FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1999
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: 54,256,498
shares of common stock outstanding, as of November 1, 1999.
38
Total Number of Pages Included in This Document
Exhibit Index is on Page 39
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
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
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) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 499.9 $ 487.9 $1,452.9 $1,479.0
Universal life and investment
product policy fees 91.4 75.0 262.9 217.2
Net investment income 157.3 148.7 469.8 447.4
Net realized investment
(losses) gains (19.8) 8.9 106.5 49.1
Other income 32.9 24.5 90.6 72.4
------- ------- ------- -------
Total revenues 761.7 745.0 2,382.7 2,265.1
------- ------- ------- -------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 451.8 463.7 1,335.2 1,364.4
Policy acquisition expenses 111.9 111.2 316.5 341.6
Sales practice litigation expense 0.0 31.0 0.0 31.0
Other operating expenses 120.5 105.9 358.2 317.9
------- ------- ------- -------
Total benefits, losses
and expenses 684.2 711.8 2,009.9 2,054.9
------- ------- ------- -------
Income from continuing operations
before federal income taxes 77.5 33.2 372.8 210.2
------- ------- ------- -------
Federal income tax expense(benefit):
Current 9.5 22.1 82.7 62.0
Deferred 4.9 (22.4) 1.4 (22.1)
------- ------- ------- -------
Total federal income tax
expense (benefit) 14.4 (0.3) 84.1 39.9
------- ------- ------- -------
Income from continuing operations
before minority interest 63.1 33.5 288.7 170.3
------- ------- ------- -------
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.0) (4.0) (12.0) (12.0)
Equity in earnings 0.0 (5.2) 0.0 (11.3)
------- ------- ------- -------
(4.0) (9.2) (12.0) (23.3)
------- ------- ------- -------
Income from continuing operations 59.1 24.3 276.7 147.0
Loss from operations of discontinued
business (less applicable income
taxes (benefit) of $(8.4) and
$(8.6) for the quarters ended
September 30, 1999 and 1998, and
$(10.1) and $(6.2) for the nine
months ended September 30, 1999
and 1998) (15.5) (16.1) (18.8) (11.7)
Loss on disposal of group life and
health business, including
provision of $73.0 for operating
losses during phase-out period for
the quarter and nine months ended
September 30, 1999 (less applicable
income taxes (benefit) of $(16.4)) (30.5) 0.0 (30.5) 0.0
------- ------- ------- -------
Net income $ 13.1 $ 8.2 $ 227.4 $ 135.3
======= ======= ======= =======
PER SHARE DATA
Basic
Income from continuing
operations $ 1.09 $ 0.40 $ 5.00 $ 2.45
Loss from operations of
discontinued business (less
applicable income taxes
(benefit) of $(0.15) and
$(0.14) for the quarters ended
September 30, 1999 and 1998,
and $(0.18) and $(0.11) for
the nine months ended
September 30, 1999 and 1998) (0.29) (0.26) (0.34) (0.19)
Loss on disposal of group life
and health business, including
provision of $1.35 and 1.32
for operating losses during
phase-out period for the
quarter and nine months
ended September 30, 1999,
(less applicable income
taxes (benefit) of $(0.30) for
the quarter and nine months
ended September 30, 1999) (0.56) 0.00 (0.55) 0.00
------- ------- ------- -------
Net income $ 0.24 $ 0.14 $ 4.11 $ 2.26
======= ======= ======= =======
Weighted average shares
outstanding 54.1 60.0 55.3 60.0
======= ======= ======= =======
Diluted
Income from continuing
operations $ 1.08 $ 0.40 $ 4.96 $ 2.43
Loss from operations of
discontinued business (less
applicable income taxes
(benefit) of $(0.15) and
$(0.16) for the quarters ended
September 30, 1999 and 1998,
and $(0.18) and $(0.11) for the
nine months ended September 30,
1999 and 1998) (0.28) (0.27) (0.34) (0.19)
Loss on disposal of group life
and health business, including
provision of $1.33 and $1.31
for operating losses during
phase-out period for the
