products to existing clients, it is a sign that the company has run out of
meaningful things to say. At Allmerica Financial, we have something meaningful
to add on the subject. In 1996, we started an institutional sales committee to
focus on cross-selling--and it is delivering results.
Last year, the number of institutional accounts to which we sell multiple
products doubled, and we are looking for an increase of an additional 50 percent
in 1997. More importantly, the cross-sell effort has broadened our clients'
awareness of our capabilities, and has made it easier for the joint development
23
<PAGE>
RETIREMENT AND ASSET MANAGEMENT CONTINUED
of one-stop solutions to a number of benefit issues.
Corporate Risk Management Services
This segment continues to undergo significant transformation. Not long ago,
Corporate Risk Management specialized in traditional indemnity health insurance.
Currently, most of its business falls within the realm of managed care, usually
provided to employers on a risk-sharing basis. We continue to offer indemnity
products, but growth lies elsewhere. Managed care solutions are a more
profitable and stable business. Since 1992, we have increased our covered lives
in health care by 91 percent, from 325,000 to 620,000 at the end of 1996, by
seeking to provide cost-effective alternatives to full-indemnity insurance.
Further enhancing profitability is the new marketing emphasis that has
accompanied our move into the managed care arena. In the past, our health care
business came primarily from small employers. Now the majority of our business
comes from mid-sized companies with up to 2,000 employees. That is where
Corporate Risk Management Services is putting its marketing effort.
Additionally, we are leveraging this group's expertise by having it manage
medical costs that arise from workers' compensation and auto insurance claims in
our P&C segment.
Financial Strength
Allmerica Financial has become a more aggressive marketer in recent years,
yet it remains conservative and prudent in its financial structure. As we look
toward completing the merger with Allmerica Property & Casualty, we are
constituted as an organization that has over $2.6 billion in total
capitalization, and we are in the position of achieving our greatest increase in
capital flexibility in our 153-year history. Since 1990, Allmerica Financial's
capital has grown by 500 percent. We are proud of that
[PHOTO APPEARS HERE]
Alliances with third parties to market non-medical products, including group
life and disability, and dental insurance, have generated solid sales growth and
increased market penetration.
24
<PAGE>
Conservative underwriting and prudent investment policies add to our financial
strength, and position us to take advantage of new growth opportunities.
[PHOTO APPEARS HERE]
achievement and excited that Allmerica Financial can demonstrate the capital
strength and flexibility needed to fuel future growth.
Total assets now exceed $18 billion, a gain of more than 20 percent since
1993. The Company's $10 billion investment portfolio is weighted toward high-
quality bonds with very little real estate or mortgage loan exposure.
Over 85 percent of our bond holdings are rated investment grade. Our well-
diversified mortgage portfolio of $764.6 million represents less than five
percent of total assets, while real estate of less than $121 million continues
to demonstrate embedded gains at its current carrying value.
In addition to establishing a successful underwriting record, Allmerica
Financial has also earned a reputation for conservative reserving against
property and casualty exposures. Loss reserves in our P&C business have exceeded
actual losses in each of the last five years. Because the duration of our
liabilities is a relatively short average of about two years, we have been able
to validate our policy of conservatism as cases close and claims are settled.
[PIE CHART APPEARS HERE]
Investment Portfolio
$9.9 Billion
Includes closed block
--------------------------
Bonds -- 79%
Mortgage loans -- 8%
Equities -- 5%
Policy loans -- 4%
Real Estate -- 1%
Cash & other -- 3%
25
<PAGE>
[PIE CHART APPEARS HERE]
Property and Casualty
Regional Focus
---------------------
Michigan -- 41%
New York/
New Jersey -- 15%
New England -- 19%
Other States -- 25%
Property & Casualty
Leveraging Strengths
The intense regional focus of our property and casualty segment gives us an
advantage in the marketplace. Most of our business is conducted in markets we
know very well, with independent agents with whom we have built strong ties, and
where our share is large enough to permit economies of scale.
Hanover, which has been in the business of helping make people secure since
1852, gets approximately two-thirds of its premiums from the Northeast, where it
holds market shares of six percent in Maine and nearly five percent in
Massachusetts. Hanover is also strong and growing in New Hampshire, New Jersey,
New York, Rhode Island and Vermont, meeting the needs of its customers through
1,900 independent agents.
Hanover owns 82.5 percent of Citizens Corporation, the third largest property
and casualty competitor in Michigan with a market share of nearly 10 percent.
Although Citizens has been a Michigan success story since 1915, its more recent
performance has been particularly noteworthy. Since 1980, Citizens' market share
has more than tripled.
Our regional focus yields rewards in many different ways. Knowing our markets
means that we have a thorough understanding of the regulatory and competitive
climate we face. This allows us to assess underwriting risks more accurately and
to price products appropriately. Over the last five years, our consolidated P&C
segments' combined ratio has outperformed the industry average. Citizens'
combined ratio has continued to trend at or below 100, outperforming the
industry average for 18 consecutive years.
Our regional focus also helps provide customers with a feeling of security. We
do most of our business in markets where we are very well known, where consumers
have experienced our quality service and have heard of our good reputation. We
believe we have
[PHOTO APPEARS HERE]
In 1996, Hanover partnered with BJ's Wholesale Club to market auto insurance to
BJ's 347,000 Massachusetts members, while Citizens added the University of
Michigan Alumni Association to its large affinity group base.
26
<PAGE>
[PIE CHART APPEARS HERE]
Property and Casualty
Product Mix
-------------------------------
Personal Auto -- 47%
Homeowners -- 12%
Workers' Comp. -- 12%
Commercial Auto -- 9%
Commercial Multiple Peril -- 13%
All other -- 7%
established generations of goodwill in key markets.
This geographic focus also helps us target profitable niches, and we are adept
at acting quickly when circumstances warrant. We are disciplined underwriters,
prepared to walk away from business when pricing gets overly ambitious. And we
have done a good job of communicating this philosophy to our agents, giving them
appropriate incentives for bringing us preferred business.
We continually refine product features to meet our target market needs. For
example, Hanover is in the midst of a program designed to improve its
underwriting profitability in the homeowners market. It has offered renewals
with a higher deductible and more stable, yet lower rates--a welcomed prospect
to policyholders. By allowing policyholders the option of self-insuring small
potential losses, we can ensure that major claims receive the utmost service and
attention.
New Market Opportunities
Analysts estimate that, industry-wide, P&C premiums will rise only about two
percent a year for the next few years. Both Hanover and Citizens intend to grow
more rapidly in total over that time frame, primarily through even more focus on
our strongest regional markets.
Driving this growth will be selective regional expansion along with worksite
and other group marketing initiatives. We expect to increase market share by
operating more efficiently and delivering better products in a variety of ways.
We believe that worksite sales may ultimately represent a substantial portion
of the P&C business-based on our current aggressive pursuit of this market. In
worksite marketing, we offer our products to employees under the sponsorship of
their employer. Employers like the arrangement because there is no cost to
provide a valued benefit to their
New technology solutions will improve
our claims processing efficiency. In policy processing, Hanover and Citizens are
among the national leaders in on-line connectivity with agents.
[PHOTO APPEARS HERE]
27
<PAGE>
RISK MANAGEMENT CONTINUED
workforce. Employees value it because they can purchase insurance conveniently
at work, at a discount, and pay via payroll deduction or electronic funds
transfer.
With worksite enrollment and product sales, we are able to offer financial
planning programs, and, in some instances, may establish a permanent on-site
presence to serve employees. In other cases, we will sell an institutional
product to a company with the right to market directly to employees.
In a third approach, we enter into marketing partnerships with banks to sell
products to their employees and, potentially, to their corporate customers. In
1996, Citizens signed three bank marketing partnerships, while Hanover signed
many new worksite clients, including state employee groups, large corporations
and professional associations.
Hanover is increasing its efforts to penetrate the group employee market.
This business is appealing because we can underwrite policies twice, the first
time based on the employee groups' overall risk profile and, secondly based on
each individual. Both Hanover and Citizens have found that the group market
offers better underwriting characteristics, lower acquisition costs and higher
retention.
Hanover has had recent success pursuing joint marketing arrangements with
large companies. In 1996, it won the right to market auto insurance to the
347,000 Massachusetts members of BJ's Wholesale Club, the largest warehouse club
in New England.
Hanover is actively seeking to increase its six percent market share of the
workers' compensation business in Maine during 1997. Regulatory reform has made
this business attractive in many states and Hanover is well positioned to gain a
sizable share of the market.
[PHOTO APPEARS HERE]
Citizens' affinity group marketing offers personal lines products to more than
one hundred affinity groups and professional associations, throughout Michigan,
Indiana, and Ohio. Affinity marketing accounts for nearly half of Citizens'
premiums.
28
<PAGE>
[PHOTO APPEARS HERE]
Citizens has grown from expansion in Indiana and Ohio by partnering with
quality, independent agencies. Premiums written in Indiana grew 15 percent in
1996, while premiums in Ohio reached $10 million in its first full year of
operations.
Technological Enhancements
Among insurers, our P&C segment is one of the nation's leading users of
technology solutions to improve strong relationships with independent agents. We
rely on our strong network of independent agents and are aware that agents may
elect to sell a competitor's product rather than our own. Like many business
people, they often follow the easiest path to do business. Our objective is to
provide that pathway. We believe that the appropriate use of technology makes it
easier for agents to do business with us through systems that speed
transactions, eliminate guesswork, and reduce errors. We use technology strateg-
ically to increase information processing, reduce costs wherever possible, and
to improve our competitive position with independent insurance agents.
So far, the agents' response indicates that we are on the right track.
We are among the top insurers in the country in terms of on-line connectivity to
agencies. The system allows both the agent and the company to speed the exchange
of information. As a result, agents can serve their customers more promptly.
Currently, the majority of all personal line policies are approved and processed
directly through the agency-company on-line management system.
In 1996, we also made progress in our effort to handle more of our commercial
lines in the same manner, a process we'll complete in late 1997.
In addition to front-line technology enhancements for agents, we are focused
on administrative process reengineering. Client service centers in Worcester and
Howell, Michigan, now handle many
[BAR GRAPH APPEARS HERE]
Citizens affinity
Group Premium
In millions
-----------------
96 -- $414
95 -- $406
94 -- $383
93 -- $345
92 -- $317
29
<PAGE>
RISK MANAGEMENT CONTINUED
Citizens Care case management program has received national praise for handling
policyholder injuries promptly and effectively. We help people get the care that
will allow them to return to a normal lifestyle as soon as possible.
[PHOTO APPEARS HERE]
administrative functions, which is changing how the Hanover and Citizens
branches do business. Branch management can now better focus on strategic,
field-based marketing and underwriting support to the independent agency sales
force which actually sells our products.
Financial Strength
Financially, our P&C segment is in excellent shape, a result of strong market
performance and conservative fiscal management. Assets total $5.7 billion, and
investments are largely in high-quality municipal government and corporate
bonds. Almost 85 percent of the bonds we hold are investment grade.
Our P&C business has been conservative in its management of loss reserves, and
that policy continues. Our financial strength is further enhanced by the nature
of our underwriting. Most business lines are short-tail, with limited exposure
to potential lingering losses. Similarly, we have low environmental exposures.
Our conservative reinsurance activity minimizes risk while allowing for solid
profitability.
30
<PAGE>
Five Year Summary of Selected Financial Highlights
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1993 1992
=======================================================================================================
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME
- -------------------
Revenues
Premiums $ 2,236.3 $ 2,222.8 $ 2,181.8 $ 2,079.3 $ 2,172.4
Universal life and investment product
policy fees 197.2 172.4 156.8 143.7 132.9
Net investment income 672.6 710.5 743.1 782.8 823.7
Net realized gains 65.9 39.8 1.1 159.6 9.6
Other income 102.7 95.4 112.3 73.8 37.1
- -------------------------------------------------------------------------------------------------------
Total revenues 3,274.7 3,240.9 3,195.1 3,239.2 3,175.7
- -------------------------------------------------------------------------------------------------------
Benefits, Losses and Expenses
Policy benefits, claims, losses and loss
adjustment expenses 1,957.0 2,010.3 2,047.0 1,987.2 2,163.8
Policy acquisition expenses 483.5 470.3 475.7 435.8 424.1
Other operating expenses 502.5 458.5 518.9 421.3 373.5
- -------------------------------------------------------------------------------------------------------
Total benefits, losses and expenses 2,943.0 2,939.1 3,041.6 2,844.3 2,961.4
- -------------------------------------------------------------------------------------------------------
Income before federal income taxes 331.7 301.8 153.5 394.9 214.3
Federal income tax expense 75.2 82.7 53.4 74.7 62.7
- -------------------------------------------------------------------------------------------------------
Income before minority interest,
extraordinary item and cumulative
effect of accounting changes 256.5 219.1 100.1 320.2 151.6
Minority interest (74.6) (73.1) (51.0) (122.8) (54.4)
- -------------------------------------------------------------------------------------------------------
Income before extraordinary item and
cumulative effect of accounting changes 181.9 146.0 49.1 197.4 97.2
Extraordinary item -
demutualization expenses -- (12.1) (9.2) (4.6) --
Cumulative effect of accounting changes -- -- (1.9) (35.4) --
- -------------------------------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0 $ 157.4 $ 97.2
=======================================================================================================
Adjusted Net Income (1) $ 137.9 $ 116.4 $ 90.4 $ 119.1 $ 109.9
==========================================================================================================
BALANCE SHEET (AT DECEMBER 31)
- ------------------------------
Total assets $18,997.7 $17,757.7 $15,921.5 $15,378.4 $14,083.1
Long-term debt 202.2 202.3 2.7 -- --
Total liabilities 16,489.0 15,425.0 14,299.4 13,711.7 12,764.1
Minority interest 784.0 758.5 629.7 615.8 422.4
Shareholders' equity 1,724.7 1,574.2 992.4 1,050.9 896.6
</TABLE>
(1) Represents net income adjusted for certain items which management believes
are not indicative of overall operating trends, including net realized
investment gains (losses), net gains and losses on disposals of businesses,
extraordinary items, the cumulative effect of accounting changes and
differential earnings tax adjustments.
- --------------------------------------------------------------------------------
31
<PAGE>
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- -------------------------------------------------------------------------------
The following analysis of the consolidated results of operations and financial
condition of the Company should be read in conjunction with the Consolidated
Financial Statements and related consolidated 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 59.5%-owned non-
insurance holding 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.
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 of the Closed Block.
The contribution from the Closed Block is included in 'Other income' in the
Consolidated Financial Statements. The pre-tax contribution from the Closed
Block was $8.6 million for the year ended December 31, 1996 and $2.9 million for
the period October 1, 1995 (date used to estimate financial information for the
date of establishment of October 16, 1995) through December 31, 1995.
FAFLIC's conversion to a stock life insurance company, which was completed
on October 16, 1995, and the establishment of the Closed Block have affected the
presentation of the Company's Consolidated Financial Statements. For
comparability with prior periods, the following table presents the results of
operations of the Closed Block for the year ended December 31, 1996 and the
period October 1, 1995 through December 31, 1995 combined with the results of
operations outside the Closed Block for the years then ended. Management's
discussion and analysis addresses the results of operations as combined unless
otherwise noted.
<TABLE>
<CAPTION>
For the Years Ended December 31
(In millions) 1996 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues
Premiums $2,298.0 $2,234.3 $2,181.8
Universal life and investment
product policy fees 197.2 172.4 156.8
Net investment income 725.2 723.3 743.1
Net realized investment gains 65.2 19.1 1.1
Realized gain on sale of mutual
fund processing business -- 20.7 --
Other income 94.1 92.5 112.3
- -------------------------------------------------------------------------------
Total revenues 3,379.7 3,262.3 3,195.1
- -------------------------------------------------------------------------------
Benefits, Losses and Expenses
Policy benefits, claims, losses
and loss adjustment expenses 2,058.2 2,030.9 2,047.0
Policy acquisition expenses 486.7 471.1 475.7
Other operating expenses 503.1 458.5 518.9
- -------------------------------------------------------------------------------
Total benefits, losses
and expenses 3,048.0 2,960.5 3,041.6
- -------------------------------------------------------------------------------
Income before federal
income taxes 331.7 301.8 153.5
- -------------------------------------------------------------------------------
Federal income tax expense (benefit)
Current 90.9 119.7 45.4
Deferred (15.7) (37.0) 8.0
- -------------------------------------------------------------------------------
Total federal income
tax expense 75.2 82.7 53.4
- -------------------------------------------------------------------------------
Income before minority
interest, extraordinary item,
and cumulative effect of
accounting change 256.5 219.1 100.1
Minority interest (74.6) (73.1) (51.0)
- -------------------------------------------------------------------------------
Income before extraordinary
item and cumulative effect of
accounting change 181.9 146.0 49.1
Extraordinary item -
demutualization expenses -- (12.1) (9.2)
Cumulative effect of change in
accounting principle -- -- (1.9)
- -------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0
===============================================================================
</TABLE>
32
<PAGE>
Results of Operations
- ---------------------
Consolidated Overview
- ---------------------
1996 Compared to 1995
- ---------------------
The Company's consolidated net income increased $48.0 million to $181.9 million
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>
For the Years Ended December 31
(In millions) 1996 1995
==============================================================================
<S> <C> <C>
Net income $181.9 $133.9
Adjustments:
Net realized investment gains (31.0) (8.5)
Net gain on sale of mutual
fund processing business -- (13.5)
Extraordinary item-
demutualization expense -- 12.1
Contingency payment from sale of mutual
fund processing business (3.1) --
Restructuring costs 0.3 --
Differential earnings tax adjustment (10.2) (7.6)
- -------------------------------------------------------------------------------
Adjusted net income $137.9 $116.4
===============================================================================
</TABLE>
The increase in adjusted net income of $21.5 million is primarily
attributable to pre-tax increases of $39.6 million and $11.1 million in the
Retail Financial Services and Institutional Services segments, respectively,
partially offset by pre-tax decreases of $12.8 million and $43.2 million in the
Corporate and Regional Property and Casualty segments, respectively. The
increase in the Retail Financial Services segment resulted primarily from
increased fees from strong variable product growth, decreased losses in the
disability income line and income earned on proceeds from the Company's October,
1995 initial public offering. The increase in the Institutional Services segment
related principally to exiting certain unprofitable businesses in 1995. These
increases were partially offset by losses in the Corporate segment primarily due
to interest expense on the Company's 7 5/8% Senior Debentures issued in October
1995. Additionally, the Regional Property and Casualty segment's adjusted net
income decreased primarily due to severe weather-related claims during 1996,
partially offset by an increase in net investment income of $25.8 million, as
well as a $5.7 million arbitrated settlement from a voluntary pool.
Premium revenue increased $63.7 million, or 2.9%, to $2,298.0 million during
1996. Property and casualty premiums earned increased $35.1 million, or 1.9%, to
$1,898.3 million, reflecting the accounting effects of restructuring a
reinsurance contract at Hanover, increasing net premiums earned by approximately
$19.0 million. In addition, a 2.0% increase in policies in force in the
homeowners line as well as moderate price increases in this line contributed to
the increase in net premiums earned. The growth in Citizens' personal lines is
due to increases in net premiums earned in Ohio and Indiana resulting from
expansion in these states as well as price increases in the personal automobile
and homeowners lines. These increases were partially offset by decreases in the
commercial line due to rate decreases in workers' compensation, Hanover's
withdrawal from a large voluntary pool and continued competitive market
conditions. Premiums in the Corporate Risk Management Services segment increased
$30.2 million, or 11.1%, to $302.9 million due to increases in reinsurance,
fully insured group dental, group life, and stop loss product lines totaling
$33.1 million. These increases were partially offset by a $4.0 million decrease
in fully insured group medical premiums. Premiums in the Retail Financial
Services segment decreased $2.4 million, or 2.4%, to $95.7 million, primarily
reflecting the Company's continued shift in focus from traditional life
insurance products to variable life insurance and annuity products.
Universal life and investment product policy fees increased $24.8 million,
or 14.4%, to $197.2 million in 1996. This reflected additional deposits and
appreciation on variable products account balances.
Net investment income before taxes was relatively flat, increasing 0.3% to
$725.2 million during 1996. This increase primarily reflects approximately $20.0
million of incremental income in 1996 on proceeds from the Company's initial
public offering and from the issuance of Senior Debentures in October 1995, as
well as approximately $17.2 million in income from increases in short-term debt
used to finance additions to the investment portfolio. In addition, the Regional
Property and Casualty segment had $10.0 million of income from limited
partnerships in 1996. These increases were substantially offset by a reduction
in invested assets due to declining Guaranteed Investment Contracts ("GICs")
deposits resulting in a decline in investment income of $54.4 million. The
average gross yield of the portfolio was 7.2% in 1996 and 1995.
Net realized gains on investments were $65.2 million and $19.1 million,
before taxes, and $42.4 million and $12.4 million, after taxes, in 1996 and
1995, respectively. In 1996, the Regional Property and Casualty segment revised
its investment strategy, resulting in the sale of a portion of its equity
portfolio and the purchase of tax-exempt securities. Consequently, Regional
Property and Casualty segment realized gains increased $22.5 million, to $31.3
million on an after-tax basis in 1996. Additionally, Institutional Services
segment realized investment
33
<PAGE>
gains increased $8.9 million on an after-tax basis in 1996, primarily reflecting
additional real estate sales in favorable market conditions.
Results in 1995 included a $20.7 million pre-tax gain from the March 1995
sale of the Company's mutual fund processing business.
Other income increased $1.6 million, or 1.7%, to $94.1 million in 1996.
Other income from the Retail Financial Services segment increased $6.8 million,
primarily attributable to increased investment management income. Additionally,
other income in the Allmerica Asset Management and Regional Property and
Casualty segments increased $4.4 million and $3.1 million, respectively. These
increases were partially offset by decreases in the Institutional Services
segment resulting primarily from the sale of the mutual fund processing business
in March of 1995, which had contributed revenues of approximately $13.7 million
in that year. Also, 1996 results included a non-recurring $4.8 million pre-tax
contingent payment related to the aforementioned sale. Other income attributable
to the Corporate Risk Management Services segment decreased $2.1 million,
primarily due to an $11.1 million litigation settlement recognized in the fourth
quarter of 1995, partially offset by growth in Administrative Services Only
("ASO") and contract fees totaling $7.9 million.
Policy benefits, claims, losses and loss adjustment expenses ("LAE")
increased $27.3 million, or 1.3%, to $2,058.2 million during 1996. This increase
is primarily attributable to an $83.1 million, or 6.4%, increase in losses and
LAE in the Company's Regional Property and Casualty segment as a result of
catastrophe losses and severe weather in 1996. Additionally, policy benefits,
claims, losses and LAE increased $14.1 million, or 7.2%, in the Corporate Risk
Management Services segment resulting primarily from product growth. These
increases were partially offset by decreased policy benefits of $57.7 million,
or 26.5%, in the Institutional Services segment primarily resulting from the
continuing decline of GICs during 1996 and decreases in the Retail Financial
Services segment of $12.2 million, or 3.9%, due primarily to reserve
strengthening in the disability income line in 1995.
Policy acquisition expenses consist primarily of commissions, premium taxes
and other policy issuance costs. Policy acquisition expenses increased $15.6
million, or 3.3%, to $486.7 million during 1996. This was primarily due to an
increase of $13.5 million, or 3.3%, to $422.6 million in the Regional Property
and Casualty segment primarily reflecting growth in net premiums earned.
Other operating expenses increased $44.6 million, or 9.7%, to $503.1 million
in 1996 across all major segments, except the Institutional Services segment.
Other operating expenses in the Retail Financial Services segment increased
$17.0 million, or 16.8%, to $118.2 million in 1996, primarily from an $8.3
million increase in short-term borrowing costs used to finance additions to the
investment portfolio. Other operating expenses in the Corporate Risk Management
Services segment increased $16.1 million, or 14.6%, to $126.4 million in 1996 as
a result of increased commissions, claims processing expenses and field office
expenses, resulting from the increased volume of both premiums and claims. The
Corporate segment's other operating expenses increased $15.1 million in 1996,
principally related to interest expense on the Company's Senior Debentures for a
full year in 1996 versus one quarter in 1995. Additionally, the Regional
Property and Casualty segment's other operating expenses increased $10.6 million
due primarily to technology and other administrative expenses. These increases
were partially offset by a decrease of $19.8 million in the Institutional
Services segment related to the sale of the mutual fund processing business in
March 1995.
Federal income tax expense decreased $7.5 million in 1996, while the
effective tax rate decreased from 27.4% to 22.7% in the same period. For the
life insurance subsidiaries, the effective rate decreased slightly from 32.0% to
28.9%, primarily due to additional reserves provided for revisions of estimated
prior year tax liabilities in 1995, as well as an increase of $2.6 million in
the differential earnings benefit from 1995 to 1996. For the property and
casualty subsidiaries, a decrease in the effective rate from 25.3% to 18.4%
resulted from a higher underwriting loss and a greater proportion of pre-tax
income from tax-exempt bonds in 1996, and to reserves provided for revisions of
estimated prior year tax liabilities in 1995.
