FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: ____________ to ____________
Commission file number: 1-13754
ALLMERICA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3263626
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
440 Lincoln Street, Worcester, Massachusetts 01653
(Address of principal executive office)
(Zip Code)
(508) 855-1000
(Registrant's telephone number, including area code)
_____________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 60,286,200 shares
of common stock outstanding, as of May 1, 1998.
32
Total Number of Pages Included in This Document
Exhibit Index is on page 33
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Interim Consolidated Financial Statements 8 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14 - 30
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 32
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions, except per
share data) 1998 1997
<S> <C> <C>
REVENUES
Premiums $ 577.5 $ 562.3
Universal life and investment
product policy fees 69.5 56.3
Net investment income 155.1 163.4
Net realized investment gains 29.2 44.0
Other income 32.6 31.2
------- -------
Total revenues 863.9 857.2
------- -------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 506.8 492.3
Policy acquisition expenses 117.2 115.2
Loss from cession of disability
income business 0.0 53.9
Other operating expenses 140.6 141.8
------- -------
Total benefits, losses and expenses 764.6 803.2
------- -------
Income before federal income taxes 99.3 54.0
------- -------
Federal income tax expense(benefit)
Current 29.8 6.0
Deferred (5.6) 3.7
------- -------
Total federal income tax expense 24.2 9.7
------- -------
Income before minority interest 75.1 44.3
Minority interest:
Distributions on mandatorily
redeemable preferred
securities of a subsidiary
trust holding solely junior
subordinated debentures
of the Company (4.0) (2.4)
Equity in earnings (4.3) (26.0)
------- -------
(8.3) (28.4)
------- -------
Net income $ 66.8 $ 15.9
======= =======
PER SHARE DATA
Net income (basic and diluted) $ 1.11 $ 0.32
======= =======
Dividends declared to shareholders $ 0.05 $ 0.05
======= =======
Weighted average shares
outstanding(diluted) 60.3 50.2
======= =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 3
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
(In millions, except per share data) 1998 1997
<S> <C> <C>
ASSETS
Investments:
Debt securities-at fair value (amortized
cost of $7,298.3 and $7,052.9) $ 7,552.3 $ 7,313.7
Equity securities-at fair value (cost of
$342.1 and $341.1) 514.4 479.0
Mortgage loans 541.5 567.5
Real estate 36.7 50.3
Policy loans 144.7 141.9
Other long-term investments 134.2 148.3
--------- ---------
Total investments 8,923.8 8,700.7
--------- ---------
Cash and cash equivalents 212.1 215.1
Accrued investment income 135.8 142.3
Deferred policy acquisition costs 999.9 965.5
Reinsurance receivable on paid and unpaid
losses, benefits and unearned premiums 1,095.0 1,040.3
Premiums, accounts and notes receivable, net 563.0 554.4
Other assets 359.3 368.6
Closed Block assets 797.5 806.7
Separate account assets 11,425.4 9,755.4
--------- ---------
Total assets $24,511.8 $22,549.0
========= =========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,604.1 $ 2,598.6
Outstanding claims, losses and loss
adjustment expenses 2,831.7 2,825.1
Unearned premiums 847.2 846.8
Contractholder deposit funds and other
policy liabilities 2,086.8 1,852.7
--------- ---------
Total policy liabilities and accruals 8,369.8 8,123.2
--------- ---------
Expenses and taxes payable 606.1 670.7
Reinsurance premiums payable 48.3 37.7
Short-term debt 40.1 33.0
Deferred federal income taxes 16.7 12.9
Long-term debt 202.1 202.1
Closed Block liabilities 879.6 885.5
Separate account liabilities 11,420.9 9,749.7
--------- ---------
Total liabilities 21,583.6 19,714.8
--------- ---------
Minority interest:
Mandatorily redeemable preferred securities
of a subsidiary trust holding solely junior
subordinated debentures of the Company 300.0 300.0
Common stock 159.4 152.9
--------- ---------
Total minority interest 459.4 452.9
--------- ---------
Commitments and contingencies (Note 9)
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 20.0
million shares authorized, none issued 0.0 0.0
Common stock, $0.01 par value, 300.0
million shares authorized, 60.3 million and
60.0 million shares issued and outstanding,
respectively 0.6 0.6
Additional paid-in capital 1,763.4 1,755.0
Accumulated other comprehensive income 233.3 217.9
Retained earnings 471.5 407.8
--------- ---------
Total shareholders' equity 2,468.8 2,381.3
--------- ---------
Total liabilities and shareholders' equity $24,511.8 $22,549.0
========= =========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 4
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
PREFERRED STOCK
Balance at beginning and end of period $ 0.0 $ 0.0
-------- --------
COMMON STOCK
Balance at beginning of period 0.6 0.5
Issuance of common stock 0.0 0.0
-------- --------
Balance at end of period 0.6 0.5
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,755.0 1,382.5
Issuance of common stock 8.4 0.0
Issuance costs of mandatorily
redeemable preferred securities of a
subsidiary trust holding solely junior
subordinated debentures of the Company 0.0 (3.7)
-------- --------
Balance at end of period 1,763.4 1,378.8
-------- --------
RETAINED EARNINGS
Balance at beginning of period 407.8 210.1
Net income 66.8 15.9
Dividends to shareholders (3.1) (2.5)
-------- --------
Balance at end of period 471.5 223.5
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 217.9 131.6
Net appreciation (depreciation) on
available-for-sale securities 25.1 (136.3)
(Provision) benefit for deferred federal
income taxes (9.0) 47.7
Minority interest (0.7) 26.2
-------- --------
Other comprehensive income 15.4 (62.4)
-------- --------
Balance at end of period 233.3 69.2
-------- --------
Total shareholders' equity $2,468.8 $1,672.0
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 5
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Net income $ 66.8 $ 15.9
Other comprehensive income
Net appreciation (depreciation) on
available-for sale securities 25.1 (136.3)
(Provision) benefit for deferred federal
income taxes (9.0) 47.7
Minority interest (0.7) 26.2
------- -------
Other comprehensive income 15.4 (62.4)
------- -------
Comprehensive income $ 82.2 $ (46.5)
======= =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 6
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 66.8 $ 15.9
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Minority interest 8.3 28.4
Net realized gains (29.2) (44.9)
Net amortization and depreciation 7.7 6.3
Loss from cession of disability income
business 0.0 53.9
Deferred federal income taxes (5.6) 3.7
Change in deferred acquisition costs (33.9) (29.8)
Change in premiums and notes receivable,
net of reinsurance payable 2.3 (10.6)
Change in accrued investment income 5.5 (3.4)
Change in policy liabilities and
accruals, net 3.1 (61.3)
Change in reinsurance receivable (54.6) 34.3
Change in expenses and taxes payable (53.0) 10.1
Separate account activity, net 1.1 0.2
Other, net 5.7 (12.1)
------- -------
Net cash used in operating activities (75.8) (9.3)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities of
available-for-sale fixed maturities 568.8 891.0
Proceeds from disposals of equity securities 45.5 116.3
Proceeds from disposals of other
investments 37.0 29.0
Proceeds from mortgages matured or collected 62.8 25.5
Purchase of available-for-sale fixed maturities (829.1) (845.7)
Purchase of equity securities (32.7) (16.0)
Purchase of other investments (50.7) (32.2)
Capital expenditures (1.7) (3.3)
Other investing activities, net 0.0 0.1
------- -------
Net cash (used in) provided by investing
activities (200.1) 164.7
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 443.5 56.7
Withdrawals from contractholder deposit funds (207.9) (175.0)
Change in short-term debt 7.1 29.2
Net proceeds from issuance of mandatorily
redeemable preferred securities of a
subsidiary trust holding solely junior
subordinated debentures of the Company 0.0 296.3
Proceeds from issuance of common stock 8.4 0.0
Dividends paid to shareholders (3.3) (3.5)
------- -------
Net cash provided by financing activities 247.8 203.7
------- -------
Net change in cash and cash equivalents (28.1) 359.1
Net change in cash held in the Closed Block 25.1 15.7
Cash and cash equivalents, beginning of period 215.1 178.5
------- -------
Cash and cash equivalents, end of period $212.1 $553.3
======= =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 7
<PAGE>
ALLMERICA FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Allmerica
Financial Corporation ("AFC" or the "Company") have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the requirements of Form 10-Q.