quarter and nine months ended
September 30, 1999,(less
applicable income taxes
(benefit) of $(0.30) and
$(0.29) for the quarter and
nine months ended
September 30, 1999) (0.56) 0.00 (0.55) 0.00
------- ------- ------- -------
Net income $ 0.24 $ 0.13 $ 4.07 $ 2.24
======= ======= ======= =======
Weighted average shares
outstanding 54.7 60.6 55.8 60.5
======= ======= ======= =======
Dividends declared to
shareholders $ 0.25 $ 0.05 $ 0.25 $ 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) 1999 1998
<S> <C> <C>
ASSETS
Investments:
Fixed maturities-at fair value
(amortized cost of $7,364.8 and
$7,618.2) $ 7,273.5 $ 7,780.8
Equity securities-at fair value
(cost of $87.1 and $253.1) 100.9 397.1
Mortgage loans 546.4 562.3
Policy loans 164.9 154.3
Real estate and other long-term
investment 180.0 163.1
--------- ---------
Total investments 8,265.7 9,057.6
--------- ---------
Cash and cash equivalents 999.3 550.3
Accrued investment income 127.4 142.3
Premiums, accounts and notes
receivable, net 600.9 510.5
Reinsurance receivable on paid and
unpaid losses, benefits and
unearned premiums 1,204.8 1,136.0
Deferred policy acquisition costs 1,333.6 1,161.2
Deferred federal income taxes 152.8 19.8
Other assets 516.3 529.4
Closed Block assets 776.3 803.1
Separate account assets 15,102.9 13,697.7
--------- ---------
Total assets $ 29,080.0 $ 27,607.9
========= =========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,862.8 $ 2,802.2
Outstanding claims, losses and
loss adjustment expenses 2,855.8 2,816.3
Unearned premiums 910.8 843.2
Contractholder deposit funds and
other policy liabilities 2,973.2 2,637.0
--------- ---------
Total policy liabilities and
accruals 9,602.6 9,098.7
--------- ---------
Expenses and taxes payable 736.0 716.1
Reinsurance premiums payable 48.3 50.2
Short-term debt 43.8 221.3
Long-term debt 199.5 199.5
Closed Block liabilities 848.0 872.0
Separate account liabilities 15,102.1 13,691.5
--------- ---------
Total liabilities 26,580.3 24,849.3
--------- ---------
Minority interest:
Mandatorily redeemable preferred
securities of a subsidiary trust
holding solely junior
subordinated debentures of
the Company 300.0 300.0
--------- ---------
Commitments and contingencies
(Note 11)
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 shares issued 0.6 0.6
Additional paid-in capital 1,772.9 1,768.8
Accumulated other comprehensive income (48.6) 180.5
Retained earnings 813.8 599.9
Treasury stock at cost (6.2 million and
1.8 million shares) (339.0) (91.2)
--------- ---------
Total shareholders' equity 2,199.7 2,458.6
--------- ---------
Total liabilities and
shareholders' equity $ 29,080.0 $ 27,607.9
========= =========
</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) 1999 1998
<S> <C> <C>
PREFERRED STOCK
Balance at beginning and end of period $ 0.0 $ 0.0
-------- --------
COMMON STOCK
Balance at beginning and end of period 0.6 0.6
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,768.8 1,755.0
Issuance of common stock 4.1 12.6
-------- --------
Balance at end of period 1,772.9 1,767.6
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 180.5 217.9
Net depreciation on available-for-
sale securities (368.4) (64.4)
Benefit for deferred federal
income taxes 139.3 22.3
Minority interest 0.0 2.3
-------- --------
Other comprehensive loss (229.1) (39.8)
-------- --------
Balance at end of period (48.6) 178.1
-------- --------
RETAINED EARNINGS
Balance at beginning of period 599.9 407.8
Net income 227.4 135.3
Dividends to shareholders (13.5) (9.1)
-------- --------
Balance at end of period 813.8 534.0
-------- --------
TREASURY STOCK
Balance at beginning of period (91.2) 0.0
Shares purchased at cost (250.2) 0.0
Shares reissued at cost 2.4 0.0
-------- --------
Balance at end of period (339.0) 0.0
-------- --------
Total shareholders' equity $ 2,199.7 $ 2,480.3
======== ========