1995 Compared to 1994
- ---------------------
The Company's consolidated net income increased $95.9 million to $133.9 million
in 1995. 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.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECMEBER 31
(IN MILLIONS) 1995 1994
===============================================================================
<S> <C> <C>
Net income $133.9 $38.0
Adjustments:
Net realized investment (gains) losses (8.5) 0.1
Net (gain) loss on disposal of businesses (13.5) 6.2
Extraordinary item - demutualization expenses 12.1 9.2
Cumulative effect of accounting change -- 1.9
Differential earnings tax adjustment (7.6) 35.0
- -------------------------------------------------------------------------------
Adjusted net income $116.4 $90.4
===============================================================================
</TABLE>
The increase in adjusted net income of $26.0 million is primarily
attributable to a pre-tax increase of $83.2 million in the Regional Property and
Casualty segment due to improved underwriting results primarily attributable to
favorable 1995 claims experience resulting from a return to more normal
34
<PAGE>
- --------------------------------------------------------------------------------
weather conditions in the Northeast and in Michigan. Additionally, adjusted net
income increased $17.3 million in the Retail Financial Services segment,
resulting primarily from an increase in fee revenue from variable products and a
decrease in policy acquisition expenses for all major products. These increases
were partially offset by an increase in disability income policy benefits and
decreased interest margins. Also, adjusted net income in the Institutional
Services segment increased $13.8 million, primarily attributable to the sale of
the Company's mutual fund processing business in March 1995, which decreased
1995 revenue from this business by $38.3 million and expenses by $49.3 million,
contributing $11.0 million to adjusted net income before taxes for this period.
Premium revenue increased $52.5 million, or 2.4%, to $2,234.3 million during
1995 as a result of increased property and casualty premiums earned, partially
offset by a decrease in premiums from traditional life products. Regional
Property and Casualty premiums earned increased $71.9 million, or 4.0%, to
$1,863.2 million, as a result of growth in the personal lines. Premiums in the
Retail Financial Services segment decreased $23.5 million, or 19.3%, to $98.1
million, reflecting the cession in January of 1995 of substantially all yearly
renewable term ("term") insurance.
Universal life and investment-type product policy fees increased $15.6
million, or 9.9%, to $172.4 million during 1995. This resulted from additional
deposits and appreciation on variable products account balances.
Net investment income before taxes decreased $19.8 million, or 2.7%, to
$723.3 million during 1995. Although overall invested assets have remained at
approximately the same level in 1995 versus 1994, net investment income has
decreased due to decreases in the average portfolio yields. The average gross
yield of the fixed maturity investment portfolio decreased from 7.5% during
1994, to 7.2% during 1995.
Net realized gains on investments before taxes were $19.1 million during
1995, versus $1.1 million during 1994. After taxes, net realized gains on
investments were $12.4 million during 1995, versus $0.7 million during 1994.
This change is primarily attributable to gains taken on sales of equity
securities and real estate, partially offset by losses on sales of fixed
maturities.
Results in 1995 include a $20.7 million pre-tax gain from the March 1995
sale of the Company's mutual fund processing business.
Policy benefits, claims, losses and LAE decreased $16.1 million, or 0.8%, to
$2,030.9 million during 1995. Property and casualty losses and LAE decreased
$15.2 million, or 1.2%, to $1,300.3 million during 1995, primarily due to a
return to more normal weather conditions during the first half of 1995 in the
Northeast and in Michigan. Institutional Services policy benefits decreased
$30.3 million, or 12.2%, to $217.8 million in 1995 as a result of the decrease
in interest credited during 1995, due to declining GIC deposits. These decreases
were partially offset by increases in Retail Financial Services policy benefits
of $14.8 million, or 4.9%, to $315.6 million during 1995, reflecting increased
policy benefits of $21.6 million due to adverse morbidity and reserve
strengthening in the disability line in 1995, partially offset by a decline in
traditional life benefits resulting from the cession of term insurance. Policy
benefits in the Corporate Risk Management Services segment also increased by
$14.6 million, or 8.0%, to $197.2 million during 1995, primarily due to a
deterioration in claims experience in all major lines.
Policy acquisition expenses decreased $4.6 million, or 1.0%, to $471.1
million during 1995. This was due primarily to a decrease of $23.4 million, or
29.4%, to $56.1 million in the Retail Financial Services segment due to reduced
profit margins resulting from increased mortality and reduced investment
margins, which resulted in a corresponding reduction in amortization, and due to
the cession of term insurance, for which the amortization of deferred
acquisition costs totaled $12.1 million in 1994. This decrease was mostly offset
by an increase in policy acquisition expenses in the Regional Property and
Casualty segment of $18.8 million, or 4.8%, to $409.1 million during 1995,
primarily related to the increase in net premiums earned.
Other operating expenses decreased $60.4 million, or 11.6%, to $458.5
million during 1995, resulting primarily from a decrease of $58.1 million in
operating expenses in the Institutional Services segment, caused by the sale of
the mutual fund processing business in March, 1995 and by reduced expenses
resulting from exiting certain other product lines and businesses, primarily
various processing services for defined contribution plans.
Federal income tax expense increased $29.3 million in 1995, while the
effective tax rate decreased from 34.8% in 1994 to 27.4% in 1995. The decrease
in the effective tax rate resulted from a lower expected differential earnings
charge for the life insurance subsidiaries in 1995, which was partially offset
by an increase in the property and casualty effective tax rate due to improved
underwriting results, a decrease in the proportion of pre-tax income
attributable to tax-exempt interest, and to reserves provided for revisions in
estimated prior year tax liabilities.
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 Regional Property and Casualty
segment consists of the Company's
35
<PAGE>
- --------------------------------------------------------------------------------
59.5% ownership of Allmerica P&C; however, all property and casualty results
presented include 100% of Allmerica P&C's pre-tax results of operations,
consistent with the presentation in the Company's consolidated financial
statements. The other segments are all owned and operated by FAFLIC and its
wholly owned subsidiaries.
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. These proceeds are invested
primarily in fixed maturities at December 31, 1996.
RISK MANAGEMENT
- ---------------
Regional Property and Casualty
- ------------------------------
The following table summarizes the results of operations for the Regional
Property and Casualty segment.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==============================================================================
<S> <C> <C> <C>
Revenues
Net premiums earned $1,898.3 $1,863.2 $1,791.3
Net investment income 235.4 209.6 202.4
Net realized gains 48.1 13.5 3.5
Other income 11.9 8.8 7.6
- ------------------------------------------------------------------------------
Total revenues 2,193.7 2,095.1 2,004.8
Losses and LAE (1) 1,383.4 1,300.3 1,315.5
Policy acquisition expenses 422.6 409.1 390.3
Other operating expenses 190.0 179.4 185.9
- ------------------------------------------------------------------------------
Income before taxes $ 197.7 $ 206.3 $ 113.1
==============================================================================
</TABLE>
(1) Includes policyholders' dividends of $11.5 million, $10.6 million and $8.8
million in 1996, 1995 and 1994, respectively.
INCOME BEFORE TAXES
- -------------------
1996 Compared to 1995
- ---------------------
Income before taxes decreased $8.6 million, or 4.2%, to $197.7 million in 1996.
This decrease resulted from catastrophes and other severe weather related losses
which contributed to an $83.1 million increase in losses and LAE to $1,383.4
million. Catastrophe losses increased $27.3 million, to $62.9 million in 1996
from $35.6 million during the previous year. The increase in losses and LAE was
partially offset by an increase in net investment income of $25.8 million, or
12.3%, to $235.4 million, attributable to an increase in higher-yielding debt
securities in the portfolio and earnings from a limited partnership. The
decrease in income before tax was also offset by a $33.5 million increase in
realized gains, primarily related to the sale of equity securities, reflecting
the Regional Property and Casualty segment's decision during the first quarter
of 1996 to increase the proportion of debt securities in the portfolio. Income
was also favorably impacted by a $5.7 million arbitrated settlement from a
voluntary pool during the third quarter.
1995 Compared to 1994
- ---------------------
Income before taxes increased $93.2 million, or 82.4%, to $206.3 million in
1995. This increase resulted primarily from improved underwriting results
attributable to favorable current year claims experience resulting from a return
to more normal weather conditions in the Northeast and in Michigan. Catastrophe
losses decreased $10.5 million, to $35.6 million in 1995, from $46.1 million
during the previous year.
LINES OF BUSINESS RESULTS
- -------------------------
Personal Lines of Business
- --------------------------
The personal lines represented 61.2%, 59.8% and 58.3% of total net premiums
earned in 1996, 1995 and 1994, respectively.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1996 1995 1994 1996 1995 1994
==============================================================================================================================
Total Regional Property
Hanover Citizens and Casualty
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned $ 607.3 $ 577.1 $ 548.2 $ 554.6 $ 536.2 $ 496.1 $ 1,161.9 $ 1,113.3 $ 1,044.3
Losses and loss adjustment
expenses incurred 452.0 368.6 366.0 404.1 413.6 391.0 856.1 782.2 757.0
Policy acquisition expenses 150.8 135.2 125.9 112.5 108.1 99.5 263.3 243.3 225.4
Other underwriting expenses 51.7 49.7 50.0 39.3 41.1 37.9 91.0 90.8 87.9
- ------------------------------------------------------------------------------------------------------------------------------
Underwriting (loss) profit $ (47.2) $ 23.6 $ 6.3 $ (1.3) $ (26.6) $ (32.3) $ (48.5) $ (3.0) $ (26.0)
==============================================================================================================================
</TABLE>
36
<PAGE>
1996 Compared to 1995
- ---------------------
Revenues
Net premiums earned by the personal lines increased $48.6 million, or 4.4%, to
$1,161.9 million in 1996, compared to $1,113.3 million in 1995. Hanover's
personal lines net premiums earned increased $30.2 million, or 5.2%, to $607.3
million during 1996. This increase is primarily attributable to an increase in
the personal automobile line associated with the accounting effects of
restructuring a reinsurance contract, increasing net premiums earned by $19.0
million. A 2.0% increase in policies in force in Hanover's homeowners line as
well as moderate price increases in this line also contributed to the increase
in net premiums earned. These increases were partially offset by a mandated 4.5%
decrease in Massachusetts personal automobile rates which became effective
January 1, 1996. Effective January 1, 1997, Massachusetts personal automobile
rates were decreased an additional 6.2% as mandated by the Massachusetts
Insurance Commissioner. In addition, in response to increasing price competition
in Massachusetts, Hanover, in February 1997, requested the Massachusetts
Division of Insurance to approve a plan to offer a safe driver's discount of 10%
on automobile insurance premiums. Management believes these actions may
unfavorably impact premium growth in Massachusetts. Approximately 39% of
Hanover's personal automobile business is currently written in Massachusetts.
[LINE GRAPH APPEARS HERE]
Personal Lines
Net Premiums Earned (In millions)
96 - $1,162
95 - $1,113
94 - $1,044
Citizens' personal lines' net premiums earned increased $18.4 million, or
3.4%, to $554.6 million in 1996. This growth is attributable to price increases
in the personal automobile and homeowners lines. The growth is partially offset
by a 3.0% decrease in policies in force in the personal automobile line,
attributable to the segment's selective reduction of writings in Michigan when
rates were viewed as inadequate, and to continued strong competition in
Michigan. While management has taken steps to increase penetration in affinity
groups and has initiated other marketing programs, heightened competition may
continue to result in reduced growth in the personal lines.
Underwriting results
The personal lines' underwriting loss in 1996 increased $45.5 million, to a loss
of $48.5 million. Hanover's underwriting results deteriorated $70.8 million to a
loss of $47.2 million, while Citizens' underwriting loss improved $25.3 million
to a loss of $1.3 million.
Hanover's personal lines' losses and LAE increased $83.4 million, or 22.6%,
to $452.0 million in 1996. This increase is partially attributable to a $28.8
million increase in losses and LAE in the homeowners line, resulting from
increased catastrophes and severe weather. Catastrophe losses in Hanover's
personal lines increased $17.2 million, to $30.6 million in 1996 from $13.4
million in 1995. Losses and LAE in the personal automobile line increased $49.6
million, or 17.8%, to $328.0 million, primarily reflecting the accounting
effects of restructuring a reinsurance contract, increasing losses by $19.0
million, in addition to a moderate increase in claims frequency and a $4.7
million reduction in favorable reserve development.
The improvement in Citizens' underwriting results reflects favorable claims
activity in both current and prior accident years in the personal automobile
line attributable to continued improvements in severity. This was partially
offset by an increase in catastrophe losses of $6.2 million to $13.4 million,
primarily in the homeowners line.
Policy acquisition expenses in the personal lines increased $20.0 million,
or 8.2%, to $263.3 million and other underwriting expenses increased $0.2
million to $91.0 million in 1996. This increase in policy acquisition expenses
is primarily attributable to an increase of $15.6 million, or 11.5%, to $150.8
million at Hanover resulting from a reapportionment of certain acquisition
expenses to the personal lines from the commercial lines, as well as an increase
in net premiums earned. The $2.0 million increase in Hanover's other
underwriting expenses resulted from an increase of approximately $4.0 million in
expenses associated with the policy administration technology project, offset by
a decrease in assessment expenses associated with the reapportionment of an
involuntary pool. Policy acquisition expenses in the personal lines at Citizens
increased $4.4 million, or 4.1%, to $112.5 million in 1996, reflecting growth in
net premiums earned. The $1.8 million decline in Citizens' other underwriting
expenses is primarily attributable to reductions in employee related expenses
and commissions, partially offset by expenses associated with a policy
administration technology project. Management anticipates an increase in this
segment's expense levels due to further planned investments in technology.
1995 Compared to 1994
- ---------------------
Revenues
Net premiums earned by the personal lines increased $69.0 million, or 6.6%, to
$1,113.3 million in 1995. Hanover's net premiums earned increased $28.9 million,
or 5.3%, to $577.1 million in 1995. The increase is primarily attributable to a
2.0% and 1.3% increase in policies in force in the personal automobile and
homeowners lines, respectively, and a 2.5% rate increase in the homeowners line.
Hanover's premium growth in the personal lines in 1995 was partially offset by a
mandated 6.5% decrease in Massachusetts automobile insurance rates, which was
effective January 1, 1995.
37
<PAGE>
Citizens' personal lines net premiums earned increased $40.1 million, or
8.1%, to $536.2 million in 1995. This increase reflects price increases in the
personal automobile and homeowners lines, and was partially offset by a 5.8%
decrease in personal automobile policies in force. This decrease is attributable
to the Company's selective reduction of writings in Michigan when rates were
viewed as inadequate, and to increased competition in affinity group franchise
sales as a result of the January 1995 order by the Michigan Insurance
Commissioner which has permitted competitors to offer similar products.
Underwriting Results
The personal lines underwriting loss decreased $23.0 million, from $26.0 million
in 1994, to $3.0 million in 1995. Hanover's underwriting results improved $17.3
million, from a profit of $6.3 million in 1994, to a profit of $23.6 million in
1995. Citizens' underwriting loss improved $5.7 million, or 17.6%, from $32.3
million in 1994, to $26.6 million in 1995.
The improvement in Hanover's underwriting results is primarily attributable
to favorable claims experience on current years claims in the homeowners line
resulting from a decrease in catastrophe losses from $27.2 million in 1994, to
$13.4 million during 1995, and to a return to more normal weather conditions
during the first half of 1995. This resulted in a decrease in losses and LAE in
the homeowners line of $17.8 million, or 17.9%, from $99.2 million in 1994, to
$81.4 million in 1995.
The change in Citizens' underwriting results reflects a return to more
normal weather conditions in Michigan as well as favorable claims activity in
both current and prior accident years in the personal automobile line
attributable to improvements in severity. Citizens' underwriting results
improved despite a $3.4 million increase in catastrophe losses in the personal
lines, primarily in the homeowners line. Catastrophe losses were $7.2 million
and $3.8 million in Citizens' personal lines in 1995 and 1994, respectively.
The increase in policy acquisition expenses in the personal lines of $17.9
million, or 7.9%, to $243.3 million in 1995, reflects the growth in net earned
premiums at both Hanover and Citizens. Other underwriting expenses at Hanover
remained relatively unchanged at $49.7 million in 1995, compared to $50.0
million in 1994. Other underwriting expenses at Citizens increased by $3.2
million, or 8.4%, to $41.1 million in 1995, reflecting the growth in net
premiums earned in 1995.
Commercial Lines of Business
- ----------------------------
The commercial lines represented 38.8%, 40.2% and 41.7% of net premiums earned
in 1996, 1995 and 1994, respectively.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1996 1995 1994 1996 1995 1994
====================================================================================================================================
Total Regional Property
Hanover Citizens and Casualty
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned $455.5 $468.3 $480.4 $280.9 $281.6 $266.6 $736.4 $749.9 $747.0
Losses and loss adjustment
expenses incurred 315.5 342.8 361.2 200.3 164.7 188.5 515.8 507.5 549.7
Policy acquisition expenses 107.7 114.3 117.6 51.6 51.5 47.3 159.3 165.8 164.9
Other underwriting expenses (1) 74.0 73.8 77.6 27.0 25.4 29.2 101.0 99.2 106.8
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting (loss) profit $(41.7) $(62.6) $(76.0) $ 2.0 $ 40.0 $ 1.6 $(39.7) $(22.6) $(74.4)
====================================================================================================================================
</TABLE>
(1) Includes policyholders' dividends.
1996 Compared to 1995
- ---------------------
Revenues
Commercial lines' net premiums earned in 1996 decreased $13.5 million, or 1.8%,
to $736.4 million. Hanover's commercial lines net premiums earned decreased
$12.8 million, or 2.7%, to $455.5 million. This decrease is primarily
attributable to Hanover's withdrawal from a large voluntary pool on December 1,
1995, and to aggregate rate decreases of 14.6% since January 1, 1995, in the
workers' compensation line. Citizens' commercial lines' net premiums earned
decreased $0.7 million, or 0.2%, to $280.9 million in 1996. This decrease
primarily reflects rate reductions and a 1.4% decrease in policies in force in
the workers' compensation line due to continuing competition in this line in
Michigan. Rates in the workers' compensation line at Citizens were decreased
8.5%, 7.0% and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996,
respectively. This decrease is partially offset by an increase in policies in
force in the commercial multiple peril and commercial automobile lines of 13.2%
and 3.7%, respectively. Management believes competitive conditions in the
workers' compensation line may impact future growth in net premiums earned.
Underwriting results
The commercial lines' underwriting loss for 1996 increased $17.1 million, or
75.7% to a loss of $39.7 million. Hanover's underwriting loss improved $20.9
million, or 33.4%, to a loss of $41.7 million and Citizens' underwriting profit
decreased $38.0 million, to a profit of $2.0 million in 1996.
Hanover's commercial lines losses and LAE decreased $27.3 million, or 8.0%,
to $315.5 million in 1996. This improvement is primarily attributable to a $41.5
million decrease in losses and LAE resulting from the withdrawal from a large
voluntary pool.
38
<PAGE>
However, this decrease was partially offset by increased losses in the workers'
compensation line of $17.9 million, primarily due to a $19.8 million decrease in
favorable reserve development during 1996.
Citizens' underwriting profit decreased primarily due to an increase in
loss severity and frequency in the commercial multiple peril line. Commercial
multiple peril losses and LAE increased $16.9 million, or 42.4%, to $56.8
million in 1996, partially offset by a $5.1 million, or 9.4% increase to $59.1
million in net premiums earned. Workers' compensation net premiums earned
decreased $17.6 million, or 11.9%, to $130.7 million in 1996, while losses and
LAE increased $9.6 million, or 15.0%, to $73.4 million in this line, primarily
due to reduced favorable development of prior year reserves. Catastrophe losses
in the commercial lines were $1.9 million in 1996 compared to $0.8 million
during 1995.
[LINE GRAPH APPEARS HERE]
Commercial Lines
Underwriting Loss ( In millions)
96 - $39.7
95 - $22.6
94 - $74.4
Policy acquisition expenses in the commercial lines decreased $6.5 million,
or 3.9%, to $159.3 million in 1996 and other underwriting expenses increased
$1.8 million, or 1.8%, to $101.0 million. Hanover's policy acquisition expenses
decreased $6.6 million, or 5.8%, to $107.7 million, primarily attributable to a
reapportionment of certain acquisition expenses from the commercial lines to the
personal lines, as well as the decrease in net earned premium. Other
underwriting expenses at Hanover increased $0.2 million, to $74.0 million as a
result of an increase of approximately $3.0 million in expenses associated with
the policy administration technology project, which were partially offset by a
net decrease in assessment expenses associated with voluntary and involuntary
pools. Citizens' policy acquisition expenses in the commercial lines remained
consistent between years, primarily as a result of flat net earned premiums.
Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million in
1996, due to investments in technology and increased policyholders' dividends,
partially offset by reductions in employee related expenses and commissions.
Management anticipates an increase in its expense levels due to further planned
investments in technology.
1995 Compared to 1994
- ---------------------
Revenues
Commercial lines' net premiums earned increased $2.9 million, to $749.9 million
in 1995. Hanover's commercial lines net premiums earned decreased $12.1 million,
or 2.5%, to $468.3 million in 1995, reflecting decreases in policies in force in
all major commercial lines, particularly a $10.7 million, or 9.4%, decrease in
commercial automobile net premiums earned to $103.1 million, resulting from
continued competitive market conditions affecting Hanover. Workers' compensation
net premiums earned at Hanover decreased $6.4 million, or 5.8%, to $104.4
million in 1995, primarily as a result of rate decreases and an increasing level
of large deductible policies.
Citizens' commercial lines' net premiums earned increased $15.0 million, or
5.6%, to $281.6 million in 1995. This increase primarily reflects growth of 8.1%
in total commercial policies in force. The overall growth includes increases in
policies in force in the commercial automobile and commercial multiple peril
lines of 12.5% and 11.6%, respectively, along with a decrease in workers'
compensation policies in force of 4.6% and rate decreases of 15.5% in the
workers' compensation line in 1995. These decreases in workers' compensation
premiums were more than offset by increased workforce coverage due to full
employment in Michigan. Price increases in the commercial automobile line also
contributed to the increase in net premiums earned.
Underwriting Results
The commercial lines' underwriting loss improved $51.8 million to $22.6 million
in 1995. Hanover's underwriting loss improved to a loss of $62.6 million, from
$76.0 million, and Citizens' underwriting profit increased from $1.6 million in
1994, to $40.0 million in 1995.
Hanover's commercial lines' losses and LAE decreased by $18.4 million, or
5.1%, to $342.8 million in 1995. This improvement is primarily attributable to
decreased losses and LAE in the workers' compensation and commercial automobile
lines. Losses and LAE in the workers' compensation line decreased $34.7 million,
or 47.6%, from $72.9 million in 1994 to $38.2 million in 1995. This decrease
resulted from continued favorable claims experience for both the current and
prior years. Commercial automobile losses and LAE decreased $14.9 million, or
17.0%, from $87.7 million in 1994 to $72.8 million in 1995. This decrease
results from favorable claims experience in this line for both the current and
prior years, and a decrease in premiums earned. Losses and LAE in Hanover's
other commercial lines, which consist primarily of voluntary pools, general
liability and inland marine, increased $28.9 million, or 55.0%, from $52.5
million in 1994, to $81.4 million in 1995. Commercial lines were also
unfavorably impacted by a $25.9 million loss in an industrial voluntary pool,
including a $12.0 million charge during the fourth quarter of 1995.
The improvement in Citizens' underwriting results in 1995 reflects
favorable claims activity in both current and prior accident years in the
workers' compensation line attributable to improvements in severity and
frequency, and to severe weather and large claims in the first half of 1994
which had an adverse impact on the commercial multiple peril and commercial
automobile lines.
39
<PAGE>
Policy acquisition expenses in the commercial lines decreased $0.9 million,
or 0.5%, to $165.8 million in 1995. Policy acquisition expenses in the
commercial lines at Citizens increased $4.2 million, or 8.9%, from $47.3 million
in 1994, to $51.5 million in 1995, reflecting the growth in net premiums earned.
Hanover's policy acquisition expenses decreased $3.3 million, or 2.8%, from
$117.6 million in 1994, to $114.3 million in 1995, reflecting the decrease in
net earned premiums. Other underwriting expenses at Hanover decreased $3.8
million, or 4.9%, from $77.6 million in 1994, to $73.8 million in 1995,
reflecting the decrease in net premiums written. Other underwriting expenses at
Citizens decreased $3.8 million, or 13.0%, from $29.2 million in 1994, to $25.4
million in 1995. This decrease reflects the unusually high level of expenses
incurred during 1994 resulting from the expansion into Ohio including the cost
of preparing to write multi-state and cross-state commercial line policies, as
well as a reduction in 1995 administrative expenses resulting from process
improvements in the commercial lines.
INVESTMENT RESULTS
- ------------------
Net investment income before tax was $235.4 million, $209.6 million and $202.4
million in 1996, 1995 and 1994, respectively. The increase from 1995 to 1996
represents an increase in average invested assets, $10.0 million of income from
limited partnerships, and the Regional Property and Casualty segment's portfolio
shift to higher yielding debt securities, including longer duration and non-
investment grade securities. Also, the average pre-tax yield on debt securities
increased from 6.1% in 1995 to 6.4% in 1996. Net investment income increased
from 1994 to 1995 as a result of increased average invested assets partially
offset by a decrease in the portfolio's average pre-tax yield from 6.2% in 1994
to 6.0% in 1995. This decrease resulted primarily from lower yields available on
new investments relative to the yields on maturing investments. Net realized
gains on investments before taxes were $48.1 million, $14.6 million and $3.5
million in 1996, 1995 and 1994, respectively. The high level of realized gains
in 1996 was primarily the result of sales of appreciated equity securities due
to the strategy of shifting to a higher level of debt securities. The $10.0
million increase in net realized gains in 1995 was due to increased gains on the
sale of equity 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, and where the technological,
judicial and political climates involving these types of claims are changing.