The interim consolidated financial statements of AFC include the accounts of
AFC, First Allmerica Financial Life Insurance Company ("FAFLIC"), its wholly-
owned life insurance subsidiary, Allmerica Financial Life Insurance and
Annuity Company ("AFLIAC"), non-insurance subsidiaries (principally brokerage
and investment advisory subsidiaries), and Allmerica Property & Casualty
Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance holding
company). The Closed Block assets and liabilities at March 31, 1998 and
December 31, 1997 are presented in the consolidated financial statements as
Single line items. Results of operations for the Closed Block for the three
month period ended March 31, 1998 and 1997 are included in other income in
the consolidated financial statements. All significant intercompany accounts
and transactions have been eliminated.
The financial statements reflect minority interest in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The financial statements also reflect
minority interest in Citizens Corporation (an 82.5%-owned non-insurance
holding company subsidiary of Hanover) and its wholly-owned subsidiary,
Citizens Insurance Company of America ("Citizens").
The accompanying interim consolidated financial statements reflect, in the
opinion of the Company's management, all adjustments, consisting of only
normal and recurring adjustments, necessary for a fair presentation of the
financial position and results of operations. Certain reclassifications
have been made to the 1997 consolidated statements of income in order to
conform to the 1998 presentation. The results of operations for the three
months ended March 31, 1998 are not necessarily indicative of the results
to be expected for the full year. These financial statements should be
read in conjunction with the Company's 1997 Annual Report to Shareholders,
as filed on Form 10-K with the Securities and Exchange Commission.
2. New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (Statement No. 130). Statement No. 130 establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. All
items that are required to be recognized under accounting standards as
components of comprehensive income are to be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This statement stipulates that comprehensive income reflect
the change in equity of an enterprise during a period from transactions
and other events and circumstances from non-owner sources. This statement
is effective for fiscal years beginning after December 15, 1997. The
Company has adopted Statement No. 130 for the first quarter of 1998,
resulting primarily in reporting unrealized gains and losses on investments
in debt and equity securities in comprehensive income.
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information"(Statement No. 131). This statement establishes
standards for the way that public enterprises report information about
operating segments in annual financial statements and requires that selected
information about those operating segments be reported in interim financial
statements. This statement supersedes Statement No. 14, "Financial
Reporting for Segments of a Business Enterprise". Statement No. 131
requires that all public enterprises report financial and descriptive
information about their reportable operating segments. Operating segments
are defined as components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. This statement is effective for fiscal years beginning after
December 15, 1997. The Company has adopted Statement No. 131 for the first
quarter of 1998, resulting in certain segment re-definitions which have no
impact on the consolidated results of operations. (See Note 7.)
PAGE 8
<PAGE>
In December 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments" ("SOP No. 97-3"). SOP
No. 97-3 provides guidance on when a liability should be recognized for
guaranty fund and other assessments and how to measure the liability. This
statement allows for the discounting of the liability if the amount and
timing of the cash payments are fixed and determinable. In addition, it
provides criteria for when an asset may be recognized for a portion or all
of the assessment liability or paid assessment that can be recovered
through premium tax offsets or policy surcharges. This statement is
effective for fiscal years beginning after December 15, 1998. The Company
believes that the adoption of this statement will not have a material
effect on the results of operations or financial position.
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for
the Cost of Computer Software Developed or Obtained for Internal Use" ("SOP
No. 98-1"). SOP No. 98-1 requires that certain costs incurred in developing
internal-use computer software be capitalized and provides guidance for
determining whether computer software is to be considered for internal use.
This statement is effective for fiscal years beginning after December 15,
1998. The Company is currently determining the impact of adoption of SOP
No. 98-1.
3. Merger with Allmerica Property & Casualty Companies, Inc.
The merger of Allmerica P&C and a wholly-owned subsidiary of the Company was
consummated on July 16, 1997. Through the merger, the Company acquired all
of the outstanding common stock of Allmerica P&C that it did not already own
in exchange for cash of $425.6 million and approximately 9.7 million shares
of AFC stock valued at $372.5 million. On February 3, 1997, the Company
issued $300.0 million of Series A Capital Securities ("Capital Securities").
Net proceeds from the offering of approximately $296.3 million funded a
portion of the July 16, 1997 acquisition.
The merger has been accounted for as a purchase. Total consideration of
approximately $798.1 million has been allocated to the minority interest in
the assets and liabilities based on estimates of their fair values. The
minority interest acquired totaled $703.5 million. A total of $90.6
million representing the excess of the purchase price over the fair values
of the net assets acquired, net of deferred taxes, has been allocated to
goodwill and is being amortized over a 40-year period.
The Company's consolidated results of operations include minority interest
in Allmerica P&C prior to July 16, 1997. The unaudited pro forma information
below presents consolidated results of operations as if the merger and
issuance of Capital Securities had occurred at the beginning of 1997 and
reflects adjustments which include interest expense related to the assumed
financing of a portion of the cash consideration paid and amortization of
goodwill.
The following unaudited pro forma information is not necessarily indicative
of the consolidated results of operations of the combined Company had the
merger and issuance of Capital Securities occurred at the beginning of 1997,
nor is it necessarily indicative of future results.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1997
<S> <C>
Revenue $837.7
=======
Net realized capital gains included in revenue $ 30.1
=======
Income before taxes and minority interest $ 33.4
Income taxes (3.0)
Minority interest:
Distributions on mandatorily redeemable preferred
securities of a subsidiary trust holding solely
junior subordinated debentures of the Company (4.0)
Equity in earnings (5.0)
-------
Net income $ 21.4
=======
Net income per common share (basic and diluted) $ 0.36
=======
Weighted average shares outstanding(basic and diluted) 59.9
=======
</TABLE>
PAGE 9
<PAGE>
4. Significant Transactions
Effective January 1, 1998, the Company entered into an agreement with a
highly rated reinsurer to reinsure the mortality risk on the universal life
and variable universal life blocks of business. This agreement did not have
a material effect on the Company's results of operations or financial
position.
On January 1, 1998, substantially all of the Company's defined benefit,
defined contribution 401(K) and postretirement plans were merged with the
existing benefit plans of FAFLIC. The transfer of benefit plans did not have
a material impact on the results of operations or financial position of the
Company.
5. Federal Income Taxes
Federal income tax expense for the periods ended March 31, 1998 and 1997,
has been computed using estimated effective tax rates. These rates are
revised, if necessary, at the end of each successive interim period to
reflect the current estimates of the annual effective tax rates.
6. Closed Block
Included in other income in the Consolidated Statements of Income in the
first three months of 1998 and 1997 is a net pre-tax contribution from the
Closed Block of $2.4 million and $5.5 million, respectively. Summarized
financial information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(In millions) (Unaudited)
March 31, December 31,
1998 1997
<S> <C> <C>
ASSETS
Fixed maturities-at fair value(amortized
cost of $407.8 and $418.5) $ 420.6 $ 412.9
Mortgage loans 123.4 112.0
Policy loans 216.4 218.8
Cash and cash equivalents (0.1) 25.1
Accrued investment income 15.0 14.1
Deferred policy acquisition costs 17.0 18.2
Other assets 5.2 5.6
------- -------
Total assets $ 797.5 $ 806.7
======= =======
LIABILITIES
Policy liabilities and accruals $ 866.1 $ 875.1
Other liabilities 13.5 10.4
------- -------
Total liabilities $ 879.6 $ 885.5
======= =======
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Three Months
Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
REVENUES
Premiums $ 28.2 $ 29.3
Net investment income 13.2 13.5
Net realized investment gains 0.0 0.9
------ ------
Total revenues 41.4 43.7
------ ------
BENEFITS AND EXPENSES
Policy benefits 37.7 37.3
Policy acquisition expenses 0.7 0.9
Other operating expenses 0.6 0.0
------ ------
Total benefits and expenses 39.0 38.2
------ ------
Contribution from the Closed Block $ 2.4 $ 5.5
====== ======
</TABLE>
Many expenses related to Closed Block operations are charged to operations
outside the Closed Block; accordingly, the contribution from the Closed
Block does not represent the actual profitability of the Closed Block
operations. Operating costs and expenses outside of the Closed Block are,
therefore, disproportionate to the business outside the Closed Block.
PAGE 10
<PAGE>
7. Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Accumulation. Within these broad areas,
the Company conducts business principally in four operating segments.
Effective January 1, 1998, the Company adopted Statement No. 131. Upon
adoption, the separate financial information of each segment was re-defined
consistent with the way results are regularly evaluated by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. A summary of the significant changes in reportable
segments is included below.