</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) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net income $ 13.1 $ 8.2 $ 227.4 $ 135.3
Other comprehensive income:
Net depreciation on
available-for-sale securities (94.4) (108.5) (368.4) (64.4)
Benefit for deferred
federal income taxes 43.5 38.0 139.3 22.3
Minority interest 0.0 5.0 0.0 2.3
------ ------ ------ ------
Other comprehensive loss (50.9) (65.5) (229.1) (39.8)
------ ------ ------ ------
Comprehensive (loss)income $ (37.8) $ (57.3) $ (1.7) $ 95.5
====== ====== ====== ======
</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) 1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 227.4 $ 135.3
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Minority interest 0.0 11.3
Net realized gains (106.3) (50.2)
Net amortization and depreciation 25.8 24.3
Loss on disposal of group life and
health business 30.5 0.0
Loss from exiting reinsurance pools 0.0 25.3
Sales practice litigation expense 0.0 31.0
Deferred federal income taxes 1.4 (23.3)
Change in deferred acquisition costs (140.0) (143.2)
Change in premiums and notes receivable,
net of reinsurance payable (92.1) 42.9
Change in accrued investment income 14.0 1.2
Change in policy liabilities and
accruals, net 157.8 177.9
Change in reinsurance receivable (69.0) (84.9)
Change in expenses and taxes payable (50.5) (108.3)
Separate account activity, net 5.4 1.3
Other, net 10.9 (33.5)
-------- --------
Net cash provided by
operating activities 15.3 7.1
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities
of available-for-sale fixed maturities 2,281.1 1,394.4
Proceeds from disposals of equity
securities 376.9 228.3
Proceeds from disposals of other
investments 27.3 79.4
Proceeds from mortgages matured or
collected 86.5 147.5
Purchase of available-for-sale fixed
maturities (2,065.9) (2,051.5)
Purchase of equity securities (71.5) (111.3)
Purchase of other investments (113.8) (221.3)
Capital expenditures (24.0) (17.7)
Purchase of Financial Profiles, Inc. 0.0 (13.0)
Other investing activities, net 0.0 5.5
-------- --------
Net cash provided by (used in)
investing activities 496.6 (559.7)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 1,368.0 1,167.0
Withdrawals from contractholder deposit
funds (1,014.8) (456.5)
Change in short-term debt (177.5) 25.5
Change in long-term debt 0.0 (2.6)
Proceeds from issuance of common stock 0.2 11.2
Purchase of treasury shares (250.2) (8.0)
Reissuance of treasury shares 2.4 0.0
Dividends paid to shareholders 0.0 (9.9)
-------- --------
Net cash (used in) provided by
financing activities (71.9) 726.7
-------- --------
Net change in cash and cash equivalents 440.0 174.1
Net change in cash held in the Closed Block 9.0 21.1
Cash and cash equivalents, beginning of period 550.3 215.1
-------- --------
Cash and cash equivalents, end of period $ 999.3 $ 410.3
======== ========
</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 and Principles of Consolidation
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
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 services); Allmerica Asset Management, Inc. ("AAM", a
wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty
Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance subsidiary of
AAM); The Hanover Insurance Company ("Hanover", a wholly-owned subsidiary of
Allmerica P&C); Citizens Corporation (a wholly-owned subsidiary of Hanover);
and Citizens Insurance Company of America ("Citizens", a wholly-owned
subsidiary of Citizens Corporation). The Closed Block assets and liabilities
and its results of operations are presented in the consolidated financial
statements as single line items. Unless specifically stated, all disclosures
contained herein supporting the consolidated financial statements exclude the
Closed Block related amounts. All significant intercompany accounts and
transactions have been eliminated.