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 YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Reserve for losses and LAE,
beginning of year $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events
of current year 1,513.3 1,427.3 1,434.8
Decrease in provision for
insured events of prior years (141.4) (137.6) (128.1)
- --------------------------------------------------------------------------------
Total incurred losses and LAE 1,371.9 1,289.7 1,306.7
- --------------------------------------------------------------------------------
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 759.6 652.2 650.2
Losses and LAE attributable to
insured events of prior years 627.6 614.3 566.9
- --------------------------------------------------------------------------------
Total payments 1,387.2 1,266.5 1,217.1
- --------------------------------------------------------------------------------
Change in reinsurance recoverable
on unpaid losses (136.6) 51.1 14.8
- --------------------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,744.1 $2,896.0 $2,821.7
================================================================================
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $141.4 million, $137.6 million and
$128.1 million in 1996, 1995, and 1994, respectively. The increase in favorable
development on prior years' reserves of $3.8 million in 1996 results primarily
from an $11.4 million increase in favorable development at Citizens. The
increase in Citizens' favorable development of $11.4 million in 1996 reflects
improved severity in the personal automobile line, where favorable development
increased $28.6 million to $33.0 million in 1996, partially offset by less
favorable development in the workers' compensation
40
<PAGE>
line. In 1995, the workers' compensation line had favorable development of $32.7
million, primarily as a result of Citizens re-estimating reserves to reflect the
new claims cost management programs and the Michigan Supreme Court ruling, which
decreases the maximum to be paid for indemnity cases on all existing and future
claims. In 1996, the favorable development in the workers' compensation line of
$21.8 million also reflected these developments. Hanover's favorable
development, including voluntary and involuntary pools, decreased $7.7 million
in 1996 to $82.9 million, primarily attributable to a decrease in favorable
development in the workers' compensation line of $19.8 million. This decrease is
primarily attributable to a re-estimate of reserves with respect to certain
types of workers' compensation policies including large deductibles and excess
of loss policies. In addition, during 1995 the Regional Property and Casualty
segment refined its estimation of unallocated loss adjustment expenses which
increased favorable development in that year. Favorable development in the
personal automobile line also decreased $4.7 million, to $42.4 million in 1996.
These decreases were offset by increases in favorable development of $1.9
million and $5.6 million, to $12.6 million and $5.7 million, in the commercial
automobile and commercial multiple peril lines, respectively. Favorable
development in other lines increased by $8.8 million, primarily as a result of
environmental reserve strengthening in 1995. Favorable development in Hanover's
voluntary and involuntary pools increased $3.7 million to $4.1 million during
1996. The Regional Property and Casualty segment expects reduced favorable
development at Hanover to continue to impact future earnings.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal automobile
and workers' compensation lines increased $16.6 million and $15.5 million, to
favorable development of $4.4 million and $32.7 million, respectively, due to
the aforementioned change in claims cost management and the Michigan Supreme
Court ruling. Hanover's favorable development, not including the effect of
voluntary and involuntary pools, was relatively unchanged at $90.2 million in
1995 compared to $91.7 million in 1994. Favorable development in Hanover's
workers' compensation line increased $27.7 million to $31.0 million during 1995.
This was offset by decreases of $14.6 million and $12.6 million, to $45.5
million and $0.1 million, in the personal automobile and commercial multiple
peril lines, respectively. Favorable development in Hanover's voluntary and
involuntary pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Regional Property and Casualty
segment's reserving philosophy consistently applied over these periods.
Conditions and trends that have affected development of the loss and LAE
reserves in the past may not necessarily occur in the future.
Due to the nature of the business written by the Regional Property and
Casualty segment, the exposure to environmental liabilities is relatively small
and therefore its reserves are relatively small compared to other types of
liabilities. Loss and LAE reserves related to environmental damage and toxic
tort liability, included in the reserve for losses and LAE were $50.8 million
and $43.2 million, net of reinsurance of $20.2 million and $8.4 million in 1996
and 1995, respectively. During 1995, the Regional Property and Casualty segment
redefined its environmental liabilities in conformity with new guidelines issued
by the NAIC. This had no impact on results of operations. The Regional Property
and Casualty segment does not specifically underwrite policies that include this
coverage, but as case law expands policy provisions and insurers' liability
beyond the intended coverage, the Regional Property and Casualty segment may be
required to defend such claims. During 1995, Hanover performed an actuarial
review of its environmental reserves. This resulted in Hanover's providing
additional reserves for "IBNR" (incurred but not reported) claims, in addition
to existing reserves for reported claims. Although these claims are not
material, their existence gives rise to uncertainty and is discussed because of
the possibility, however remote, that they may become material. The Regional
Property and Casualty segment believes that, notwithstanding the evolution of
case law expanding liability in environmental claims, recorded reserves related
to these claims are adequate. In addition, the Regional Property and Casualty
segment is not aware of any litigation or pending claims that may result in
additional material liabilities in excess of recorded reserves. The
environmental liability could be revised in the near term if the estimates used
in determining the liability are revised.
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the Regional Property and Casualty segment
varies by product. Property and casualty insurance premiums are established
before the amount of losses and LAE, and the extent to which inflation may
affect such expenses, are known. Consequently, the Regional Property and
Casualty segment attempts, in establishing rates, to anticipate the potential
impact of inflation in the projection of ultimate costs. The impact of inflation
has been relatively insignificant in recent years. However, inflation could
contribute to increased losses and LAE in the future.
The 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 Regional Property and Casualty segment
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,
41
<PAGE>
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.
Corporate Risk Management Services
- ----------------------------------
The following table summarizes the results of operations for the Corporate Risk
Management Services ("CRMS") segment.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================
<S> <C> <C> <C>
Premiums and premium equivalents
Premiums $302.9 $272.7 $268.0
Premium equivalents 581.4 513.4 459.7
- ----------------------------------------------------------------
Total premiums and
premium equivalents $884.3 $786.1 $727.7
================================================================
Revenues
Premiums $302.9 $272.7 $268.0
Net investment income 21.7 17.6 14.0
Net realized gains (losses) 0.3 (0.5) 0.1
Other income 36.6 38.7 20.3
- ----------------------------------------------------------------
Total revenues 361.5 328.5 302.4
Policy benefits, claims and losses 211.3 197.2 182.6
Policy acquisition expenses 3.1 2.7 2.5
Other operating expenses 126.4 110.3 97.4
- ----------------------------------------------------------------
Income before taxes $ 20.7 $ 18.3 $ 19.9
================================================================
</TABLE>
1996 Compared to 1995
- ---------------------
Income before taxes increased $2.4 million, or 13.1%, to $20.7 million in 1996.
In 1995, CRMS received a one time litigation settlement of $11.1 million.
Excluding this item, income before taxes increased $13.5 million, or 187.5%.
This increase is primarily attributable to premium growth in the Company's
reinsurance, fully insured group dental and group life product lines, and to
improved overall loss trends.
Premiums increased $30.2 million, or 11.1%, to $302.9 million in 1996,
primarily due to increases in reinsurance, fully insured group dental, group
life and stop loss product lines totaling $33.1 million. These increases were
partially offset by a decrease of $4.0 million in fully insured medical
premiums.
Net investment income increased $4.1 million, or 23.3%, to $21.7 million in
1996, due primarily to a $1.6 million increase in income earned on proceeds from
the Company's October, 1995 initial public offerings and approximately $1.4
million from increases in short-term debt used to finance additions to the
investment portfolio. In addition, net investment income increased approximately
$1.2 million from growth in invested assets.
Other income decreased $2.1 million, or 5.4%, to $36.6 million in 1996, due
primarily to the absence in 1996 of the aforementioned $11.1 million litigation
settlement. This decrease was partially offset by growth in ASO and contract
fees of $7.9 million in 1996.
Policy benefits, claims and losses increased $14.1 million, or 7.2%, to
$211.3 million in 1996. This increase is principally related to the growth in
premiums, partially offset by favorable claims experience overall.
Other operating expenses increased $16.1 million, or 14.6%, to $126.4
million in 1996, due primarily to increases in commissions, claims processing
expenses and field office expenses, resulting from the increased volume of both
premiums and claims. In addition, other operating expenses includes
approximately $1.0 million of short-term borrowing costs related to the short-
term debt used to finance additions to the investment portfolio.
1995 Compared to 1994
- ---------------------
Income before taxes decreased $1.6 million, or 8.0%, to $18.3 million in 1995.
This decrease was primarily attributable to adverse claims experience in all
major lines, partially offset by an $11.1 million fourth quarter litigation
settlement representing the recovery of claims paid in prior years.
Premiums increased $4.7 million, or 1.8%, in 1995 as a result of increases
in risk sharing and stop loss products and other products such as group life,
long term disability, and reinsurance, totaling $20.4 million. These increases
were partially offset by decreases of $15.7 million in full indemnity medical
products. The decrease in full indemnity health business is consistent with the
Company's plan to de-emphasize these products in favor of the more profitable
risk sharing arrangements.
Net investment income increased $3.6 million, or 25.7%, to $17.6 million in
1995 due to growth in invested assets.
Other income increased $18.3 million, or 89.7%, to $38.7 million in 1995.
This change is primarily due to an $11.1 million litigation settlement,
recognized in the fourth quarter of 1995, which represents the recovery of prior
years' claims paid. In addition, fees from the administrative services only
business increased $4.0 million, or 27.2%, to $18.7 million in 1995.
Policy benefits, claims and losses increased $14.6 million, or 8.0% in
1995. This increase is principally due to a deterioration in long term
disability, medical, and dental loss experience as well as to growth in
substantially all products except full indemnity medical.
Other operating expenses increased $12.8 million, or 13.1%, in 1995,
primarily due to increases in commissions, increased employee costs, and
increased expenses associated with the Company's client center in Atlanta,
Georgia.
42
<PAGE>
- --------------------------------------------------------------------------------
Retail Financial Services
- -------------------------
The following table summarizes the results of operations for the Retail
Financial Services segment.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==============================================================
<S> <C> <C> <C>
Revenues
Premiums $ 95.7 $ 98.1 $121.6
Fees 181.2 157.9 143.9
Net investment income 251.3 229.1 223.9
Net realized (losses) gains (1.5) 0.6 (3.1)
Other income 29.2 22.4 21.6
- --------------------------------------------------------------
Total revenues 555.9 508.1 507.9
Policy benefits, claims and losses 303.4 315.6 300.8
Policy acquisition expenses 58.1 56.1 79.5
Other operating expenses 118.2 101.2 113.4
- --------------------------------------------------------------
Income before taxes $ 76.2 $ 35.2 $ 14.2
==============================================================
</TABLE>
1996 Compared to 1995
- ---------------------
Income before taxes increased $41.0 million, or 116.5%, to $76.2 million in 1996
compared to 1995. This increase was primarily attributable to growth in variable
products' fee revenue, decreased losses in the disability income line and income
earned on the proceeds from the October, 1995 initial public offerings.
[GRAPH APPEARS HERE]
Policy Fees
(In millions)
96 - $181
95 - $158
94 - $144
The decrease in premiums of $2.4 million, or 2.4%, to $95.7 million in 1996
is primarily due to the Company's shift in focus from traditional life insurance
products to variable life insurance and annuity products. Premiums from
traditional life products decreased $3.4 million, or 5.1%, to $62.8 million in
1996.
The increase in fee revenue of $23.3 million, or 14.8%, to $181.2 million in
1996 is due to additional deposits and appreciation on variable products account
balances. Fees from annuities increased $20.1 million, or 54.5%, to $57.0
million in 1996. Fees from variable universal life policies increased $8.0
million, or 22.7%, to $43.3 million in 1996. These increases were partially
offset by a continued decline in fees from non-variable universal life of $4.8
million, to $80.9 million, in 1996. The Company expects fees on this product to
decrease as policies in force and related contract values decline.
Net investment income increased $22.2 million, or 9.7%, to $251.3 million in
1996 primarily from $15.4 million in additional income on proceeds from the
October, 1995 initial public offerings. Also, increases in short-term debt used
to finance additions to the investment portfolio resulted in approximately $10.9
million in additional investment income. Partially offsetting these increases
was a slightly lower portfolio yield in 1996.
Other income increased $6.8 million, or 30.4%, to $29.2 million in 1996.
This increase was primarily attributable to increased investment management
income.
Policy benefits, claims, and losses decreased $12.2 million, or 3.9%, to
$303.4 million in 1996. Losses in the disability income line decreased $16.3
million due primarily to reserve strengthening of $14.5 million in 1995.
Additionally, non-variable universal life benefits decreased $2.5 million
principally due to improved mortality experience in 1996. These decreases were
partially offset by an increase in variable products' policy benefits of $6.2
million, which related primarily to growth in these product lines.
Other operating expenses include insurance taxes, licenses, fees, and
administrative expenses incurred to support sales and marketing of products sold
in this segment. The increase of $17.0 million, or 16.8%, to $118.2 million in
1996 was primarily attributable to $8.3 million of additional interest expense
in 1996 relating to the short-term debt used to finance additions to the
investment portfolio. Additionally, other operating expenses in 1995 included a
$7.5 million decrease due to the cession of substantially all term life
insurance business.
1995 Compared to 1994
- ---------------------
Income before taxes increased $21.0 million, or 147.9%, to $35.2 million in
1995. This increase was primarily attributable to an increase in fee revenue
from variable products and a decrease in policy acquisition expenses for all
major products. These increases were partially offset by an increase in
disability income policy benefits and decreased interest margins.
The decrease in premiums of $23.5 million during 1995 is primarily due to
the Company's ceding substantially all of its term life insurance business,
which contributed $18.7 million in premiums in 1994.
The increase in fee revenue of $14.0 million in 1995 is due to additional
deposits and appreciation on variable products account balances. Fees from
variable universal life increased from $28.9 million during 1994 to $35.3
million in 1995. Fees from annuities increased from $24.1 million for 1994 to
$36.9 million for 1995. Fees from non-variable universal life decreased $5.2
million in 1995 as a result of a decline in policies in force and related
contract values. The Company expects fees on this product to decrease as
policies in force and related contract values continue to decline.
The increase in policy benefits, claims and losses of $14.8 million in 1995
is primarily a result of increases in disability income policy benefits, non-
variable universal life policy benefits, annuity benefits and variable life
benefits, partially offset by a decrease in traditional life benefits due to
cession of substantially all of the term life insurance business. Disability
43
<PAGE>
- --------------------------------------------------------------------------------
income policy benefits increased $21.6 million, reflecting reserve strengthening
and adverse morbidity in 1995, including fourth quarter reserve strengthening of
$11.7 million. Non-variable universal life policy benefits increased $1.8
million due to adverse mortality. Annuity benefits and variable universal life
benefits increased by $3.7 million in total, due primarily to growth in business
and higher crediting rates for annuities. Total traditional policy benefits,
claims and losses decreased from $116.7 million during 1994 to $104.4 million
during 1995. The largest component of this $12.3 million decrease is a $12.5
million decrease in term life insurance benefits due to the cession of
substantially all of this block of business in 1995.
The decrease in policy acquisition expenses of $23.4 million, or 29.4%, to
$56.1 million in 1995 is primarily due to reduced profit margins resulting from
increased mortality and reduced investment margins, which resulted in a
corresponding reduction in amortization. In addition, the 1994 amortization
includes an increase of $9.6 million for the term life insurance product due to
revised estimates of future profits.
Other operating expenses decreased $12.2 million, or 10.8%, to $101.2
million in 1995, resulting primarily from a $7.5 million decrease due to the
cession of substantially all term life insurance business and to significant
non-recurring 1994 expenses.
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>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=======================================================================
<S> <C> <C> <C>
Net investment income $145.9 $152.7 $157.5
Less: Interest credited 101.3 107.7 102.0
- -----------------------------------------------------------------------
Interest margins (1) $ 44.6 $ 45.0 $ 55.5
=======================================================================
</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 1996, as compared to 1995.
The decrease in interest margins from 1994 to 1995 is a result of a decline in
policies in force and higher crediting rates resulting from the competetive
environment.
Institutional Services
- ----------------------
The following table summarizes the results of operations for the Institutional
Services segment.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
============================================================
<S> <C> <C> <C>
Revenues
Fees, premiums and
non-insurance income (1) $ 33.5 $ 37.6 $ 72.6
Net investment income
GICs 98.5 152.9 188.2
Other 115.5 113.5 114.6
Net realized gains 19.2 5.5 0.6
Gain on sale of mutual fund
processing business -- 20.7 --
- ------------------------------------------------------------
Total revenues 266.7 330.2 376.0
- ------------------------------------------------------------
Policy benefits, claims and losses
Interest credited to GICs 89.2 137.2 166.6
Other 70.9 80.6 81.5
- ------------------------------------------------------------
Total policy benefits, claims
and losses 160.1 217.8 248.1
Policy acquisition expenses 2.9 3.2 3.4
Other operating expenses 50.9 66.4 120.1
- ------------------------------------------------------------
Income before taxes $ 52.8 $ 42.8 $ 4.4
============================================================
</TABLE>
(1) Fees, premiums and non-insurance income includes fees from retirement
services, mutual fund services, institutional 401(k) recordkeeping services
and other miscellaneous non-insurance related fees. In March 1995, the
Company sold its mutual fund processing business.
1996 Compared to 1995
- ---------------------
Income before taxes increased $10.0 million, or 23.4%, to $52.8 million in 1996.
This change was primarily attributable to increased realized gains of $13.7
million and to decreased other policy benefits, claims and losses of $9.7
million resulting from defined benefit and defined contribution plan
cancellations. These items were partially offset by a net decline of $9.8
million related to the sale of the mutual fund processing business in 1995 and a
decline in the interest margins on GICs of $6.4 million.
Fees, premiums, non-insurance and other income decreased $4.1 million, or
10.9%, to $33.5 million in 1996. This decrease was primarily attributable to a
$13.7 million decrease in revenues due to the absence of the mutual fund
processing business in 1996, partially offset by the 1996 receipt of a non-
recurring $4.8 million contingent payment related to the aforementioned sale and
to $3.0 million from growth in retail telemarketing revenues. Additionally, fee
income increased $1.5 million from the appreciation of separate account balances
in related defined benefit and defined contribution plans.
44
<PAGE>
- --------------------------------------------------------------------------------
Net investment income related to GICs and interest credited to GIC
contractholders have declined in 1996 as a result of declining GIC deposits due
to the downgrading in March 1995 of FAFLIC's S&P Rating to A+ (Good). As a
result, sales of traditional GICs have substantially ceased. Management expects
GIC deposits and related income to continue to decline.
Net realized gains increased $13.7 million, to $19.2 million in 1996. This
change resulted primarily from increased gains from sales of real estate
properties totaling $12.2 million.
Other policy benefits, claims and losses consist primarily of benefits
provided by the Company's defined contribution and defined benefit plans,
including annuity benefits for certain defined benefit plan participants
electing that option. Other policy benefits, claims and losses declined from
$80.6 million in 1995 to $70.9 million in 1996. This was primarily due to
reductions in the interest credited to participants resulting from the
aforementioned cancellations in defined benefit and defined contribution plans.
Other operating expenses decreased $15.5 million, or 23.3%, to $50.9 million
in 1996. This decrease was primarily attributable to the sale of the mutual fund
processing business, which incurred $19.8 million of operating expenses in 1995.
1995 Compared to 1994
- ---------------------
Income before taxes increased $38.4 million to $42.8 million in 1995. This
increase was primarily attributable to the sale of the Company's mutual fund
processing business in March 1995, resulting in a pre-tax gain of $20.7 million,
and to a $4.9 million increase in realized investment gains. Additionally, in
1995 revenue from the mutual fund processing business decreased $38.3 million
and expenses decreased $49.3 million, contributing another $11.0 million to the
increase in net income before taxes for this period.
Fees, premiums and non-insurance income decreased $35.0 million, or 48.2% in
1995. As noted above, this decrease was primarily attributable to the $38.3
million decrease in revenues from the mutual fund processing business, which was
sold in March 1995.
Net investment income related to GICs and interest credited to GIC
contractholders have declined as a result of declining GIC deposits due to the
downgrading in March 1995 of FAFLIC's S&P Rating to A+ (Good). Management
expects GIC deposits and related income to continue to decline.
Net realized gains increased $4.9 million, to $5.5 million in 1995 due to
decreased mortgage loan impairments.
Other operating expenses decreased $53.7 million, or 44.7% in 1995. This
decrease was primarily attributable to the $49.3 million decrease in expenses
for the mutual fund processing business. The remainder of the decrease was due
primarily to decreases in consulting fees, system development costs, and
employee costs as a result of exiting certain other product lines and
businesses, primarily various processing services for defined contribution
plans.
Allmerica Asset Management
- --------------------------
The following table summarizes the results of operations for the Allmerica Asset
Management segment.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=================================================================
<S> <C> <C> <C>
Fees and other income:
External $ 1.1 $ 1.0 $ 0.7
Internal 7.7 3.4 3.3
- -----------------------------------------------------------------
Total revenues 8.8 4.4 4.0
Other operating expenses 7.7 2.1 2.1
- -----------------------------------------------------------------
Income before taxes $ 1.1 $ 2.3 $ 1.9
=================================================================
</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 $4.3 million for the year ended
December 31, 1996.
Corporate
- ---------
The following table summarizes the results of operations for the Corporate
segment.
<TABLE>
<CAPTION>
Period from
October 1
through
December 31 December 31
(IN MILLIONS) 1996 1995
==============================================================================
<S> <C> <C>
Revenues
Investment and other income $ 2.7 $ 0.4
Realized loss (0.9) --
- ------------------------------------------------------------------------------
Total revenues 1.8 0.4
Other operating expenses 18.6 3.5
- ------------------------------------------------------------------------------
Loss before taxes $(16.8) $(3.1)
==============================================================================
</TABLE>
This segment consists primarily of $32.9 million of cash, investments and
other assets remaining from the $52.9 million in net proceeds retained by the
holding company in the Company's initial public offerings. These investments
earned $2.7 million in net investment income in 1996 and $0.4 million for the
period from October 1, 1995 to December 31, 1995. The segment incurred $18.6
million and $3.5 million of other operating expenses in 1996 and for the period
from October 1, 1995 to December 31, 1995, respectively, primarily $15.3 million
and $3.2 million, respectively, in interest expense on the Company's 7 5/8%
Senior Debentures issued in October 1995.
45
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
- --------------------
The Company had investment assets diversified across several asset classes, as
follows:
<TABLE>
<CAPTION>
December 31
(Dollars in millions) 1996(1) 1995(1)
================================================================================
% of Total % of Total
Carrying Carrying Carrying Carrying
Value Value Value Value
<S> <C> <C> <C> <C>
Fixed maturities (2) $7,891.7 79.4% $ 8,197.3 78.1%
Equity securities (2) 473.6 4.8 517.2 4.9
Mortgages 764.6 7.7 856.5 8.2
Policy loans 362.6 3.6 365.7 3.5
Real estate 120.7 1.2 179.6 1.7
Cash and cash equivalents 202.6 2.0 307.1 2.9
Other invested assets 128.8 1.3 71.9 0.7
- --------------------------------------------------------------------------------
Total $9,944.6 100.0% $10,495.3 100.0%
================================================================================
</TABLE>
(1) Includes Closed Block invested assets with a carrying value of $772.7
million and $775.1 million at December 31, 1996 and 1995, respectively.
(2) The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
Total investment assets decreased $550.7 million, or 5.2%, to $9.9 billion
during 1996. This decrease is primarily attributable to a decline in invested
assets resulting from the settlement of GIC contracts and to market value
depreciation in the fixed maturities portfolio. Equity securities decreased
$43.6 million, or 8.4%, to $473.6 million, as a result of the Regional Property
and Casualty segment's shift in portfolio holdings from equity securities to
tax-exempt fixed maturity securities. Despite this portfolio shift, fixed
maturities decreased $305.6 million, or 3.7%, due primarily to financing of net
GIC withdrawals and to market value depreciation of $93.0 million. Additionally,
mortgage loans decreased $91.9 million, or 10.7%, to $764.6 million caused
primarily by loan repayments. The real estate portfolio decreased $58.9 million,
or 32.8%, to $120.7 million during 1996 due to sales of investment properties.
The increase in other invested assets of $56.9 million, or 79.1% to $128.8
million primarily relates to third and fourth quarter purchases of limited
partnerships by FAFLIC. Cash and cash equivalents decreased $104.5 million, or
34.0%, to $202.6 million.
[PIE CHART APPEARS HERE]
Bond Portfolio
Credit Quality
Aaa/Aa/A -- 54%
Baa -- 31%
Ba & Below -- 15%
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 84.8% and 88.7% of the Company's total fixed maturity portfolio at
December 31, 1996 and December 31, 1995, respectively. In 1996, 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 7.3%
and 7.2% for 1996 and 1995, 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.
46
<PAGE>
The following table illustrates asset valuation allowances and additions to or
deductions from such allowances for the periods indicated.
<TABLE>
<CAPTION>
For the Years Ended December 31
(Dollars in millions)
================================================================================
Other
Real Invested
1995 Mortgages Estate Assets Total
- ----
<S> <C> <C> <C> <C>
Beginning balance $ 47.2 $22.9 $ 3.7 $ 73.8
Provision (benefits) 1.5 (0.6) -- 0.9
Write-offs (1) (14.9) (2.7) -- (17.6)
- --------------------------------------------------------------------------------
Ending balance $ 33.8 $19.6 $ 3.7 $ 57.1
Valuation allowance as a percentage
of carrying value before reserves 3.8% 9.8% 4.9% 4.9%
1996
- ----
Provision 5.5 -- -- 5.5
Write-offs (1) (19.7) (4.7) (3.7) (28.1)
- --------------------------------------------------------------------------------
Ending balance $ 19.6 $14.9 $ -- $ 34.5
Valuation allowance as a percentage
of carrying value before reserves 2.5% 11.0% --% 3.8%
</TABLE>
(1) Write-offs reflect asset sales, foreclosures and forgiveness of debt upon
restructuring.
