FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 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 offices)
(Zip Code)
508) 855-1000
(Registrant's telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 60,353,982
shares of common stock outstanding, as of November 1, 1998.
Page 1
<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 8-14
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-38
PART II. OTHER INFORMATION
Item 6.Exhibits and Reports on Form 8-K 39
SIGNATURES 40
Page 2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions, except per
share data) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 570.4 $ 585.6 $ 1,730.0 $1,726.7
Universal life and investment
product policy fees 75.0 61.4 217.2 174.8
Net investment income 153.0 164.5 462.5 498.5
Net realized investment gains 9.5 14.7 50.5 56.7
Other income 35.7 29.5 104.0 86.4
------ ------ ------- ------
Total revenues 843.6 855.7 2,564.2 2,543.1
------ ------ ------- ------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims,losses
and loss adjustment Expenses 524.1 515.1 1,549.5 1,516.1
Policy acquisition expenses 111.6 114.2 344.0 344.7
Sales practice litigation expense 31.0 0.0 31.0 0.0
Loss from exiting reinsurance pools 25.3 0.0 25.3 0.0
Loss from cession of disability
income business 0.0 0.0 0.0 53.9
Other operating expenses 143.1 136.3 422.1 408.1
Total benefits, losses and ------ ------ -------- -------
expenses 835.1 765.6 2,371.9 2,322.8
------ ------ -------- -------
Income before federal
income taxes 8.5 90.1 192.3 220.3
------ ------- -------- -------
Federal income tax expense
(benefit)
Current 13.1 33.8 57.0 66.2
Deferred (22.0) (9.8) (23.3) (13.2)
------- ------- -------- -------
Total federal income tax expense (8.9) 24.0 33.7 53.0
------- ------- -------- -------
Income before minority interest 17.4 66.1 158.6 167.3
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.0) (4.1) (12.0) (10.5)
Equity in earnings (5.2) (1.3) (11.1) (42.5)
------- ------- -------- --------
(9.2) (5.4) (23.3) (53.0)
------- ------- -------- --------
Net income $ 8.2 $ 60.7 $ 135.3 $ 114.3
======= ======= ======== ========
PER SHARE DATA
Basic
Net income $ 0.14 $ 1.04 $ 2.26 $ 2.16
Weighted average shares ======= ======= ======== ========
outstanding 60.0 58.2 60.0 52.9
======= ======= ======== ========
Diluted
Net income $ 0.13 $ 1.04 $ 2.24 $ 2.16
Weighted average shares ======= ======= ======== ========
outstanding 60.6 58.4 60.5 53.0
======= ======= ======== ========
Dividends declared to
shareholders $ 0.05 $ 0.05 $ 0.15 $ 0.15
======= ======= ======== ========
</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)
September 30, December 31,
(In millions, except per share data) 1998 1997
<S> <C> <C>
ASSETS
Investments:
Debt securities-at fair value (amortized
cost of $7,679.2 and $7,052.9) $ 7,917.9 $ 7,313.7
Equity securities-at fair value (cost of
$290.5 and $341.1) 371.9 479.0
Mortgage loans 561.5 567.5
Real estate 25.1 50.3
Policy loans 153.4 141.9
Other long-term investments 139.2 148.3
--------- ---------
Total investments 9,169.0 8,700.7
--------- ---------
Cash and cash equivalents 410.3 215.1
Accrued investment income 140.4 142.3
Deferred policy acquisition costs 1,108.3 965.5
Deferred federal income taxes 39.4 0.0
Reinsurance receivable on paid and unpaid
losses, benefits and unearned premiums 1,155.2 1,040.3
Premiums, accounts and notes receivable, net 551.8 554.4
Other assets 441.5 368.6
Closed Block assets 803.8 806.7
Separate account assets 11,424.9 9,755.4
--------- ---------
Total assets $25,244.6 $22,549.0
========= =========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,748.5 $ 2,598.6
Outstanding claims, losses and loss
adjustment expenses 2,856.3 2,825.1
Unearned premiums 883.4 846.8
Contractholder deposit funds and other
policy liabilities 2,567.1 1,852.7
--------- ---------
Total policy liabilities and accruals 9,055.3 8,123.2
--------- ---------
Expenses and taxes payable 621.0 670.7
Reinsurance premiums payable 77.5 37.7
Short-term debt 58.5 33.0
Deferred federal income taxes 0.0 12.9
Long-term debt 199.5 202.1
Closed Block liabilities 878.4 885.5
Separate account liabilities 11,420.4 9,749.7
--------- ---------
Total liabilities 22,310.6 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 153.7 152.9
--------- ---------
Total minority interest 453.7 452.9
--------- ---------
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, 60.4 million and
60.0 million shares issued and outstanding,
respectively 0.6 0.6
Additional paid-in capital 1,767.6 1,755.0
Accumulated other comprehensive income 178.1 217.9
Retained earnings 534.0 407.8
--------- ---------
Total shareholders' equity 2,480.3 2,381.3
--------- ---------
Total liabilities and shareholders'
equity $25,244.6 $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)
Nine Months Ended
September 30
(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 0.1
-------- --------
Balance at end of period 0.6 0.6
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,755.0 1,382.5
Issuance of common stock 12.6 375.9
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 1,767.3 1,754.7
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 217.9 131.6
Net (depreciation)appreciation on
available-for-sale securities (64.4) 130.6
Benefit (provision) for deferred federal
income taxes 22.3 (46.4)
Minority interest 2.3 (24.0)
-------- --------
Other comprehensive income (39.8) 60.2
-------- --------
Balance at end of period 178.1 191.8
-------- --------
RETAINED EARNINGS
Balance at beginning of period 407.8 210.1
Net income 135.3 114.3
Dividends to shareholders (9.1) (8.1)
-------- --------
Balance at end of period 534.0 316.3
-------- --------
Total shareholders' equity $2,480.3 $2,263.4
======== ========
</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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income $ 8.2 $ 60.7 $135.3 $114.3
Other comprehensive income
Net (depreciation)appreciation
on available-for sale
securities (108.5) 105.8 (64.4) 130.6
Benefit(provision)for deferred
federal income taxes 38.0 (37.7) 22.3 (46.4)
Minority interest 5.0 (17.8) 2.3 (24.0)
------ ------- ------- -------
Other comprehensive income (65.5) 50.3 (39.8) 60.2
------ ------- ------- -------
Comprehensive income $(57.3) $111.0 $ 95.5 $174.5
====== ======= ======= =======
</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)
Nine Months Ended
September 30
(In millions) 1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 135.3 $ 114.3
Adjustments to reconcile net income to
net cash(used in)provided by
operating activities:
Minority interest 11.3 42.5
Net realized gains (50.2) (57.8)
Net amortization and depreciation 24.3 20.5
Loss from exiting reinsurance pools 25.3 0.0
Sales practice litigation expense 31.0 0.0
Loss from cession of disability income
business 0.0 53.9
Deferred federal income taxes (23.3) (13.3)
Change in deferred acquisition costs (143.2) (70.2)
Change in premiums and notes receivable,
net of reinsurance payable 42.9 (0.9)
Change in accrued investment income 1.2 7.2
Change in policy liabilities and
accruals, net 177.9 (86.1)
Change in reinsurance receivable (84.9) 46.8
Change in expenses and taxes payable (108.3) 8.8
Separate account activity, net 1.3 0.2
Other, net (46.5) (12.0)
Net cash (used in) provided by -------- --------
operating activities (5.9) 53.9
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities of
available-for-sale fixed maturities 1,552.5 2,068.3
Proceeds from disposals of equity securities 228.3 126.6
Proceeds from disposals of other investments 79.4 96.0
Proceeds from mortgages matured or collected 147.5 157.4
Purchase of available-for-sale fixed maturities (2,209.6) (2,064.4)
Purchase of equity securities (111.3) (45.8)
Purchase of other investments (221.3) (94.3)
Capital expenditures (4.3) (5.4)
Purchase of minority interest in Allmerica P & C 0.0 (425.6)
Other investing activities, net (7.9) 1.2
Net cash used in investing -------- --------
activities (546.7) (186.0)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 1,167.0 173.8
Withdrawals from contractholder deposit funds (456.5) (501.2)
Change in short-term debt 25.5 150.8
Change in long-term debt (2.6) 0.0
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
Net proceeds from issuance of common stock 11.2 2.6
Dividends paid to shareholders (9.9) (8.1)
Treasury stock purchased at cost (8.0) 0.0
Net cash provided by financing -------- --------
activities 726.7 114.2
-------- --------
Net change in cash and cash equivalents 174.1 (17.9)
Net change in cash held in the Closed Block 21.1 2.7
Cash and cash equivalents, beginning of period 215.1 178.5
-------- --------
Cash and cash equivalents, end of period $ 410.3 $ 163.3
======== ========
</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 September 30,
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 quarter ended and nine months ended September 30, 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 83.2%-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 quarter and nine
months ended September 30, 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 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (Statement No. 133), which
establishes accounting and reporting standards for derivative instruments.
Statement No. 133 requires that an entity recognize all derivatives as either
assets or liabilities at fair value in the statement of financial position,
and establishes special accounting for the following three types of hedges:
fair value hedges, cash flow hedges, and hedges of foreign currency exposures
of net investments in foreign operations. This statement is effective for
fiscal years beginning after June 15, 1999. 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 American Institute of Certified Public Accountants
("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. In the second
quarter, the Company adopted SoP No. 98-1 effective January 1, 1998, resulting
in an increase in pre-tax income of $6.2 million. The adoption of SoP No.
98-1 did not have a material effect on the results of operations or financial
position for the three months ended March 31, 1998. Through the nine months
ended September 30, 1998, the adoption of this SoP resulted in a $7.5 million
increase to pre-tax income.
In December 1997, the 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.
Page 8
<PAGE>
In June 1997, the 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 adopted Statement No. 130 for the first quarter of 1998, which
resulted 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 adopted Statement No. 131 for
the first quarter of 1998, which resulted in certain segment re-definitions
which have no impact on the consolidated results of operations. (See Note 7.)