The Risk Management group includes two segments: Property and Casualty and
Corporate Risk Management Services. The 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 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 Accumulation group includes two segments: Allmerica
Financial Services and Allmerica Asset Management. The Allmerica Financial
Services segment includes variable annuities, variable universal life and
traditional life insurance products distributed via retail channels as well
as group retirement products, such as defined benefit and 401(K) plans and
tax-sheltered annuities distributed to institutions. Through its Allmerica
Asset Management segment, the Company offers its customers the option of
investing in three types of Guaranteed Investment Contracts (GICs); the
traditional GIC, the synthetic GIC and the "floating rate" GIC. This
segment is also a Registered Investment Advisor providing investment advisory
services, primarily to affiliates, and to other institutions, such as
insurance companies and pension plans.
In addition to the four operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Capital Securities and corporate overhead expenses. Corporate overhead
expenses reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the legal department.
Significant changes to the Company's segmentation include a reclassification
of corporate overhead expenses from each operating segment into the
Corporate segment. Additionally, certain products (group retirement
products, such as 401(K) plans and tax-sheltered annuities, group variable
universal life), and certain other non-insurance operations (telemarketing
and trust services) previously reported in the Allmerica Financial
Institutional Services segment were combined with the Allmerica Financial
Services segment. Also, the Company reclassified the GIC product line
previously reported in the Allmerica Financial Institutional Services
segment into the Allmerica Asset Management segment.
PAGE 11
<PAGE>
Management evaluates the results of the aforementioned segments based on
pre-tax segment income. Pre-tax segment income is determined by adjusting
net income for net realized investment gains and losses, net gains and
losses on disposals of businesses, extraordinary items, the cumulative
effect of accounting changes and certain other items which management
believes are not indicative of overall operating trends. While these items
may be significant components in understanding and assessing the Company's
financial performance, management believes that the presentation of pre-tax
segment income enhances its understanding of the Company's results of
operations by highlighting net income attributable to the normal, recurring
operations of the business. However, pre-tax segment income should not be
construed as a substitute for net income determined in accordance with
generally accepted accounting principles.
Summarized below is financial information with respect to business segments
for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment revenues:
Risk Management
Property and Casualty $ 553.5 $ 538.2
Corporate Risk Management Services 105.1 95.8
------- -------
Subtotal 658.6 634.0
Retirement and Asset Accumulation
Allmerica Financial Services 191.2 191.2
Allmerica Asset Management 23.9 23.9
------- -------
Subtotal 215.1 215.1
Corporate 2.0 4.1
Intersegment revenues (2.1) (2.6)
------- -------
Total segment revenues including Closed
Block 873.6 850.6
Adjustment for Closed Block (38.9) (37.4)
------- -------
Total segment revenues 834.7 813.2
Other revenues:
Net realized gains 29.2 44.0
------- -------
Total revenues $ 863.9 $ 857.2
======= =======
Segment income (loss) before income taxes
and minority interest:
Risk Management
Property and Casualty $ 37.7 $ 37.7
Corporate Risk Management Services 5.1 3.4
------- -------
Subtotal 42.8 41.1
Retirement and Asset Accumulation
Allmerica Financial Services 41.7 29.8
Allmerica Asset Management 3.9 3.2
------- -------
Subtotal 45.6 33.0
Corporate (12.3) (11.0)
------- -------
Segment income before income taxes and
minority interest 76.1 63.1
Adjustments to segment income:
Net realized investment gains 23.9 44.0
Loss on cession of disability income business 0.0 (53.9)
Other items (0.7) 0.8
------- -------
Income before taxes and minority interest $ 99.3 $ 54.0
======= =======
</TABLE>
PAGE 12
<PAGE>
<TABLE>
<CAPTION>
Identifiable Deferred Acquisition
Assets Costs
(In millions) (Unaudited) (Unaudited)
March 31, December 31, March 31, December 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Risk Management
Property and Casualty $ 5,545.5 $ 5,650.4 $ 164.9 $ 167.2
Corporate Risk
Management Services 627.1 621.9 2.9 2.9
--------- --------- ------- -------
Subtotal 6,172.6 6,272.3 167.8 170.1
Retirement and
Asset Accumulation
Allmerica Financial
Services 16,811.1 15,159.2 831.2 794.5
Allmerica Asset
Management 1,280.8 1,035.1 0.9 0.9
--------- --------- ------- -------
Subtotal 18,091.9 16,194.3 832.1 795.4
Corporate 247.3 82.4 0.0 0.0
--------- --------- ------- -------
Total $24,511.8 $22,549.0 $ 999.9 $ 965.5
========= ========= ======= =======
</TABLE>
8. Earnings Per Share
In 1997, the FASB issued Statement of Financial Accounting Standards No.
128, "Earnings Per Share", (Statement No. 128) which supersedes Accounting
Principle Board Opinion No. 15, "Earnings Per Share". This standard
replaces the primary earnings per share with a basic and diluted earnings
per share computation and requires a dual presentation of basic and diluted
earnings per share for those companies with complex capital structures. All
earnings per share amounts for all periods have been presented to conform to
the Statement No. 128 requirements. The adoption of the aforementioned
standard had no effect on the company's previously reported earnings per
share.
The weighted average number of shares of common stock and equivalents which
were utilized in the calculation of basic earnings per share were 59.9
million and 50.1 million for the three months ended March 31, 1998 and 1997,
respectively. The weighted average shares outstanding used in the
calculation of diluted earnings per share include the 0.4 million and 0.1
million share effect of dilutive employee stock options for the periods
ended March 31, 1998 and 1997, respectively. However, this difference in
weighted average shares outstanding was of insufficient magnitude to cause
a difference between reported basic and diluted earnings per share.
9. Commitments and Contingencies
Litigation
In July 1997, a lawsuit was instituted in Louisiana against AFC and certain
of its subsidiaries by individual plaintiffs alleging fraud, unfair or
deceptive acts, breach of contract, misrepresentation and related claims in
the sale of life insurance policies. In October 1997, plaintiffs
voluntarily dismissed the Louisiana suit and refiled the action in Federal
District Court in Worcester, Massachusetts. The plaintiffs seek to be
certified as a class. The case is in early stages of discovery and the
Company is evaluating the claims. Although the Company believes it has
meritorious defenses to plaintiffs' claims, there can be no assurance that
the claims will be resolved on a basis which is satisfactory to the Company.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
Although the Company does not believe that there is a material contingency
associated with the Year 2000 project, there can be no assurance that
exposure for material contingencies will not arise.
PAGE 13
<PAGE>
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations
and financial condition of the Company should be read in conjunction with
the interim Consolidated Financial Statements and related footnotes included
elsewhere herein.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
subsidiaries ("AFC" or "the Company") include the accounts of AFC, First
Allmerica Financial Life Insurance Company ("FAFLIC") its wholly-owned life
insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company
("AFLIAC"), Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C",
a wholly-owned non-insurance company), The Hanover Insurance Company
("Hanover", a wholly-owned subsidiary of Allmerica P&C), Citizens
Corporation ("Citizens", an 82.5%-owned subsidiary of Hanover), Citizens
insurance Company of America (a wholly-owned subsidiary of Citizens) and
certain other insurance and non-insurance subsidiaries.
The results of operations reflect minority interest in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The results of operations also
reflect minority interest in Citizens Corporation.
CLOSED BLOCK
On completion of its demutualization, FAFLIC established a Closed Block for
the payment of future benefits, policyholders' dividends and certain
expenses and taxes relating to certain classes of policies. FAFLIC
allocated to the Closed Block an amount of assets expected to produce cash
flows which, together with anticipated revenues from the Closed Block
business, are reasonably expected to be sufficient to support the Closed
Block business. The Closed Block includes only those revenues, benefit
payments, dividends and premium taxes considered in funding the Closed Block
and excludes many costs and expenses associated with operating the Closed
Block and administering the policies included therein. Since many expenses
related to the Closed Block were excluded from the calculation of the Closed
Block contribution, the contribution from the Closed Block does not represent
the actual profitability of the Closed Block. As a result of such exclusion,
operating costs and expenses outside the Closed Block are disproportionate
to the business outside the Closed Block.
The contribution from the Closed Block is included in `Other income' in the
interim Consolidated Financial Statements. The pre-tax contribution from
the Closed Block was $2.4 million for the three months ended March 31, 1998
and $5.5 million for the three months ended March 31,1997.