The increase in write-offs of mortgages during 1996 as compared to 1995
reflects an increase in the disposal of modified loans which were previously
impaired.
Income Taxes
- ------------
AFC and its life insurance subsidiaries (including certain non-insurance
operations) file a consolidated United States federal income tax return.
Entities included within the consolidated group are 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. Allmerica P&C and its subsidiaries file a separate United States
federal income tax return.
For the years ended December 31, 1995 and 1994, 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 amount in the current period related to an
adjustment for the 1994 tax year based on the actual average mutual life
insurance companies' earnings rate issued by the IRS in 1996.
Provision for federal income taxes before minority interest was $75.2
million during 1996 compared to $82.7 million during 1995. These provisions
resulted in consolidated effective federal tax rates of 22.7% and 27.4%,
respectively. The effective tax rates for AFLIAC and FAFLIC and its non-
insurance subsidiaries were 28.9% and 32.0% during 1996 and 1995, respectively.
The effective tax rates for the Regional Property and Casualty subsidiaries were
18.4% and 25.3% during 1996 and 1995, respectively. The reduction in the rate
for FAFLIC in 1996 resulted primarily from additional reserves provided for
revisions of estimated prior year tax liabilities in 1995, as well as an
increase of $2.6 million in the differential earnings benefit from 1995 to 1996.
The decrease in the rate for Regional Property and Casualty subsidiaries
reflects a higher underwriting loss and greater proportion of pre-tax income
from tax-exempt bonds in 1996, and to reserves provided for revisions in
estimated prior year tax liabilities in 1995.
Provision for federal income taxes before minority interest was $82.7
million during 1995 compared to $53.4 million during 1994. These provisions
resulted in consolidated effective federal tax rates of 27.4% and 34.8% in 1995
and 1994, respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 32.0% and 122.4% during 1995 and 1994,
respectively. The effective tax rates for the Regional Property and Casualty
subsidiaries were 25.3% and 3.5% during 1995 and 1994, respectively. The
significant reduction in the rate for FAFLIC primarily resulted from a
47
<PAGE>
- --------------------------------------------------------------------------------
differential earnings benefit of $7.6 million, or 7.9% of taxable income, during
1995, including a benefit of $15.2 million recognized during the fourth quarter,
versus a charge of $35.0 million, or 86.5% of taxable income, during 1994. The
increase in the rate for the Regional Property and Casualty subsidiaries is
attributable to improved underwriting results, a decrease in the proportion of
pre-tax income attributable to tax-exempt interest, and to reserves provided for
revisions in estimated prior year tax liabilities, including $7.2 million
provided during the fourth quarter of 1995.
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 was $156.0 million, $131.2 million
and $331.7 million in 1996, 1995 and 1994, respectively. The increase in 1996
was primarily attributable to an increase in cash provided by the operations of
the life insurance subsidiaries. This increase was partially offset by increased
underwriting losses in the Regional Property and Casualty Insurance subsidiaries
which resulted in an increase in claims payments. The decrease during 1995 was
due primarily to the timing of payments of losses and LAE in the Regional
Property and Casualty Insurance subsidiaries; the timing of cash receipts and
payments relating to reinsurance due primarily to the cession of the yearly
renewable term product in 1995; the decrease in investment income due to the
decrease in GIC assets; and the decrease in other income resulting from the sale
of the mutual fund processing business.
Net cash provided by investing activities was $424.6 in 1996 and $327.2
million in 1994. Net cash used in investing activities was $128.1 million in
1995. The increase from 1995 to 1996 was primarily attributable to increased
sales of investments used to finance net withdrawals from GICs partially offset
by additional purchases of fixed maturities and other long-term investments
financed through an increase in investable cash generated by operations. During
1996, cash flows from investing activities were impacted by delayed sales of
investments financed instead with repurchase agreements. Although the repurchase
agreements were entirely settled by year end, management may utilize this policy
again in future periods.
In 1995, the net cash used resulted from net purchases of fixed maturities
and equity securities which were partially offset by mortgage loan repayments
and proceeds from the sale of the mutual fund processing business. In 1994, a
larger amount of mortgage loan repayments and net sales and maturities of fixed
maturities resulted in the net cash provided.
Net cash used for financing activities was $685.1 million, $235.7 million,
and $410.6 million in 1996, 1995, and 1994 respectively. The Company made cash
payments on withdrawals from GICs that exceeded cash received from deposits on
these contracts by $636.3 million, $624.1 million and $400.7 million in 1996,
1995 and 1994, respectively. Although the Company expects this trend in negative
financing cash flows from GIC withdrawals to continue, the Company does not
expect GIC withdrawals to have a material impact on liquidity. Also, cash used
to purchase subsidiary common stock increased $21.1 million, to $42.0 million
during the year ended December 31, 1996.
In 1995, the cash used for financing activities was positively impacted by
the Company's receipt of proceeds of $248.0 million and $197.2 million from its
initial public offering of stock and debt, respectively.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300 million Series A 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 are intended to fund a portion of the
acquisition of the 24.2 million publicly held shares of Allmerica P&C pursuant
to an Agreement and Plan of Merger dated February 19, 1997.
On October 16, 1995, FAFLIC converted from a policyholder owned to
stockholder owned insurance company and AFC became the holding company for
FAFLIC. AFC also raised net proceeds of $248.0 million from the sale of Common
Stock and issued $200.0 million principal amount 7 5/8% Senior
48
<PAGE>
- --------------------------------------------------------------------------------
Debentures due 2025 with net proceeds to the Company of $197.2 million. The
Company will also pay approximately $15.3 million per year in interest payments
on the Senior Debentures.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC 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 December
31, 1996, no amounts were outstanding and $90.2 million and $12.0 million were
available for borrowing by FAFLIC and Allmerica P&C, respectively. FAFLIC and
Allmerica P&C had $9.8 million and $28.0 million, respectively, of commercial
paper borrowings outstanding at December 31, 1996.
RECENT DEVELOPMENTS
- -------------------
On February 19, 1997, the Company and Allmerica P&C entered into an Agreement
and Plan of Merger (the "Merger Agreement") pursuant to which the Company will
acquire all of the outstanding Common Stock, $1.00 par value per share, of
Allmerica P&C that it does not already own for consideration consisting of
$33.00 per share of Common Stock, subject to adjustment, payable in cash and
shares of common stock, par value $0.01 per share, of the Company (the "AFC
Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive
the consideration in cash, without interest, or in shares of AFC Common Stock,
subject to proration as set forth in the Merger Agreement. The maximum number of
shares of AFC Common Stock to be issued in the Merger is approximately 9.67
million shares. The acquisition will be accomplished by merging a newly created,
wholly-owned subsidiary of the Company with and into Allmerica P&C ( the
"Merger") resulting in Allmerica P&C becoming a wholly-owned subsidiary of the
Company. Also, immediately prior to the Merger, Allmerica P&C's Certificate of
Incorporation will be amended to authorize a new class of Common Stock, one
share of which will be exchanged for each share of Common Stock currently held
by SMA Financial Corp., a wholly-owned subsidiary of the Company. The
consummation of the Merger is subject to the satisfaction of various conditions,
including the approval of regulatory authorities.
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 1996
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, 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)
possible claims relating to sales practices for insurance products.
49
<PAGE>
Report of Independent Accountants
- --------------------------------------------------------------------------------
To the Board of Directors and Shareholders of Allmerica Financial Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity, and of cash flows
present fairly, in all material respects, the financial position of Allmerica
Financial Corporation and its subsidiaries at December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
As discussed in the accompanying notes to the consolidated financial
statements, the Company changed its method of accounting for investments (Note
1) and postemployment benefits (Note 11) in 1994.
/s/ Price Waterhouse LLP
Boston, Massachusetts
February 3, 1997, except as to Notes 1 and 2,
which are as of February 19, 1997
Management Report on Responsibility For Financial Reporting
- --------------------------------------------------------------------------------
The management of Allmerica Financial Corporation has the responsibility for
preparing the accompanying consolidated financial statements and for their
integrity and objectivity. The statements were prepared in conformity with
generally accepted accounting principles and include amounts based on
management's informed estimates and judgments. We believe that these statements
present fairly the company's financial position and results of operations and
that the other information contained in the annual report is accurate and
consistent with the financial statements.
Allmerica Financial Corporation's Board of Directors annually appoints
independent accountants to perform an audit of its consolidated financial
statements. The financial statements have been audited by Price Waterhouse LLP,
independent accountants, in accordance with generally accepted auditing
standards. Their audit included consideration of the company's system of
internal control in order to determine the audit procedures required to express
their opinion on the consolidated financial statements.
Management of Allmerica Financial Corporation has established and maintains
a system of internal control that provides reasonable assurance that assets are
safeguarded and that transactions are properly authorized and recorded. The
system of internal control provides for appropriate division of responsibility
and is documented by written policies and procedures that are communicated to
employees with significant roles in the financial reporting process and updated
as necessary. Management continually monitors the system of internal control for
compliance. Allmerica Financial Corporation and its subsidiaries maintain a
strong internal audit program that independently assesses the effectiveness of
the internal controls and recommends possible improvements thereto. Management
recognizes the inherent limitations in all internal control systems and believes
that our system of internal control provides an appropriate balance between the
costs and benefits desired. Management believes that the company's system of
internal control provides reasonable assurance that errors or irregularities
that would be material to the financial statements are prevented or detected in
the normal course of business.
The Audit Committee of the Board of Directors, composed solely of outside
directors, oversees management's discharge of its financial reporting
responsibilities. The committee meets periodically with management, our internal
auditors and our independent accountants, Price Waterhouse LLP. Both our
internal auditors and Price Waterhouse LLP have direct access to the Audit
Committee.
Management recognizes its responsibility for fostering a strong ethical
climate. This responsibility is reflected in the Company's policies which
address, among other things, potential conflicts of interest; compliance with
all domestic and foreign laws including those relating to financial disclosure
and the confidentiality of proprietary information. Allmerica Financial
Corporation maintains a systematic program to assess compliance with these
policies.
/s/ John F. O'Brien /s/ Edward J. Parry, III
John F. O'Brien Edward J. Parry, III
President and Chief Vice President, Chief Financial
Executive Officer Officer, Principal Accounting Officer
50
<PAGE>
Consolidated Statements of Income
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS, EXCEPT PER SHARE DATA) 1996 1995 1994
==============================================================================
<S> <C> <C> <C>
REVENUES
- --------
Premiums $2,236.3 $2,222.8 $2,181.8
Universal life and investment
product policy fees 197.2 172.4 156.8
Net investment income 672.6 710.5 743.1
Net realized investment gains 65.9 19.1 1.1
Realized gain on sale of
mutual fund processing
business -- 20.7 --
Other income 102.7 95.4 112.3
- ------------------------------------------------------------------------------
Total revenues 3,274.7 3,240.9 3,195.1
- ------------------------------------------------------------------------------
BENEFITS, LOSSES AND EXPENSES
- -----------------------------
Policy benefits, claims,
losses and loss adjustment
expenses 1,957.0 2,010.3 2,047.0
Policy acquisition expenses 483.5 470.3 475.7
Other operating expenses 502.5 458.5 518.9
- ------------------------------------------------------------------------------
Total benefits, losses and
expenses 2,943.0 2,939.1 3,041.6
- ------------------------------------------------------------------------------
Income before federal income taxes 331.7 301.8 153.5
- ------------------------------------------------------------------------------
Federal income tax expense (benefit)
Current 90.9 119.7 45.4
Deferred (15.7) (37.0) 8.0
- ------------------------------------------------------------------------------
Total federal income tax
expense 75.2 82.7 53.4
- ------------------------------------------------------------------------------
Income before minority interest,
extraordinary item and cumulative
effect of accounting change 256.5 219.1 100.1
Minority interest (74.6) (73.1) (51.0)
- ------------------------------------------------------------------------------
Income before extraordinary item
and cumulative effect
of accounting change 181.9 146.0 49.1
Extraordinary item -
demutualization expenses -- (12.1) (9.2)
Cumulative effect of change in
accounting principle -- -- (1.9)
- ------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0
==============================================================================
<CAPTION>
For the Period Year Ended
October 1 December 31,
Year Ended through 1995
December 31, December 31, Pro Forma*
1996 1995 (Unaudited)
<S> <C> <C> <C>
Net income after demutualization $ 181.9 $ 40.7 $ 130.6
===============================================================================
Net income after demutualization
per share $ 3.63 $ 0.82 $ 2.61
===============================================================================
Weighted average shares outstanding 50.1 49.4 50.1
===============================================================================
</TABLE>
*The pro forma information gives effect to the transactions referred to in
Note 1N.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
51
<PAGE>
Consolidated Balance Sheets
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
DECEMBER 31
(IN MILLIONS, EXCEPT PER SHARE DATA) 1996 1995
====================================================================================
<S> <C> <C>
ASSETS
Investments:
Fixed maturities-at fair value (amortized cost of
$7,305.5 and $7,467.9) $ 7,487.8 $ 7,739.3
Equity securities-at fair value (cost of $328.2 and
$410.6) 473.6 517.2
Mortgage loans 650.1 799.5
Real estate 120.7 179.6
Policy loans 132.4 123.2
Other long-term investments 128.8 71.9
- ------------------------------------------------------------------------------------
Total investments 8,993.4 9,430.7
- ------------------------------------------------------------------------------------
Cash and cash equivalents 178.5 289.5
Accrued investment income 149.0 163.2
Deferred policy acquisition costs 822.7 735.7
- ------------------------------------------------------------------------------------
Reinsurance receivables:
Future policy benefits 102.8 97.1
Outstanding claims, losses and loss adjustment
expenses 663.8 799.6
Unearned premiums 46.2 43.8
Other 62.8 58.9
- ------------------------------------------------------------------------------------
Total reinsurance receivables 875.6 999.4
- ------------------------------------------------------------------------------------
Deferred federal income taxes 93.2 81.2
Premiums, accounts and notes receivable 533.0 526.7
Other assets 307.5 363.6
Closed Block assets 811.8 818.9
Separate account assets 6,233.0 4,348.8
- ------------------------------------------------------------------------------------
Total assets $18,997.7 $17,757.7
====================================================================================
LIABILITIES
- -----------
Policy liabilities and accruals:
Future policy benefits $ 2,613.7 $ 2,639.3
Outstanding claims, losses and loss adjustment
expenses 2,944.1 3,081.3
Unearned premiums 822.5 800.9
Contractholder deposit funds and other policy
liabilities 2,060.4 2,737.4
- ------------------------------------------------------------------------------------
Total policy liabilities and accruals 8,440.7 9,258.9
====================================================================================
Expenses and taxes payable 622.3 603.0
Reinsurance premiums payable 31.4 42.0
Short-term debt 38.4 31.2
Deferred federal income taxes 34.7 47.8
Long-term debt 202.2 202.3
Closed Block liabilities 892.1 902.0
Separate account liabilities 6,227.2 4,337.8
- ------------------------------------------------------------------------------------
Total liabilities 16,489.0 15,425.0
- ------------------------------------------------------------------------------------
Minority interest 784.0 758.5
- ------------------------------------------------------------------------------------
Commitments and contingencies (Notes 15 and 20)
SHAREHOLDERS' EQUITY
- --------------------
Preferred stock, $0.01 par value, 20.0 million shares
authorized, none issued -- --
Common stock, $0.01 par value, 300.0 million shares
authorized, 50.1 million
shares issued and outstanding 0.5 0.5
Additional paid-in capital 1,382.5 1,382.5
Unrealized appreciation on investments, net 131.6 153.0
Retained earnings 210.1 38.2
- ------------------------------------------------------------------------------------
Total shareholders' equity 1,724.7 1,574.2
- ------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $18,997.7 $17,757.7
====================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
52
<PAGE>
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
COMMON STOCK
- ------------
Balance at beginning of year $ 0.5 $ -- $ --
Demutualization transaction -- 0.4 --
Initial public offering -- 0.1 --
- --------------------------------------------------------------------------------
Balance at end of year 0.5 0.5 --
- --------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
- --------------------------
Balance at beginning of year 1,382.5 -- --
Demutualization transaction -- 1,134.6 --
Initial public offering -- 247.9 --
- --------------------------------------------------------------------------------
Balance at end of year 1,382.5 1,382.5 --
- --------------------------------------------------------------------------------
RETAINED EARNINGS
- -----------------
Balance at beginning of year 38.2 1,071.4 1,033.4
Net income prior to
demutualization -- 93.2 38.0
- --------------------------------------------------------------------------------
38.2 1,164.6 1,071.4
Demutualization transaction -- (1,164.6) --
Net income subsequent to
demutualization 181.9 40.7 --
Dividends to shareholders (10.0) (2.5) --
- --------------------------------------------------------------------------------
Balance at end of year 210.1 38.2 1,071.4
- --------------------------------------------------------------------------------
NET UNREALIZED APPRECIATION
- ---------------------------
(DEPRECIATION) ON INVESTMENTS
- -----------------------------
Balance at beginning of year 153.0 (79.0) 17.5
- --------------------------------------------------------------------------------
Cumulative effect of accounting
change:
Net appreciation on
available-for-sale debt
securities -- -- 296.1
Provision for deferred federal
income taxes and minority
interest -- -- (149.1)
- --------------------------------------------------------------------------------
-- -- 147.0
- --------------------------------------------------------------------------------
Effect of transfer of
securities from
held-to-maturity
to available-for-sale:
Net appreciation on
available-for-sale debt
securities -- 22.4 --
Provision for deferred federal
income taxes and minority
interest -- (9.6) --
- --------------------------------------------------------------------------------
-- 12.8 --
- --------------------------------------------------------------------------------
(Depreciation) appreciation
during the period:
Net (depreciation) appreciation
on available-for-sale
securities (35.1) 466.0 (492.1)
Benefit (provision) for
deferred federal income taxes 12.3 (163.1) 171.9
Minority interest 1.4 (83.7) 76.7
- --------------------------------------------------------------------------------
(21.4) 219.2 (243.5)
- --------------------------------------------------------------------------------
Balance at end of year 131.6 153.0 (79.0)
- --------------------------------------------------------------------------------
Total shareholders' equity $1,724.7 $ 1,574.2 $ 992.4
================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
53
<PAGE>
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 199
================================================================================
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
- -------------------------
ACTIVITIES
- ----------
Net income $ 181.9 $ 133.9 $ 38.0
Adjustments to reconcile net
income to net cash provided
by operating activities:
Minority interest 74.6 73.1 50.1
Net realized gains (65.2) (39.8) (1.1)
Net amortization and
depreciation 44.7 57.7 45.9
Deferred federal income taxes (15.7) (37.0) 8.0
Change in deferred acquisition
costs (73.9) (38.4) (34.6)
Change in premiums and notes
receivable, net of
reinsurance payable (16.7) (42.0) (25.6)
Change in accrued investment
income 16.5 6.8 4.6
Change in policy liabilities
and accruals, net (184.3) 116.2 175.9
Change in reinsurance receivable 123.7 (75.6) (31.9)
Change in expenses and taxes
payable 27.1 7.7 88.0
Separate account activity, net 5.2 (0.1) 0.4
Other, net 38.1 (31.3) 14.0
- --------------------------------------------------------------------------------
Net cash provided by operating
activities 156.0 131.2 331.7
- --------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
------------------------------------
Proceeds from disposals and
maturities of
available-for-sale fixed
maturities 4,018.5 2,738.4 2,097.8
Proceeds from disposals of
held-to-maturity fixed
maturities -- 271.3 304.4
Proceeds from disposals of
equity securities 228.7 120.0 143.9
Proceeds from disposals of
other investments 99.3 40.5 25.9
Proceeds from mortgages matured
or collected 176.9 230.3 256.4
Purchase of available-for-sale
fixed maturities (3,830.7) (3,273.3) (2,150.1)
Purchase of held-to-maturity
fixed maturities -- -- (111.6)
Purchase of equity securities (91.6) (254.0) (172.2)
Purchase of other investments (168.0) (24.8) (26.6)
Proceeds from sale of mutual
fund processing business -- 32.9 --
Capital expenditures (12.8) (14.1) (43.1)
Other investing activities, net 4.3 4.7 2.4
- --------------------------------------------------------------------------------
Net cash provided by (used in)
investing activities 424.6 (128.1) 327.2
- --------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Deposits and interest credited
to contractholder deposit funds 268.7 445.8 786.3
Withdrawals from contractholder
deposit funds (905.0) (1,069.9) (1,187.0)
Change in short-term debt 7.2 (1.6) (6.0)
Change in long-term debt (0.1) 0.2 0.3
Dividends paid to shareholders (13.9) (6.6) (4.2)
Net proceeds from issuance of
common stock -- 248.0 --
Payments for policyholders'
membership interests -- (27.9) --
Net proceeds from issuance of
long-term debt -- 197.2 --
Subsidiary treasury stock
purchased, at cost (42.0) (20.9) --
- --------------------------------------------------------------------------------
Net cash used in financing
activities (685.1) (235.7) (410.6)
- --------------------------------------------------------------------------------
Net change in cash and cash
equivalents (104.5) (232.6) 248.3
Net change in cash held in the
Closed Block (6.5) (17.6) --
Cash and cash equivalents,
beginning of year 289.5 539.7 291.4
- --------------------------------------------------------------------------------
Cash and cash equivalents, end
of year $ 178.5 $ 289.5 $ 539.7
================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION
- ----------------------------------
Interest paid $ 33.8 $ 4.1 $ 4.3
Income taxes paid $ 68.1 $ 90.6 $ 46.1
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
54
<PAGE>
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
------------------------------------------
A. Basis of Presentation and Principles of Consolidation
- --------------------------------------------------------
First Allmerica Financial Life Insurance Company ("FAFLIC") was organized as a
mutual life insurance company until October 16, 1995. FAFLIC converted to a
stock life insurance company pursuant to a plan of reorganization effective
October 16, 1995 and became a wholly owned subsidiary of Allmerica Financial
Corporation ("AFC" or the "Company"). The consolidated financial statements have
been prepared as if FAFLIC were organized as a stock life insurance company for
all periods presented. Thus, generally accepted accounting principles for stock
life insurance companies have been applied retroactively for all periods
presented.
The consolidated financial statements of AFC include the accounts of
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 and Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned non-
insurance holding company). The Closed Block assets and liabilities at December
31, 1996 and 1995 and its results of operations subsequent to demutualization
are presented in the consolidated financial statements as single line items.
Prior to demutualization such amounts are presented line by line in the
consolidated financial statements (see Note 6). Unless specifically stated, all
disclosures contained herein supporting the consolidated financial statements at
December 31, 1996 and 1995 and the years then ended exclude the Closed Block
related amounts. All significant intercompany accounts and transactions have
been eliminated.
Minority interest relates to the Company's investment in Allmerica P&C and
its only significant subsidiary, The Hanover Insurance Company ("Hanover").
Hanover's 82.5%-owned subsidiary is Citizens Corporation, the holding company
for Citizens Insurance Company of America ("Citizens"). Minority interest also
includes an amount related to the minority interest in Citizens Corporation.
On February 19, 1997, the Company announced a definitive merger agreement
under which it would acquire, at consideration of $33.00 per share, all of the
shares of Allmerica P&C currently held by the minority stockholders. Additional
information pertaining to the merger agreement is included in Note 2,
Significant Transactions.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
B. Closed Block
- ---------------
As of October 16, 1995, FAFLIC established and began operating a closed block
(the "Closed Block") for the benefit of the participating policies included
therein, consisting of certain individual life insurance participating policies,
individual deferred annuity contracts and supplementary contracts not involving
life contingencies which were in force on October 16, 1995; such policies
constitute the "Closed Block Business". The purpose of the Closed Block is to
protect the policy dividend expectations of such FAFLIC dividend paying policies
and contracts after the demutualization. Unless the Commissioner consents to an
earlier termination, the Closed Block will continue to be in effect until the
date none of the Closed Block policies is in force. On October 16, 1995, FAFLIC
allocated to the Closed Block assets in an amount that is expected to produce
cash flows which, together with future revenues from the Closed Block Business,
are reasonably sufficient to support the Closed Block Business, including
provision for payment of policy benefits, certain future expenses and taxes and
for continuation of policyholder dividend scales payable in 1994 so long as the
experience underlying such dividend scales continues. The Company expects that
the factors underlying such experience will fluctuate in the future and
policyholder dividend scales for Closed Block Business will be set accordingly.
Although the assets and income allocated to the Closed Block inure solely
to the benefit of the holders of policies included in the Closed Block, the
excess of Closed Block liabilities over Closed Block assets at October 16, 1995
measured on a GAAP basis represent the expected future post-tax income from the
Closed Block which may be recognized in income over the period the policies and
contracts in the Closed Block remain in force.
If the actual income from the Closed Block in any given period equals or
exceeds the expected income for such period as determined at October 16, 1995,
the expected income would be recognized in income for that period. Further, any
excess of the actual income over the expected income would also be recognized in
income to the extent that the aggregate expected income for all prior periods
exceeded the aggregate actual income. Any remaining excess of actual income over
expected income would be accrued as a liability for policyholder dividends in
the Closed Block to be paid to the Closed Block policyholders. This accrual for
future dividends effectively limits the actual Closed Block income recognized in
income to the Closed Block income expected to emerge from operation of the
Closed Block as determined as of October 16, 1995.
If, over the period the policies and contracts in the Closed Block remain
in force, the actual income from the Closed Block is less than the expected
income from the Closed Block, only such actual income (which could reflect a
loss) would be recognized in income. If the actual income from the Closed Block
in any given period is less than the expected income for that period and changes
in dividends scales are inadequate to
55
<PAGE>
- --------------------------------------------------------------------------------
offset the negative performance in relation to the expected performance, the
income inuring to shareholders of the Company will be reduced. If a policyholder
dividend liability had been previously established in the Closed Block because
the actual income to the relevant date had exceeded the expected income to such
date, such liability would be reduced by this reduction in income (but not below
zero) in any periods in which the actual income for that period is less than the
expected income for such period.