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.
Page 9
<PAGE>
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)
Nine Months Ended
September 30,
(In millions) 1997
<S> <C>
Revenue $ 2,521.6
=========
Net realized capital gains included in revenue $ 43.2
=========
Income before taxes and minority interest $ 196.4
Income taxes (45.1)
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary
trust holding solely junior subordinated
debentures of the Company (12.0)
Equity in earnings (10.9)
---------
Net income $ 128.4
=========
Net income per common share (basic and diluted) $ 2.14
=========
Weighted average shares outstanding( diluted) 60.0
=========
Weighted average shares outstanding(basic) 59.9
=========
</TABLE>
4. Significant Transactions
On October 27, 1998, the Company announced that it, or one of its
subsidiaries, shortly will commence a cash tender offer to acquire the
outstanding shares of Citizens Corporation common stock that AFC or its
subsidiaries do not already own at a price of $29.00 per share. On November
2, 1998, AFC commenced the tender offer which, unless extended, will expire
on December 2, 1998. Based on the number of shares of Citizens Corporation
common stock held by unaffiliated stockholders, the transaction is valued at
$171.0 million. Citizens Corporation has established a special committee of
the Board of Directors, consisting of directors unaffiliated with AFC, to
study the offer and make a recommendation to Citizens Corporation
stockholders.
On October 27, 1998, the Board of Directors of AFC authorized the repurchase
of up to $200.0 million of its issued common stock.
Effective July 1, 1998, the Company entered into a reinsurance agreement with
a highly rated reinsurer that cedes current and future underwriting losses,
including unfavorable development of prior year reserves, up to a $40.0
million maximum, relating to the Company's accident and health assumed
reinsurance pool business. These pools consist primarily of the Corporate Risk
Management segment's assumed stop loss business, small group managed care
pools, long-term disability and long-term care pools, student accident and
special risk business. The agreement is consistent with management's decision
to exit this line of business, which the Company expects to run-off over the
next three years. As a result of this transaction, the Company recognized a
$25.3 million pre-tax loss in the third quarter of 1998.
On January 1, 1998, substantially all of the Company's defined benefit,
defined contribution 401(K) and post retirement 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 September 30, 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. Significant items,
such as the loss from exiting reinsurance pools, sales practice litigation
expenses and the loss from the cession of disability income business, are
reflected in Federal income tax expense as discreet items, based on the
statutory tax rate.
Page 10
<PAGE>
6. Closed Block
Included in other income in the Consolidated Statements of Income is a net
pre-tax contribution from the Closed Block of $0.1 million and $6.1 million
for the third quarter and nine months ended September 30, 1998, respectively,
compared to $2.3 million and $8.3 million, for the third quarter and nine
months ended September 30, 1997, respectively. Summarized financial
information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
(In millions) 1998 1997
<S> <C> <C>
ASSETS
Fixed maturities-at fair value
(amortized cost of $396.7 and $400.1) $417.4 $412.9
Mortgage loans 137.1 112.0
Policy loans 212.5 218.8
Cash and cash equivalents 4.0 25.1
Accrued investment income 14.8 14.1
Deferred policy acquisition costs 15.9 18.2
Other assets 2.1 5.6
------- -------
Total assets $803.8 $806.7
======= =======
LIABILITIES
Policy liabilities and accruals $865.6 $875.1
Other liabilities 12.8 10.4
------- -------
Total liabilities $878.4 $885.5
======= =======
</TABLE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 9.1 $ 9.3 $46.3 $48.3
Net investment income 13.5 13.1 39.9 39.8
Net realized investment
gains(losses) (2.0) 0.1 (0.4) 1.1
------ ------ ------ ------
Total revenues 20.6 22.5 85.8 89.2
------ ------ ------ ------
BENEFITS AND EXPENSES
Policy benefits 19.5 19.3 76.9 78.4
Policy acquisition expenses 0.9 0.7 2.2 2.1
Other operating expenses 0.1 0.2 0.6 0.4
------ ------ ------ ------
Total benefits and
expenses 20.5 20.2 79.7 80.9
------ ------ ------ ------
Contribution from the
Closed Block $ 0.1 $ 2.3 $ 6.1 $ 8.3
====== ====== ====== ======
</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 11
<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.
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.
Page 12
<PAGE>
Summarized below is financial information with respect to business segments
for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment revenues:
Risk Management
Property and Casualty $545.0 $556.6 $1,654.4 $1,645.6
Corporate Risk
Management Services 102.3 103.2 310.7 301.9
------- ------- --------- ---------
Subtotal 647.3 659.8 1,965.1 1,947.5
Retirement and Asset
Accumulation
Allmerica Financial
Services 174.4 177.1 538.0 543.3
Allmerica Asset
Management 32.8 22.3 86.6 69.8
------- ------- --------- ---------
Subtotal 207.2 199.4 624.6 613.1
Corporate 3.8 4.5 9.9 14.3
Intersegment revenues (1.5) (2.6) (5.8) (8.7)
------- ------- --------- ---------
Total segment revenues
including Closed
Block 856.8 861.1 2,593.8 2,566.2
Adjustment for
Closed Block (22.7) (20.1) (80.1) (79.8)
Net realized gains
(losses) 9.5 14.7 50.5 56.7
------- ------- --------- ---------
Total revenues $843.6 $855.7 $2,564.2 $2,543.1
======= ======= ========= =========
Segment income (loss)
beforeincome taxes and
minority interest:
Risk Management
Property and Casualty $23.5 $35.9 $98.0 $119.0
Corporate Risk
Management Services 0.3 9.0 6.8 18.9
------- ------- --------- ---------
Subtotal 23.8 44.9 104.8 137.9
Retirement and Asset
Accumulation
Allmerica Financial
Services 38.6 37.8 123.9 99.6
Allmerica Asset
Management 6.9 5.2 17.0 13.8
------- ------- --------- ---------
Subtotal 45.5 43.0 140.9 113.4
Corporate (9.3) (11.8) (35.6) (30.8)
------- ------- --------- ---------
Segment income before
income taxes and
minority interest 60.0 76.1 210.1 220.5
Adjustments to segment
income:
Net realized investment
gains, net of
amortization 4.8 17.1 39.4 59.3
Loss on exiting
reinsurance pools (25.3) 0.0 (25.3) 0.0
Sales practice
litigation expense (31.0) 0.0 (31.0) 0.0
Loss on cession of
disability income
business 0.0 0.0 0.0 (53.9)
Other items 0.0 (3.1) (0.9) (5.6)
------- ------- --------- ---------
Income before taxes and
minority interest $ 8.5 $90.1 $192.3 $220.3
======= ======= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Identifiable Assets Deferred Acquisition Costs
(Unaudited) (Unaudited)
September 30, December 31, September 30, December 31,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Risk Management
Property and Casualty $ 5,591.5 $ 5,650.4 $ 167.7 $ 167.2
Corporate Risk
Management Services 667.1 621.9 2.7 2.9
--------- --------- ------- -------
Subtotal 6,258.6 6,272.3 170.4 170.1
Retirement and Asset
Accumulation
Allmerica Financial
Services 16,979.6 15,159.2 937.2 794.5
Allmerica Asset
Management 1,764.4 1,035.1 0.7 0.9
---------- ---------- -------- -------
Subtotal 18,744.0 16,194.3 937.9 795.4
Corporate 230.9 82.4 0.0 0.0
---------- ---------- -------- -------
Total $25,233.5 $22,549.0 $1,108.3 $965.5
========== ========== ======== =======
</TABLE>
Page 13
<PAGE>
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 60.0
million and 52.9 million for the nine months ended September 30, 1998 and
1997, respectively and 60.0 million and 58.2 million for the quarters ended
September 30, 1998 and 1997, respectively. The weighted average shares
outstanding used in the calculation of diluted earnings per share include the
0.5 million and 0.1 million share effect of dilutive employee stock options
and grants for the nine months ended September 30, 1998 and 1997,
respectively, and a 0.6 million and 0.2 million share effect of dilutive
employee stock options and grants for the quarter ended September 30, 1998
and 1997, respectively. This difference causes a $0.02 per share difference
between basic and diluted earnings per share for the quarter and nine months
ended September 30, 1998.
9. Commitments and Contingencies
Litigation
In July 1997, a lawsuit on behalf of a punitive class 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
filed a substantially similar action in Federal District Court in Worcester,
Massachusetts. The Company and the plaintiffs have entered into a settlement
agreement which they will present to the court for approval. Although the
Company believes it has meritorious defenses to plaintiffs' claims, it
concluded that this settlement was best for the Company. Accordingly, AFC
recognized a $31.0 million pre-tax expense during the third quarter of 1998
related to this litigation. Although the Company believes it has established
an appropriate reserve, this reserve may be revised based on changes in the
Company's estimate of the ultimate cost of the settlement.
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 14
<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 holding company), The Hanover Insurance Company
("Hanover", a wholly-owned subsidiary of Allmerica P&C), Citizens Corporation
("Citizens", an 83.2%-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 $0.1 million and $6.1 million for the third quarter and nine
months ended September 30, 1998, respectively, compared to $2.3 million and
$8.3 million for the third quarter and nine months ended September 30, 1997,
respectively.