PAGE 14
<PAGE>
The following table presents the results of operations of the Closed Block
combined with the results of operations outside the Closed Block for all
periods presented. Management's discussion and analysis addresses the
results of operations as combined unless otherwise noted.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
REVENUES
Premiums $ 605.7 $ 591.6
Universal life and investment product
policy fees 69.5 56.3
Net investment income 168.3 176.9
Net realized investment gains 29.2 44.9
Other income 30.2 25.7
------- -------
Total revenues 902.9 895.4
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses and loss
adjustment expenses 544.5 529.6
Policy acquisition expenses 117.9 116.1
Loss from cession of disability income
business 0.0 53.9
Other operating expenses 141.2 141.8
------- -------
Total benefits, losses and expenses 803.6 841.4
------- -------
Income before federal income taxes 99.3 54.0
Federal income tax expense(benefit):
Current 29.8 6.0
Deferred (5.6) 3.7
------- -------
Total federal income tax expense 24.2 9.7
------- -------
Income before minority interest 75.1 44.3
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary trust
holding solely junior subordinated debentures
of the Company (4.0) (2.4)
Equity in earnings (4.3) (26.0)
------- -------
(8.3) (28.4)
------- -------
Net income $ 66.8 $ 15.9
======= =======
</TABLE>
PAGE 15
<PAGE>
Description of Operating Segments
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Accumulation. Within these broad areas,
the Company conducts business principally in four operating segments.
These segments are Property and Casualty; Corporate Risk Management
Services; Allmerica Financial Services; and Allmerica Asset Management.
Effective January 1, 1998, the Company adopted Statement No. 131.
Consistent with the Company's adoption of this statement, the separate
financial information of each segment was re-defined consistent with the
way results are regularly evaluated by the chief operating decision maker
in deciding how to allocate resources and in assessing performance. A
summary of the significant changes in reportable segments is included below.
The Risk Management group includes two segments: Property and Casualty and
Corporate Risk Management Services. The 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 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). Prior to 1998,
certain corporate overhead expenses were allocated to the Property and
Casualty business and were reflected in the results of this segment. In
addition, results of operations from the property and casualty holding
companies and certain non-insurance subsidiaries of Allmerica P&C were
reflected in the results of this segment. These overhead expenses and the
activity from the holding companies are now reported in the Corporate
segment. Results from certain non-insurance subsidiaries are no longer
being reflected in the results of the Property and Casualty segment.
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.
Prior to 1998, certain corporate overhead expenses were allocated to the
Corporate Risk Management Services business and were reflected in the
results of this segment. These overhead expenses are now reported in the
Corporate segment. In addition, results from certain non-insurance
subsidiaries, which were previously reported in the Property and Casualty
segment, are now being reported in the Corporate Risk Management Services
segment.
The Retirement and Asset Accumulation group includes two segments:
Allmerica Financial Services and Allmerica Asset Management. The Allmerica
Financial Services segment includes variable annuities, variable universal
life and traditional life insurance products distributed via retail channels
as well as group retirement products, such as defined benefit and 401(K)
plans and tax-sheltered annuities distributed to institutions. Prior to 1998,
certain corporate overhead expenses were allocated to the Allmerica
Financial Services business and were reflected in the results of this
segment. These overhead expenses are now reported in the Corporate segment.
Certain products (including defined benefit and defined contribution plans,
group variable universal life) and certain other non-insurance operations
(telemarketing and trust services) previously reported in the Allmerica
Financial Institutional Services segment have been combined with the
Allmerica Financial Services segment.
Through its Allmerica Asset Management segment, the Company offers its
customers the option of investing in three types of Guaranteed Investment
Contracts (GICs); the traditional GIC, the synthetic GIC and the "floating
rate" GIC. This segment is also a Registered Investment Advisor providing
investment advisory services, primarily to affiliates, and to other
institutions, such as insurance companies and pension plans. Prior to 1998,
certain corporate overhead expenses were allocated to the Allmerica Asset
Management business and were reflected in the results of this segment. These
overhead expenses are now reported in the Corporate segment. Additionally,
the GIC products, now offered through Allmerica Asset Management, were
previously reported in the results of the Allmerica Financial Institutional
Services segment.
In addition to the four operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Series A Capital Securities ("Capital Securities") and corporate overhead
expenses. Corporate overhead expenses reflect costs not attributable to a
particular segment, such as those generated by certain officers and
directors, Corporate Technology, Corporate Finance, Human Resources and the
legal department. Through implementation of Statement No. 131, the
definition of the Corporate segment was redefined to include all holding
companies, as well as the parent company and the corporate debt. Corporate
overhead expenses, which were previously allocated to the operating
segments, are now included in the Corporate segment.
PAGE 16
<PAGE>
Results of Operations
Consolidated Overview
Quarter Ended March 31, 1998 Compared to Quarter Ended March 31, 1997
The Company's consolidated net income for the first quarter increased $50.9
million, or 320.1%, to $66.8 million, compared to the same period in 1997.
Net income includes certain items which management believes are not
indicative of overall operating trends, such as net realized investment
gains and losses, net gains and losses on disposals of businesses,
extraordinary items and the cumulative effect of accounting changes. While
these items may be significant components in understanding and assessing
the Company's financial performance, management believes adjusted net income
enhances the understanding of the Company's results of operations by
highlighting net income attributable to the normal, recurring operations of
the business. However, adjusted net income should not be construed as a
substitute for net income determined in accordance with generally accepted
accounting principles.
For purposes of assessing each segment's contribution to adjusted net income,
management evaluates the results of these segments on a pre-tax basis. The
following table reflects each segment's contribution to adjusted net income
and a reconciliation to consolidated net income as adjusted for these items.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment income (loss) before income taxes and
minority interest:
Risk Management
Property and Casualty $ 37.7 $ 37.7
Corporate Risk Management Services 5.1 3.4
------ ------
Subtotal 42.8 41.1
Retirement and Asset Accumulation
Allmerica Financial Services 41.7 29.8
Allmerica Asset Management 3.9 3.2
------ ------
Subtotal 45.6 33.0
Corporate (12.3) (11.0)
------ ------
Segment income before income taxes and
minority interest 76.1 63.1
Federal income taxes on segment income (17.9) (12.9)
Minority interest on preferred dividends (4.0) (2.4)
Minority interest on segment income (3.8) (14.6)
------ ------
Adjusted net income 50.4 33.2
Adjustments (net of tax):
Net realized investment gains 17.5 29.0
Loss on cession of disability income business 0.0 (35.0)
Other items (0.6) 0.1
Minority interest on adjustments (0.5) (11.4)
------ ------
Net income $ 66.8 $ 15.9
====== ======
</TABLE>
The Company's segment income before taxes and minority interest increased
$13.0 million, or 20.6%, to $76.1 million in the first quarter of 1998.
This increase is primarily attributable to increases of $11.9 million from
the Allmerica Financial Services segment and $1.7 million from the Corporate
Risk Management segment. The increase in the Allmerica Financial Services
Segment was primarily attributable to growth in the variable annuity and
variable universal life assets resulting in increased fee revenue. Fee
revenue from these products increased $13.2 million or 23.4% to $69.5
million in the first quarter of 1998. The increase in the Corporate Risk
Management segment income is due to growth in the contribution from
administrative services, affinity group life and health, stop loss and
risk sharing product lines totaling $5.2 million, as well as more favorable
experience in its group life and group dental product lines. The increases
related to the Corporate Risk Management Services segment were partially
offset by $4.0 million of higher expenses and less favorable experience in
the fully insured medical product line. Property and Casualty's segment
income for the first quarter of 1998 was positively impacted by
modest growth in earned premiums and lower policy acquisition and other
underwritng expenses at
Page 17
<PAGE>
both Hanover and Citizens. These items were offset by increased personal
automobile claim severity at Hanover and reduced favorable development on
prior year reserves at both companies, as well as a decrease in net
investment income. As a result, Property and Casualty segment income
remained consistent with the prior year. Allmerica Asset Management
segment income for the first quarter of 1998 remained consistent with the
first quarter of 1997 as sales of "floating rate" GICs more than offset
the withdrawals of traditional GICs. The operating loss in the Corporate
segment for the first quarter of 1998 is comparable with the first quarter
of 1997.
The effective tax rate for segment income was 23.5% for the first quarter
of 1998 compared to 20.3% for the first quarter of 1997. The change in
the overall effective segment tax rate is due primarily to an increase in
the proportion of pre-tax results contributed by the Retirement and Asset
Accumulation business, which has a higher overall tax rate.