C. Valuation of Investments
- ---------------------------
Effective January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain
Investments in Debt and Equity Securities", which requires investments be
classified into one of three categories: held-to-maturity, available-for-sale or
trading. The effect of implementing SFAS No. 115, as of January 1, 1994, was an
increase in the carrying value of fixed maturity investments of $335.3 million,
a decrease in deferred policy acquisition costs of $20.8 million, an increase in
policyholder liabilities of $18.4 million, a net increase in deferred income tax
liabilities of $103.7 million, an increase in minority interest of $45.4 million
and an increase in shareholders' equity of $147.0 million, which resulted from
changing the carrying value of certain fixed maturities from amortized cost to
fair value and related adjustments. The implementation had no effect on net
income.
In November 1995, the Financial Accounting Standards Board issued a Special
Report, A Guide to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities, which permitted companies to
reclassify securities, where appropriate, based on the new guidance. As a
result, the Company transferred securities with amortized cost and fair value of
$696.4 million and $725.6 million, respectively, from the held-to-maturity
category to the available-for-sale category, which resulted in a net increase in
shareholders' equity of $12.8 million.
Realized gains and losses on sales of fixed maturities and equity
securities are determined on the specific-identification basis using amortized
cost for fixed maturities and cost for equity securities. Fixed maturities and
equity securities with other than temporary declines in fair value are written
down to estimated fair value resulting in the recognition of realized losses.
Mortgage loans on real estate are stated at unpaid principal balances, net
of unamortized discounts and reserves. Reserves on mortgage loans are based on
losses expected by management to be realized on transfers of mortgage loans to
real estate (upon foreclosure), on the disposition or settlement of mortgage
loans and on mortgage loans which management believes may not be collectible in
full. In establishing reserves, management considers, among other things, the
estimated fair value of the underlying collateral.
Fixed maturities and mortgage loans that are delinquent are placed on non-
accrual status, and thereafter interest income is recognized only when cash
payments are received.
Policy loans are carried principally at unpaid principal balances.
Real estate that has been acquired through the foreclosure of mortgage
loans is valued at the estimated fair value at the time of foreclosure. The
Company considers several methods in determining fair value at foreclosure,
using primarily third-party appraisals and discounted cash flow analyses. After
foreclosure, the Company makes a determination as to whether the asset should be
held for production of income or held for sale.
Real estate investments held for the production of income and held for
sale are carried at depreciated cost less valuation allowances, if necessary, to
reduce the carrying value to fair value. Depreciation is generally calculated
using the straight-line method.
Realized investment gains and losses, other than those related to separate
accounts for which the Company does not bear the investment risk, are reported
as a component of revenues based upon specific identification of the investment
assets sold. When an other than temporary impairment of the value of a specific
investment or a group of investments is determined, a realized investment loss
is recorded. Changes in the valuation allowance for mortgage loans and real
estate are included in realized investment gains or losses.
D. Financial Instruments
- ------------------------
In the normal course of business, the Company enters into transactions involving
various types of financial instruments, including debt, investments such as
fixed maturities, mortgage loans and equity securities, investment and loan
commitments, swap contracts and interest rate futures contracts. These
instruments involve credit risk and also may be subject to risk of loss due to
interest rate fluctuation. The Company evaluates and monitors each financial
instrument individually and, when appropriate, obtains collateral or other
security to minimize losses.
E. Cash and Cash Equivalents
- ----------------------------
Cash and cash equivalents includes cash on hand, amounts due from banks and
highly liquid debt instruments purchased with an original maturity of three
months or less.
F. Deferred Policy Acquisition Costs
- ------------------------------------
Acquisition costs consist of commissions, underwriting costs and other costs,
which vary with, and are primarily related to, the production of revenues.
Property and casualty, group life and group health insurance business
acquisition costs are deferred and amortized over the terms of the insurance
policies. Acquisition costs related to universal life products and
contractholder deposit funds are deferred and amortized in proportion to total
estimated gross profits over the expected life of the contracts using a revised
interest rate applied to the remaining benefit period. Acquisition costs related
to annuity and other life insurance businesses are deferred and amortized,
56
<PAGE>
- --------------------------------------------------------------------------------
generally in proportion to the ratio of annual revenue to the estimated total
revenues over the contract periods based upon the same assumptions used in
estimating the liability for future policy benefits. Deferred acquisition costs
for each product are reviewed to determine if they are recoverable from future
income, including investment income. If such costs are determined to be
unrecoverable, they are expensed at the time of determination.
Although realization of deferred policy acquisition costs is not assured,
management believes it is more likely than not that all of these costs will be
realized. The amount of deferred policy acquisition costs considered realizable,
however, could be reduced in the near term if the estimates of gross profits or
total revenues discussed above are reduced. The amount of amortization of
deferred policy acquisition costs could be revised in the near term if any of
the estimates discussed above are revised.
G. Property and Equipment
- -------------------------
Property, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is provided using the
straight-line or accelerated method over the estimated useful lives of the
related assets which generally range from 3 to 30 years. Amortization of
leasehold improvements is provided using the straight-line method over the
lesser of the term of the leases or the estimated useful life of the
improvements.
H. Separate Accounts
- --------------------
Separate account assets and liabilities represent segregated funds administered
and invested by the Company for the benefit of certain pension, variable annuity
and variable life insurance contractholders. Assets consist principally of
bonds, common stocks, mutual funds, and short-term obligations at market value.
The investment income, gains, and losses of these accounts generally accrue to
the contractholders and, therefore, are not included in the Company's net
income. Appreciation and depreciation of the Company's interest in the separate
accounts, including undistributed net investment income, is reflected in
shareholders' equity or net investment income.
I. Policy Liabilities and Accruals
- ----------------------------------
Future policy benefits are liabilities for life, health and annuity products.
Such liabilities are established in amounts adequate to meet the estimated
future obligations of policies in force. The liabilities associated with
traditional life insurance products are computed using the net level premium
method for individual life and annuity policies, and are based upon estimates as
to future investment yield, mortality and withdrawals that include provisions
for adverse deviation. Future policy benefits for individual life insurance and
annuity policies are computed using interest rates ranging from 2 1/2% to 6% for
life insurance and 2% to 9 1/2% for annuities. Estimated liabilities are
established for group life and health policies that contain experience rating
provisions. Mortality, morbidity and withdrawal assumptions for all policies are
based on the Company's own experience and industry standards. Liabilities
for universal life include deposits received from customers and investment
earnings on their fund balances, less administrative charges. Universal life
fund balances are also assessed mortality and surrender charges.
Liabilities for outstanding claims, losses and loss adjustment expenses are
estimates of payments to be made on property and casualty and health insurance
for reported losses and estimates of losses incurred but not reported. These
liabilities are determined using case basis evaluations and statistical analyses
and represent estimates of the ultimate cost of all losses incurred but not
paid. These estimates are continually reviewed and adjusted as necessary; such
adjustments are reflected in current operations. Estimated amounts of salvage
and subrogation on unpaid property and casualty losses are deducted from the
liability for unpaid claims.
Premiums for property and casualty, group life, and accident and health
insurance are reported as earned on a pro-rata basis over the contract period.
The unexpired portion of these premiums is recorded as unearned premiums.
Contractholder deposit funds and other policy liabilities include
investment-related products such as guaranteed investment contracts, deposit
administration funds and immediate participation guarantee funds and consist of
deposits received from customers and investment earnings on their fund balances.
All policy liabilities and accruals are based on the various estimates
discussed above. Although the adequacy of these amounts cannot be assured,
management believes that it is more likely than not that policy liabilities and
accruals will be sufficient to meet future obligations of policies in force. The
amount of liabilities and accruals, however, could be revised in the near term
if the estimates discussed above are revised.
J. Premium and Fee Revenue and Related Expenses
- -----------------------------------------------
Premiums for individual life and health insurance and individual and group
annuity products, excluding universal life and investment-related products, are
considered revenue when due. Property and casualty and group life, accident and
health insurance premiums are recognized as revenue over the related contract
periods. Benefits, losses and related expenses are matched with premiums,
resulting in their recognition over the lives of the contracts. This matching is
accomplished through the provision for future benefits, estimated and unpaid
losses and amortization of deferred policy acquisition costs. Revenues for
investment-related products consist of net investment income and contract
charges assessed against the fund values. Related benefit expenses primarily
consist of net investment income credited to the fund values after deduction for
investment and risk charges. Revenues for universal life products consist of net
investment income, and mortality, administration and surrender charges assessed
against the fund values. Related benefit expenses include universal life benefit
claims in excess of fund values and net investment income credited to universal
life fund values.
57
<PAGE>
- --------------------------------------------------------------------------------
K. Policyholder Dividends
- -------------------------
Prior to demutualization, certain life, health and annuity insurance policies
contained dividend payment provisions that enabled the policyholder to
participate in the earnings of the Company. The amount of policyholders'
dividends was determined annually by the Board of Directors. The aggregate
amount of policyholders' dividends was related to the actual interest,
mortality, morbidity and expense experience for the year and the Company's
judgment as to the appropriate level of statutory surplus to be retained. Upon
demutualization, certain participating individual life insurance policies and
individual annuity and supplemental contracts were transferred to the Closed
Block. The Closed Block was funded to protect the dividend expectations of such
policies and contracts. Accordingly, these policies no longer participate in the
earnings and surplus of the Open Block. Subsequent to demutualization, the
Company ceased issuance of participating policies.
Prior to demutualization, the participating life insurance in force was
16.2% of the face value of total life insurance in force at December 31, 1994.
The premiums on participating life, health and annuity policies were 11.3% and
6.4% of total life, health and annuity statutory premiums prior to
demutualization in 1995 and 1994, respectively. Total policyholders' dividends
were $23.3 million and $32.8 million prior to demutualization in 1995 and 1994,
respectively.
L. Federal Income Taxes
- -----------------------
AFC, FAFLIC, AFLIAC and FAFLIC's non-insurance domestic subsidiaries file a
consolidated United States federal income tax return. Entities included within
the consolidated group are segregated into either a life insurance or 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. Allmerica P&C and its
subsidiaries file a separate United States federal income tax return.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes, and
for other temporary taxable and deductible differences as defined by Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
No. 109). These differences result primarily from loss reserves, policy
acquisition expenses, and unrealized appreciation/depreciation on investments.
M. New Accounting Pronouncements
- --------------------------------
In March 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of" was issued. This statement requires
companies to write down to fair value long-lived assets whose carrying value is
greater than the undiscounted cash flows of those assets. The statement also
requires that long-lived assets of which management is committed to dispose,
either by sale or abandonment, be valued at the lower of their carrying amount
or fair value less costs to sell. This statement is effective for fiscal years
beginning after December 15, 1995. The adoption of this statement has not had a
material effect on the financial statements.
N. Earnings Per Share
- ---------------------
Earnings per share for the year ended December 31, 1996 is based on a weighted
average of the number of shares outstanding during 1996. Earnings per share for
the period October 1, 1995 (date used to estimate financial information for the
effective date of the demutualization transaction of October 16, 1995) through
December 31, 1995 is based on a weighted average of the number of shares
outstanding between October 16, 1995 and December 31, 1995.
The unaudited pro forma earnings per share for the year ended December 31,
1995 is based on a weighted average of the number of shares that would have been
outstanding between January 1, 1995 and December 31, 1995 had the
demutualization transaction occurred as of January 1, 1995.
The unaudited pro forma earnings and earnings per share information give
effect to the demutualization transaction and the Senior Debentures transaction
as if these transactions had occurred as of January 1, 1995. The effect on
earnings is to eliminate demutualization expenses of $12.1 million, to eliminate
a differential earnings adjustment tax credit of $7.6 million and to increase
interest and amortization expense related to the Senior Debentures by $7.8
million, for a net decrease in pro forma earnings of $3.3 million.
The unaudited pro forma information is provided for informational purposes
only and should not be construed to be indicative of the Company's consolidated
results of operations had the transactions been consummated on January 1, 1995,
and does not represent a projection or forecast of the Company's consolidated
results of operations for any future period.
O. Reclassifications
- --------------------
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. SIGNIFICANT TRANSACTIONS
------------------------
On February 19, 1997, the Company and Allmerica P&C entered into an Agreement
and Plan of Merger (the "Merger Agreement") pursuant to which the Company will
acquire all of the outstanding Common Stock, $1.00 par value per share, of
Allmerica P&C that it does not already own for consideration consisting of
$33.00 per share of Common Stock, subject to adjustment, payable in cash and
shares of common stock, par value $0.01 per share, of the Company (the "AFC
Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive
the consideration in cash, without interest, or in shares of AFC Common Stock,
subject to proration as set forth in the Merger Agreement. The maximum number of
shares of AFC Common Stock to be issued in the Merger is approximately 9.67
million shares. The acquisition will be accomplished by merging a newly created,
wholly-owned subsidiary of the Company with and into Allmerica P&C ( the
"Merger")
58
<PAGE>
- --------------------------------------------------------------------------------
resulting in Allmerica P&C becoming a wholly-owned subsidiary of the Company.
Also, immediately prior to the Merger, Allmerica P&C's Certificate of
Incorporation will be amended to authorize a new class of Common Stock, one
share of which will be exchanged for each share of Common Stock currently held
by SMA Financial Corp., a wholly-owned subsidiary of the Company. The
consummation of the Merger is subject to the satisfaction of various conditions,
including the approval of regulatory authorities.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300 million Series A 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 are intended to fund a portion of the
acquisition of the 24.2 million publicly held shares of Allmerica P&C pursuant
to an Agreement and Plan of Merger dated February 19, 1997.
Pursuant to the plan of reorganization effective October 16, 1995, the
Company issued 37.5 million shares of its common stock to eligible
policyholders. The Company also issued 12.6 million shares of its common stock
at a price of $21.00 per share in a public offering, resulting in net proceeds
of $248.0 million, and issued Senior Debentures in the principal amount of
$200.0 million which resulted in net proceeds of $197.2 million.
Effective March 31, 1995, the Company entered into an agreement with TSSG,
a division of First Data Corporation, pursuant to which the Company sold its
mutual fund processing business and agreed not to engage in this business for
four years after that date. In accordance with this agreement, the Company
received proceeds of $32.1 million. A gain of $13.5 million, net of taxes of
$7.2 million, was recorded in March 1995. Additionally, the Company received a
non-recurring $3.1 million contingent payment, net of taxes of $1.7 million, in
1996 related to the aforementioned sale.
3. INVESTMENTS
-----------
A. Summary of Investments
- -------------------------
The Company accounts for its investments, all of which are classified as
available-for-sale, in accordance with the provisions of SFAS No. 115.
The amortized cost and fair value of available-for-sale fixed maturities
and equity securities were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996
- --------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost (1) Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
U.S. government and agency
securities $ 279.1 $ 9.3 $ 1.6 $ 286.8
States and political
subdivisions 2,236.9 48.5 7.7 2,277.7
Foreign governments 108.8 7.4 -- 116.2
Corporate fixed maturities 4,297.6 140.4 16.0 4,422.0
Mortgage-backed securities 383.1 4.7 2.7 385.1
- --------------------------------------------------------------------------------
Total fixed maturities $ 7,305.5 $ 210.3 $ 28.0 $ 7,487.8
================================================================================
Equity securities $ 328.2 $ 149.1 $ 3.7 $ 473.6
================================================================================
DECEMBER 31
(IN MILLIONS) 1995
- --------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost (1) Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
U.S. government and agency
securities $ 377.0 $ 21.0 $ -- $ 398.0
States and political
subdivisions 2,110.6 60.7 4.0 2,167.3
Foreign governments 60.6 3.4 0.6 63.4
Corporate fixed maturities 4,582.1 200.8 16.4 4,766.5
Mortgage-backed securities 337.6 8.6 2.1 344.1
- --------------------------------------------------------------------------------
Total fixed maturities $ 7,467.9 $ 294.5 $ 23.1 $ 7,739.3
================================================================================
Equity securities $ 410.6 $111.7 $ 5.1 $ 517.2
================================================================================
</TABLE>
(1) Amortized cost for fixed maturities and cost for equity securities.
59
<PAGE>
- --------------------------------------------------------------------------------
In March 1994, AFLIAC voluntarily withdrew its license in New York in order to
provide for certain commission arrangements prohibited by New York comparable to
AFLIAC's competitors. In connection with the withdrawal, FAFLIC, which is
licensed in New York, became qualified to sell the products previously sold by
AFLIAC in New York. AFLIAC agreed with the New York Department of Insurance to
maintain, through a custodial account in New York, a security deposit, the
market value of which will at all times equal 102% of all outstanding general
account liabilities of AFLIAC for New York policyholders, claimants and
creditors. At December 31, 1996, the amortized cost and market value of assets
on deposit were $284.9 million and $292.2 million, respectively. At December 31,
1995, the amortized cost and market value of assets on deposit were $295.0
million and $303.6 million, respectively. In addition, fixed maturities,
excluding those securities on deposit in New York, with an amortized cost of
$98.0 million and $82.2 million were on deposit with various state and
governmental authorities at December 31, 1996 and 1995, respectively.
There were no contractual fixed maturity investment commitments at December
31, 1996 and 1995, respectively.
The amortized cost and fair value by maturity periods for fixed maturities are
shown below. Actual maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties, or the Company may have the right to put or sell the
obligations back to the issuers. Mortgage backed securities are included in the
category representing their ultimate maturity.
<TABLE>
<CAPTION>
December 31
(In millions) 1996
================================================================================
AMORTIZED FAIR
COST VALUE
<S> <C> <C>
Due in one year or less $ 567.6 $ 571.2
Due after one year through five years 2,216.4 2,297.2
Due after five years through ten years 2,398.2 2,456.9
Due after ten years 2,123.3 2,162.5
- --------------------------------------------------------------------------------
Total $7,305.5 $7,487.8
================================================================================
</TABLE>
The proceeds from voluntary sales of available-for-sale securities and the
gross realized gains and gross realized losses on those sales were as follows:
<TABLE>
<CAPTION>
For the Years Ended December 31
(In millions)
================================================================================
Proceeds from Gross Gross
1996 Voluntary Sales Gains Losses
- ----
<S> <C> <C> <C>
Fixed maturities $2,463.3 $ 19.3 $ 31.0
================================================================================
Equity securities $ 228.7 $ 56.3 $ 1.3
================================================================================
1995
- ----
Fixed maturities $1,612.3 $ 23.7 $ 33.0
================================================================================
Equity securities $ 122.2 $ 23.1 $ 6.9
================================================================================
1994
- ----
Fixed maturities $1,026.2 $ 12.6 $ 21.6
================================================================================
Equity securities $ 124.3 $ 17.4 $ 4.5
================================================================================
</TABLE>
Unrealized gains and losses on available-for-sale and other securities, are
summarized as follows:
<TABLE>
<CAPTION>
For the Years Ended December 31
(In millions)
================================================================================
Equity
Fixed Securities
1996 Maturities and Other(1) Total
- ----
<S> <C> <C> <C>
Net appreciation, beginning
of year $ 108.7 $ 44.3 $153.0
- --------------------------------------------------------------------------------
Net (depreciation) appreciation
on available-for-sale securities (94.3) 36.1 (58.2)
Net appreciation from the
effect on deferred policy
acquisition costs and on
policy liabilities 23.1 -- 23.1
Benefit (provision) for deferred
federal income taxes
and minority interest 33.6 (19.9) 13.7
- --------------------------------------------------------------------------------
(37.6) 16.2 (21.4)
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 71.1 $ 60.5 $131.6
================================================================================
</TABLE>
60
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Equity
Fixed Securities
1995 Maturities and Other(1) Total
- ----
<S> <C> <C> <C>
Net (depreciation) appreciation,
beginning of year $ (89.4) $ 10.4 $ (79.0)
- --------------------------------------------------------------------------------
Effect of transfer of securities
between classifications:
Net appreciation on available-
for-sale fixed maturities 29.2 -- 29.2
Effect of transfer on
deferred policy acquisition
costs and on policy liabilities (6.8) -- (6.8)
Provision for deferred
federal income taxes
and minority interest (9.6) -- (9.6)
- --------------------------------------------------------------------------------
12.8 -- 12.8
- --------------------------------------------------------------------------------
Net appreciation on
available-for-sale securities 465.4 87.5 552.9
Net depreciation from the
effect on deferred policy
acquisition costs and
on policy liabilities (86.9) -- (86.9)
Provision for deferred
federal income taxes
and minority interest (193.2) (53.6) (246.8)
- --------------------------------------------------------------------------------
185.3 33.9 219.2
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 108.7 $ 44.3 $ 153.0
================================================================================
1994
- ----
Net appreciation, beginning of year $ -- $ 17.5 $ 17.5
- --------------------------------------------------------------------------------
Cumulative effect of accounting
change:
Net appreciation on available-
for-sale fixed maturities 335.3 -- 335.3
Net depreciation from the
effect of accounting change
on deferred policy acquisition
costs and on policy liabilities (39.2) -- (39.2)
Provision for deferred federal
income taxes and minority
interest (149.1) -- (149.1)
- --------------------------------------------------------------------------------
147.0 17.5 164.5
- --------------------------------------------------------------------------------
Net depreciation on
available-for-sale securities (547.9) (17.4) (565.3)
Net appreciation from the effect
on deferred policy acquisition
costs and on policy liabilities 73.2 -- 73.2
Benefit for deferred federal income
taxes and minority interest 238.3 10.3 248.6
- --------------------------------------------------------------------------------
(236.4) (7.1) (243.5)
- --------------------------------------------------------------------------------
Net (depreciation) appreciation,
end of year $ (89.4) $ 10.4 $ (79.0)
================================================================================
</TABLE>
(1) Includes net appreciation on other investments of $0.6 million, $2.2
million, and $0.6 million in 1996, 1995, and 1994 respectively.
B. Mortgage Loans and Real Estate
- ---------------------------------
AFC's mortgage loans and real estate are diversified by property type and
location. Real estate investments have been obtained primarily through
foreclosure. Mortgage loans are collateralized by the related properties and
generally are no more than 75% of the property's value at the time the original
loan is made.
The carrying values of mortgage loans and real estate investments net of
applicable reserves were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
<S> <C> <C>
Mortgage loans $650.1 $799.5
- --------------------------------------------------------------------------------
Real estate:
Held for sale 110.4 168.9
Held for production of income 10.3 10.7
- --------------------------------------------------------------------------------
Total real estate 120.7 179.6
- --------------------------------------------------------------------------------
Total mortgage loans and real estate $770.8 $979.1
================================================================================
</TABLE>
Reserves for mortgage loans were $19.6 million and $33.8 million at December
31, 1996 and 1995, respectively.
During 1996, 1995 and 1994, non-cash investing activities included real estate
acquired through foreclosure of mortgage loans, which had a fair value of $0.9
million, $26.1 million and $39.2 million, respectively.
At December 31, 1996, contractual commitments to extend credit under
commercial mortgage loan agreements amounted to approximately $22.1 million, of
which $3.1 million related to the Closed Block. These commitments generally
expire within one year.
Mortgage loans and real estate investments comprised the following property
types and geographic regions:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
<S> <C> <C>
Property type:
Office building $317.1 $435.9
Residential 95.4 145.3
Retail 177.0 205.6
Industrial / warehouse 124.8 93.8
Other 91.0 151.9
Valuation allowances (34.5) (53.4)
- --------------------------------------------------------------------------------
Total $770.8 $979.1
================================================================================
Geographic region:
South Atlantic $227.0 $281.4
Pacific 154.4 191.9
East North Central 119.2 118.2
Middle Atlantic 112.6 148.9
West South Central 41.6 79.7
New England 50.9 94.9
Other 99.6 117.5
Valuation allowances (34.5) (53.4)
- --------------------------------------------------------------------------------
Total $770.8 $979.1
================================================================================
</TABLE>
61
<PAGE>
- --------------------------------------------------------------------------------
At December 31, 1996, scheduled mortgage loan maturities were as follows: 1997 -
$131.9 million; 1998 - $161.7 million; 1999 - $99.9 million; 2000 - $138.0
million; 2001 - $34.4 million; and $84.2 million thereafter. Actual maturities
could differ from contractual maturities because borrowers may have the right to
prepay obligations with or without prepayment penalties and loans may be
refinanced. During 1996, the Company refinanced $7.8 million of mortgage loans
based on terms which differed from those granted to new borrowers.
C. Investment Valuation Allowances
- ----------------------------------
Investment valuation allowances which have been deducted in arriving at
investment carrying values as presented in the consolidated balance sheets and
changes thereto are shown below.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS)
================================================================================
Balance at Balance at
1996 January 1 Additions Deductions December 31
- ----
<S> <C> <C> <C> <C>
Mortgage loans $33.8 $ 5.5 $19.7 $19.6
Real estate 19.6 - 4.7 14.9
- --------------------------------------------------------------------------------
Total $53.4 $ 5.5 $24.4 $34.5
================================================================================
1995
- ----
Mortgage loans $47.2 $ 1.5 $14.9 $33.8
Real estate 22.9 (0.6) 2.7 19.6
- --------------------------------------------------------------------------------
Total $70.1 $ 0.9 $17.6 $53.4
================================================================================
1994
- ----
Mortgage loans $73.8 $14.6 $41.2 $47.2
Real estate 21.0 3.2 1.3 22.9
- --------------------------------------------------------------------------------
Total $94.8 $17.8 $42.5 $70.1
================================================================================
</TABLE>
The carrying value of impaired loans was $33.6 million and $55.7 million,
with related reserves of $11.9 million and $22.3 million as of December 31, 1996
and 1995, respectively. All impaired loans were reserved as of December 31, 1996
and 1995.