Page 15
<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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
REVENUES
Premiums $579.5 $594.9 $1,776.3 $1,775.0
Universal life and investment
product policy fees 75.0 1.4 217.2 174.8
Net investment income 166.5 177.6 502.4 538.3
Net realized investment gains 7.5 14.8 50.1 57.8
Other income 35.6 27.2 97.9 78.1
------- ------- --------- ---------
Total revenues 864.1 875.9 2,643.9 2,624.0
------- ------- --------- ---------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims,
losses and loss adjustment
expenses 543.6 534.4 1,626.4 1,594.5
Policy acquisition expenses 112.5 114.9 346.2 346.8
Loss from exiting reinsurance
pools 31.0 0.0 31.0 0.0
Sales practice litigation
expenses 25.3 0.0 25.3 0.0
Loss from cession of disability
income business 0.0 0.0 0.0 53.9
Other operating expenses 143.2 136.5 422.7 408.5
------- ------- --------- ---------
Total benefits, losses and
expenses 855.6 785.8 2,451.6 2,403.7
------- ------- --------- ---------
Income before federal income
taxes 8.5 90.1 192.3 220.3
------- ------- --------- ---------
Federal income tax expense
(benefit):
Current 13.1 33.8 57.0 66.2
Deferred (22.0) (9.8) (23.3) (13.2)
------- ------- --------- ---------
Total federal income tax
expense (8.9) 24.0 33.7 53.0
------- ------- --------- ---------
Income before minority interest 17.4 66.1 158.6 167.3
Minority interest:
Distributions on mandatorily
redeemable preferred
securities of a subsidiary
trust holding solely junior
subordinated debentures of
the Company (4.0) (4.1) (12.0) (10.5)
Equity in earnings (5.2) (1.3) (11.3) (42.5)
------- ------- --------- ---------
(9.2) (5.4) (23.3) (53.0)
------- ------- --------- ---------
Net income $ 8.2 $ 60.7 $ 135.3 $ 114.3
======= ======= ========= =========
</TABLE>
Page 16
<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 17
<PAGE>
Results of Operations
Consolidated Overview
The Company's consolidated net income decreased $52.5 million, or 86.5%, to
$8.2 million, and increased $21.0 million, or 18.4%, to $135.3 million, for
the third quarter and nine months ended September 30, 1998, respectively,
compared to the same periods 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, the cumulative effect of accounting
changes, and certain other items. While these items may be significant
components in understanding and assessing the Company's financial
performance, management believes that the presentation of adjusted net 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, 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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment income (loss)
before income taxes and
minority interest:
Risk Management
Property and Casualty $23.5 $35.9 $98.0 $119.0
Corporate Risk
Management Services 0.3 9.0 6.8 18.9
------ ------ ------- -------
Subtotal 23.8 44.9 104.8 137.9
Retirement and Asset
Accumulation
Allmerica Financial
Services 38.6 37.8 123.9 99.6
Allmerica Asset
Management 6.9 5.2 17.0 13.8
------ ------ ------- -------
Subtotal 45.5 43.0 140.9 113.4
Corporate (9.3) (11.8) (35.6) (30.8)
------ ------ ------- -------
Segment income before
income taxes and
minority interest 60.0 76.1 210.1 220.5
------ ------ ------- -------
Federal income taxes on
segment income (10.7) (19.1) (41.4) (53.1)
Minority interest:
Distributions on Capital
Securities (4.0) (4.1) (12.0) (10.5)
Equity in earnings (1.9) (0.5) (7.4) (31.6)
------ ------ ------- -------
Adjusted net income 43.4 52.4 149.3 125.3
Adjustments (net of taxes,
minority interest and
amortization,as applicable):
Net realized investment
gains 1.4 10.1 23.2 26.8
Sales practice litigation
expense (20.2) 0.0 (20.2) 0.0
Loss from exiting
reinsurance pools (16.4) 0.0 (16.4) 0.0
Loss on cession of
disability income
business 0.0 0.0 0.0 (35.0)
Other items 0.0 (1.8) (0.6) (2.8)
------ ------ ------- -------
Net income $ 8.2 $60.7 $135.3 $114.3
====== ====== ======= =======
</TABLE>
Page 18
<PAGE>
Quarter Ended September 30, 1998 Compared to Quarter Ended September 30, 1997
The Company's segment income before taxes and minority interest declined $16.1
million, or 21.2%, to $60.0 million in the third quarter of 1998, compared to
the same period in 1997. This decrease is primarily attributable to reduced
income of $21.1 million from the Risk Management segment, partially offset by
increased income of $2.5 million from the Retirement and Asset Accumulation
segment and decreased losses of $2.5 million in the Corporate segment.
Property and Casualty segment income decreased $12.4 million primarily
attributable to a $19.3 million increase in catastrophe losses, as well as a
decrease in net premiums earned and net investment income. These decreases
were partially offset by a $9.4 million increase in favorable development on
prior year reserves and a decrease in policy acquisition and other operating
expenses. The decrease in Corporate Risk Management segment income of $8.7
million is due to unfavorable loss experience in the risk sharing and long-
term disability product lines totaling approximately $7.3 million, as well as
increased expenses related to claims processing costs of approximately $3.2
million. Allmerica Asset Management segment income increased $1.7 million for
the third quarter of 1998 primarily due to the receipt of a $2.6 million
equity participation payment from a mortgage loan, partially offset by a
decline in interest margins on GICs. The increase of $0.8 million in the
Allmerica Financial Services segment is primarily attributable to higher
asset based fee income driven by growth in the variable annuity and variable
universal life product lines. This increase was largely offset by losses on
hedge fund partnership investments during the quarter. The Corporate
segment's decreased net loss primarily reflects the absence of expenses
related to the Company's merger with Allmerica P&C on July 16, 1997, as well
as the Company's exit from certain non-insurance business during 1998.
The effective tax rate for segment income was 17.8% for the third quarter of
1998 compared to 25.1% for the third quarter of 1997. The decrease in tax
rates was principally driven by the reduction in underwriting income from the
Property and Casualty segment.
Net realized gains on investments were $1.4 million in the third quarter of
1998, resulting primarily from after-tax net realized gains on equity
securities of $32.4 million, partially offset by after-tax net realized
losses of $16.9 million and $12.0 million on fixed maturities and hedge fund
partnerships, respectively. During the third quarter of 1997, net realized
gains on investments of $10.1 million resulted primarily from sales of equity
securities in the Property and Casualty segment.
In July 1997, a lawsuit on behalf of a punitive class 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
filed a substantially similar action in Federal District Court in Worcester,
Massachusetts. The Company and the plaintiffs have entered into a settlement
agreement which they will present to the court for approval. Although the
Company believes it has meritorious defenses to plaintiffs' claims, it
concluded that this settlement was best for the Company. Accordingly, AFC
recognized a $20.2 million expense, net of taxes, during the third quarter
of 1998 related to this litigation. Although the Company believes it has
established an appropriate reserve, this reserve may be revised based on
changes in the Company's estimate of the ultimate cost of the settlement.
Effective July 1, 1998, the Company entered into a reinsurance agreement
with a highly rated reinsurer that cedes current and future underwriting
losses, including unfavorable development of prior year reserves, up to a
$40.0 million maximum, relating to the Company's accident and health assumed
reinsurance pool business. These pools consist primarily of the Corporate
Risk Management segment's assumed stop loss business, small group managed
care pools, long-term disability and long-term care pools, student accident
and special risk business. The agreement is consistent with management's
decision to exit this line of business, which the Company expects to run-off
over the next three years. As a result of this transaction, the Company
recognized a $16.4 million loss, net of taxes, in the third quarter of 1998.
Minority interest on segment income increased in the current period as compared
to the prior year due primarily to the aforementioned merger with Allmerica
P&C. Prior to the acquisition, minority interest reflected 40.5% of the results
of operations from this subsidiary.
Page 19
<PAGE>
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September
30, 1997
The Company's segment income before taxes and minority interest decreased
$10.4 million, or 4.7%, to $210.1 million during the first nine months of
1998. This decrease is primarily attributable to reduced income of $33.1
million and increased losses of $4.8 million from the Risk Management and
Corporate segments, respectively, partially offset by increased income of
$27.5 million from the Retirement and Asset Accumulation segment. Property
and Casualty segment income declined $21.0 million for the first nine months
of 1998 primarily attributable to an increase in catastrophe losses of $56.5
million, partially offset by a $16.5 million increase in favorable
development on prior year reserves and lower policy acquisition and other
underwriting expenses. The $12.1 million decrease in Corporate Risk
Management segment income was primarily due to unfavorable loss experience
in the risk-sharing and long-term disability lines of business and increased
operating expenses. The increase of $24.3 million in the Allmerica Financial
Services segment was primarily attributable to growth from new deposits and
market appreciation in the variable annuity and variable universal life
assets resulting in increased fee revenue. The increase in segment income of
$3.2 million in the Allmerica Asset Management segment resulted primarily
from the aforementioned $2.6 million equity participation payment from a
mortgage loan. The operating loss in the Corporate segment increased $4.8
million, primarily due to the absence of $8.1 million of net investment
income earned on the proceeds from the prior year issuance of Capital
Securities, and to increased overhead costs. This was partially offset by
additional net investment income generated by transfers of investments from
the Property and Casualty segment.
The effective tax rate for segment income was 19.7% for the first nine months
of 1998 compared to 24.1% for the same time period in 1997. The decrease in
tax rates was principally driven by the reduction in underwriting income
from the Property and Casualty segment.
Net realized gains on investments were $23.2 million during the first nine
months of 1998, primarily due to after-tax net realized gains from sales of
appreciated equity securities of $45.4 million, partially offset by $8.6
million of after-tax realized losses from sales of fixed maturities. During
the nine months of 1997, net realized gains on investments of $26.8 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 an agreement in principal to transfer the business.
Minority interest on segment 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.
Page 20
<PAGE>
Risk Management
Property and Casualty
The following table summarizes the results of operations for the Property and
Casualty segment.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment revenues
Net premiums earned $487.2 $493.4 $1,476.5 $1,454.4
Net investment income 56.1 62.1 170.8 187.8
Other income 1.7 1.1 7.1 3.4
------ ------ -------- --------
Total segment revenues 545.0 556.6 1,654.4 1,645.6
Losses and loss adjustment
expenses <F1> 385.5 373.7 1,135.5 1,084.1
Policy acquisition and other
operating expenses 136.0 147.0 420.9 442.5
------ ------ -------- --------
Segment income before taxes and
minority interest $ 23.5 $ 35.9 $ 98.0 $ 119.0
====== ====== ======== ========
<FN>
<FN1> Includes policyholders' dividends of $2.5 million, $2.8 million, $8.1
million and $6.9 million for the quarters ended September 30, 1998 and
1997 and the nine months ended September 30, 1998 and 1997, respectively.