After-tax net realized gains on investments were $17.5 million in the
first quarter of 1998, resulting primarily from net realized gains on
equity securities and fixed maturities of $10.7 million and $6.5
million, respectively. During the first quarter of 1997, after-tax
net realized gains on investments of $29.0 million resulted primarily
from the sale of appreciated equity securities, due to the Company's
strategy of shifting to a higher level of debt securities, as well as
sales of real estate investment properties.
Effective October 1, 1997, the Company ceded substantially all of its
individual disability income line of business. The Company recognized a
$35.0 million loss, net of taxes, during the first quarter of 1997 upon
entering into agreement in principal to transfer the business.
Minority interest on both segment income and adjustments to net income
decreased in the current period as compared to the prior year due primarily
to the Company's merger with Allmerica P&C on July 16, 1997. Prior to the
acquisition, minority interest reflected 40.5% of the results of operations
from this subsidiary.
Segment Results
The following is management's discussion and analysis of the Company's
results of operations by business segment. The segment results are
presented before taxes and minority interest and other items which
management believes are not indicative of overall operating trends,
including realized gains and losses.
Page 18
<PAGE>
Risk Management
Property and Casualty
The following table summarizes the results of operations for the Property
and Casualty segment.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment revenues
Net premiums earned $491.2 $475.1
Net investment income 59.0 60.6
Other income 3.3 2.5
------ ------
Total segment revenues 553.5 538.2
Losses and loss adjustment expenses<FN1> 371.2 348.2
Policy acquisition and other
operating expenses 144.6 152.3
------ ------
Segment income before taxes and
minority interest $ 37.7 $ 37.7
====== ======
<FN>
<FN1>
Includes policyholders' dividends of $3.7 million and $1.6 million
for the quarters ended March 31, 1998 and 1997, respectively.
</FN>
</TABLE>
Quarter Ended March 31, 1998 Compared to Quarter Ended March 31, 1997
Property and Casualty's segment income before taxes and minority interest
remained consistent in the first quarter of 1998 as compared to the
same period in 1997. Growth in earned premium and lower policy
acquisition and other underwriting expenses at both Hanover and Citizens
were partially offset by increased personal automobile claims severity
at Hanover and reduced favorable development of prior year reserves at
both Hanover and Citizens. Net investment income before taxes
decreased $1.6 million, or 2.6%, to $59.0 million during the first
quarter of 1998 compared to $60.6 million in the comparable quarter of
1997. The decrease is primarily the result of a slight decrease in
yields on debt securities. The average pre-tax yield on debt
securities was 6.7% and 6.8% for the first quarter of 1998 and 1997,
respectively.
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 61.6% and 62.2% of total net
premiums earned in the first quarter of 1998 and 1997, respectively.
<TABLE>
<CAPTION>
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended 1998 1997 1998 1997 1998 1997
March 31, (In millions)
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $154.8 $151.7 $147.9 $143.7 $302.7 $295.4
Losses and loss
Adjustment expenses 125.1 112.8 99.1 113.8 224.2 226.6
Policy acquisition and
other underwriting
expenses 47.1 49.5 38.1 39.0 85.2 88.5
------ ------ ------ ------ ----- ------
Underwriting (loss)
profit $(17.4) $(10.6) $ 10.7 $ (9.1) $ (6.7) $ (19.7)
====== ====== ====== ====== ===== =======
</TABLE>
Revenues
Personal lines' net premiums earned increased $7.3 million, or 2.5%, to
$302.7 million during the first quarter of 1998, compared to $295.4 million
in the first quarter of 1997. Hanover's personal lines net premiums earned
increased $3.1 million, or 2.0%, to $154.8 million during the first quarter
of 1998. A 3.5% increase in polices in force in the personal automobile line
since March 31, 1997, as well as rate increases in the homeowners line,
contributed to the increase in net
Page 19
<PAGE>
premiums earned. These increases were partially offset by a mandated 4.0%
decrease in Massachusetts personal automobile rates which became effective
January 1, 1998.
Citizens' personal lines net premiums earned increased $4.2 million, or
2.9%, to $147.9 million in the first quarter of 1998. This growth is
attributable to rate increases in the personal automobile and homeowners
lines and a 2.6% increase in policies in force in the homeowners line. This
increase is partially offset by a decrease, attributable to changes in the
Michigan Catastrophic Claims Association ("MCCA") surcharges, effective
January 1, 1997 and January 1, 1998, respectively, for personal automobile
policies written.
While management has taken steps to increase penetration in affinity
groups and has initiated other marketing programs, the Company believes
that heightened competition may result in reduced premium growth in the
personal lines of business.
Underwriting results
The personal lines' underwriting results in the first quarter of 1998
improved $13.0 million, to a loss of $6.7 million, compared to a loss of
$19.7 million for the same period in 1997. Hanover's underwriting results
deteriorated $6.8 million, to a loss of $17.4 million. Citizens'
underwriting results improved $19.8 million, to a profit of $10.7 million.
Hanover's personal lines losses and loss adjustment expenses ("LAE")
increased $12.3 million, or 10.9%, to $125.1 million in the first quarter
of 1998. This increase is primarily attributable to an increase in
severity in the personal automobile line. In addition, catastrophe losses
increased $4.5 million, to $6.2 million, in the first quarter of 1998 from
$1.7 million in 1997. A severe winter ice storm that struck Maine in
January 1998 generated $4.2 million of the first quarter 1998 catastrophe
losses.
Citizens' losses and LAE decreased by $14.7 million, or 12.9%, to $99.1
million. This decrease is primarily due to more favorable claims
activity in the homeowners and personal automobile lines, and a
reduction in catastrophe losses of $5.9 million, primarily in the
homeowners line.
Policy acquisition and other underwriting expenses in the personal lines
decreased $3.3 million, or 3.7%, to $85.2 million in the first quarter
of 1998, primarily reflecting reductions in employee related expenses,
partially offset by growth in earned premium.
Commercial Lines of Business
The commercial lines of business represented 38.4% and 37.8% of total net
premiums earned in the first quarter of 1998 and 1997, respectively.
<TABLE>
<CAPTION>
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended 1998 1997 1998 1997 1998 1997
March 31, (In millions)
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $119.3 $113.5 $ 69.2 $ 66.2 $188.5 $179.7
Losses and loss
adjustment expenses 84.2 75.3 59.1 44.7 143.3 120.0
Policy acquisition and
other underwriting
expenses 40.5 45.3 17.2 17.4 57.7 62.7
Policyholder's dividends 1.8 0 1.9 1.6 3.7 1.6
------ ------ ------ ------ ------ -----
Underwriting (loss)
profit $ (7.2) $ (7.1) $ (9.0) $ 2.5 $(16.2) $(4.6)
====== ====== ====== ===== ====== =====
</TABLE>
Page 20
<PAGE>
Revenues
Commercial lines' net premiums earned increased $8.8 million, or 4.9%, to
$188.5 million for the quarter ended March 31, 1998 from $179.7 million
for the quarter ended March 31, 1997. Hanover's commercial lines net
premiums earned increased $5.8 million, or 5.1%, to $119.3 million.
Policies in force in the workers' compensation line and commercial
automobile line for Hanover increased 5.9% and 7.3%, respectively.
Citizens' commercial lines net premiums earned increased $3.0 million,
or 4.5%, to $69.2 million, in the first quarter of 1998. This increase
is primarily attributable to policy in force growth in the commercial
multiple peril and commercial automobile lines of Citizens. These
factors were partially offset by rate decreases in the workers'
compensation line at both companies. Management believes competitive
conditions in the workers' compensation line may impact future growth
in net premiums earned.
Underwriting results
The commercial lines' underwriting loss was $16.2 million compared to a
loss of $4.6 million for the quarters ended March 31, 1998 and 1997,
respectively. Hanover's underwriting loss of $7.1 million was consistent
with the prior year and Citizens' underwriting results decreased $11.5
million, to a loss of $9.0 million in the first quarter of 1998, compared
to a $2.5 million profit in 1997.
Hanover's commercial lines' losses and LAE increased $8.9 million, or 11.8%,
to $84.2 million in the first quarter of 1998 from $75.3 million in the first
quarter of 1997. This increase is primarily attributable to increases in
losses and LAE in the workers' compensation and commercial automobile lines
of $6.7 million and $3.3 million, respectively. The increase in the
workers' compensation line resulted from a decrease in favorable claims
experience on prior accident years in addition to an increase in current
year loss severity. Commercial automobile losses and LAE increased as a
result of a reduction in favorable claims experience on prior accident
years.