The average carrying value of impaired loans was $50.4 million, $117.9
million and $155.5 million, with related interest income while such loans were
impaired, of $5.8 million, $9.3 million and $12.4 million as of December 31,
1996, 1995 and 1994 respectively.
D. Futures Contracts
- --------------------
AFC purchases long futures contracts and sells short futures contracts on margin
to hedge against interest rate fluctuations and their effect on the net cash
flows from the sales of guaranteed investment contracts. The notional amount of
such futures contracts outstanding were $(40.0) million net short contracts and
$74.7 million long contracts at December 31, 1996 and 1995, respectively.
Because the Company purchases and sells futures contracts through brokers
who assume the risk of loss, the Company's exposure to credit risk under futures
contracts is limited to the margin deposited with the broker. The maturity of
all futures contracts outstanding are less than one year. The fair value of
futures contracts outstanding were $(39.4) million and $75.7 million at December
31, 1996 and 1995, respectively.
Gains and losses on hedge contracts related to interest rate fluctuations
are deferred and recognized in income over the period being hedged corresponding
to related guaranteed investment contracts. Deferred hedging gains (losses) were
$0.6 million, $5.6 million and $(7.7) million in 1996, 1995 and 1994,
respectively. Gains and losses on hedge contracts that are deemed ineffective by
management are realized immediately.
A reconciliation of the notional amount of futures contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Contracts outstanding,
beginning of year $ 74.7 $ 126.6 $ 141.7
New contracts (44.0) 349.2 816.0
Contracts terminated (70.7) (401.1) (831.1)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $(40.0) $ 74.7 $ 126.6
================================================================================
</TABLE>
62
<PAGE>
- --------------------------------------------------------------------------------
E. Foreign Currency Swap Contracts
- ----------------------------------
The Company enters into foreign currency swap contracts to hedge exposure to
currency risk on foreign fixed maturity investments. Interest and principal
related to foreign fixed maturity investments payable in foreign currencies, at
current exchange rates, are exchanged for the equivalent payment translated at a
specific currency exchange rate. The Company's maximum exposure to counterparty
credit risk is the difference between the foreign currency exchange rate, as
agreed upon in the swap contract, and the foreign currency spot rate on the date
of the exchange. The fair values of the foreign currency swap contracts
outstanding were $(9.2) million and $(1.8) million at December 31, 1996 and
1995, respectively.
The difference between amounts paid and received on foreign currency swap
contracts is reflected in the net investment income related to the underlying
assets and is not material in 1996, 1995 and 1994. The Company had no deferred
gains or losses on foreign currency swap contracts.
A reconciliation of the notional amount of swap contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Contracts outstanding,
beginning of year $104.6 $118.7 $128.8
New contracts -- -- 10.1
Contracts expired (36.0) -- (15.1)
Contracts terminated -- (14.1) (5.1)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 68.6 $104.6 $118.7
================================================================================
</TABLE>
Expected maturities of foreign currency swap contracts are $18.2 million in
1997 and $50.4 million in 1999 and thereafter. There are no expected maturities
of foreign currency swap contracts in 1998.
F. Interest Rate and Other Swap Contracts
- -----------------------------------------
The Company enters into interest rate swap contracts to hedge exposure to
interest rate fluctuations. Under these swap contracts, the Company agrees to
exchange, at specified intervals, the difference between fixed and floating
interest amounts calculated on an agreed-upon notional principal amount. In
addition, the Company has entered into two new types of swap contracts in 1996:
security return-linked swap contracts and insurance portfolio-linked swap
contracts for investment purposes. Under the security return-linked contracts,
the Company agrees to exchange cash flows according to the performance of a
specified security or portfolio of securities. Under the insurance portfolio-
linked swap contracts, the Company agrees to exchange cash flows according to
the performance of a specified underwriter's portfolio of insurance business.
Because the underlying principal of swap contracts is not exchanged, the
Company's maximum exposure to counterparty credit risk is the difference in
payments exchanged.
The net amount receivable or payable is recognized over the life of the
swap contract as an adjustment to net investment income. The increase or
(decrease) in net investment income related to interest rate and other swap
contracts was $0.6 million, $0.7 million and $(1.3) million for the years ended
December 31, 1996, 1995, and 1994, respectively. The Company had no deferred
gains or losses relating to interest rate and other swap contracts. The fair
values of interest rate and other swap contracts outstanding were $0.1 million,
$0.4 million and $0.6 million at December 31, 1996, 1995 and 1994, respectively.
A reconciliation of the notional amount of interest rate and other swap
contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Contracts outstanding,
beginning of year $ 17.5 $22.8 $22.8
New contracts 63.6 -- --
Contracts expired (17.5) (5.3) --
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 63.6 $17.5 $22.8
================================================================================
</TABLE>
Expected maturities of interest rate and other swap contracts outstanding
at December 31 are as follows: $43.6 million in 1997, $5.0 million in 1998, and
$15.0 million in 1999 and thereafter.
G. Other
- --------
At December 31, 1996, AFC had no concentration of investments in a single
investee exceeding 10% of shareholders' equity, except for investments with the
U.S. Treasury with a carrying value of $268.3 million.
4. INVESTMENT INCOME AND GAINS AND LOSSES
--------------------------------------
A. Net Investment Income
- ------------------------
The components of net investment income were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Fixed maturities $555.8 $555.1 $578.3
Mortgage loans 69.5 97.0 119.9
Equity securities 11.1 13.2 9.9
Policy loans 10.3 20.3 23.3
Real estate 40.8 48.7 44.6
Other long-term investments 19.0 7.1 5.7
Short-term investments 11.3 21.6 10.3
- --------------------------------------------------------------------------------
Gross investment income 717.8 763.0 792.0
Less investment expenses (45.2) (52.5) (48.9)
- --------------------------------------------------------------------------------
Net investment income $672.6 $710.5 $743.1
================================================================================
</TABLE>
At December 31, 1996, fixed maturities and mortgage loans on non-accrual
status were $2.0 million and $6.8 million, including restructured loans of $4.4
million. The effect of non-
63
<PAGE>
- --------------------------------------------------------------------------------
accruals, compared with amounts that would have been recognized in accordance
with the original terms of the investments, was to reduce net income by $0.5
million, $0.6 million and $5.1 million in 1996, 1995 and 1994, respectively.
The payment terms of mortgage loans may from time to time be restructured
or modified. The investment in restructured mortgage loans, based on amortized
cost, amounted to $51.3 million, $98.9 million and $126.8 million at December
31, 1996, 1995 and 1994, respectively. Interest income on restructured mortgage
loans that would have been recorded in accordance with the original terms of
such loans amounted to $7.7 million, $11.1 million and $14.4 million in 1996,
1995 and 1994, respectively. Actual interest income on these loans included in
net investment income aggregated $4.5 million, $7.1 million and $8.2 million in
1996, 1995 and 1994, respectively.
At December 31, 1996, fixed maturities with a carrying value of $2.0
million were non-income producing for the twelve months ended December 31, 1996.
There were no mortgage loans which were non-income producing for the twelve
months ended December 31, 1996.
Included in other long-term investments is income from limited partnerships
of $13.7 million, $0.1 million and $0.6 million in 1996, 1995 and 1994
respectively.
B. Realized Investment Gains and Losses
- ---------------------------------------
Realized gains (losses) on investments were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==========================================================================
<S> <C> <C> <C>
Fixed maturities $(10.1) $(7.0) $ 2.4
Mortgage loans (2.4) 1.4 (12.1)
Equity securities 55.0 16.2 12.4
Real estate 21.1 5.3 1.4
Other 2.3 3.2 (3.0)
- --------------------------------------------------------------------------
Net realized investment gains $ 65.9 $19.1 $ 1.1
==========================================================================
</TABLE>
Proceeds from voluntary sales of investments in fixed maturities were
$2,463.3 million, $1,612.3 million and $1,036.5 million in 1996, 1995 and 1994,
respectively. Realized gains on such sales were $19.3 million, $23.7 million and
$12.9 million; and realized losses were $31.0 million, $33.0 million and $21.6
million for 1996, 1995 and 1994, respectively.
5. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
-----------------------------------------------
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosure of fair value information about certain financial instruments
(insurance contracts, real estate, goodwill and taxes are excluded) for which it
is practicable to estimate such values, whether or not these instruments are
included in the balance sheet. The fair values presented for certain financial
instruments are estimates which, in many cases, may differ significantly from
the amounts which could be realized upon immediate liquidation. In cases where
market prices are not available, estimates of fair value are based on discounted
cash flow analyses which utilize current interest rates for similar financial
instruments which have comparable terms and credit quality. Fair values of
interest rate futures were not material at December 31, 1996 and 1995.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Cash and Cash Equivalents
For these short-term investments, the carrying amount approximates fair value.
Fixed Maturities
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models using discounted cash flow
analyses.
Equity Securities
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models.
Mortgage Loans
Fair values are estimated by discounting the future contractual cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings. The fair value of below investment grade mortgage loans are
limited to the lesser of the present value of the cash flows or book value.
Reinsurance Receivables
The carrying amount reported in the consolidated balance sheets approximates
fair value.
Policy Loans
The carrying amount reported in the consolidated balance sheets approximates
fair value since policy loans have no defined maturity dates and are inseparable
from the insurance contracts.
Investment Contracts (Without Mortality Features)
Fair values for the Company's liabilities under guaranteed investment type
contracts are estimated using discounted cash flow calculations using current
interest rates for similar contracts with maturities consistent with those
remaining for the contracts being valued. Other liabilities are based on
surrender values.
Debt
The carrying value of short-term debt reported in the balance sheet approximates
fair value. The fair value of long-term debt was estimated using market quotes,
when available, and, when not available, discounted cash flow analyses.
64
<PAGE>
- --------------------------------------------------------------------------------
The estimated fair values of the financial instruments were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Carrying Fair Carrying Fair
FINANCIAL ASSETS Value Value Value Value
- ----------------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 178.5 $ 178.5 $ 289.5 $ 289.5
Fixed maturities 7,487.8 7,487.8 7,739.3 7,739.3
Equity securities 473.6 473.6 517.2 517.2
Mortgage loans 650.1 675.7 799.5 845.4
Policy loans 132.4 132.4 123.2 123.2
- --------------------------------------------------------------------------------
$8,922.4 $8,948.0 $9,468.7 $9,514.6
================================================================================
FINANCIAL LIABILITIES
- ---------------------
Guaranteed investment contracts $1,101.3 $1,119.2 $1,632.8 $1,677.0
Supplemental contracts without
life contingencies 23.1 23.1 24.4 24.4
Dividend accumulations 87.3 87.3 86.2 86.2
Other individual contract
deposit funds 76.9 74.3 95.7 92.8
Other group contract deposit
funds 789.1 788.3 894.0 902.8
Individual annuity contracts 935.6 719.0 966.3 810.0
Short-term debt 38.4 38.4 31.2 31.2
Long-term debt 202.2 199.1 202.3 212.4
- --------------------------------------------------------------------------------
$3,253.9 $3,048.7 $3,932.9 $3,836.8
================================================================================
</TABLE>
6. CLOSED BLOCK
------------
Included in other income in the Consolidated Statements of Income in 1996 and
1995 is a net pre-tax contribution from the Closed Block of $8.6 million and
$2.9 million, respectively. Summarized financial information of the Closed Block
as of December 31, 1996 and 1995 and for the period ended December 31, 1996 and
the period from October 1, 1995 through December 31, 1995 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
==================================================================
Assets
<S> <C> <C>
Fixed maturities, at fair value (amortized
cost of $397.2 and $447.4, respectively) $403.9 $458.0
Mortgage loans 114.5 57.1
Policy loans 230.2 242.4
Cash and cash equivalents 24.1 17.6
Accrued investment income 14.3 16.6
Deferred policy acquisition costs 21.1 24.5
Other assets 3.7 2.7
- -----------------------------------------------------------------
Total assets $811.8 $818.9
=================================================================
Liabilities
Policy liabilities and accruals $883.4 $899.2
Other liabilities 8.7 2.8
- -----------------------------------------------------------------
Total liabilities $892.1 $902.0
=================================================================
</TABLE>
65
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Period from
October 1
through
December 31 December 31
(In millions) 1996 1995
================================================================================
<S> <C> <C>
Revenues
Premiums $ 61.7 $ 11.5
Net investment income 52.6 12.8
Realized investment loss (0.7) --
- --------------------------------------------------------------------------------
Total revenues 113.6 24.3
- --------------------------------------------------------------------------------
Benefits and expenses
Policy benefits 101.2 20.6
Policy acquisition expenses 3.2 0.8
Other operating expenses 0.6 --
- --------------------------------------------------------------------------------
Total benefits and expenses 105.0 21.4
- --------------------------------------------------------------------------------
Contribution from the Closed Block $ 8.6 $ 2.9
================================================================================
Cash flows
Cash flows from operating activities:
Contribution from the Closed Block $ 8.6 $ 2.9
Initial cash transferred to the Closed Block -- 139.7
Change in deferred policy acquisition
costs, net 3.4 0.4
Change in premiums and other receivables 0.2 (0.1)
Change in policy liabilities and accruals (13.9) 2.0
Change in accrued investment income 2.3 (1.3)
Other, net 2.5 0.8
- --------------------------------------------------------------------------------
Net cash provided by operating activities 3.1 144.4
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Sales, maturities and repayments of
investments 188.1 29.0
Purchases of investments (196.9) (158.8)
Other, net 12.2 3.0
- --------------------------------------------------------------------------------
Net cash provided by
(used in) investing activities 3.4 (126.8)
- --------------------------------------------------------------------------------
Net increase in cash and cash equivalents 6.5 17.6
Cash and cash equivalents, beginning
of the year 17.6 --
- --------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 24.1 $ 17.6
================================================================================
</TABLE>
On October 16, 1995, there were no valuation allowances transferred to the
Closed Block on mortgage loans. There were no valuation allowances on mortgage
loans at December 31, 1996 and 1995, respectively.
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.
7. DEBT
----
Short- and long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
<S> <C> <C>
Short-term
Commercial paper $ 37.8 $ 27.7
Other 0.6 3.5
- --------------------------------------------------------------------------------
Total short-term debt $ 38.4 $ 31.2
================================================================================
Long-term
Senior Debentures (unsecured) $199.5 $199.5
Other 2.7 2.8
- --------------------------------------------------------------------------------
Total long-term debt $202.2 $202.3
================================================================================
</TABLE>
AFC issues commercial paper primarily to manage imbalances between
operating cash flows and existing commitments. Commercial paper borrowing
arrangements are supported by various lines of credit. At December 31, 1996, the
weighted average interest rate for outstanding commercial paper was
approximately 5.5%.
At December 31, 1996, AFC had approximately $140.0 million in committed
lines of credit provided by U.S. banks, of which $102.2 million was available
for borrowing. These lines of credit generally have terms of less than one year,
and require the Company to pay annual commitment fees of 0.07% of the available
credit. Interest that would be charged for usage of these lines of credit is
based upon negotiated arrangements.
During 1996, the Company utilized repurchase agreements to finance certain
investments. Although the repurchase agreements were entirely settled by year
end, management may utilize this policy again in future periods.
In October, 1995, AFC issued $200.0 million face amount of Senior
Debentures for proceeds of $197.2 million net of discounts and issuance costs.
These securities have an effective interest rate of 7.65%, and mature on October
16, 2025. Interest is payable semiannually on October 15 and April 15 of each
year. The Senior Debentures are subject to certain restrictive covenants,
including limitations on issuance of or disposition of stock of restricted
subsidiaries and limitations on liens. The Company is in compliance with all
covenants.
66
<PAGE>
- --------------------------------------------------------------------------------
Interest expense was $32.1 million, $7.3 million and $4.3 million in 1996,
1995 and 1994, respectively. Interest expense in 1996 included $15.3 million
related to the Company's Senior Debentures and $11.0 million related to interest
payments on repurchase agreements. Interest expense in 1995 included $3.2
million related to the Company's Senior Debentures. All interest expense is
recorded in other operating expenses.
8. Federal Income Taxes
--------------------
Provisions for federal income taxes have been calculated in accordance with the
provisions of SFAS No. 109. A summary of the federal income tax expense
(benefit) in the consolidated statements of income is shown below:
<TABLE>
<CAPTION>
For the Years Ended December 31
(In millions) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Federal income tax expense (benefit)
Current $ 90.9 $119.7 $45.4
Deferred (15.7) (37.0) 8.0
- --------------------------------------------------------------------------------
Total $ 75.2 $ 82.7 $53.4
================================================================================
</TABLE>
The federal income taxes attributable to the consolidated results of
operations are different from the amounts determined by multiplying income
before federal income taxes by the expected federal income tax rate. The sources
of the difference and the tax effects of each were as follows:
<TABLE>
<CAPTION>
For the Years Ended December 31
(In millions) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Expected federal income tax expense $116.1 $105.6 $ 53.7
Tax-exempt interest (35.3) (32.2) (35.9)
Differential earnings amount (10.2) (7.6) 35.0
Dividend received deduction (1.6) (4.0) (2.5)
Changes in tax reserve estimates 4.7 19.3 4.0
Other, net 1.5 1.6 (0.9)
- --------------------------------------------------------------------------------
Federal income tax expense $ 75.2 $ 82.7 $ 53.4
================================================================================
</TABLE>
Until conversion to a stock life insurance company, FAFLIC, as a mutual
company, reduced its deduction for policyholder dividends by the differential
earnings amount. 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 Internal Revenue Service (IRS). The
differential earnings amount included in 1996 related to an adjustment for the
1994 tax year based on the actual average mutual life insurance companies'
earnings rate issued by the IRS in 1996. As a stock life company, FAFLIC is no
longer required to reduce its policyholder dividend deduction by the
differential earnings amount.
The deferred income tax asset represents the tax effects of temporary
differences attributable to Allmerica P&C, a separate consolidated group for
federal tax return purposes. Its components were as follows:
<TABLE>
<CAPTION>
December 31
(In millions) 1996 1995
================================================================================
<S> <C> <C>
Deferred tax (assets) liabilities
AMT carryforwards $ (16.3) $ (9.8)
Loss reserve discounting (182.1) (178.3)
Deferred acquisition costs 57.5 55.1
Employee benefit plans (25.1) (25.5)
Investments, net 73.4 77.4
Bad debt reserve (1.7) (1.8)
Other, net 1.1 1.7
- --------------------------------------------------------------------------------
Deferred tax asset, net $ (93.2) $ (81.2)
================================================================================
</TABLE>
The deferred income tax liability represents the tax effects of temporary
differences attributable to the FAFLIC/AFLIAC consolidated federal tax return
group. Its components were as follows:
<TABLE>
<CAPTION>
December 31
(In millions) 1996 1995
================================================================================
<S> <C> <C>
Deferred tax (assets) liabilities
Loss reserve discounting $(153.7) $(129.1)
Deferred acquisition costs 189.6 169.7
Employee benefit plans (16.3) (14.6)
Investments, net 55.2 67.0
Bad debt reserve (24.5) (26.3)
Other, net (15.6) (18.9)
- --------------------------------------------------------------------------------
Deferred tax liability, net $ 34.7 $ 47.8
================================================================================
</TABLE>
Gross deferred income tax assets totaled $435.3 million and $405.1 million
at December 31, 1996 and 1995, respectively. Gross deferred income tax
liabilities totaled $376.8 million and $371.7 million at December 31, 1996 and
1995, respectively.
67
<PAGE>
Management believes, based on the Company's recent earnings history and its
future expectations, that the Company's taxable income in future years will be
sufficient to realize all deferred tax assets. In determining the adequacy of
future income, management considered the future reversal of its existing
temporary differences and available tax planning strategies that could be
implemented, if necessary. At December 31, 1996, there are available non-life
net operating loss carryforwards of $0.8 million, and alternative minimum tax
credit carryforwards of $16.3 million.
The Company's federal income tax returns are routinely audited by the IRS,
and provisions are routinely made in the financial statements in anticipation of
the results of these audits. The IRS has examined the FAFLIC/AFLIAC consolidated
group's federal income tax returns through 1991. The IRS has also examined the
Allmerica P&C consolidated group's federal income tax returns through 1991. The
Company is currently considering its response to certain adjustments proposed by
the IRS with respect to the federal income tax returns for 1989, 1990, and 1991
for both the FAFLIC/AFLIAC consolidated group as well as the Allmerica P&C
consolidated group. Also, certain adjustments proposed by the IRS with respect
to FAFLIC/AFLIAC's federal income tax returns for 1982 and 1983 remain
unresolved. If upheld, these adjustments would result in additional payments;
however, the Company will vigorously defend its position with respect to these
adjustments. In management's opinion, adequate tax liabilities have been
established for all years. However, the amount of these tax liabilities could be
revised in the near term if estimates of the Company's ultimate liability are
revised.
9. PENSION PLANS
-------------
AFC provides retirement benefits to substantially all of its employees under
three separate defined benefit pension plans. Through December 31, 1994,
retirement benefits were based primarily on employees' years of service and
compensation during the highest five consecutive plan years of employment.
Benefits under this defined benefit formula were frozen for most employees (but
not for eligible agents) effective December 31, 1994. In their place, the
Company adopted a defined benefit cash balance formula, under which the Company
annually provides an allocation to each eligible employee as a percentage of
that employee's salary, similar to a defined contribution plan arrangement. The
1996 and 1995 allocations were based on 7.0% of each eligible employee's salary.
The Company's policy for the plans is to fund at least the minimum amount
required by the Employee Retirement Income Security Act of 1974.
Components of net pension expense were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Service cost - benefits
earned during the year $ 19.0 $ 19.7 $ 13.0
Interest accrued on projected
benefit obligations 21.9 21.1 20.0
Actual return on assets (42.2) (89.3) (2.6)
Net amortization and deferral 9.3 66.1 (16.3)
- --------------------------------------------------------------------------------
Net pension expense $ 8.0 $ 17.6 $ 14.1
================================================================================
</TABLE>
The following table summarizes the combined status of the three pension
plans. At December 31, 1996 the plans' assets exceeded their projected benefit
obligations and in 1995 the plans' projected benefit obligation exceeded their
assets.
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $308.9 $325.6
Unvested benefit obligation 6.6 5.0
- --------------------------------------------------------------------------------
Accumulated benefit obligation $315.5 $330.6
================================================================================
Pension liability included in
Consolidated Balance Sheets:
Projected benefit obligation $344.2 $367.1
Plan assets at fair value 347.8 321.2
- --------------------------------------------------------------------------------
Plan assets greater (less) than
projected benefit obligation 3.6 (45.9)
Unrecognized net (gain) loss from
past experience (9.1) 48.8
Unrecognized prior service benefit (11.5) (13.8)
Unamortized transition asset (24.7) (26.5)
- --------------------------------------------------------------------------------
Net pension liability $(41.7) $(37.4)
================================================================================
</TABLE>
Determination of the projected benefit obligations was based on a weighted
average discount rate of 7.0% in 1996 and 1995, and the assumed long-term rate
of return on plan assets was 9.0%. The actuarial present value of the projected
benefit obligations was determined using assumed rates of increase in future
compensation levels ranging from 5.5% to 6.5%. Plan assets are invested
primarily in various separate accounts and the general account of FAFLIC. The
plans also hold stock of AFC.
The Company has a profit sharing and 401(k) plan for its employees.
Effective for plan years beginning after 1994, the profit sharing formula for
employees has been discontinued and a 401(k) match feature has been added to the
continuing 401(k)
68
<PAGE>
- --------------------------------------------------------------------------------
plan for the employees. Total plan expense in 1996, 1995 and 1994 was $5.5
million, $5.2 million and $12.6 million, respectively. In addition to this Plan,
the Company has a defined contribution plan for substantially all of its agents.
The Plan expense in 1996, 1995 and 1994 was $2.0 million, $3.5 million and $2.7
million, respectively.
10. OTHER POSTRETIREMENT BENEFIT PLANS
----------------------------------
In addition to the Company's pension plans, the Company currently provides
postretirement medical and death benefits to certain full-time employees and
dependents, under several plans sponsored by FAFLIC, Hanover and Citizens.
Generally, employees become eligible at age 55 with at least 15 years of
service. Spousal coverage is generally provided for up to two years after death
of the retiree. Benefits include hospital, major medical and a payment at death
equal to retirees' final compensation up to certain limits. Effective January 1,
1996, the Company revised these benefits so as to establish limits on future
benefit payments and to restrict eligibility to current employees. The medical
plans have varying copayments and deductibles, depending on the plan. These
plans are unfunded.
The plan changes effective January 1, 1996 resulted in a negative plan
amendment (change in eligibility and medical benefits) of $26.8 million and
curtailment (no future increases in life insurance) of $5.3 million. The
negative plan amendment will be amortized as prior service cost over the average
number of years to full eligibility (approximately 9 years or $3.0 million per
year). Of the $5.3 million curtailment gain, $3.3 million has been deducted from
unrecognized loss and $2.0 million has been recorded as a reduction of the net
periodic postretirement benefit expense.