</FN>
</TABLE>
Quarter Ended September 30, 1998 Compared to Quarter Ended September 30, 1997
Property and Casualty segment's income before taxes and minority interest
decreased $12.4 million, to $23.5 million, in the third quarter of 1998,
compared to $35.9 million, for the same period in 1997. This decrease is
primarily attributable to a $19.3 million increase in catastrophe losses,
to $28.5 million for the third quarter of 1998, compared to $9.2 million for
the comparable quarter of 1997, as well as decreases in net premiums earned
and net investment income. These decreases were partially offset by a $9.4
million increase in favorable development on prior year reserves and a
decrease in policy acquisition and other operating expenses. Net investment
income before taxes decreased $6.0 million, or 9.7%, to $56.1 million during
the third quarter of 1998, compared to $62.1 million in the comparable
quarter of 1997.The decrease is primarily the result of a decrease in
average invested assets at Hanover and a $2.1 million decrease in limited
partnership income at both Hanover and Citizens. The average pre-tax yield
on debt securities was 6.6% and 6.7% for the third quarter of 1998, and
1997, respectively.
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 62.2% and 61.7% of total net
premiums earned in the third quarter of 1998 and 1997, respectively.
<TABLE>
<CAPTION>
Total
(Unaudited) Property
Quarter Ended September 30, Hanover Citizens & Casualty
(In millions) 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $152.9 $158.8 $150.2 $145.7 $303.1 $304.5
Losses and loss adjustment
expenses 114.8 128.6 124.3 114.1 239.1 242.7
Policy acquisition and
other underwriting
expenses 46.5 52.8 35.9 37.0 82.4 89.8
------- ------- ------- ------- ------- -------
Underwriting loss $ (8.4) $(22.6) $(10.0) $ (5.4) $(18.4) $(28.0)
======= ======= ======= ======= ======= =======
</TABLE>
Page 21
<PAGE>
Revenues
Personal lines' net premiums earned decreased $1.4 million, or 0.5%, to $303.1
million during the third quarter of 1998, compared to $304.5 million in the
third quarter of 1997. Hanover's personal lines' net premiums earned decreased
$5.9 million, or 3.7%, to $152.9 million during the third quarter of 1998. This
decrease is primarily due to decreases in policies in force, since
September 30, 1997, of 4.5% and 3.9%, in the personal automobile and
homeowner's lines, respectively. This decline is associated with the
Company's decision last year to exit certain Western and Southern states. A
mandated 4.0% decrease in Massachusetts' personal automobile rates which
became effective January 1, 1998, also contributed to the decrease in net
premiums earned.
Citizens' personal lines' net premiums earned increased $4.5 million, or
3.1%, to $150.2 million for the quarter ended September 30, 1998, from $145.7
million for the quarter ended September 30, 1997. This increase is primarily
attributable to a twelve month average rate increase of 15.9% in the
homeowner's line. This is partially offset by a decrease in policies in force
since September 30, 1997, of 2.5% and 1.8% in the personal automobile and
homeowner's lines, respectively.
While management has taken steps to increase penetration in the affinity
groups and has initiated other marketing programs, the Company believes that
heightened competition may continue to impact premium growth in the personal
segment.
Underwriting results
The personal lines' underwriting results in the third quarter of 1998
improved $9.6 million, to a loss of $18.4 million, compared to a loss of
$28.0 million for the same period in 1997. Hanover's underwriting results
improved $14.2 million, to a loss of $8.4 million. Citizens' underwriting
results deteriorated $4.6 million, to a loss of $10.0 million.
The improvement in Hanover's underwriting results is primarily attributable
to favorable non-catastrophe current year claims activity in the personal
automobile line and an aggregate $2.0 million increase in favorable
development on prior year reserves in the personal automobile and
homeowner's lines. This was partially offset by a $6.1 million increase in
catastrophe losses, primarily in the homeowner's line.
The deterioration in Citizens' underwriting results is attributed to an
increase in losses and loss adjustment expense (LAE) of $10.2 million, or
8.9%, to $124.3 million. This increase is primarily the result of a $7.4
million increase in catastrophe losses, to $14.3 million for the quarter
ended September 30, 1998, from $6.9 million for the same period ended 1997,
primarily in the homeowner's line.
Policy acquisition and other underwriting expenses in the personal lines
decreased $7.4 million, or 8.2%, to $82.4 million in the third quarter of
1998, primarily reflecting reductions in employee related expenses at both
Hanover and Citizens.
Commercial Lines of Business
The commercial lines of business represented 37.8% and 38.3% of total net
premiums earned in the third quarter of 1998 and 1997, respectively.
<TABLE>
<CAPTION>
Total
(Unaudited) Property
Quarter Ended September 30, Hanover Citizens & Casualty
(In millions) 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $ 113.5 $120.0 $70.6 $68.9 $184.1 $188.9
Losses and loss adjustment
expenses 87.2 70.7 56.7 57.5 143.9 128.2
Policy acquisition and
other underwriting expenses 37.5 39.4 16.6 17.7 54.1 57.1
Policyholders' dividends 1.6 1.5 0.9 1.3 2.5 2.8
------ ----- ----- ----- ----- -----
Underwriting (loss) profit $ (12.8) $ 8.4 $(3.6) $(7.6)$(16.4) $ 0.8
====== ===== ===== ===== ===== =====
</TABLE>
Page 22
<PAGE>
Revenues
Commercial lines' net premiums earned decreased $4.8 million, or 2.5%, to
$184.1 million for the quarter ended September 30, 1998, from $188.9 for
the quarter ended September 30, 1997. Hanover's commercial lines' net
premiums earned decreased $6.5 million, or 5.4%, to $113.5 million. This
decrease is primarily related to the Company's disposal of the majority of
its assumed reinsurance business, which contributed $0.9 million in net
premiums earned for the quarter ended September 30, 1998, compared to $9.1
million for the same period of 1997. Also contributing to this decrease is
a twelve month average rate decrease of 12.0% in the workers' compensation
line. These decreases were partially offset by increases in policies in
force since September 30,1997, in the workers' compensation and commercial
automobile lines of 10.9% and 9.4%, respectively.
Citizens' commercial lines' net premiums earned increased $1.7 million, or
2.5%, to $70.6 million, in the third quarter of 1998. This increase
primarily reflects growth in policies in force of 11.9% in the commercial
multiple peril line since September 30, 1997, and twelve month average rate
increases of 8.0% and 6.2% in the commercial multiple peril and commercial
automobile lines, respectively. These increases are partially offset by a
13.6% decrease in policies in force and a twelve month average rate decrease
of 6.6% in the workers' compensation line. Management believes competitive
conditions in the workers' compensation line may impact future growth in net
premiums earned.
Underwriting results
The commercial lines' underwriting results in the third quarter of 1998
deteriorated $17.2 million, to a loss of $16.4 million compared to a gain
of $0.8 million for the same period in 1997. Hanover's underwriting results
declined $21.2 million, to a loss of $12.8 million. Citizens' underwriting
results improved $4.0 million, to a loss of $3.6 million.
The deterioration in Hanover's underwriting results reflects a $16.5
million increase in losses and LAE, attributed to unfavorable current year
claims activity in the workers' compensation and commercial multiple peril
lines, as well as a $3.7 million increase in catastrophe losses.
The improvement in Citizens' underwriting results reflects an aggregate
$6.1 million increase in favorable development on prior year reserves,
partially offset by a $2.1 million increase in catastrophe losses,
primarily in the commercial multiple peril line.
Policy acquisition and other underwriting expenses in the commercial lines
decreased $3.0 million, or 5.3%, to $54.1 million in the third quarter of
1998, primarily reflecting reductions in employee related expenses at both
Hanover and Citizens.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Property and Casualty's segment income before taxes and minority interest
decreased $21.0 million, or 17.6%, to $98.0 million for the nine months
ended September 30 1998, compared to $119.0 million, for the same period
in 1997. This decrease is primarily attributable to an increase in
catastrophe losses of $56.5 million, partially offset by a $16.5 million
increase in favorable development on prior year reserves and lower policy
acquisition and other underwriting expenses. Net investment income before
taxes decreased $17.0 million, or 9.1%, to $170.8 million during the first
nine months of 1998, compared to $187.8 million in the comparable period
of 1997. The decrease is primarily the result of a decrease in Hanover's
average invested assets and a $6.2 decrease in limited partnership income
at both Hanover and Citizens. The average pre-tax yield on debt securities
was 6.7% and 6.8% for the nine months ended September 30,1998 and 1997,
respectively.
Page 23
<PAGE>
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 62.0% and 61.8% of total net
premiums earned in the nine months ended September 30, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
Total
(Unaudited) Property
Nine Months Ended September 30, Hanover Citizens & Casualty
(In millions) 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $ 466.3 $466.7 $448.6 $432.7 $914.9 $899.4
Losses and loss adjustment
expenses 359.2 362.1 349.0 336.0 708.2 698.1
Policy acquisition and
other underwriting expenses 136.4 147.9 112.2 112.6 248.6 260.5
------ ----- ------ ----- ------ ------
Underwriting loss $ (29.3) $(43.3) $(12.6) $(15.9) $(41.9) $(59.2)
====== ===== ====== ===== ====== ======
</TABLE>
Revenues
Personal lines' net premiums earned increased $15.5 million, or 1.7%, to
$914.9 million during the nine months ended September 30, 1998, compared to
$899.4 million in the same period of 1997. Hanover's personal lines' net
premiums earned decreased $0.4 million, or 0.1%, to $466.3 million during
the nine months ended September 30, 1998. This decrease is primarily due to
decreases in policies in force, since September 30, 1997, of 4.5% and 3.9%,
in the personal automobile and homeowner's lines, respectively. This
decline is associated with the Company's decision last year to exit certain
Western and Southern states. A mandated 4.0% decrease in Massachusetts'
personal automobile rates which became effective January 1, 1998, also
contributed to the decrease in net premiums earned.