In December 1998, the Company acquired all of the outstanding common stock of
Citizens Corporation that it did not already own. Prior to this acquisition,
the financial statements reflect minority interest in Citizens Corporation and
its wholly-owned subsidiary, Citizens, of 17.5% (see Note 4).
The accompanying interim consolidated financial statements reflect, in the
opinion of the Company's management, all adjustments necessary for a fair
presentation of the financial position and results of operations. The results
of operations for the nine months ended September 30, 1999, 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 1998
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 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. This
statement is effective for fiscal years beginning after June 15, 2000. The
Company is currently assessing the impact of the adoption of Statement No.
133.
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 adoption of
SoP No. 97-3 had no effect on the results of operations or financial position
of the Company.
Page 8
<PAGE>
3. Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit its
group life and health insurance business, consisting of its Employee Benefit
Services ("EBS") business, its Affinity Group Underwriters ("AGU") business
and its accident and health assumed reinsurance pool business ("reinsurance
pool business"). During the third quarter of 1998, the Company ceased writing
new premium in the reinsurance pool business, subject to certain contractual
obligations. Prior to 1999, these businesses comprised substantially all of
the former Corporate Risk Management Services segment. Accordingly, the
operating results of the discontinued segment, including its reinsurance pool
business, have been reported in the Consolidated Statements of Income as
discontinued operations in accordance with Accounting Principles Board Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" ("APB Opinion No. 30"). In
the third quarter of 1999, the operating results from the discontinued
segment were adjusted to reflect the recording of additional reserves related
to accident claims from prior years. On October 6, 1999, the Company entered
into an agreement with Great-West Life and Annuity Insurance Company of
Denver, which provides for the sale of the Company's EBS business effective
March 1, 2000. The Company has recorded a $30.5 million loss, net of taxes,
on the disposal of its group life and health business.
As permitted by APB Opinion No. 30, the Consolidated Balance Sheet has not
been segregated between continuing and discontinued operations. At September
30, 1999, the discontinued segment had assets of approximately $528.7 million
consisting primarily of invested assets, premiums and fees receivable, and
reinsurance recoverables, and liabilities of approximately $475.6 million
consisting primarily of policy liabilities. Revenues for the discontinued
operations were $91.9 million and $98.6 million for the quarters ended
September 30, 1999 and 1998, respectively, and $279.0 million and $299.1
million for the nine months ended September 30, 1999 and 1998, respectively.
4. Acquisition of Minority Interest of Citizens Corporation
On December 3, 1998, Citizens Acquisition Corporation, a wholly-owned
subsidiary of the Company, completed a cash tender offer to acquire the
outstanding shares of Citizens Corporation common stock that AFC or its
subsidiaries did not already own at a price of $33.25 per share.
Approximately 99.8% of publicly held shares of Citizens Corporation common
stock were tendered. On December 14, 1998, the Company completed a short-
form merger, acquiring all shares of common stock of Citizens Corporation
not purchased in its tender offer, through the merger of its wholly-owned
subsidiary, Citizens Acquisition Corporation, with Citizens Corporation at
a price of $33.25 per share. Total consideration for the transactions
amounted to $195.9 million. The acquisition has been recognized as a
purchase. The minority interest acquired totaled $158.5 million. A total
of $40.8 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
Citizens Corporation prior to December 3, 1998. The unaudited proforma
information below presents consolidated results of operations as if the
acquisition had occurred at the beginning of 1998.
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
acquisition occurred at the beginning of 1998, nor is it necessarily
indicative of future results.