The plans' funded status reconciled with amounts recognized in the
Company's consolidated balance sheet were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $40.4 $ 44.9
Fully eligible active plan participants 7.5 14.0
Other active plan participants 24.4 45.9
- --------------------------------------------------------------------------------
72.3 104.8
Plan assets at fair value -- --
- --------------------------------------------------------------------------------
Accumulated postretirement benefit
obligation in excess of plan assets 72.3 104.8
Unrecognized prior service benefit 23.8 --
Unrecognized loss (5.0) (13.4)
- --------------------------------------------------------------------------------
Accrued postretirement benefit costs $91.1 $ 91.4
================================================================================
</TABLE>
The components of net periodic postretirement benefit expense were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
<S> <C> <C> <C>
Service cost $ 3.2 $ 4.2 $ 6.6
Interest cost 4.6 6.9 6.9
Amortization of (gain) loss (2.8) (0.5) 1.4
- --------------------------------------------------------------------------------
Net periodic postretirement
benefit expense $ 5.0 $10.6 $14.9
================================================================================
</TABLE>
For purposes of measuring the accumulated postretirement benefit obligation
at December 31, 1996, health care costs were assumed to increase 9.0% in 1997,
declining thereafter until the ultimate rate of 5.5% is reached in 2001 and
remains at that level thereafter. The health care cost trend rate assumption has
a significant effect on the amounts reported. For example, increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation at December 31, 1996
by $5.3 million, and the aggregate of the service and interest cost components
of net periodic postretirement benefit expense for 1996 by $0.7 million.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0% at December 31, 1996 and 1995.
11. POSTEMPLOYMENT BENEFITS
-----------------------
Effective January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 112, (SFAS No. 112), "Employers' Accounting
for Postemployment Benefits", which requires employers to recognize the costs
and obligations of severance, disability and related life insurance and health
care benefits to be paid to inactive or former employees after employment but
before retirement. Prior to adoption, the Company had recognized the cost of
these benefits on an accrual or paid basis, depending on the plan.
Implementation of SFAS No. 112 resulted in a transition obligation of $1.9
million, net of federal income taxes and minority interest, and is reported as a
cumulative effect of a change in accounting principle in the consolidated
statement of income. The impact of this accounting change, after recognition of
the cumulative effect, was not significant.
69
<PAGE>
- --------------------------------------------------------------------------------
12. STOCK-BASED COMPENSATION PLANS
In October 1995 the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation"("SFAS 123"). The Standard is
effective for fiscal years beginning after December 15, 1995, and requires the
Company either to apply a fair value measure to any stock-based compensation
granted by the Company, or continue to apply the valuation provisions of
existing accounting standards, but with pro-forma net income and earnings per
share disclosures using a fair value methodology to value the stock-based
compensation. Beginning for the year ended December 31, 1996, the Company has
elected to continue to apply the valuation provisions of existing accounting
standards (APB 25). The pro forma effect of applying SFAS 123 is not material.
Effective June 17, 1996, The Company adopted a Long Term Stock Incentive Plan
for employees of the Company (the "Employees' Plan"). Key employees of the
Company and its subsidiaries are eligible for awards pursuant to the Plan
administered by the Compensation Committee of the Board of Directors (the
"Committee") of the Company. Under the terms of the Employees' Plan, options may
be granted to eligible employees at a price not less than the market price of
the Company's common stock on the date of grant. Option shares may be exercised
subject to the terms prescribed by the Committee at the time of grant, otherwise
options vest at the rate of 20% annually for five consecutive years and must be
exercised not later than ten years from the date of grant. At June 17, 1996,
231,500 option shares were granted at an option price of $27.50. During 1996,
22,000 option shares were forfeited leaving 209,500 option shares outstanding at
December 31, 1996. There were no options exercised during 1996. At December 31,
1996, there were no options exercisable and 2,140,500 option shares were
available for future grant.
13. DIVIDEND RESTRICTIONS
Massachusetts, Delaware, New Hampshire and Michigan have enacted laws governing
the payment of dividends to stockholders by insurers. These laws affect the
dividend paying ability of FAFLIC, AFLIAC, Hanover and Citizens, respectively.
Massachusetts' statute limits the dividends an insurer may pay in any
twelve month period, without the prior permission of the Commonwealth of
Massachusetts Insurance Commissioner, to the greater of (i) 10% of its statutory
policyholder surplus as of the preceding December 31 or (ii) the individual
company's statutory net gain from operations for the preceding calendar year (if
such insurer is a life company), or its net income for the preceding calendar
year (if such insurer is not a life company). In addition, under Massachusetts
law, no domestic insurer shall pay a dividend or make any distribution to its
shareholders from other than unassigned funds unless the Commissioner shall have
approved such dividend or distribution. At January 1, 1997, FAFLIC could pay
dividends of $151.8 million to AFC without prior approval of the Commissioner.
Pursuant to Delaware's statute, the maximum amount of dividends and other
distributions that an insurer may pay in any twelve month period, without the
prior approval of the Delaware Commissioner of Insurance, is limited to the
greater of (i) 10% of its policyholders' surplus as of the preceding December 31
or (ii) the individual company's statutory net gain from operations for the
preceding calendar year (if such insurer is a life company) or its net income
(not including realized capital gains) for the preceding calendar year (if such
insurer is not a life company). Any dividends to be paid by an insurer, whether
or not in excess of the aforementioned threshold, from a source other than
statutory earned surplus would also require the prior approval of the Delaware
Commissioner of Insurance. At January 1, 1997, AFLIAC could pay dividends of
$11.9 million to FAFLIC without prior approval.
Pursuant to New Hampshire's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without the
prior approval of the New Hampshire Insurance Commissioner, is limited to 10% of
such insurer's statutory policyholder surplus as of the preceding December 31.
At January 1, 1997, the maximum dividend and other distributions that could be
paid to Allmerica P&C by Hanover, without prior approval of the Insurance
Commissioner, was approximately $15.4 million, which considers dividends
declared to Allmerica P&C of $105.0 million during 1996, including $80.0 million
which was declared in December. On January 2, 1997, Hanover declared an
extraordinary dividend in the amount of $120.0 million, payable on or after
January 21, 1997 to Allmerica P&C. The dividend which was approved by the New
Hampshire Insurance Department on January 9, 1997 is to be paid in a lump sum or
in such installments as Allmerica P&C, in its discretion, may determine.
Pursuant to Michigan's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without prior
approval of the Michigan Insurance Commissioner, is limited to the greater of
10% of policyholders' surplus as of December 31 of the immediately preceding
year or the statutory net income less realized gains, for the immediately
preceding calendar year. At January 1, 1997, Citizens Insurance could pay
dividends of $39.9 million to Citizens Corporation without prior approval.
70
<PAGE>
- -------------------------------------------------------------------------------
14. 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.
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-type, traditional and health insurance products distributed via
retail channels to individuals across the country. The Institutional Services
segment includes primarily group retirement products such as 401(k) plans, tax-
sheltered annuities and GIC contracts which are distributed to institutions
across the country via work-site 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.
Summarized below is financial information with respect to business segments for
the years ended and as of December 31.
<TABLE>
<CAPTION>
(IN MILLIONS) 1996 1995 1994
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Risk Management
Regional Property and
Casualty $ 2,193.7 $ 2,095.1 $ 2,004.8
Corporate Risk Management 361.5 328.5 302.4
- ---------------------------------------------------------------------
Subtotal 2,555.2 2,423.6 2,307.2
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 450.9 486.7 507.9
Institutional Services 266.7 330.2 397.9
Allmerica Asset Management 8.8 4.4 4.0
- ---------------------------------------------------------------------
Subtotal 726.4 821.3 909.8
- ---------------------------------------------------------------------
Corporate 1.8 0.4 --
Eliminations (8.7) (4.4) (21.9)
- ---------------------------------------------------------------------
Total $ 3,274.7 $ 3,240.9 $ 3,195.1
=====================================================================
Income from continuing
operations before income taxes:
Risk Management
Regional Property and
Casualty $ 197.7 $ 206.3 $ 113.1
Corporate Risk Management 20.7 18.3 19.9
- ---------------------------------------------------------------------
Subtotal 218.4 224.6 133.0
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 76.2 35.2 14.2
Institutional Services 52.8 42.8 4.4
Allmerica Asset Management 1.1 2.3 1.9
- ---------------------------------------------------------------------
Subtotal 130.1 80.3 20.5
- ---------------------------------------------------------------------
Corporate (16.8) (3.1) --
- ---------------------------------------------------------------------
Total $ 331.7 $ 301.8 $ 153.5
=====================================================================
Identifiable assets:
Risk Management
Regional Property and
Casualty $ 5,703.9 $ 5,741.8 $ 5,408.7
Corporate Risk Management 506.0 458.9 386.3
- ---------------------------------------------------------------------
Subtotal 6,209.9 6,200.7 5,795.0
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 8,873.5 7,218.6 5,639.8
Institutional Services 3,879.0 4,280.9 4,484.5
Allmerica Asset Management 2.4 2.1 2.2
- ---------------------------------------------------------------------
Subtotal 12,754.9 11,501.6 10,126.5
- ---------------------------------------------------------------------
Corporate 32.9 55.4 --
- ---------------------------------------------------------------------
Total $18,997.7 $17,757.7 $15,921.5
=====================================================================
</TABLE>
71
<PAGE>
- --------------------------------------------------------------------------------
15. LEASE COMMITMENTS
-----------------
Rental expenses for operating leases, principally with respect to buildings,
amounted to $33.6 million, $36.4 million and $35.2 million in 1996, 1995 and
1994, respectively. At December 31, 1996, future minimum rental payments under
non-cancellable operating leases were approximately $71.7 million, payable as
follows: 1997 - $26.4 million; 1998 - $19.6 million; 1999 - $12.8 million; 2000
- - $8.0 million; and $5.0 million thereafter. It is expected that, in the normal
course of business, leases that expire will be renewed or replaced by leases on
other property and equipment; thus, it is anticipated that future minimum lease
commitments will not be less than the amounts shown for 1997.
16. REINSURANCE
-----------
In the normal course of business, the Company seeks to reduce the loss that may
arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers. Reinsurance transactions are
accounted for in accordance with the provisions of SFAS No. 113.
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy. Reinsurance
contracts do not relieve the Company from its obligations to policyholders.
Failure of reinsurers to honor their obligations could result in losses to the
Company; consequently, allowances are established for amounts deemed
uncollectible. The Company determines the appropriate amount of reinsurance
based on evaluation of the risks accepted and analyses prepared by consultants
and reinsurers and on market conditions (including the availability and pricing
of reinsurance). The Company also believes that the terms of its reinsurance
contracts are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limit and retention,
arbitration and occurrence. Based on its review of its reinsurers' financial
statements and reputations in the reinsurance marketplace, the Company believes
that its reinsurers are financially sound.
The Company is subject to concentration of risk with respect to reinsurance
ceded to various residual market mechanisms. As a condition to the ability to
conduct certain business in various states, the Company is required to
participate in various residual market mechanisms and pooling arrangements which
provide various insurance coverages to individuals or other entities that are
otherwise unable to purchase such coverage voluntarily provided by private
insurers. These market mechanisms and pooling arrangements include the
Massachusetts Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers'
Compensation Residual Market Pool ("MWCRP") and the Michigan Catastrophic Claims
Association ("MCCA"). At December 31, 1996, the MCCA and CAR were the only two
reinsurers which represented 10% or more of the Company's reinsurance business.
As a servicing carrier in Massachusetts, the Company cedes a significant portion
of its private passenger and commercial automobile premiums to CAR. Net premiums
earned and losses and loss adjustment expenses ceded to CAR in 1996, 1995 and
1994 were $38.0 million and $21.8 million, $49.1 million and $33.7 million, and
$50.0 million and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool, which is administered by The
National Council on Compensation Insurance ("NCCI"). The Company is currently
involved in legal proceedings regarding the MWCRP's deficit which through a
legislated settlement issued on June 23, 1995 provided for an initial funding of
$220.0 million, of which the insurance carriers were responsible for $65.0
million. Hanover paid its allocation of $4.2 million in December 1995. Some of
the small carriers appealed this decision. The Company's right to recover
reinsurance balances for claims properly paid is not at issue in any such
proceedings. The Company expects to collect its reinsurance balance; however,
funding of the cash flow needs of the MWCRP may in the future be affected by
issues related to certain litigation, the outcome of which the Company cannot
predict. The Company ceded to MCCA premiums earned and losses and loss
adjustment expenses in 1996, 1995 and 1994 of $50.5 million and $(52.9) million,
$66.8 million and $62.9 million, and $80.0 million and $24.2 million,
respectively. Because the MCCA is supported by assessments permitted by statute,
and all amounts billed by the Company to CAR, MWCRP and MCCA have been paid when
due, the Company believes that it has no significant exposure to uncollectible
reinsurance balances.
72
<PAGE>
- --------------------------------------------------------------------------------
The effects of reinsurance were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
======================================================================
<S> <C> <C> <C>
Life insurance premiums:
Direct $ 389.1 $ 438.9 $ 447.2
Assumed 87.8 71.0 54.3
Ceded (138.9) (150.3) (111.0)
- ----------------------------------------------------------------------
Net premiums $ 338.0 $ 359.6 $ 390.5
======================================================================
Property and casualty premiums
written:
Direct $2,039.7 $2,039.4 $1,992.4
Assumed 108.7 125.0 128.6
Ceded (234.0) (279.1) (298.1)
- ----------------------------------------------------------------------
Net premiums $1,914.4 $1,885.3 $1,822.9
======================================================================
Property and casualty premiums
earned:
Direct $2,018.5 $2,021.7 $1,967.1
Assumed 112.4 137.7 116.1
Ceded (232.6) (296.2) (291.9)
- ----------------------------------------------------------------------
Net premiums $1,898.3 $1,863.2 $1,791.3
======================================================================
Life insurance and other individual
policy benefits, claims, losses
and loss adjustment expenses:
Direct $ 618.0 $ 749.6 $ 773.0
Assumed 44.9 38.5 28.9
Ceded (77.8) (69.5) (61.6)
- ----------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $ 585.1 $ 718.6 $ 740.3
======================================================================
Property and casualty benefits,
claims,losses and loss
adjustment expenses:
Direct $1,288.3 $1,372.7 $1,364.4
Assumed 85.8 146.1 102.7
Ceded (2.2) (229.1) (160.4)
- ----------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $1,371.9 $1,289.7 $1,306.7
======================================================================
</TABLE>
17. DEFERRED POLICY ACQUISITION COSTS
---------------------------------
The following reflects the changes to the deferred policy acquisition asset:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================
<S> <C> <C> <C>
Balance at beginning of year $ 735.7 $ 802.8 $ 746.9
Acquisition expenses deferred 560.8 504.8 510.3
Amortized to expense during
the year (483.5) (470.3) (475.7)
Adjustment to equity during
the year 9.7 (50.4) 21.3
Transferred to the Closed Block -- (24.8) --
Adjustment for cession of term
life insurance -- (26.4) --
- ----------------------------------------------------------------
Balance at end of year $ 822.7 $ 735.7 $ 802.8
================================================================
</TABLE>
18. LIABILITIES FOR OUTSTANDING CLAIMS, LOSSES AND LOSS ADJUSTMENT EXPENSES
-----------------------------------------------------------------------
The Company regularly updates its estimates of liabilities for outstanding
claims, losses and loss adjustment expenses as new information becomes available
and further events occur which may impact the resolution of unsettled claims for
its property and casualty and its accident and health lines of business. Changes
in prior estimates are reflected in results of operations in the year such
changes are determined to be needed and recorded.
The liability for future policy benefits and outstanding claims, losses and
loss adjustment expenses related to the Company's accident and health business
was $471.7 million, $446.9 million and $371.4 million at December 31, 1996, 1995
and 1994, respectively. Accident and health claim liabilities have been re-
estimated for all prior years and were decreased by $0.6 million and $2.2
million in 1996 and 1994, respectively, and increased by $17.6 million in 1995.
Unfavorable development in the accident and health business during 1995 was
primarily due to reserve strengthening and adverse experience in the Company's
individual disability line of business.
73
<PAGE>
- --------------------------------------------------------------------------------
The following table provides a reconciliation of the beginning and ending
property and casualty reserve for unpaid losses and loss adjustment expenses
(LAE):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=======================================================================
<S> <C> <C> <C>
Reserve for losses and LAE,
beginning of year $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net
of reinsurance recoverable:
Provision for insured events
of current year 1,513.3 1,427.3 1,434.8
Decrease in provision for
insured events of prior years (141.4) (137.6) (128.1)
- -----------------------------------------------------------------------
Total incurred losses and LAE 1,371.9 1,289.7 1,306.7
- -----------------------------------------------------------------------
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 759.6 652.2 650.2
Losses and LAE attributable to
insured events of prior years 627.6 614.3 566.9
- -----------------------------------------------------------------------
Total payments 1,387.2 1,266.5 1,217.1
- -----------------------------------------------------------------------
Change in reinsurance
recoverable on unpaid losses (136.6) 51.1 14.8
- -----------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,744.1 $2,896.0 $2,821.7
=======================================================================
</TABLE>
As part of an ongoing process, the property and casualty reserves have been
re-estimated for all prior accident years and were decreased by $141.4 million,
$137.6 million and $128.1 million in 1996, 1995 and 1994, respectively. The
increase in favorable development on prior years' reserves of $3.8 million in
1996 results primarily from an $11.4 million increase in favorable development
at Citizens.
The increase in Citizens' favorable development of $11.4 million in 1996
reflects improved severity in the personal automobile line, where favorable
development increased $28.6 million to $33.0 million in 1996, partially offset
by less favorable development in the workers' compensation line. In 1995, the
workers' compensation line had favorable development of $32.7 million, primarily
as a result of Citizens re-estimating reserves to reflect the new claims cost
management programs and the Michigan Supreme Court ruling, which decreases the
maximum to be paid for indemnity cases on all existing and future claims. In
1996, the favorable development in the workers' compensation line of $21.8
million also reflected these developments. Hanover's favorable development,
including voluntary and involuntary pools, decreased $7.7 million in 1996 to
$82.9 million, primarily attributable to a decrease in favorable development in
the workers' compensation line of $19.8 million. This decrease is primarily
attributable to a re-estimate of reserves with respect to certain types of
workers' compensation policies including large deductibles and excess of loss
policies. In addition, during 1995 the Regional Property and Casualty
subsidiaries refined their estimation of unallocated loss adjustment expenses
which increased favorable development in that year. Favorable development in the
personal automobile line also decreased $4.7 million, to $42.4 million in 1996.
These decreases were offset by increases in favorable development of $1.9
million and $5.6 million, to $12.6 million and $5.7 million, in the commercial
automobile and commercial multiple peril lines, respectively. Favorable
development in other lines increased by $8.8 million, primarily as a result of
environmental reserve strengthening in 1995. Favorable development in Hanover's
voluntary and involuntary pools increased $3.7 million to $4.1 million during
1996.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal automobile
and workers' compensation lines increased $16.6 million and $15.5 million, to
favorable development of $4.4 million and $32.7 million, respectively, due to
the aforementioned change in claims cost management and the Michigan Supreme
Court ruling. Hanover's favorable development, not including the effect of
voluntary and involuntary pools, was relatively unchanged at $90.2 million in
1995 compared to $91.7 million in 1994. Favorable development in Hanover's
workers' compensation line increased $27.7 million to $31.0 million during 1995.
This was offset by decreases of $14.6 million and $12.6 million, to $45.5
million and $0.1 million, in the personal automobile and commercial multiple
peril lines, respectively. Favorable development in Hanover's voluntary and
involuntary pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Regional Property and Casualty
subsidiaries' reserving philosophy consistently applied over these periods.
Conditions and trends that have affected development of the loss and LAE
reserves in the past may not necessarily occur in the future.
Due to the nature of business written by the Regional Property and Casualty
subsidiaries, the exposure to environmental liabilities is relatively small and
therefore their reserves are relatively small compared to other types of
74
<PAGE>
- --------------------------------------------------------------------------------
liabilities. Losses and LAE reserves related to environmental damage and toxic
tort liability, included in the total reserve for losses and LAE, were $50.8
million and $43.2 million, net of reinsurance of $20.2 million and $8.4 million,
at the end of 1996 and 1995, respectively. During 1995, the Regional Property
and Casualty subsidiaries redefined their environmental liabilities in
conformity with new guidelines issued by the NAIC. This had no impact on results
of operations. The Regional Property and Casualty subsidiaries do not
specifically underwrite policies that include this coverage, but as case law
expands policy provisions and insurers' liability beyond the intended coverage,
the Regional Property and Casualty subsidiaries may be required to defend such
claims. During 1995, Hanover performed an actuarial review of its environmental
reserves. This resulted in Hanover's providing additional reserves for "IBNR"
(incurred but not reported) claims in addition to existing reserves for reported
claims. Although these claims are not material, their existence gives rise to
uncertainty and is discussed because of the possibility, however remote, that
they may become material. Management believes that, notwithstanding the
evolution of case law expanding liability in environmental claims, recorded
reserves related to these claims for environmental liability are adequate. In
addition, management is not aware of any litigation or pending claims that may
result in additional material liabilities in excess of recorded reserves. The
environmental liability could be revised in the near term if the estimates used
in determining the liability are revised.
19. MINORITY INTEREST
-----------------
The Company's interest in Allmerica P&C, through its wholly-owned subsidiary
FAFLIC, is represented by ownership of 59.5%, 58.3% and 57.4% of the outstanding
shares of common stock at December 31, 1996, 1995 and 1994, respectively.
Earnings and shareholders' equity attributable to minority shareholders are
included in minority interest in the consolidated financial statements.
20. CONTINGENCIES
-------------
Regulatory and Industry Developments
Unfavorable economic conditions may contribute to an increase in the number of
insurance companies that are under regulatory supervision. This may result in an
increase in mandatory assessments by state guaranty funds, or voluntary payments
by, solvent insurance companies to cover losses to policyholders of insolvent or
rehabilitated companies. Mandatory assessments, which are subject to statutory
limits, can be partially recovered through a reduction in future premium taxes
in some states. The Company is not able to reasonably estimate the potential
effect on it of any such future assessments or voluntary payments.
Litigation
On June 23, 1995, the governor of Maine approved a legislative settlement for
the Maine Workers' Compensation Residual Market Pool deficit for the years 1988
through 1992. The settlement provides for an initial funding of $220.0 million
toward the deficit. The insurance carriers were liable for $65.0 million and
employers would contribute $110.0 million payable through surcharges on premiums
over the course of the next ten years. The major insurers are responsible for
90% of the $65.0 million. Hanover's allocated share of the settlement is
approximately $4.2 million, which was paid in December 1995. The remainder of
the deficit of $45.0 million will be paid by the Maine Guaranty Fund, payable in
quarterly contributions over ten years. A group of smaller carriers filed
litigation to appeal the settlement. The Company believes that adequate reserves
have been established for any additional liability.
The Company has been named a defendant in various other legal
proceedings arising in the normal course of business. In the opinion of
management, based on the advice of legal counsel, the ultimate resolution of
these proceedings will not have a material effect on the Company's consolidated
financial statements. However, liabilities related to these proceedings could be
established in the near term if estimates of the ultimate resolution of these
proceedings are revised.
Residual Markets
The Company is required to participate in residual markets in various states.
The results of the residual markets are not subject to the predictability
associated with the Company's own managed business, and are significant to the
workers' compensation line of business and both the private passenger and
commercial automobile lines of business.
75
<PAGE>
- --------------------------------------------------------------------------------
21. Statutory Financial Information
-------------------------------
The insurance subsidiaries are required to file annual statements with state
regulatory authorities prepared on an accounting basis prescribed or permitted
by such authorities (statutory basis). Statutory surplus differs from
shareholders' equity reported in accordance with generally accepted accounting
principles for stock life insurance companies primarily because policy
acquisition costs are expensed when incurred, investment reserves are based on
different assumptions, postretirement benefit costs are based on different
assumptions and reflect a different method of adoption, life insurance reserves
are based on different assumptions and income tax expense reflects only taxes
paid or currently payable.
Statutory net income and surplus are as follows:
<TABLE>
<CAPTION>
(In millions) 1996 1995 1994
===========================================================
<S> <C> <C> <C>
Statutory net income
- --------------------
(combined)
----------
Property and Casualty
Companies $ 155.3 $ 155.3 $ 79.9
Life and Health Companies 133.3 134.3 40.7
- -----------------------------------------------------------
Statutory Shareholders'
- -----------------------
Surplus (combined)
------------------
Property and Casualty
Companies $1,201.6 $1,128.4 $974.3
Life and Health Companies 1,120.1 965.6 465.3
- -----------------------------------------------------------
</TABLE>
22. Quarterly Results of Operations (unaudited)
-------------------------------------------
The quarterly results of operations for 1996 and 1995 are summarized below:
<TABLE>
<CAPTION>
For the Three Months Ended
(In millions)
================================================================================
1996 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ----
<S> <C> <C> <C> <C>
Total revenues $828.4 $800.3 $806.3 $839.7
================================================================================
Net income $ 47.3 $ 42.6 $ 46.7 $ 45.3
================================================================================
Net income per share $ 0.94 $ 0.85 $ 0.93 $ 0.91
================================================================================
Dividends declared per share $ 0.05 $ 0.05 $ 0.05 $ 0.05
================================================================================
1995
- ----
Total revenues $841.4 $791.9 $822.8 $784.8
================================================================================
Income before extraordinary
item $ 39.2 $ 29.9 $ 34.8 $ 42.1
Extraordinary item -
demutualization expense (2.5) (3.5) (4.7) (1.4)
- --------------------------------------------------------------------------------
Net income $ 36.7 $ 26.4 $ 30.1 $ 40.7
================================================================================
Net income after
demutualization per share $ -- $ -- $ -- $ 0.82
================================================================================
Dividends declared per share $ -- $ -- $ -- $ 0.05
================================================================================
</TABLE>
76
<PAGE>
Allmerica Financial Corporation
- --------------------------------------------------------------------------------
BOARD OF DIRECTORS
Michael P. Angelini (A)
Partner, Bowditch & Dewey
DAVID A. BARRETT (A)
Consultant, Memorial Health Care
(MCCM, Inc.)