Citizens' personal lines' net premiums earned increased $15.9 million, or
3.7%, to $448.6 million for the nine months ended September 30, 1998, from
$432.7 million for the nine months ended September 30, 1997. This increase
is primarily attributable to a twelve month average rate increase of 15.9%
in the homeowner's line, partially offset by decreases in policies in force
since September 30, 1997, of 2.5% and 1.8% in the personal automobile and
homeowner's lines, respectively.
Underwriting results
The personal lines' underwriting results for the nine months ended September
30, 1998, improved $17.3 million, to a loss of $41.9 million, compared to a
loss of $59.2 million for the same period in 1997. Hanover's underwriting
results improved $14.0 million, to a loss of $29.3 million. Citizens'
underwriting results improved $3.3 million, to a loss of $12.6 million.
The improvement in Hanover's underwriting results is primarily attributable
to an $11.1 million total increase in favorable development on prior year
reserves in the personal automobile and homeowner's lines, as well as
favorable current year claims activity in the personal automobile line.
This was partially offset by a $16.4 million increase in catastrophe
losses, primarily in the homeowner's line.
The improvement in Citizens' underwriting results is attributable to
improved current year claims activity in both the personal automobile
and homeowner's lines, and a $3.2 million increase in favorable
development on prior year reserves. This is significantly offset by an
increase in catastrophe losses of $18.1 million over the prior year,
primarily in the homeowner's line.
Policy acquisition and other underwriting expenses in the personal lines
decreased $11.9 million, or 4.6%, to $248.6 million in the first nine
months of 1998, primarily reflecting reductions in employee related
expenses at both Hanover and Citizens.
Page 24
<PAGE>
Commercial Lines of Business
The commercial lines of business represented 38.0% and 38.2% of total net
premiums earned in the nine months ended September 30, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
Total
(Unaudited) Property
Nine Months Ended September 30, Hanover Citizens & Casualty
(In millions) 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $ 351.0 $353.1 $210.6 $201.9 $561.6 $555.0
Losses and loss adjustment
expenses 250.1 227.3 169.1 151.8 419.2 379.1
Policy acquisition and
other underwriting expenses 120.5 129.9 52.0 52.5 172.5 182.4
Policyholders' dividends 4.4 2.2 3.7 4.7 8.1 6.9
------ ----- ------ ----- ------ ------
Underwriting loss $ (24.0) $ (6.3) $(14.2) $ (7.1) $(38.2) $(13.4)
====== ====== ====== ====== ====== ======
</TABLE>
Revenues
Commercial lines' net premiums earned increased $6.6 million, or 1.2%, to
$561.6 million in the nine months ended September 30, 1998, from $555.0
million in the same period of 1997. Hanover's commercial lines' net
premiums earned decreased $2.1 million, or 0.6%, to $351.0 million. This
decrease is attributable to the effect of the Company's disposal of the
majority of its assumed reinsurance business, which contributed $7.8
million and $24.9 million in net premium earned during the nine months
ended September 30, 1998, and 1997, respectively. This is partially
offset by increases in policies in force in the workers' compensation and
commercial automobile lines of 10.9% and 9.4%, respectively since
September 30, 1997.
Citizens' commercial lines' net premiums earned increased $8.7 million, or
4.3%, to $210.6 million, for the nine months ended September 30, 1998, from
$201.9 million, for the nine months ended September 30, 1997. The increase
in net premiums earned primarily reflects growth in policies in force of
11.9% in the commercial multiple peril line since September 30, 1997, and
twelve month average rate increases of 8.0% and 6.2% in the commercial
multiple peril and commercial automobile lines, respectively. These
increases are partially offset by a 13.6% decrease in policies in force
and a twelve month average rate decrease of 6.6% in the workers'
compensation line.
Underwriting results
The commercial lines' underwriting loss for the nine months ended September
30, 1998, increased $24.8 million, to a loss of $38.2 million, compared to
a loss of $13.4 million for the same period in 1997. Hanover's underwriting
results declined $17.7 million, to a loss of $24.0 million. Citizens'
underwriting results deteriorated $7.1 million, to an underwriting loss of
$14.2 million.
The deterioration in Hanover's underwriting results is attributable to an
increase in catastrophe losses of $10.5 million, primarily in the
commercial multiple peril line, as well as unfavorable current year claims
activity in the workers' compensation and commercial multiple peril lines.
This is partially offset by a $4.9 million increase in favorable
development on prior year reserves.
The deterioration in Citizens' underwriting results is primarily
attributable to an $11.5 million increase in catastrophe losses, primarily
in the commercial multiple peril line, and unfavorable current year claims
activity in the workers' compensation line. These increases are partially
offset by favorable current year claims activity in the commercial multiple
peril and commercial automobile lines.
Policy acquisition and other underwriting expenses in the commercial lines
decreased $9.9 million, or 5.4%, to $172.5 million in the nine months ended
September 30, 1998, primarily reflecting reductions in employee related
expenses.
Page 25
<PAGE>
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, where the technological, judicial, and
political climates involving these types of claims are changing.
The Property & 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)
Nine Months Ended
September 30,
(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 1,220.3 1,156.5
Decrease in provision for insured
events of prior years (92.9) (76.4)
-------- --------
Total incurred losses and LAE 1,127.4 1,080.1
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 551.7 536.9
Losses and LAE attributable to
insured events of prior years 587.9 592.8
------- --------
Total payments 1,139.7 1,129.7
Change in reinsurance recoverable on
unpaid losses (16.8) (54.1)
Other 0.0 (7.4)
-------- --------
Reserve for losses and LAE, end of
period $2,586.4 $2,663.0
======== ========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $92.9 million and $76.4 million
for the nine months ended September 30, 1998, and 1997, respectively.
Hanover's favorable development increased $16.4 million to $55.0 million
during 1998, from $38.6 million in 1997. This increase is primarily
attributable to a reduction in LAE, in most major lines, due to claims
process improvement initiatives. Favorable reserve development at Citizens
increased $.1 million, to $37.9 million, from $37.8 million, for the nine
months ended September 30, 1998 and September 30, 1997, respectively. The
overall favorable reserve development in both years primarily reflects
the initiatives taken by the Company to manage claims adjusting costs and
a modest shift over the past few years of the workers' compensation
business to Western and Northern Michigan which have demonstrated more
favorable loss experience than Eastern Michigan.
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.
Page 26
<PAGE>
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.
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. Effective June 1, 1998, the Company
purchased an additional treaty for losses in excess of $180.0 million and
up to $230.0 million, of which the Company retains 10% of the loss. Amounts
in excess of $230.0 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 million 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 27
<PAGE 27>
INVESTMENT RESULTS
Net investment income before taxes decreased $6.0 million, or 9.7%, to
$56.1 million during the third quarter of 1998, compared to $62.1 million
in the comparable quarter of 1997. The decrease is primarily the result of
a decrease in Hanover's average invested assets as a result of asset
transfers of $117.1 million and $53.9 million to the Corporate Segment
in April 1998 and December 1997, respectively. Also contributing to this
decrease is a $2.1 million decrease in limited partnership income to a
loss of $0.9 million in 1998, from income of $1.2 million in 1997. The
limited partnerships pursue investment opportunities primarily through
global fixed-income trading strategies. The average pre-tax yield on debt
securities was 6.6% and 6.7% for the third quarter of 1998 and 1997,
respectively.
Net investment income before taxes decreased $17.0 million, or 9.1%, to
$170.8 million during the nine months ended September 30, 1998, compared
to $187.8 million in the comparable period of 1997. The decrease is
primarily the result of the aforementioned decrease in Hanover's average
invested assets and a $6.2 million decrease in limited partnership income
to a loss of $0.9 million in 1997, from income of $5.3 million in 1997.
The average pre-tax yield on debt securities was 6.7% and 6.8% for the
nine months ended September 30, 1998 and 1997, respectively.
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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Premiums and premium
equivalents
Premiums $ 82.8 $ 84.9 $252.1 $247.9
Premium equivalents 173.1 150.3 504.9 448.5
------ ------ ------ ------
Total premiums and premium
equivalents $255.9 $235.2 $757.0 $696.4
====== ====== ====== ======
Segment revenues
Premiums $ 82.8 $ 84.9 $252.1 $247.9
Net investment income 4.4 6.0 15.8 17.5
Other income 15.1 12.3 42.8 36.5
------ ------ ------ ------
Total segment revenues 102.3 103.2 310.7 301.9
Policy benefits, claims and
losses 60.7 59.3 186.2 178.1
Policy acquisition expenses 0.4 0.8 2.4 2.5
Other operating expenses 40.9 34.1 115.3 102.4
------ ------ ------ ------
Segment income before taxes $ 0.3 $ 9.0 $ 6.8 $ 18.9
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1998 Compared to Quarter Ended September 30,
1997
Segment income before taxes decreased $8.7 million, or 96.7%, to $0.3
million in the third quarter of 1998. This decrease was primarily due to
unfavorable loss experience in the risk-sharing and long-term disability
product lines totaling approximately $7.3 million, as well as increased
expenses related to claims processing costs of approximately $3.2 million.
These decreases were partially offset by favorable loss experience in the
fully insured medical and dental product lines of approximately $1.7
million. In addition, segment results reflect the Company's entrance into
an agreement with a highly rated reinsurer to cede the excess underwriting
losses of the accident and health assumed reinsurance pool business,
effective July 1, 1998. As a result of this transaction, segment income
before taxes for the accident and health assumed reinsurance pool business
improved $0.7 million, primarily attributable to a decrease in losses.
Premiums decreased $2.1 million, or 2.5%, to $82.8 million. This decrease
was primarily due to total decreases of $5.6 million in the fully insured
medical and dental and the accident and health assumed reinsurance pool
business. The decline in fully insured medical and dental product lines
primarily reflects the Company's cancellation of several large
unprofitable accounts. Decreases were partially offset by growth in the
group life, risk sharing, and affinity group life and health reinsurance
product lines totaling approximately $3.5 million.
Page 28
<PAGE>
Other income increased $2.8 million, or 22.8%, to $15.1 million due to an
increase in administrative service fees.