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions, except per share data) 1998
<S> <C>
Revenue $ 2,252.8
========
Net realized capital gains included in revenue $ 46.1
========
Income before taxes and minority interest $ 197.1
Income taxes (35.6)
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary
trust holding solely junior subordinated
debentures of the Company (12.0)
--------
Income from continuing operations 149.5
Income from operations of discontinued business (11.7)
--------
Net income $ 137.8
========
PER SHARE DATA
Basic
Income from continuing operations $ 2.49
========
Weighted average shares outstanding 60.0
========
Diluted
Income from continuing operations $ 2.47
========
Weighted average shares outstanding 60.5
========
</TABLE>
5. Significant Transactions
Effective January 1, 1999, the Company entered into a whole account aggregate
excess of loss reinsurance agreement with a highly rated reinsurer. The
reinsurance agreement provides accident year coverage for the three years 1999
to 2001 for the Company's property and casualty business, and is subject to
cancellation or commutation annually at the Company's option. The program
covers losses and allocated loss adjustment expenses ("LAE"), including those
incurred but not yet reported, in excess of a specified whole account loss and
allocated LAE ratio. The annual and aggregate coverage limits for losses and
allocated LAE are $150.0 million and $300.0 million, respectively. The effect
of this agreement on results of operations in each reporting period is based
on losses and allocated LAE ceded, reduced by a sliding scale premium of 50.0-
67.0% depending on the size of the loss, and increased by a ceding commission
of 20.0% of ceded premium. In addition, net investment income is reduced for
amounts credited to the reinsurer. As a result of this agreement, the Company
recognized no benefit for the third quarter and a net benefit of $16.9
million for the nine months ended September 30, 1999, based on year-to-date
and annual estimates of losses and allocated loss adjustment expenses for
accident year 1999.
During March 1999, the Company completed the repurchase of $200.0 million of
its common stock under its October, 1998 repurchase program authorized by the
Board of Directors of AFC. On March 23, 1999, the Board of Directors of AFC
authorized the repurchase of up to an additional $200.0 million of its issued
common stock. As of September 30, 1999, under this additional program, the
Company had repurchased an additional $132.6 million of its issued common
stock.
6. Federal Income Taxes
Federal income tax expense for the nine months ended September 30, 1999 and
1998, has been computed using estimated effective tax rates. These rates are
revised, if necessary, at the end of each successive interim period to reflect
the current estimates of the annual effective tax rates.
Page 10
<PAGE>
7. Other Comprehensive Income
The following table provides a reconciliation of gross unrealized losses to
the net balance shown in the Statements of Comprehensive Income:
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Unrealized (losses) gains on
securities:
Unrealized holding losses
arising during period
(net of taxes and minority
interest of $(48.2) million
and $(39.7) million for the
quarters ended September 30,
1999 and 1998 and $(109.2)
million and $(10.5) million
for the nine months ended
September 30, 1999 and 1998) $ (67.0) $ (64.2) $ (156.0) $ (20.1)
Less: reclassification
adjustment for (losses) gains
included in net income (net of
taxes and minority interest of
$(4.7) million and $3.3 million
for the quarters ended
September 30, 1999 and 1998 and
$30.1 million and $14.1 million
for the nine months ended
September 30, 1999 and 1998) (16.1) 1.3 73.1 19.7
------- ------- ------- -------
Other comprehensive loss $ (50.9) $ (65.5) $ (229.1) $ (39.8)
======= ======= ======= =======
</TABLE>
8. Closed Block
Included in other income in the Consolidated Statements of Income is a net
pre-tax contribution from the Closed Block of $3.3 million and $10.4 million
for the quarter and nine months ended September 30, 1999, respectively,
compared to $0.1 million and $6.1 million for the quarter and nine
months ended September 30, 1998, respectively. Summarized financial
information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
(In millions) 1999 1998
<S> <C> <C>
ASSETS
Fixed maturities-at fair
value (amortized cost
of $407.2 and $399.1) $ 398.4 $ 414.2
Mortgage loans 137.5 136.0
Policy loans 203.0 210.9
Cash and cash equivalents 0.4 9.4
Accrued investment income 15.0 14.1
Deferred policy acquisition costs 13.6 15.6
Other assets 8.4 2.9
-------- --------
Total assets $ 776.3 $ 803.1
======== ========
LIABILITIES
Policy liabilities and accruals $ 840.2 $ 862.9
Other liabilities 7.8 9.1
-------- --------
Total liabilities $ 848.0 $ 872.0
======== ========
</TABLE>
Page 11
<PAGE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 8.0 $ 9.1 $ 43.6 $ 46.3
Net investment income 13.9 13.5 40.5 39.9
Net realized investment losses (0.7) (2.0) (0.2) (0.4)
------ ------ ------ ------
Total revenues 21.2 20.6 83.9 85.8
------ ------ ------ ------
BENEFITS AND EXPENSES
Policy benefits 17.2 19.5 71.6 76.9
Policy acquisition expenses 0.6 0.9 1.7 2.2
Other operating expenses 0.1 0.1 0.2 0.6
------ ------ ------ ------
Total benefits and expenses 17.9 20.5 73.5 79.7
------ ------ ------ ------
Contribution from the
Closed Block $ 3.3 $ 0.1 $ 10.4 $ 6.1
====== ====== ====== ======
</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.
9. Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management, Allmerica Financial Services, and Allmerica Asset Management.
The separate financial information of each segment is presented 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 Company's reportable segments is included below.
In 1999, the Company reorganized its Property and Casualty and Corporate Risk
Management Services operations within the Risk Management segment. Under the
new structure, the Risk Management segment manages its business through five
distribution channels identified as Hanover North, Hanover South, Citizens
Midwest, Allmerica Voluntary Benefits, and Allmerica Specialty. During the
second quarter of 1999, the Company approved a plan to exit its group life and
health business, consisting of its EBS business, its AGU business and its
reinsurance pool business. Results of operations from this business, relating
to both the current and the prior periods, have been segregated and reported
as a component of discontinued operations in the Consolidated Statements of
Income. Operating results from this business were previously reported in the
Allmerica Voluntary Benefits and Allmerica Specialty distribution channels.
Prior to 1999, results of the group life and health business were included in
the Corporate Risk Management Services segment, while all other Risk
Management business was reflected in the Property and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States, maintaining a
strong regional focus. Allmerica Voluntary Benefits focuses on worksite
distribution, which offers discounted property and casualty products through
employer sponsored programs, and affinity group property and casualty
business. Allmerica Specialty offers special niche property and casualty
products in selected markets.
Page 12
<PAGE>
The 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 Guaranteed Investment Contracts ("GICs") such as the traditional
GIC, synthetic GIC and other funding agreements. Funding agreements are
investment contracts issued to institutional buyers, such as money market
funds, corporate cash management programs and securities lending collateral
programs, which typically have short maturities and periodic interest rate
resets based on an index such as LIBOR. 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 three 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.
Management evaluates the results of the aforementioned segments based on a
pre-tax and minority interest basis. Segment income is determined by
adjusting net income for net realized investment gains and losses, net gains
and losses on disposals of businesses, discontinued operations, 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 segment income enhances understanding of the Company's
results of operations by highlighting net income attributable to the normal,
recurring operations of the business. However, segment income should not be
construed as a substitute for net income determined in accordance with
generally accepted accounting principles.
Summarized below is financial information with respect to business segments
for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues:
Risk Management $ 558.4 $ 549.3 $1,634.2 $1,667.4
------- ------- ------- -------
Asset Accumulation:
Allmerica Financial Services 200.2 174.4 598.8 538.0
Allmerica Asset Management 41.5 32.8 116.3 86.6
------- ------- ------- -------
Subtotal 241.7 207.2 715.1 624.6
------- ------- ------- -------
Corporate 1.3 3.8 4.9 9.9
Intersegment revenues (1.3) (1.5) (4.3) (5.8)
------- ------- ------- -------
Total segment revenues
including Closed Block 800.1 758.8 2,349.9 2,296.1
Adjustments to segment
revenues:
Adjustment for Closed Block (18.6) (22.7) (73.7) (80.1)
Net realized (losses) gains (19.8) 8.9 106.5 49.1
------- ------- ------- -------
Total revenues $ 761.7 $ 745.0 $2,382.7 $2,265.1
======= ======= ======= =======
Segment income (loss) before federal
income taxes and minority interest:
Risk Management $ 49.5 $ 24.6 $ 134.6 $ 97.2
------- ------- ------- -------
Asset Accumulation:
Allmerica Financial Services 54.7 39.1 151.3 125.5
Allmerica Asset Management 5.7 6.9 18.2 17.0
------- ------- ------- -------
Subtotal 60.4 46.0 169.5 142.5
------- ------- ------- -------
Corporate (13.7) (10.6) (43.2) (35.6)
------- ------- ------- -------
Segment income before federal
income taxes and minority
interest 96.2 60.0 260.9 204.1
Adjustments to segment income:
Net realized investment (losses)
gains, net of amortization (18.7) 4.2 111.9 37.9
Sales practice litigation expense 0.0 (31.0) 0.0 (31.0)
Other items 0.0 0.0 0.0 (0.8)
------- ------- ------- -------
Income from continuing operations
before federal income taxes and
minority interest $ 77.5 $ 33.2 $ 372.8 $ 210.2
======= ======= ======= =======
</TABLE>
Page 13
<PAGE>
<TABLE>
<CAPTION>
Identifiable Assets Deferred Acquisition Costs
(Unaudited) (Unaudited)
September 30, December 31, September 30, December 31,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Risk Management $ 5,894.1 $ 6,219.0 $ 175.6 $ 167.5
-------- -------- -------- --------
Asset Accumulation:
Allmerica Financial
Services 20,863.5 19,416.6 1,157.6 993.1
Allmerica Asset
Management 2,231.3 1,810.9 0.4 0.6
-------- -------- -------- --------
Subtotal 23,094.8 21,227.5 1,158.0 993.7
Corporate 91.1 161.4 0.0 0.0
-------- -------- -------- --------
Total $29,080.0 $27,607.9 $ 1,333.6 $ 1,161.2
======== ======== ======== ========
</TABLE>
10. Earnings Per Share
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions, except per share data) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Basic shares used in the
calculation of earnings
per share 54.1 60.0 55.3 60.0
Dilutive effect of securities:
Employee stock options 0.4 0.4 0.3 0.4
Non-vested stock grants 0.2 0.2 0.2 0.1
----- ----- ------ ------
Diluted shares used in the
calculation of earnings per share 54.7 60.6 55.8 60.5
===== ===== ====== ======
Per share effect of dilutive
securities on income
from continuing operations $ 0.01 $ 0.00 $ 0.04 $ 0.02
===== ===== ====== ======
Per share effect of dilutive
securities on net income $ 0.00 $ 0.01 $ 0.04 $ 0.02
===== ===== ====== ======
</TABLE>
11. Commitments and Contingencies
Litigation
In July 1997, a lawsuit on behalf of a putative 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, the plaintiffs voluntarily dismissed the Louisiana suit and
filed a substantially similar action in Federal District Court in Worcester,
Massachusetts. In early November 1998, the Company and the plaintiffs entered
into a settlement agreement. The court granted preliminary approval of the
settlement on December 4, 1998. On May 19, 1999, the court issued an order
certifying the class for settlement purposes and granting final approval of
the settlement agreement. AFC recognized a $31.0 million pre-tax expense
during the third quarter of 1998 related to this litigation. Although the
Company believes that this expense reflects appropriate recognition of its
obligation under the settlement, this estimate assumes the availability of
insurance coverage for certain claims, and the estimate may be revised based
on the amount of reimbursement actually tendered by AFC's insurance carriers,
and based on changes in the Company's estimate of the ultimate cost
of the benefits to be provided to members of the class.
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 Asset Management, Inc. ("AAM", a wholly owned non-
insurance subsidiary of AFC);Allmerica Property & Casualty Companies, Inc.
("Allmerica P&C," a wholly-owned non-insurance subsidiary of AAM); The Hanover
Insurance Company ("Hanover," a wholly-owned subsidiary of Allmerica P&C);
Citizens Corporation (a wholly-owned non-insurance subsidiary of Hanover);
Citizens Insurance Company of America ("Citizens," a wholly-owned subsidiary
of Citizens Corporation) and certain other insurance and non-insurance
subsidiaries.
In December 1998, the Company acquired all of the outstanding common stock of
Citizens Corporation that it did not already own. Prior to this acquisition,
the results of operations reflect minority interest in Citizens Corporation
and its wholly-owned subsidiary, Citizens, of 17.5%.