GAIL L. HARRISON (D)
Founding Principal,
The Wexler Group
ROBERT P. HENDERSON
Chairman, Greylock
Management Corporation
ROBERT J. MURRAY (D)
Chairman, President and
Chief Executive Officer, New England
Business Service, Inc.
TERRENCE MURRAY (D)
Chairman, President and Chief Executive Officer,
Fleet Financial Group, Inc.
JOHN F. O'BRIEN
President and Chief Executive Officer,
Allmerica Financial Corporation
JOHN L. SPRAGUE (A)
President, John L. Sprague
Associates, Inc.
ROBERT G. STACHLER (C)
Partner, Taft, Stettinius & Hollister
HERBERT M. VARNUM (A,C)
Former Chairman and Chief Executive Officer,
Quabaug Corporation
RICHARD MANNING WALL (C)
General Counsel and Assistant to the Chairman,
Flexcon Company, Inc.
(A) Audit Committee
(C) Compensation Committee
(D) Directors Committee
OPERATING COMMITTEE
BRUCE C. ANDERSON
Vice President, Corporate Services
JOHN P. KAVANAUGH
Vice President and Chief Investment Officer
JOHN F. KELLY
Vice President, General Counsel
and Assistant Secretary
J. BARRY MAY
President, The Hanover Insurance
Company
JAMES R. MCAULIFFE
President, Citizens Insurance
Company of America
JOHN F. O'BRIEN
President and Chief Executive Officer
EDWARD J. PARRY III
Vice President, Chief Financial Officer
and Treasurer
RICHARD M. REILLY
Vice President, Retail Financial Services
LARRY C. RENFRO
Vice President, Institutional Services
ERIC A. SIMONSEN
President, Allmerica Services Corporation
PHILLIP E. SOULE
Vice President, Corporate Risk
Management Services
77
<PAGE>
Shareholder Information
- --------------------------------------------------------------------------------
ANNUAL MEETING OF SHAREHOLDERS
The management and Board of Directors of Allmerica Financial Corporation invite
you to attend the Company's Annual Meeting of Shareholders. The meeting will be
held on May 20, 1997, at 9:00 a.m. at Allmerica Financial, 440 Lincoln Street,
Worcester, MA.
COMMON STOCK AND SHAREHOLDER OWNERSHIP PROFILE
The common stock of Allmerica Financial Corporation is traded on the New York
Stock Exchange under the symbol "AFC." On February 28, 1997, the Company had
65,397 shareholders of record. On the same date, the trading price of the
Company's common stock was $37 3/8 per share.
DIVIDENDS
Allmerica Financial Corporation declared a cash dividend of $0.05 on February
24, 1997, payable on May 15, 1997 for shareholders of record on May 1, 1997.
COMMON STOCK PRICES AND DIVIDENDS
<TABLE>
<CAPTION>
1996 HIGH LOW DIVIDENDS
<S> <C> <C> <C>
FIRST QUARTER $28 $24 3/4 $0.05
- -------------------------------------------------------------------
SECOND QUARTER $30 1/8 $25 1/4 $0.05
- -------------------------------------------------------------------
THIRD QUARTER $32 7/8 $27 1/2 $0.05
- -------------------------------------------------------------------
FOURTH QUARTER $33 3/4 $30 1/8 $0.05
- -------------------------------------------------------------------
</TABLE>
REGISTRAR AND STOCK TRANSFER AGENT
First Chicago Trust Company of New York
525 Washington Boulevard
Jersey City, NJ 07303-2512
1-800-317-4454
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
160 Federal Street
Boston, MA 02110
TOLL-FREE INVESTOR INFORMATION LINE
Call our toll-free investor information line, 1-800-407-5222, to receive
additional printed information, including the 1996 Form 10-K or quarterly
reports on Form 10-Q filed with the Securities and Exchange Commission, fax-on-
demand services, access to shareholder services, pre-recorded messages and other
services.
Alternatively, investors may address questions to:
Jean Peters, Vice President - Investor Relations
Allmerica Financial Corporation
440 Lincoln Street, Worcester, MA 01653
tel. (508) 855-1000 fax (508) 852-7588
MacArthur Starks, Jr., Director - Investor Relations
tel. (508) 855-1000 fax (508) 855-3675
CORPORATE OFFICES AND PRINCIPAL SUBSIDIARIES
Allmerica Financial Corporation
440 Lincoln Street
Worcester, MA 01653
The Hanover Insurance Company
100 North Parkway
Worcester, MA 01605
Citizens Insurance Company of America
645 West Grand River
Howell, MI 48843
INDUSTRY RATINGS
<TABLE>
<CAPTION>
A.M. Standard Duff &
Claims Paying Ability Best & Poors Moody's Phelps
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
First Allmerica Financial
Life Insurance Company A A+ A1 AA
- --------------------------------------------------------------------------------
Allmerica Financial
Life Insurance and
Annuity Company A A+ A1 -
- --------------------------------------------------------------------------------
The Hanover Insurance
Company A AA- A1 -
- --------------------------------------------------------------------------------
Citizens Insurance
Company of America A+ - - -
- --------------------------------------------------------------------------------
<CAPTION>
Standard Duff &
Debt Ratings & Poors Moody's Phelps
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Allmerica Financial
Corporation Senior Debt A- A2 A+
- --------------------------------------------------------------------------------
</TABLE>
PRINTED ENTIRELY ON RECYCLED PAPER
DESIGN
The Graphic Expression Inc., New York
78
<PAGE>
EXHIBIT 21
DIRECT AND INDIRECT SUBSIDIARIES OF THE REGISTRANT
I.Allmerica Financial Corporation (Delaware)
A.Allmerica Funding Corp. (Massachusetts)
B.First Allmerica Financial Life Insurance Company (Massachusetts)
1.Logan Wells Water Company, Inc. (New Jersey)
2.SMA Financial Corp. (Massachusetts)
a.Allmerica Property & Casualty Companies, Inc. (Delaware) (59.5%
owned)
i.APC Funding Corp. (Massachusetts)
ii.Allmerica Financial Insurance Brokers, Inc. (Massachusetts)
iii.The Hanover Insurance Company (New Hampshire)
1.Allmerica Financial Benefit Insurance Company
(Pennsylvania)
2.Allmerica Employees Insurance Agency, Inc. (Massachusetts)
3.The Hanover American Insurance Company (New Hampshire)
4.Hanover Texas Insurance Management Company, Inc. (Texas)
5.Citizens Corporation (Delaware) (82.5% owned)
a.Citizens Insurance Company of Ohio (Ohio)
b.Citizens Insurance Company of America (Michigan)
i.Citizens Management Inc. (Michigan)
c.Citizens Insurance Company of the Midwest (Indiana)
6.AMGRO, Inc. (Massachusetts)
a.Lloyds Credit Corporation (Massachusetts)
7.Massachusetts Bay Insurance Company (New Hampshire)
8.Allmerica Financial Alliance Insurance Company (New
Hampshire)
b.Sterling Risk Management Services, Inc. (Delaware)
c.Allmerica Trust Company, N.A. (Federally Chartered) (99.2% owned)
d.Somerset Square, Inc. (Massachusetts)
e.Allmerica Financial Life Insurance and Annuity Company (Delaware)
f.Allmerica Institutional Services, Inc. (Massachusetts)
g.Allmerica Investments, Inc. (Massachusetts)
h.Allmerica Investment Management Company, Inc. (Massachusetts)
i.Allmerica Asset Management, Inc. (Massachusetts)
j.Allmerica Financial Services Insurance Agency, Inc.
(Massachusetts)
k.Linder Skokie Real Estate Corporation (Massachusetts)
1
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 333-576, No. 333-578, No. 333-580 and No. 333-582)
of Allmerica Financial Corporation of our report dated February 3, 1997,
except as to Notes 1 and 2, which are as of February 19, 1997, appearing in
the Allmerica Financial Corporation 1996 Annual Report to Shareholders which
is incorporated in this Annual Report on Form 10-K. We also consent to the
incorporation by reference of our report on the Financial Statement Schedules,
which also appears in this Form 10-K.
/s/ Price Waterhouse LLP
- -------------------------------
Price Waterhouse LLP
Boston, Massachusetts
March 17, 1997
1
<PAGE>
EXHIBIT 24
POWER OF ATTORNEY
WE, THE UNDERSIGNED, HEREBY SEVERALLY CONSTITUTE AND APPOINT JOHN F.
O'BRIEN, JOHN F. KELLY AND EDWARD J. PARRY III, AND EACH OF THEM SINGLY, OUR
TRUE AND LAWFUL ATTORNEYS, WITH FULL POWER IN EACH OF THEM, SIGN FOR AND IN
EACH OF OUR NAMES AND IN ANY AND ALL CAPACITIES, FORM 10-K OF ALLMERICA
FINANCIAL CORPORATION (THE "COMPANY") AND ANY OTHER FILINGS MADE ON BEHALF OF
SAID COMPANY PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF
1934, AND TO FILE THE SAME WITH ALL EXHIBITS AND OTHER DOCUMENTS IN CONNECTION
THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO SAID
ATTORNEYS AND EACH OF THEM, ACTING ALONE, FULL POWER AND AUTHORITY TO DO AND
PERFORM EACH AND EVERY ACT AND THING REQUISITE OR NECESSARY TO BE DONE, HEREBY
RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS OR ANY OF THEM MAY LAWFULLY
DO OR CAUSE TO BE DONE BY VIRTUE HEREOF. WITNESS OUR HANDS AND COMMON SEAL ON
THE DATE SET FORTH BELOW.
SIGNATURE TITLE DATE
/s/ John F. O'Brien Director, President 2/24/97
- ------------------------------------- and CEO
JOHN F. O'BRIEN
/s/ Michael P. Angelini Director 2/24/97
- -------------------------------------
MICHAEL P. ANGELINI
- ------------------------------------- Director 2/24/97
DAVID A. BARRETT
/s/ Gail L. Harrison Director 2/24/97
- -------------------------------------
GAIL L. HARRISON
Director 2/24/97
- -------------------------------------
ROBERT P. HENDERSON
/s/ J. Terrence Murray Director 2/24/97
- -------------------------------------
J. TERRENCE MURRAY
/s/ Robert J. Murray Director 2/24/97
- -------------------------------------
ROBERT J. MURRAY
1
<PAGE>
SIGNATURE TITLE DATE
/s/ John L. Sprague Director 2/24/97
- -------------------------------------
JOHN L. SPRAGUE
/s/ Robert G. Stachler Director 2/24/97
- -------------------------------------
ROBERT G. STACHLER
/s/ Herbert M. Varnum Director 2/24/97
- -------------------------------------
HERBERT M. VARNUM
/s/ Richard Manning Wall Director 2/24/97
- -------------------------------------
RICHARD MANNING WALL
2
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 7,488
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 474
<MORTGAGE> 650
<REAL-ESTATE> 121
<TOTAL-INVEST> 8,993
<CASH> 179
<RECOVER-REINSURE> 876
<DEFERRED-ACQUISITION> 823
<TOTAL-ASSETS> 18,998
<POLICY-LOSSES> 2,614
<UNEARNED-PREMIUMS> 823
<POLICY-OTHER> 2,944
<POLICY-HOLDER-FUNDS> 2,060
<NOTES-PAYABLE> 241
0
0
<COMMON> 1
<OTHER-SE> 1,724
<TOTAL-LIABILITY-AND-EQUITY> 18,998
2,236
<INVESTMENT-INCOME> 673
<INVESTMENT-GAINS> 66
<OTHER-INCOME> 300
<BENEFITS> 1,957
<UNDERWRITING-AMORTIZATION> 484
<UNDERWRITING-OTHER> 502
<INCOME-PRETAX> 332
<INCOME-TAX> 75
<INCOME-CONTINUING> 257
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 182
<EPS-PRIMARY> 3.63
<EPS-DILUTED> 3.63
<RESERVE-OPEN> 2,896
<PROVISION-CURRENT> 1,513
<PROVISION-PRIOR> (141)
<PAYMENTS-CURRENT> 760
<PAYMENTS-PRIOR> 627
<RESERVE-CLOSE> 2,744
<CUMULATIVE-DEFICIENCY> (137)
</TABLE>
<PAGE>
EXHIBIT 99.2
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected the Company's results and in the
future could cause actual results and needs of the Company to vary materially
from forward-looking statements made from time to time by the Company on the
basis of management's then-current expectations. The businesses in which the
Company is engaged are in rapidly changing and competitive markets and involve
a high degree of risk, and accuracy with respect to forward looking
projections is difficult.
GEOGRAPHIC CONCENTRATION IN THE PROPERTY AND CASUALTY INSURANCE BUSINESS
Substantially all of the Company's property and casualty insurance
subsidiaries net premiums written and earnings are generated in Michigan and
the Northeast (Connecticut, Massachusetts, New York, New Jersey, New
Hampshire, Rhode Island, Vermont and Maine). The revenues and profitability of
the Company's property and casualty insurance subsidiaries are therefore
subject to prevailing economic, regulatory, demographic and other conditions,
including adverse weather, in Michigan and the Northeast.
CYCLICALITY IN THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
Historically, the property and casualty insurance industry has been highly
cyclical. The property and casualty industry's profitability can be affected
significantly by price competition, volatile and unpredictable developments
such as extreme weather conditions and natural disasters, legal developments
affecting insurer liability and the size of jury awards, fluctuations in
interest rates and other factors that affect investment returns and other
general economic conditions and trends that may affect the adequacy of
reserves.
Over the past several years, the property and casualty insurance industry as
a whole has been in a soft market. Competition for premiums in the property
and casualty insurance markets may continue to have an adverse impact on the
Company's rates and profitability.
CATASTROPHE LOSSES IN THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
Property and casualty insurers are subject to claims arising out of
catastrophes, which may have a significant impact on their results of
operations and financial condition. The Company may experience catastrophe
losses in the future which could have a material adverse impact on the
Company. Catastrophes can be caused by various events including hurricanes,
earthquakes, tornadoes, wind, hail, fires, severe winter weather and
explosions, and the frequency and severity of catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of two
factors: the total amount of insured exposure in the area affected by the
event and the severity of the event. Although catastrophes can cause losses in
a variety of property and casualty lines, homeowners and commercial property
insurance have in the past generated the vast majority of the Company's
catastrophe-related claims. The Company purchases catastrophe reinsurance as
protection against catastrophe losses. The Company believes, based upon its
review of its reinsurers' financial statements and reputations in the
reinsurance marketplace, that the financial condition of its reinsurers is
sound. However, there can be no assurance that reinsurance will be adequate to
protect the Company against such losses or that such reinsurance will continue
to be available to the Company in the future at commercially reasonable rates.
UNCERTAINTY REGARDING ADEQUACY OF PROPERTY AND CASUALTY LOSS RESERVES
The Company's property and casualty insurance subsidiaries maintain reserves
to cover their estimated ultimate liability for losses and loss adjustment
expenses ("LAE") with respect to reported and unreported claims incurred as of
the end of each accounting period. These reserves are estimates, involving
actuarial projections at a given time, of what the Company's property and
casualty insurance subsidiaries expect the ultimate settlement and
administration of claims will cost based on facts and circumstances then
known,
1
<PAGE>
predictions of future events, estimates of future trends in claims severity
and judicial theories of liability, legislative activity and other factors.
The inherent uncertainties of estimating reserves are greater for certain
types of property and casualty insurance lines, particularly workers'
compensation, where a longer period of time may elapse before a definitive
determination of ultimate liability may be made, and environmental liability,
where the technological, judicial and political climates involving these types
of claims are changing.
The company's property and casualty insurance subsidiaries regularly review
reserving techniques, reinsurance and overall reserve adequacy. Based upon (i)
review of historical data, legislative enactments, judicial decisions, legal
developments in imposition of damages, changes in political attitudes and
trends in general economic conditions; (ii) review of per claim information;
(iii) historical loss experience of the property and casualty insurance
subsidiaries and the industry; and (iv) the relatively short-term nature of
most of its property and casualty insurance policies, management believes that
adequate provision has been made for reserves. However, establishment of
appropriate reserves is an inherently uncertain process involving estimates of
future losses and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience. The
Company's property and casualty insurance subsidiaries' reserves are annually
certified as required by insurance regulatory authorities.
SENSITIVITY TO INTEREST RATES RELATIVE TO LIFE INSURANCE SUBSIDIARIES
The Company's life insurance subsidiaries are exposed to risk of
disintermediation and reduction in interest spread or profit margins when
interest rates fluctuate. Bond calls, mortgage prepayments, contract
surrenders and withdrawals of life insurance policies, annuities and
guaranteed investment contracts are influenced by the interest rate
environment. Since the Company's life insurance subsidiaries' investment
portfolios consist primarily of fixed income assets, the investment portfolio
market value and the yields on newly invested and reinvested assets vary
depending on interest rates. Management attempts to mitigate any negative
impact of interest rate changes through asset/liability management, product
design (including an increased focus on variable insurance products),
management of crediting rates, use of hedging techniques, relatively high
surrender charges and management of mortality charges and dividend scales with
respect to its in force life insurance policies.
REGULATORY, SURPLUS, CAPITAL, RATING AGENCY AND RELATED MATTERS
Insurance companies are subject to supervision and regulation by the state
insurance authority in each state in which they transact business. Such
supervision and regulation relate to numerous aspects of an insurance
company's business and financial condition, including limitations on the
authorization of lines of business, underwriting limitations, the setting of
premium rates, the establishment of standards of solvency, the licensing of
insurers and agents, concentration of investments, levels of reserves, the
payment of dividends, transactions with affiliates, changes of control and the
approval of policy forms. Such regulation is concerned primarily with the
protection of policyholders.
State regulatory oversight and various proposals at the federal level
(including the proposed adoption of a federal regulatory framework for
insurance companies) may in the future adversely affect the Company's ability
to sustain adequate returns in certain lines of business. In recent years, the
state insurance regulatory framework has come under increased federal
scrutiny, and certain state legislatures have considered or enacted laws that
alter and, in many cases, increase state authority to regulate insurance
companies and insurance holding company systems. Further, the National
Association of Insurance Commissioner ("NAIC") and state insurance regulators
are reexamining existing laws and regulations, and as a condition to
accreditation have required the adoption of certain model laws which
specifically focus on insurance company investments, issues relating to the
solvency of insurance companies, risk-based capital ("RBC") guidelines,
interpretations of existing laws, the development of new laws, and the
definition of extraordinary dividends.
The capacity for an insurance company's growth in premiums is in part a
function of its statutory surplus. Maintaining appropriate levels of statutory
surplus, as measured by state insurance regulators, is considered
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important by state insurance regulatory authorities and the private agencies
that rate insurers' claims-paying abilities and financial strength. Failure to
maintain certain levels of statutory surplus could result in increased
regulatory scrutiny, action by state regulatory authorities or a downgrade by
the private rating agencies.
The NAIC has created a new system for assessing the adequacy of statutory
capital for life and health insurers and property and casualty insurers. The
new system, known as risk-based capital, is in addition to the states' fixed
dollar minimum capital and other requirements. The new system is based on
risk-based formulas (separately defined for life and health insurers and
property and casualty insurers) that apply prescribed factors to the various
risk elements in an insurer's business to report a minimum capital requirement
proportional to the amount of risk assumed by the insurer.
Because the investment of First Allmerica Financial Life Insurance Company
("FAFLIC"), a life insurance subsidiary of the Company, in Allmerica Property
& Casualty Companies, Inc. ("Allmerica P&C") represents a significant
percentage of FAFLIC's surplus, the trading price of the common stock of
Allmerica P&C will affect FAFLIC's RBC calculations and may affect the
FAFLIC's claims-paying ability and financial strength ratings. There can be no
assurance that capital requirements applicable to the FAFLIC's businesses will
not increase or that the FAFLIC will be able to meet minimum RBC requirements
in the future.
In addition, in March 1995, S&P lowered its claims-paying ability ratings of
FAFLIC and Allmerica Financial Life Insurance and Annuity Company to A+
(Good), and Moody's reduced FAFLIC's FinancialStrength Rating From Aa3
(Excellent) to A1 (Good). Management believes that its strong ratings are
important factors in marketing the products of its insurance companies to its
agents and customers, since rating information is broadly disseminated and
generally used throughout the industry. Insurance company ratings are assigned
to an insurer based upon factors relevant to policyholders and are not
directed toward protection of investors. Such ratings are neither a rating of
securities nor a recommendation to buy, hold or sell any security. Further
downgrades may have a material adverse effect on the Company's business and
prospects.
STATE GUARANTY FUNDS, SHARED MARKETS MECHANISMS AND POOLING ARRANGEMENTS
All fifty states of the United States have insurance guaranty fund laws
requiring all life and health and property and casualty insurance companies
doing business within the state to participate in guaranty associations, which
are organized to pay contractual obligations under insurance policies issued
by impaired or insolvent insurance companies. These associations levy
assessments (up to prescribed limits) on all member insurers in a particular
state on the basis of the proportionate share of the premiums written by
member insurers in the lines of business in which the impaired or insolvent
insurer is engaged. Mandatory assessments by state guaranty funds are used to
cover losses to policyholders of insolvent or rehabilitated companies and can
be partially recovered through a reduction in future premium taxes in many
states. These assessments may increase in the future depending upon the rate
of insolvencies of insurance companies.
In addition, as a condition to the ability to conduct business in various
states, the Company's property and casualty insurance subsidiaries are
required to participate in mandatory property and casualty shared market
mechanisms or pooling arrangements, which provide various insurance coverages
to individuals or other entities that otherwise are unable to purchase such
coverage voluntarily provided by private insurers. The Company cannot predict
whether its participation in these shared market mechanisms or pooling
arrangements will provide underwriting profits or losses to the Company.
COMPETITION
The Company's business is composed of four principal segments: Property and
Casualty Insurance, Corporate Risk Management Services, Retail Financial
Services, and Institutional Services. Each of these industry segments in
general is highly competitive. The Company's products and services compete not
only with those offered by insurance companies but also with products offered
by other financial institutions and health maintenance organizations. In all
of its segments, many of the Company's competitors are larger and have greater
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financial, technical and operating resources than those of the Company. In
addition, the Company may face additional competition from banks and other
financial institutions should current regulatory restrictions on the sale of
insurance and securities by these institutions be repealed.
RETENTION OF KEY EXECUTIVES
The future success of the Company will be affected by its continued ability
to attract and retain qualified executives. The Company's success is dependent
in large part on John F. O'Brien, the loss of whom could adversely affect the
Company's business. The Company does not have an employment agreement with Mr.
O'Brien.
FEDERAL INCOME TAX LEGISLATION
Currently, under the Code, holders of certain life insurance and annuity
products are entitled to tax-favored treatment on these products. For example,
income tax payable by policyholders on investment earnings under certain life
insurance and annuity products is deferred during the product's accumulation
period and is payable, if at all, only when the insurance or annuity benefits
are actually paid or to be paid. Also, for example, interest on loans up to
$50,000 secured by the cash value of certain insurance policies owned by
businesses is eligible for deduction even though investment earnings during
the accumulation period are tax-deferred.
In the past, legislation has been proposed that would have curtailed the
tax-favored treatment of the life insurance and annuity products offered by
the Company. These proposals were not enacted, and no such proposals or
similar proposals are currently under active consideration by the Congress.
Nevertheless, if these or similar proposals directed at limiting the tax-
favored treatment of life insurance policies and annuity contracts were
enacted, market demand for such products offered by the Company would be
adversely affected.
SALES PRACTICES
A number of civil jury verdicts have been returned against life and health
insurers in the jurisdictions in which the Company does business involving the
insurers' sales practices, alleged agent misconduct, failure to properly
supervise agents, and other matters. Some of the lawsuits have resulted in the
award of substantial judgments against the insurer, including material amounts
of punitive damages. In some states, juries have substantial discretion in
awarding punitive damages in these circumstances. The Company and its
subsidiaries, like other life and health insurers, from time to time are
involved in such litigation. Although the outcome of any litigation cannot be
predicted with certainty, to date, no such lawsuit has resulted in the award
of any material amount of damages against the Company.
In December 1996, the Company received notice from the Securities and
Exchange Commission (the "Commission") that it would be conducting a limited
inspection concerning the Company's marketing and sales practices associated
with variable insurance products. The Commission requested that certain
information be provided to it by the Company, which the Company promptly
complied with. No litigation has been instituted, nor has the Commission
initiated any further action with respect to this matter.
HEALTH CARE REFORM LEGISLATION
In the past, there have been, and currently there are, a number of proposals
introduced in the United States Congress and currently there are proposals
pending in state legislatures to reform the current health care system. Many
states have already enacted comprehensive health care reform legislation and a
number of legislative and regulatory proposals are currently being considered
at the state and federal level. Legislative proposals have included
requirements with respect to mandated universal health insurance coverage,
restrictions on preexisting condition limitations, community rating standards,
guaranteed issue and renewal requirements and restrictions on premium
increases. Some states have passed and many other states are considering
legislation that include voluntary health care purchasing alliances,
differential limitations in rates for new and renewal business or for
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demographic groups, and underwriting practice restrictions. These reforms
generally include the formation of voluntary purchasing alliances for small
employers (typically with less than 50-100 employees) and require insurers to
accept all qualified small employer groups as a condition of providing small
group insurance, prohibit the imposition of preexisting condition limitations
or medical condition terminations, and phase out experience-rating for small
employer groups. Certain jurisdictions also have enacted so-called "any
willing provider" laws which may decrease the demand for managed care plans.
While the Company cannot predict whether any of the proposals currently being
considered will be enacted or whether any new federal or state proposals will
be considered, and thus cannot predict what specific effects health care
reform may have on the Company's business, the Company's operations may be
adversely affected by changes to the health care system.
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