Policy benefits, claims and losses increased $1.4 million, or 2.4%, to
$60.7 million. This increase is principally attributable to increases of
$6.3 million and $2.0 million from the risk-sharing and group life
business, respectively, due to growth in these product lines as well as
less favorable loss experience. In addition, long-term disability policy
benefits increased $1.7 million due to less favorable loss experience.
These increases were partially offset by lower policy benefits of $5.1
million due to more favorable loss experience in the remaining policies
of the fully insured medical and dental product lines. This favorable loss
experience is primarily related to the aforementioned cancellation of
several large unprofitable accounts. Lower benefits on the Company's
accident and health assumed reinsurance pool business resulted from the
aforementioned reinsurance transaction.
Operating expenses increased $6.8 million, or 19.9%, to $40.9 million,
primarily due to increased claims processing, customer service, and
technology expenses, as well as increased commissions, expense allowances,
and premium taxes.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Segment income before taxes decreased $12.1 million, or 64.0%, to $6.8
million in the nine months ended September 30, 1998. This decrease was
primarily due to unfavorable loss experience in the risk-sharing and
long-term disability lines of approximately $7.5 million, and to
increased operating expenses of $12.9 million, primarily from higher
claims processing and customer service costs. These decreases were
partially offset by a $6.3 million increase in administrative fees, and
to favorable loss experience in the fully insured medical and dental
product lines of $1.2 million. In addition, segment results reflect the
Company's entrance into an agreement with a highly rated reinsurer to
cede the excess underwriting losses of the accident and health assumed
reinsurance pool business, effective July 1, 1998. After consideration
of this transaction, segment income before taxes declined $0.7 million in
the accident and health assumed reinsurance pool business, primarily due
to unfavorable experience in the first half of 1998, which more than
offset the effect of a breakeven combined ratio for the third quarter.
Premiums increased $4.2 million, or 1.7%, to $252.1 million, primarily
due to growth in the risk sharing product line of $5.1 million, accident
and health assumed reinsurance pool business of $3.8 million, and the
group life product line of $2.8 million. These increases were partially
offset by decreases in fully insured medical and dental products of $7.9
million, which reflect the cancellation of several large unprofitable
accounts.
Other income increased $6.3 million, or 17.3%, to $42.8 million during
the nine months ended September 30, 1998, due to an increase in
administrative service fees.
Policy benefits, claims and losses increased $8.1 million, or 4.5%, to
$186.2 million. This increase is primarily attributable to increases of
$10.5 million in the risk sharing product line due to growth and
unfavorable experience. Increased policy benefits totaling $2.2 million
in the group life and $2.2 million in the long-term disability product
line were primarily due to growth and unfavorable loss experience,
respectively. In addition, benefits increased $4.9 million in the
accident and health reinsurance pool business primarily due to growth
and unfavorable loss experience through the second quarter of 1998.
This increase was partially offset by the effects of the aforementioned
reinsurance transaction in the third quarter of 1998 which resulted in a
decrease in losses during this time period. These increases were
partially offset by reduced losses in the fully insured medical and
dental product lines totaling $9.1 million, primarily due to improved
loss experience.
Operating expenses increased $12.9 million, or 12.6%, to $115.3 million
primarily due to increased claims processing, customer service, and
technology expenses, as well as growth related increases in commissions,
expense allowances, and premium taxes.
Page 29
<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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment revenues
Premiums $ 9.5 $ 16.6 $ 47.7 $ 72.7
Fees 75.0 61.4 217.2 174.8
Net investment income 72.6 85.6 229.0 257.5
Other income 17.3 13.5 44.1 38.3
------ ------ ------ ------
Total segment revenues 174.4 177.1 538.0 543.3
Policy benefits, claims and
losses 73.6 85.7 241.5 280.2
Policy acquisition expenses 15.0 15.7 45.1 46.2
Other operating expenses 47.2 37.9 127.5 117.3
------ ------ ------ ------
Segment income before taxes $ 38.6 $ 37.8 $123.9 $ 99.6
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1998 Compared to Quarter Ended September
30, 1997
Segment income before taxes increased $0.8 million, or 2.1%, to $38.6
million. This increase is primarily attributable to higher asset based
fee income driven by growth in the variable annuity and variable universal
life product lines, as well as a reduction in employee related costs
resulting from the restructuring of defined benefit plan and defined
contribution plan business during the fourth quarter of 1997. These items
were partially offset by losses incurred on hedge fund partnership
investments during the third quarter of 1998.
Premiums decreased $7.1 million, or 42.8%, to $9.5 million. This decrease
is due primarily to the cession in 1997 of substantially all of the
Company's individual disability income block of business, which contributed
premiums of $7.0 million in the third quarter of 1997 compared to $0.1
million in the same period of 1998.
The increase in fee revenue of $13.6 million, or 22.1%, to $75.0 million is
due to additional deposits and appreciation on variable products' account
balances. Fees from individual annuities increased $10.5 million, or 43.0%,
to $34.9 million in the third quarter of 1998. Distribution arrangements
with several third party mutual fund advisors continue to contribute to the
increase in annuity sales. Fees from individual variable universal life
policies increased $3.0 million, or 22.6%, to $16.3 million in the third
quarter of 1998. These increases were partially offset by a continued
decline in fees from non-variable universal life of $1.0 million. The
Company expects fees from this product to continue decreasing as policies
in force and related contract values decline.
Net investment income decreased $13.0 million, or 15.2%, to $72.6
million. This decrease is primarily due to losses incurred on hedge fund
partnership investments of $9.3 million, a reduction in average fixed
maturities invested resulting from the aforementioned cession of the
individual disability income line of business, and to transfers to the
separate accounts in the annuity and retirement product lines.
Other income increased $3.8 million, or 28.1%, to $17.3 million, primarily
as a result of higher distribution and investment management fee income
attributable to growth in variable product assets under management.
Policy benefits, claims and losses decreased $12.1 million, or 14.1%, to
$73.6 million. This decrease is primarily due to the aforementioned
cession of substantially all of the individual disability income line of
business, which incurred policy benefits of $10.9 million in the third
quarter of 1997, compared to $0.7 million in the third quarter of 1998.
Also contributing to the overall decrease was improved mortality experience
in the universal life product lines as a result of the January 1, 1998
reinsurance of a significant portion of the mortality risk in these product
lines.
Page 30
<PAGE>
Policy acquisition expenses decreased $0.7 million, or 4.5%, to $15.0
million. This decrease is due primarily to lower policy acquisition
expenses in the individual universal life and variable universal life
lines of business, which is due to a change in mortality assumptions in
1997. This change was consistent with the January 1, 1998 reinsurance of
a significant portion of the related mortality risk on these lines. This
decrease was partially offset by higher policy acquisition expenses in the
individual variable annuity product line, due to growth.
Other operating expenses increased $9.3 million, or 24.5%, to $47.2
million. This increase was primarily attributable to continued growth
in the variable product lines, and to increased interest expense due to
an increase in commercial paper used to manage short-term cash flows.
These increases were partially offset by reductions in employee
related costs resulting from the restructuring of defined benefit plan
and defined contribution plan business during the fourth quarter of 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Segment income before taxes increased $24.3 million, or 24.4%, to $123.9
million. This increase is primarily attributable to continued growth from
new deposits and market appreciation in the variable annuity and variable
universal life assets resulting in increased fee revenue, and a reduction
in employee related costs resulting from the restructuring of defined
benefit plan and defined contribution plan business during the fourth
quarter of 1997, partially offset by losses incurred on hedge fund
partnership investments during the third quarter of 1998.Premiums
decreased $25.0 million, or 34.4%, to $47.7 million during the nine
months ended September 30, 1998. This decrease is due primarily to the
cession in 1997 of substantially all of the Company's individual
disability income line of business, which contributed premiums of $23.4
million in the nine months ended September 30, 1997, compared to $0.5
million for the same period in 1998. The remaining decrease in premiums
is 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 $42.4 million, or 24.3%, to $217.2 million
is due to additional deposits and appreciation on variable products' account
balances. Fees from individual annuities increased $35.7 million, or 57.2%,
to $98.1 million in the first nine months 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 $8.7 million, or 22.4%, to $47.5 million in the
first nine months of 1998. These increases were partially offset by a
continued decline in fees from non-variable universal life of $3.8 million.
Net investment income decreased $28.5 million, or 11.1%, to $229.0
primarily due to a reduction in average fixed maturities invested resulting
from the aforementioned cession of the individual disability income line
of business, losses incurred on hedge fund investments in the current year,
and transfers to the separate accounts in the annuity and retirement
product lines.
Other income increased $5.8 million, or 15.1%, to $44.1 million. This
increase is primarily attributable to higher investment management fee
income resulting from growth in variable product assets under management.
Policy benefits, claims and losses decreased $38.7 million, or 13.8%, to
$241.5 million. This decrease is primarily due to the cession of
substantially all of the individual disability income line of business,
which incurred policy benefits of $30.8 million in the first nine months
of 1997, compared to $1.8 million for the same period in 1998. Also
contributing to the overall decrease was a reduction in interest credited
on group retirement products of $5.2 million due to the aforementioned
shift to the separate accounts, and to improved mortality experience in
the traditional life line of business of $1.5 million.
Policy acquisition expenses decreased $1.1 million, or 2.4%, to $45.1
million. This decrease is due, in part, to the aforementioned cession in
1997 of the individual disability income 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 substantially offset by
higher policy acquisition expenses in the individual variable annuity
lines, due to growth.
Other operating expenses increased $10.2 million, or 8.7%, to $127.5
million. This increase was primarily attributable to continued growth
in the variable product lines, and to increased interest expense due to
an increase in commercial paper used to manage short-term cash flows.
These increases were partially offset by reductions in employee related
costs resulting from the restructuring of defined benefit plan and defined
contribution plan business during the fourth quarter of 1997.