Citizens' losses and LAE were $59.1 million and $44.7 million for the
quarters ended March 31, 1998 and 1997, respectively. The increase is
primarily due to increased current year claims activity and less
favorable development of prior year reserves in the commercial automobile
and workers' compensation lines.
Policy acquisition and other underwriting expenses in the commercial
lines decreased $5.0 million, or 8.0%, to $57.7 million in the first
quarter of 1998, primarily reflecting reductions in employee related
expenses, partially offset by the effect of higher premiums.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The 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 definitive determination of
ultimate liability may be made, and where the technological, judicial,
and political climates involving these types of claims are changing.
Page 21
<PAGE>
The 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>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Reserve for losses and LAE, beginning of period $ 2,615.4 $ 2,744.1
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events of the
current year 396.0 382.2
Decrease in provision for insured
events of prior years (28.5) (35.6)
--------- ---------
Total incurred losses and LAE 367.5 346.6
payments, net of reinsurance recoverable:
Losses and LAE attributable to
insured events of current year 116.2 111.4
Losses and LAE attributable to
insured events of prior years 260.2 269.2
--------- ---------
Total payments 376.4 380.6
Change in reinsurance recoverable on
unpaid losses (1.1) (31.6)
--------- ---------
Reserve for losses and LAE, end of period $ 2,605.4 $ 2,678.5
========= =========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $28.5 million and $35.6 million
for the three month periods ended March 31, 1998 and 1997, respectively.
Favorable reserve development at Citizens decreased $5.4 million, to $15.1
million, from $20.5 million, for the quarters ended March 31, 1998 and
March 31, 1997, respectively. This decrease is primarily due to unfavorable
development in the commercial automobile line for the quarter ended
March 31, 1998. Hanover's favorable development decreased $1.7 million,
to $13.4 million, during the first quarter of 1998, from $15.1 million in
the first quarter of 1997. This decrease is primarily attributable to
decreased favorable development in all major commercial lines of business,
partially offset by an increase in favorable development in the personal
automobile line.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the losses and LAE reserves in the past may not
necessarily occur in the future.
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the 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 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.
Page 22
<PAGE>
The Company regularly reviews its reserving techniques, its overall
reserving position and its reinsurance. Based on (i) review of historical
data, legislative enactments, judicial decisions, legal developments in
impositions of damages, changes in political attitudes and trends in general
economic conditions, (ii) review of per claim information, (iii) historical
loss experience of the Company and the industry, (iv) the relatively short-
term nature of most policies and (v) internal estimates of required
reserves, management believes that adequate provision has been made for
loss reserves. However, establishment of appropriate reserves is an
inherently uncertain process and there can be no certainty that current
established reserves will prove adequate in light of subsequent actual
experience. The Company believes that a significant change to the
estimated reserves could have a material impact on the results of
operations.
REINSURANCE
The Property and Casualty segment maintains a reinsurance program designed
to protect against large or unusual losses and allocated LAE activity, which
includes pro-rata, excess of loss reinsurance and catastrophe reinsurance.
Catastrophe reinsurance serves to protect the ceding insurer from significant
aggregate losses arising from a single event such as windstorm, hail,
hurricane, tornado, riot or other extraordinary events. The Property and
Casualty segment determines the appropriate amount of reinsurance based on
the evaluation of the risks accepted and analyses prepared by consultants
and reinsurers and on market conditions including the availability and
pricing of reinsurance. The Property and Casualty segment also has
reinsurance for casualty business.
Effective January 1, 1998, the Property and Casualty segment modified its
catastrophe reinsurance program to include a higher retention. Under the 1998
catastrophe reinsurance program, the Company retains the first $45.0 million.
For losses in excess of $45.0 million and up to $180.0 million, the Company
retains 10% of the loss. Amounts in excess of $180.0 million are retained
100% by the Company. Under the 1997 catastrophe reinsurance program,
Hanover retained the first $25.0 million of loss per occurrence and all
amounts in excess of $180.0 million, 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. Also, under the
1997 catastrophic reinsurance program, Citizens retained 5% of losses in
excess of $10.0 million, up to $25.0 million, and 10% of losses in excess
of $25.0 million up to $180.0 million. Amounts in excess of $180.0 were
retained 100% by the Company.
Under the Property and Casualty segment's casualty reinsurance program, the
reinsurers are responsible for 100% of the amount of each loss in excess of
$0.5 million per occurrence up to $30.5 million for general liability and
workers' compensation. Additionally, this reinsurance covers workers'
compensation losses in excess of $30.5 million to $60.5 million per
occurrence. Amounts in excess of $60.5 million are retained 100% by the
Company.
The 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 in the Property and
Casualty segment. 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.
Page 23
<PAGE>
Corporate Risk Management Services
The following table summarizes the results of operations for the Corporate
Risk Management Services segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Premiums and premium equivalents
Premiums $ 85.6 $ 78.7
Premium equivalents 166.6 150.8
------- -------
Total premiums and premium equivalents $ 252.2 $ 229.5
======= =======
Segment revenues
Premiums $ 85.6 $ 78.7
Net investment income 6.0 5.6
Other income 13.5 11.5
------- -------
Total segment revenues 105.1 95.8
Policy benefits, claims and losses 62.3 58.6
Policy acquisition expenses 0.8 0.9
Other operating expenses 36.9 32.9
------- -------
Segment income before taxes $ 5.1 $ 3.4
======= =======
</TABLE>
Quarter Ended March 31, 1998 Compared to Quarter Ended March 31, 1997
Segment income before taxes increased $1.7 million, or 50.0%, to $5.1
million in the first quarter of 1998. This increase was primarily due to
growth in the contribution from administrative services, affinity group
life and health business, and stop loss and risk sharing product lines
totaling $5.2 million. Also, improved mortality in the group life
product line and more favorable experience in the group dental product
line contributed $1.1 million and $0.6 million, respectively. These
increases were partially offset by $4.0 million of higher expenses and
$1.1 million of less favorable experience in the fully insured medical
product line.
Premiums increased $6.9 million, or 8.8%, to $85.6 million in the first
quarter of 1998 primarily due to increases in reinsurance, which includes
affinity group life and health business, and stop loss product lines
totaling $8.7 million. These increases were partially offset by decreased
premium in the fully insured medical and dental lines of $1.1 million and
$0.7 million, respectively. These decreases reflect the cancellation of
several large unprofitable accounts.
Other income increased $2.0 million, or 17.4%, to $13.5 million in the
first quarter of 1998 due to an increase in administrative service fees.
Policy benefits, claims and losses increased $3.7 million, or 6.3%, to
$62.3 million in the first quarter of 1998. This increase is principally
attributable to the aforementioned premium growth, partially offset by
favorable overall loss experience. In particular, increased policy
benefits resulting from growth in reinsurance and stop loss product lines
and less favorable experience in the fully insured medical product line
was partially offset by improved experience in the group life, risk
sharing and fully insured dental product lines.
Operating expenses increased $4.0 million, or 12.2%, to $36.9 million in
the first quarter of 1998 due to growth related increases in commissions,
expense allowances, and premium taxes, as well as an increase in the
volume of claims processed.
Page 24
<PAGE>
Retirement and Asset Accumulation
Allmerica Financial Services
The following table summarizes the results of operations, including the
Closed Block, for the Allmerica Financial Services segment for the
periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment revenues
Premiums $ 28.9 $ 37.8
Fees 69.5 56.3
Net investment income 80.6 85.5
Other income 12.2 11.6
------- -------
Total segment revenues 191.2 191.2
Policy benefits, claims and losses 93.5 105.1
Policy acquisition expenses 14.5 16.4
Other operating expenses 41.5 39.9
------- -------
Segment income before taxes $ 41.7 $ 29.8
======= =======
</TABLE>
Quarter Ended March 31, 1998 Compared to Quarter Ended March 31, 1997
Segment income before taxes increased $11.9 million, or 39.9%, to $41.7
million in the first quarter of 1998. This increase is primarily due to
continued growth from new deposits and market appreciation in the variable
annuity and variable universal life assets resulting in increased fee
revenue.
Premiums decreased $8.9 million, or 23.5%, to $28.9 million during the first
quarter of 1998. This decrease is due primarily to the cession, effective
October 1, 1997, of substantially all of the Company's individual disability
income business, which contributed premiums of $8.0 million in the first
quarter of 1997. The remaining decrease in premiums was a result of the
Company's continued shift in focus from traditional life insurance products
to variable life insurance and annuity products.