Page 31
<PAGE>
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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net investment income $33.2 $34.4 $100.7 $105.0
Less: Interest credited 23.8 24.6 67.6 73.8
----- ----- ------ ------
Interest margins <F1> $ 9.4 $ 9.8 $ 33.1 $ 31.2
===== ===== ====== ======
<FN>
<F1>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 relatively consistent in 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) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment revenues:
Net investment income<F1> $30.2 $20.2 $79.4 $63.2
Fees and other income:
External 1.1 0.2 2.3 1.6
Internal 1.5 1.9 4.9 5.0
----- ----- ----- -----
Total segment revenues 32.8 22.3 86.6 69.8
Policy benefits, claims
and losses<F1> 23.8 15.0 63.2 49.2
Other operating expenses 2.1 2.1 6.4 6.8
----- ----- ----- -----
Segment income before taxes $ 6.9 $ 5.2 $17.0 $13.8
===== ===== ===== =====
<FN>
<F1> For all periods presented, net investment income and policy
benefits, claims and losses primarily reflect the income earned and
interest credited, respectively, on GICs. Interest margins on GICs reflect
the difference between income earned on deposits from policyholder contracts
and interest credited to these policies.
</FN>
</TABLE>
Quarter Ended September 30, 1998 compared to Quarter Ended September 30,
1997
Segment income before taxes increased $1.7 million, or 32.7%, to $6.9
million primarily as a result of a 1998 payment of $2.6 million from a
mortgage loan equity participation interest. Excluding this item, segment
income before taxes decreased $0.9 million, or 17.3%, to $4.3 million.
This decrease primarily reflects a decline in interest margins on
traditional GICs, partially offset by growth in income from assets under
management. Interest margins on traditional GICs declined $4.3 million,
which more than offset a $2.9 million increase in interest margins from
floating rate GICs. Interest margins on traditional GICs decreased as a
result of a decline in investment portfolio yields and from the continuing
runoff of the traditional GIC portfolio. This decline was partially offset
by increased deposits generated by floating rate GICs.
Page 32
<PAGE>
Nine Months Ended September 30, 1998 compared to Nine Months Ended
September 30, 1997
Segment income before taxes increased $3.2 million, or 23.2% to $17.0
million. The increase is primarily attributable to the 1998 receipt of the
aforementioned $2.6 million equity participation payment from a mortgage
loan. Excluding this item, segment income before taxes increased $0.6
million, or 4.3%, to $14.4 million. This increase reflects growth in
assets under management, partially offset by lower interest margins on
traditional GICs. Interest margins on traditional GICs declined $7.0
million, which more than offset a $6.6 million increase in interest
margins from floating rate GICs. Interest margins on traditional GICs
decreased as a result of a decline in investment portfolio yields and
from the continuing runoff of the traditional GIC portfolio. This decline
was partially offset by increased deposits generated by floating rate
GICs.
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Segment revenues
Investment and other
income $ 3.8 $ 4.5 $ 9.9 $ 14.3
Interest expense 3.8 4.9 11.4 12.5
Other operating expenses 9.3 11.4 34.1 32.6
------ ------ ------- -------
Segment loss before taxes
and minority interest $(9.3) $(11.8) $(35.6) $(30.8)
====== ====== ======= =======
</TABLE>
Quarter Ended September 30, 1998 compared to Quarter Ended September 30,
1997
Segment loss before taxes and minority interest decreased $2.5 million,
or 21.2%, to $9.3 million in the third quarter of 1998 primarily due to
reduced interest and other expenses.
Net investment and other income decreased $0.7 million in 1998, primarily
from the absence of $2.3 million of short-term income generated by the
temporary investment of the net proceeds from the issuance of Capital
Securities in 1997. This was partially offset by increased income from
fixed maturities, due to higher average invested assets resulting from
transfers of $125 million and $195 million from the Property and Casualty
segment in April 1998 and December 1997, respectively.
Interest expense for both periods relates principally to the interest paid
on the Senior Debentures of the Company. Interest expense in 1997 also
reflects $1.1 million of Allmerica P&C merger-related interest expense.
Other operating expenses for the quarter ended September 30, 1998
decreased $2.1 million, or 18.4%. This expense category consists primarily
of certain non-insurance subsidiary expenses and 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.
The decrease in other operating expenses primarily reflects the Company's
exit from certain non-insurance businesses during 1998, partially offset by
higher corporate overhead costs.
Nine Months Ended September 30, 1998 compared to Nine Months Ended
September 30, 1997
Segment loss before taxes and minority interest increased $4.8 million, or
15.6%, to $35.6 million for the nine months ended September 30, 1998
primarily due to lower net investment income. Net investment and other
income decreased $4.4 million in 1998 primarily from the absence of $8.1
million of short-term income generated by the temporary investment of the
net proceeds from the issuance of Capital Securities in 1997. This was
partially offset by additional income due to higher average invested
assets from the aforementioned transfers of assets from the Property and
Casualty segment.
Interest expense for both periods relates principally to the interest paid
on the Senior Debentures of the Company. Interest expense in 1997 also
reflects $1.1 million of merger-related interest expense.
Other operating expenses increased $1.5 million, or 4.6%, primarily due to
$3.6 million of higher corporate overhead costs, partially offset by the
absence of certain non-insurance subsidiary expenses.
Page 33
<PAGE>
Investment Portfolio
The Company had investment assets diversified across several asset classes,
as follows:
<TABLE>
<CAPTION>
September 30, 1998 <F1> December 31, 1997 <F1>
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
<S> <C> <C> <C> <C>
Fixed Maturities <F2> $ 8,335.3 80.5% $7,726.6 79.8%
Equity securities <F2> 371.9 3.6 479.0 4.9
Mortgages 698.6 6.8 679.5 7.0
Policy loans 365.9 3.5 360.7 3.7
Real estate 25.1 0.2 50.3 0.5
Cash and cash equivalents 414.3 4.0 240.1 2.5
Other invested assets 139.2 1.4 148.3 1.6
--------- ----- -------- -----
Total $10,350.3 100.0% $9,684.5 100.0%
========= ===== ======== =====
<FN>
<FN1> Includes Closed Block invested assets with a carrying value of
$771.0 million and $768.8 million at September 30, 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 $665.8 million, or 6.9%, to $10.4
billion during 1998. Fixed maturities increased $608.7 million, or 7.9%.
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 decreased $107.1 million, or 22.4% to $371.9
million during 1998 primarily due to the sale of equity securities during
the third quarter of 1998. Real estate decreased $25.2 million, or 50.1%,
to $25.1 million during the nine months of 1998 due to continued sales of
investment properties. The Company intends to sell its remaining holdings
in the real estate portfolio.
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 82.9% and 82.5% of
the Company's total fixed maturity portfolio at September 30, 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
was 7.3% and 7.6% for the nine months ended September 30, 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>
(Dollars in millions) Mortgages Real 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 <F1> (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%
Nine months ended September
30, 1998
Provision (benefits) (7.1) 0.0 (7.1)
Write-offs <F1> (2.3) 0.0 (2.3)
------ ------ ------
Ending balance $11.3 $ 0.0 $11.3
====== ====== ======
Valuation allowance as a
percentage of carrying value
before reserves 1.6% 0.0% 1.6%
<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.
Page 34
<PAGE>
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 in
July 1997, Allmerica P&C and its subsidiaries filed a separate United
States federal income tax return.
The benefit from federal income taxes before minority interest was $8.9
million during the third quarter of 1998 compared to a provision of $24.0
million during the same period in 1997. The benefit and provision
resulted in consolidated effective federal tax rates of (104.0%) and
26.6%, respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were (36.7%) and 36.8% during the third quarter
of 1998 and 1997, respectively. The decrease in the rate for AFLIAC and
FAFLIC and its non-insurance subsidiaries resulted primarily from a $10.8
million tax benefit and an $8.9 million tax benefit related to the
Company's 1998 sales practice litigation expense and loss from exiting the
Company's accident and health reinsurance pool business, respectively.
The effective tax rates for Allmerica P&C and its subsidiaries were 12.3%
and 14.5% during the third quarter of 1998 and 1997, respectively. The
decrease in the rate for the Allmerica P&C and its subsidiaries primarily
reflects lower underwriting income in 1998.
The provision for federal income taxes before minority interest was $33.7
million during the first nine months of 1998 compared to $53.0 million
during the same period in 1997. These provisions resulted in consolidated
effective federal tax rates of 17.5% and 24.1%, respectively. The
effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 29.1% and 39.2% during the first nine months of 1998
and 1997, respectively. The decrease in the rate for AFLIAC and FAFLIC and
its non-insurance subsidiaries resulted primarily from a $10.8 million tax
benefit and an $8.9 million tax benefit related to the Company's 1998 sales
practice litigation expense and loss from exiting the Company's accident
and health reinsurance pool business, respectively, partially offset by
prior year's tax benefit related to a loss from cession of disability
income business. The effective tax rates for Allmerica P&C and its
subsidiaries were 11.8% and 17.1% during the first nine months of 1998
and 1997, respectively. The decrease in the rate for the Allmerica P&C
subsidiaries primarily reflects higher underwriting losses 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 s
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.
Net cash used in operating activities was $5.9 million for the first nine
months of 1998, compared to $53.9 million provided by operating activities
during the same period in 1997. The change in 1998 resulted primarily
from the timing of recoveries of reinsurance related to the universal life
and variable universal life reinsurance agreement, which was effective
January 1, 1998. Also, 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, and to pay the Internal Revenue Service for current audits of
prior tax years. These cash uses were partially offset by a change in
the timing of reinsurance payments relating to the Property and Casualty
segment.
Net cash used in investing activities was $546.7 million during the first
nine months of 1998, as compared to $186.0 million during the same period
in 1997. This change is primarily due to greater net purchases of fixed
maturities resulting from an increase in funds available from floating
rate GIC deposits, partially offset by increased net sales of equity
securities during the nine months ended September 30, 1998.
Page 35
<PAGE>
Net cash provided by financing activities was $726.7 million during the
first nine months of 1998, as compared to $114.2 million during the
comparable prior year period. In 1998, cash provided by financing
activities was positively impacted by net GIC deposits of $710.6
million compared to net GIC withdrawals of $327.4 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. On January
12, 1998, FAFLIC's Board of Directors declared a common stock dividend to
AFC of $50.0 million, to be paid in installments upon the Company's request.