The increase in fee revenue of $13.2 million, or 23.4%, to $69.5 million in
the first quarter of 1998 is due to additional deposits and appreciation on
variable products' account balances. Fees from annuities increased $11.4
million, or 64.3%, to $29.1 million in the first quarter of 1998.
Distribution arrangements with several third party mutual fund advisors
continue to contribute to the increase in annuity sales in 1998. Fees from
individual variable universal life policies increased $3.1 million, or
25.2%, to $15.4 million in the first quarter of 1998. These increases were
partially offset by a decline in fees from non-variable universal life of
$1.6 million. The Company expects fees from this product to continue to
decrease as policies in force and related contract values decline.
Net investment income decreased $4.9 million, or 5.7%, to $80.6 million in
The first quarter of 1998. This decrease is primarily due to a reduction
in average fixed maturities invested resulting from the transfer of assets
related to the aforementioned cession of substantially all of the individual
disability income line of business.
Policy benefits, claims and losses decreased $11.6 million, or 11.0%, to
$93.5 million in the first quarter of 1998. This decrease is primarily due
to the cession of substantially all of the individual disability income line
of business, which incurred policy benefits of $10.3 million in the first
quarter of 1997. Additionally, this decrease resulted from lower mortality
costs.
Policy acquisition expenses decreased $1.9 million, or 11.6%, to $14.5
million in the first quarter of 1998. This decrease is due, in part, to
the aforementioned cession of the individual disability line of business.
In addition, a decrease in amortization in the individual universal life
and variable universal life lines of business resulted from the change in
mortality assumptions in 1997 which are consistent with the aforementioned
reinsurance transaction. These decreases were partially offset by an
increase in deferred acquisition costs related to variable products due to
the growth in these lines of business.
Page 25
<PAGE>
The increase in other operating expenses of $1.6 million, or 4.0%, to
$41.5 million for the quarter ended March 31, 1998 is primarily due to
the continued growth in the variable product lines as well as increased
technology spending in the current quarter related to the replacement of
certain administrative systems. These increases were partially offset
by reductions in employee related costs generated by the restructuring
of defined benefit plan and defined contribution plan business during
the fourth quarter of 1998.
Interest Margins
The results of the Allmerica Financial Services segment depend, in part,
on the maintenance of profitable margins between investment results from
investment assets supporting universal life and general account annuity
products and the interest credited on those products.
The following table sets forth interest earned, interest credited and
the related interest margin.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Net investment income $ 32.9 $ 34.4
Less: Interest credited 23.1 24.6
------- -------
Interest margins <FN1> $ 9.8 $ 9.8
======= =======
<FN>
<FN1>
Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal life and
general account annuity policies. Earnings on surplus assets are excluded
from net investment income in the calculation of the above interest margins.
</FN>
</TABLE>
Interest margins were consistent in the first quarter of 1998 as compared to
1997.
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica
Asset Management segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment revenues:
Net investment income $ 21.6 $ 21.6
Fees and other income:
External 0.6 0.4
Internal 1.7 1.9
------- -------
Total segment revenues 23.9 23.9
Policy benefits, claims and losses 17.5 17.7
Other operating expenses 2.5 3.0
------- -------
Segment income before taxes $ 3.9 $ 3.2
======= =======
</TABLE>
Quarter Ended March 31, 1998 compared to Quarter Ended March 31, 1997
Segment income before taxes increased $0.7 million, or 21.9% to $3.9
million. The increase is primarily attributable to a decrease in expenses
combined with improved interest margins on GICs. Interest margins on GICs
increased slightly as new deposits generated by "floating rate" GICs more
than offset withdrawals of traditional GICs. In addition, a greater
concentration of higher yielding bonds contributed to the increased margins
in the first quarter of 1998.
Page 26
<PAGE>
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended
March 31,
(In millions) 1998 1997
<S> <C> <C>
Segment revenues
Investment and other income $ 2.0 $ 4.1
Interest expenses 3.8 3.8
Other operating expenses 10.5 11.3
------ ------
Segment loss before taxes
and minority interest $(12.3) $(11.0)
====== ======
</TABLE>
Quarter Ended March 31, 1998 compared to Quarter Ended March 31, 1997
Segment loss before taxes and minority interest for the first quarter of
1998 and 1997 was relatively consistent. Net investment income decreased
$2.1 million in 1998 primarily from the absence of $2.5 million of
short-term income generated by the temporary investment of the net
proceeds from the issuance of Capital Securities in 1997. Interest
expense for both periods relates solely to the interest paid on the Senior
Debentures of the Company. Other operating expenses for the quarter ended
March 31, 1998 and 1997 consists primarily of corporate overhead expenses
which reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the legal department.
Investment Portfolio
The Company had investment assets diversified across several asset
classes, as follows:
<TABLE>
<CAPTION>
March 31, 1998<FN1> December 31, 1997<FN1>
Carrying % of Total Carrying % of Total
Value Carrying Value Value Carrying Value
(Dollars in millions)
<S> <C> <C> <C> <C>
Fixed Maturities <FN2> $ 7,972.9 80.6% $ 7,726.6 79.8%
Equity securities<FN2> 514.4 5.2 479.0 4.9
Mortgages 664.9 6.7 679.5 7.0
Policy loans 361.1 3.6 360.7 3.7
Real estate 36.7 0.4 50.3 0.5
Cash and cash equivalents 212.0 2.1 240.1 2.5
Other invested assets 134.2 1.4 148.3 1.6
--------- ------ --------- ------
Total $ 9,896.2 100.0% $ 9,684.5 100.0%
========= ====== ========= ======
<FN>
<FN1>
Includes Closed Block invested assets with a carrying value of $760.3
million and $768.7 million at March 31, 1998 and December 31, 1997,
respectively.
<FN2>
The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
</FN>
</TABLE>
Total investment assets increased $211.7 million, or 2.2%, to $9.9 billion
during the first quarter of 1998. Fixed maturities increased $246.3
million, or 3.2%. The increase in fixed maturities was primarily due to an
increase in funds available for investment generated from the sale of
"floating rate" GICs. Equity securities increased $35.4 million, or 7.4%,
to $514.4 million during the first quarter of 1998 primarily due to market
appreciation. Mortgages decreased $14.6 million, or 2.1%, to $664.9 million
due to loan repayments. Additionally, real estate decreased $13.6 million,
or 27.0%, to $36.7 million during the first three months of 1998 due to
continued sales of investment properties. The Company intends to sell its
remaining holdings in the real estate portfolio. Cash and cash equivalents
decreased $28.1 million, or 11.7%, to $212.0 million.
The Company's fixed maturity portfolio is comprised of primarily investment
grade corporate securities, tax-exempt issues of state and local
governments, U.S. government and agency securities and other issues. Based
on ratings by the National Association of Insurance Commissioners,
investment grade securities comprised 80.9% and 82.5% of the Company's
total fixed maturity portfolio at March 31, 1998 and December 31, 1997,
respectively. In 1997, there was a modest shift to higher yielding debt
securities, including longer duration and non-investment grade securities.
The average yield on debt securities
Page 27
<PAGE>
was 7.4% and 7.6% for the three months ended March 31, 1998 and 1997,
respectively. Although management expects that a substantial portion of
new funds will be invested in investment grade fixed maturities, the
Company may invest a portion of new funds in below investment grade fixed
maturities or equity interests.
The following table illustrates asset valuation allowances and additions
to or deductions from such allowances for the periods indicated.
<TABLE>
<CAPTION>
Real
(Dollars in millions) Mortgage Estate Total
<S> <C> <C> <C>
Year Ended December 31, 1997
Beginning balance $ 19.6 $ 14.9 $ 34.5
Provision 2.5 6.0 8.5
Write-offs <FN1> (1.4) (20.9) (22.3)
------- ------- -------
Ending balance $ 20.7 $ 0.0 $ 20.7
Valuation allowance as a
percentage of carrying value
before reserves 3.0% 0.0% 3.0%
Three months ended March 31, 1998
Provision (benefits) (0.3) 0.0 (0.3)
Write-offs <FN1> (0.5) 0.0 (0.5)
------ ------ ------
Ending balance $ 19.9 $ 0.0 $ 19.9
====== ====== ======
Valuation allowance as a
percentage of carrying value
before reserves 3.0% 0.0% 3.0%
<FN>
<FN1>
Write-offs reflect asset sales, foreclosures and forgiveness of debt upon
restructurings.