As of September 30, 1998, approximately $35.0 million has been paid, with
the remaining balance to be paid during the fourth quarter of 1998. 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. Effective May 29, 1998, AFC entered
into a committed syndicated credit agreement with Chase Manhattan Bank
as the administrative agent. This agreement, which replaces lines of
credit previously held by FAFLIC and Allmerica P&C, provides for a $150.0
million credit facility, which expires on May 28, 1999. Borrowings under
this agreement are unsecured and incur interest at a rate per annum equal
to, at the Company's option, a designated base rate or the eurodollar rate
plus applicable margin. There were no amounts outstanding under this
credit facility agreement during the period. Additionally, the Company
had commercial paper borrowings outstanding at September 30, 1998 of
$59.0 million.
Contingencies
In July 1997, a lawsuit on behalf of a punitive class 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 filed a substantially similar action in Federal District Court in
Worcester, Massachusetts. The Company and the plaintiffs have entered into
a settlement agreement which they will present to the court for approval.
Although the Company believes it has meritorious defenses to plaintiffs'
claims, it concluded that this settlement was best for the Company.
Accordingly, AFC recognized a $31.0 million pre-tax expense during the
third quarter of 1998 related to this litigation. Although the Company
believes it has established an appropriate reserve, this reserve may be
revised based on changes in the Company's estimate of the ultimate cost of
this settlement.
Recent Developments
On October 27, 1998, Allmerica Financial Corporation announced that it,
or one of its wholly-owned subsidiaries, shortly will commence a cash
tender offer to acquire the outstanding shares of Citizens Corporation
common stock that it or its subsidiaries do not already own at a price
of $29.00 per share. On November 2, 1998, the Allmerica Financial
Corporation commenced the tender offer which, unless extended, will
expire on December 2, 1998. Based on the number of shares of Citizens
Corporation common stock held by unaffiliated stockholders, the
transaction is valued at approximately $171 million. Citizens Corporation
has established a special committee of the Board of Directors, consisting
of directors unaffiliated with AFC, to study the offer and make a
recommendation to Citizens Corporation stockholders.
Page 36
<PAGE>
Since the announcement by AFC of its intention to commence a tender offer
to acquire all of the outstanding shares of Citizens Corporation Common
Stock that it or its subsidiaries do not own, five lawsuits have been
commenced by Citizens stockholders in Delaware Court of Chancery: Susser v.
O'Brien, et. al., Civil Action No. 16745; Specht v. O'Brien, et. al.,
Civil Action No. 16746; Steiner v. O'Brien, et. al., Civil Action No.
16747; Finkelstein v. O'Brien, et. al., Civil Action No. 16748; McKinnie v.
O'Brien, et. al., Civil Action No. 16749. Each of the actions purports to
be a class action brought on behalf of the Citizens stockholders
unaffiliated with AFC and asserts claims against AFC, Citizens Corporation
and the members of the Citizens Corporation Board of Directors.
The actions each allege that, through the conduct of the defendants, AFC
has proposed to acquire the shares owned by unaffiliated Citizens
stockholders at an unfair and inadequate price, in violation of fiduciary
duties allegedly owed by the defendant to the unaffiliated Citizens
stockholders. The various complaints purport by their terms to seek
injunctive relief preventing consummation of the tender offer and related
merger, or rescission if they are successfully consummated, and
compensatory damages. No motion for the injunctive relief has been filed.
The complaints have been formally served upon the defendants with regard
to Susser v. O'Brien, et. al., Civil Action No. 16745, and the time within
which the defendants have to respond to the complaints has not expired.
For the four remaining lawsuits, the complaints have not yet been formally
served upon the defendants and the time within which the defendants have
to respond to the complaints accordingly has not expired. The defendants
anticipate that the complaints will be consolidated into a single action.
Allmerica Financial believes the actions to be without merit, and it
intends to defend the action vigorously.
On October 27, 1998, the Board of Directors of Allmerica Financial
Corporation authorized the repurchase of up to $200.0 million of its
issued common stock.
On October 29, 1998, the Company announced that, in restructuring its Risk
Management business, it will incur a loss of approximately $10 million to
$12 million in the fourth quarter of 1998. In addition to exiting the
Company's accident and health assumed reinsurance pool business, the
Corporate Risk Management segment will exit its administrative services
only business, close nearly half of its nationwide sales offices, and
take additional expense reductions in the home office. Further expense
improvements in the Property and Casualty segment are anticipated from
the consolidation of field support activities from fourteen regional
branches into three hub locations. The Company has also commenced the
implementation of additional technology enhancements, which enable agents
to issue small commercial and personal lines policies on a largely
automated basis.
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 third party assessment, the Company determined that significant
portions of its software required modification or replacement to enable
its computer systems to properly process dates beyond December 31, 1999.
The Company is presently modifying or replacing and believes this action
will resolve the Year 2000 issue. However, if such modifications and
conversions are not made, or are not completed timely, or should there be
serious unanticipated interruptions from unknown sources, the Year 2000
issue could have a material adverse impact on the operations of the
Company. Specifically, the Company could experience, among other things,
an interruption in its ability to collect and process premiums, process
claim payments, safeguard and manage its invested assets, accurately
maintain policyholder information, accurately maintain accounting records,
and perform customer service. Any of these specific events, depending on
duration, could have a material adverse impact on the results of operations
and the financial position of the Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company
is vulnerable to those third parties' failure to remediate their own Year
2000 issue. The Company's total Year 2000 project cost and estimates to
complete the project include the estimated costs and time associated with
the impact of a third party's Year 2000 issue, and are based on presently
available information. However, there can be no guarantee that the systems
of other companies on which the Company's systems rely will be timely
converted, or that a failure to convert by another company, or a conversion
that is incompatible with the Company's systems, would not have material
adverse effect on the Company. The Company does not believe that it has
material exposure to contingencies related to the Year 2000 Issue for the
products it has sold. Although the Company does not believe that there is a
material contingency associated with the Year 2000 project, there can be
no assurance that exposure for material contingencies will not arise.
Page 37
<PAGE>
The Company will utilize both internal and external resources to reprogram
or replace, and test both information technology and embedded technology
systems 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 cost and is
not expected to have a material effect on the results of operations.
Through September 30, 1998, the Company has incurred and expensed
approximately $47 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 $30-40 million.
The Company's contingency plans related to the Year 2000 issue are
addressed in a plan developed jointly with an outside vendor. The plan
contains immediate steps to keep business functions operating while
unforeseen Year 2000 issues are being addressed. It outlines responses to
situations that may affect critical business functions and also provides
triage guidance, a documented order of actions to respond to problems.
During the triage process, business priorities are established and
"Critical Points of Failure" are identified as having a significant
impact on the business. The Company's contingency plans are designed to
keep a business unit's operation functioning in the event of a failure or
delay due to Year 2000 record format and date calculation changes.
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 and liabilities relating to
sales practices for insurance products; (xvi) uncertainty related to the
Year 2000 issue; (xvii) failure of a reinsurer of the Company's policies
to pay its liabilities under reinsurance contracts; and (xviii) potential
liabilities associated with the Company's tender offer for shares of
Citizens Corporation common stock held by unaffiliated stockholders.
Page 38
<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 October 15, 1998, a report on Form 8-K was filed reporting under item 5,
Other Events, that third quarter results will be negatively impacted by an
estimated $0.25 to $0.30 per share as a result of losses relating to
increased frequency of catastrophes and lower investment income.
On October 27, 1998, a report on Form 8-K was filed reporting under item
5, Other Events, that Allmerica Financial Corporation announced that it,
or a subsidiary, will shortly commence a cash tender offer to acquire all
of the outstanding shares of Citizens Corporation common stock that it
does not already own at a price of $29.00 per share
On November 3, 1998, a report on Form 8-K was filed reporting under item 5,
other Events, that Allmerica Financial Corporation announced its financial
results for the three months ended September 30, 1998. The Company also
announced that the Board of Directors of AFC authorized the repurchase of
up to $200.0 million of its issued common stock.
Page 39
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
-------------------------------
Registrant
Dated November 13, 1998
----------------- /s/ John F. O'Brien
-------------------
John F. O'Brien
President and Chief
Executive Officer
Dated November 13, 1998
-----------------
/s/ Edward J. Parry III
-----------------------
Edward J. Parry III.
Vice President, Chief
Financial Officer
And Treasurer
Page 40
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit
- -------------- -------
27 Financial Data Schedule
Page 41
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
This schedule contains summary financial extracted from the interim
consolidated balance sheet and income statement of Allmerica Financial
Corporation as of September 30, 1998 and for the period then ended, and
is qualified in its entirety by reference to such financial statements.
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 7918
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 372
<MORTGAGES> 562
<REAL-ESTATE> 25
<TOTAL-INVEST> 9169
<CASH> 410
<RECOVER-REINSURE> 1155
<DEFERRED-ACQUISITION> 1108
<TOTAL-ASSETS> 25245
<POLICY-LOSSES> 2749
<UNEARNED-PREMIUMS> 883
<POLICY-OTHER> 2856
<POLICY-HOLDER-FUNDS> 2567
<NOTES-PAYABLE> 258
300
0
<COMMON> 1
<OTHER-SE> 2479
<TOTAL-LIABILITY-AND-EQUITY> 25245
1730
<INVESTMENT-INCOME> 463
<INVESTMENT-GAINS> 51
<OTHER-INCOME> 321
<BENEFITS> 1550
<UNDERWRITING-AMORTIZATION> 344
<UNDERWRITING-OTHER> 478
<INCOME-PRETAX> 192
<INCOME-TAX> 34
<INCOME-CONTINUING> 159
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 135
<EPS-PRIMARY> 2.26
<EPS-DILUTED> 2.24
<RESERVE-OPEN> 2615
<PROVISION-CURRENT> 1220
<PROVISION-PRIOR> (93)
<PAYMENTS-CURRENT> 552
<PAYMENTS-PRIOR> 588
<RESERVE-CLOSE> 2586
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