</FN>
</TABLE>
Write-offs of real estate reserves during 1997 reflect the permanent
write down of all real estate assets to the estimated fair value less
costs of disposal. During 1997, the Company adopted a definitive plan
to sell its real estate holdings.
Income Taxes
AFC and its domestic 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. Prior to the merger,
Allmerica P&C and its subsidiaries filed a separate United States federal
income tax return.
Provision for federal income taxes before minority interest was $24.2
million during the first quarter of 1998 compared to $9.7 million during
the same period in 1997. These provisions resulted in consolidated
effective federal tax rates of 24.4% and 17.8%, respectively. The
effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 31.6% and 29.9% during the first quarter of 1998 and
1997, respectively. The increase in the rate for AFLIAC and FAFLIC and
its non-insurance subsidiaries resulted primarily from an $18.9 million
tax benefit related to the agreement to cede the individual disability
income business in the first quarter of 1997. This increase was
partially offset by tax credits on investment partnerships in the first
quarter of 1998. The effective tax rates for Allmerica P&C and its
subsidiaries were 13.7% and 20.8% during the first quarter of 1998 and
1997, respectively. The decrease in the rate for the Allmerica P&C
subsidiaries primarily reflects a smaller proportion of pre-tax income
from realized capital gains in 1998.
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, claims, 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.
Page 28
<PAGE>
Net cash used by operating activities was $75.7 million in the first quarter
of 1998, compared to $9.3 million for the same period of 1997. The change
in 1998 resulted primarily from the timing of recoveries of reinsurance
related to the universal life reinsurance agreement which was effective
January 1, 1998. In addition, cash was used in 1998 operations to fund
increased commissions and other deferrable expenses related to continued
growth in the variable annuity product lines of the Allmerica Financial
Services segment.
Net cash used in investing activities was $200.1 million during the first
three months of 1998, as compared to $164.7 million provided by investing
activities during the same period in 1997. This change is primarily due
to greater net purchases of fixed maturities in 1998 resulting from an
increase in funds available for investment from new "floating rate" GIC
deposits.
Net cash provided by financing activities was $247.7 million during the
first three months of 1998, as compared to $203.7 million during the
comparable prior year period. In 1998, cash provided by financing
activities was positively impacted by net GIC deposits of $235.6 million
compared to net GIC withdrawals of $118.3 million in the prior year.
This increase was partially offset by the 1997 receipt of net proceeds of
$296.3 million from the issuance of mandatorily redeemable preferred
securities of a subsidiary trust holding solely junior debentures of
the Company.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C to meet its obligations to pay
interest on the Senior Debentures, Capital Securities 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 March 31, 1998, no amounts were
outstanding and $100.0 million and $7.1 million were available for
borrowing by FAFLIC and Allmerica P&C, respectively. FAFLIC had no
commercial paper borrowings outstanding and Allmerica P&C had $32.9 million
of commercial paper borrowings outstanding at March 31, 1998. In addition,
FAFLIC and AFLIAC had no repurchase agreements outstanding as of March 31,
1998, as compared to $29.5 million outstanding at March 31, 1997. The
repurchase agreements in 1997 were used to satisfy short-term cash
requirements.
Contingencies
In July 1997, a lawsuit was instituted in Louisiana against AFC and certain
of its subsidiaries by individual plaintiffs alleging fraud, unfair or
deceptive acts, breach of contract, misrepresentation and related claims in
the sale of life insurance policies. In October 1997, plaintiffs voluntarily
dismissed the suit and refiled the action in Federal District Court in
Worcester, Massachusetts. The plaintiffs seek to be classified as a class.
The case is in early stages of discovery and the Company is evaluating the
claims. Although the Company believes it has meritorious defenses to
plaintiffs' claims, there can be no assurance that the claims will be
resolved on a basis which is satisfactory to the Company.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it will be
required to modify or replace significant portions of its software so that
its computer systems will properly utilize dates beyond December 31, 1999.
The Company presently believes that with modifications to existing software
and conversions to new software, the Year 2000 issue will be resolved.
However, if such modifications and conversions are not made, or are not
completed timely, the Year 2000 issue could have a material impact on the
operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company
is vulnerable to those third parties' failure to remediate their own Year
2000 issue. The Company's total Year 2000 project cost and estimates to
complete the project include the estimated costs and time associated with
the impact of a third party's Year 2000 issue, and are based on presently
available information. However, there can be
Page 29
<PAGE>
no guarantee that the systems of other companies on which the Company's
systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Company's
systems, would not have material adverse effect on the Company. The
Company does not believe that it has material exposure to contingencies
related to the Year 2000 Issue for the products it has sold. Although
the Company does not believe that there is a material contingency
associated with the Year 2000 project, there can be no assurance that
exposure for material contingencies will not arise.
The Company will utilize both internal and external resources to reprogram
or replace, and test the software for Year 2000 modifications. The Company
plans to complete the mission critical elements of the Year 2000 by December
31, 1998. The cost of the Year 2000 project will be expensed as incurred
over the next two years and is being funded primarily through a
reallocation of resources from discretionary projects. Therefore, the Year
2000 project is not expected to result in any significant incremental
technology costs and is not expected to have a material effect on the
results of operations. Through March 31, 1998, the Company has incurred
and expensed approximately $30.5 million related to the assessment of,
and preliminary efforts in connection with, the project and the
development of a remediation plan. The total remaining cost of the
project is estimated at between $50-70 million.
The costs of the project and the date on which the Company plans to complete
the Year 2000 modifications are based on management's best estimates, which
were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification
plans and other factors. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially
from those plans. Specific factors that might cause such material
differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct
all relevant computer codes, and similar uncertainties.
Forward-Looking Statements
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected and in the future could affect,
the Company's actual results and could cause the Company's actual results
for 1997 and beyond to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company. When
used in the MD&A discussion, the words "believes", "anticipated",
"expects" and similar expressions are intended to identify forward
looking statements. See "Important Factors Regarding Forward-Looking
Statements" filed as Exhibit 99-2 to the Company's Annual Report on
Form 10-K for the period ended December 31, 1997.
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 and annuity 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
renegotiations 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 Poor's,
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;(xv) possible claims relating to sales practices
for insurance products; and (xvi) uncertainty related to the
Year 2000 issue.
Page 30
<PAGE>
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX - 27 Financial Data Schedule
(b) Reports on Form 8K
On February 10, 1998, a report on Form 8-K was filed reporting
under item 5, Other Events, that first quarter results will be
negatively impacted by catastrophe losses resulting from a severe winter
ice storm which struck Maine during January. Currently, the Company
expects approximately $4.2 million of pre-tax losses in its property
and casualty personal lines of business and $2.6 million of pre-tax
losses in its property and casualty commercial lines of business
related to this catastrophe.
Page 31
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
-------------------------------
Registrant
Dated May 14, 1998
/s/ John F. O'Brien
-----------------------------------
John F. O'Brien
President and Chief Executive
Officer
Dated May 14, 1998
/s/ Edward J. Parry III
-----------------------------------
Edward J. Parry III
Vice President, Chief
Financial Officer,
and Treasurer
Page 32
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit
- -------------- --------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
interim consolidated balance sheet and income statement of Allmerica
Financial Corporation as of March 31, 1998 and for the period then ended,
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 7552
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 514
<MORTGAGE> 542
<REAL-ESTATE> 38
<TOTAL-INVEST> 8924
<CASH> 212
<RECOVER-REINSURE> 1095
<DEFERRED-ACQUISITION> 1000
<TOTAL-ASSETS> 24512
<POLICY-LOSSES> 2604
<UNEARNED-PREMIUMS> 847
<POLICY-OTHER> 2832
<POLICY-HOLDER-FUNDS> 2087
<NOTES-PAYABLE> 242
300
0
<COMMON> 1
<OTHER-SE> 2468
<TOTAL-LIABILITY-AND-EQUITY> 24512
578
<INVESTMENT-INCOME> 155
<INVESTMENT-GAINS> 29
<OTHER-INCOME> 102
<BENEFITS> 507
<UNDERWRITING-AMORTIZATION> 117
<UNDERWRITING-OTHER> 141
<INCOME-PRETAX> 99
<INCOME-TAX> 24
<INCOME-CONTINUING> 75
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 67
<EPS-PRIMARY> 1.11
<EPS-DILUTED> 1.11
<RESERVE-OPEN> 2615
<PROVISION-CURRENT> 396
<PROVISION-PRIOR> (29)
<PAYMENTS-CURRENT> 116
<PAYMENTS-PRIOR> 260
<RESERVE-CLOSE> 2605
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