Description of Operating Segments
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management, Allmerica Financial Services, and Allmerica Asset Management.
The separate financial information of each segment is presented 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 Company's reportable segments is included below.
In 1999, the Company reorganized its Property and Casualty and Corporate Risk
Management Services operations within the Risk Management segment. Under the
new structure, the Risk Management segment manages its business through five
distribution channels identified as Hanover North, Hanover South, Citizens
Midwest, Allmerica Voluntary Benefits, and Allmerica Specialty. During the
second quarter of 1999, the Company approved a plan to exit its group life and
health business, consisting of its Employee Benefit Services ("EBS") business,
its Affinity Group Underwriters ("AGU") business and its accident and health
assumed reinsurance pool business ("reinsurance pool business"). Results of
operations from this business, relating to both the current and the prior
periods, have been segregated and reported as a component of discontinued
operations in the Consolidated Statements of Income. Operating results from
this business were previously reported in the Allmerica Voluntary Benefits and
Allmerica Specialty distribution channels. Prior to 1999, results of the
group life and health business were included in the Corporate Risk Management
Services segment, while all other Risk Management business was reflected in
the Property and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States, maintaining a
strong regional focus. Allmerica Voluntary Benefits focuses on worksite
distribution, which offers discounted property and casualty products through
employer sponsored programs, and affinity group property and casualty
business. Allmerica Specialty offers special niche property and casualty
products in selected markets.
Page 15
<PAGE>
The 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 Guaranteed Investment Contracts ("GICs") such as the traditional GIC,
synthetic GIC and other funding agreements. Funding agreements are investment
contracts issued to institutional buyers, such as money market funds,
corporate cash management programs and securities lending collateral programs,
which typically have short maturities and periodic interest rate resets based
on an index such as LIBOR. 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 three 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.
Results of Operations
Consolidated Overview
The Company's consolidated net income for the third quarter increased $4.9
million, or 59.8%, to $13.1 million, compared to $8.2 million for the same
period in 1998. Consolidated net income for the first nine months increased
$92.1 million, or 68.1%, to $227.4 million, compared to $135.3 million for the
first nine months of 1998. 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,
discontinued operations, 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 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 and minority
interest basis. The following table reflects each segment's contribution to
adjusted net income and reconciliation to consolidated net income as adjusted
for these items.
Page 16
<PAGE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment income (loss) before federal
income taxes and minority
interest:
Risk Management $ 49.5 $ 24.6 $ 134.6 $ 97.2
------ ------ ------ ------
Asset Accumulation
Allmerica Financial Services 54.7 39.1 151.3 125.5
Allmerica Asset Management 5.7 6.9 18.2 17.0
------ ------ ------ ------
Subtotal 60.4 46.0 169.5 142.5
Corporate (13.7) (10.6) (43.2) (35.6)
------ ------ ------ ------
Segment income before federal
income taxes and minority
interest 96.2 60.0 260.9 204.1
Federal income taxes on
segment income (16.4) (10.7) (48.8) (39.3)
Minority interest on
preferred dividends (4.0) (4.0) (12.0) (12.0)
Minority interest on segment
income 0.0 (1.9) 0.0 (7.4)
------ ------ ------ ------
Adjusted net income 75.8 43.4 200.1 145.4
Adjustments (net of taxes,
minority interest and
amortization, as applicable):
Net realized investment
(losses) gains (16.7) 1.1 76.6 22.4
Other items 0.0 (20.2) 0.0 (20.8)
------ ------ ------ ------
Income from continuing
operations 59.1 24.3 276.7 147.0
Discontinued operations:
Loss from operations of
discontinued group life and
health business (net of
applicable taxes) (15.5) (16.1) (18.8) (11.7)
Loss on disposal of group life
and health business (net of
applicable taxes) (30.5) 0.0 (30.5) 0.0
------ ------ ------ ------
Net income $ 13.1 $ 8.2 $ 227.4 $ 135.3
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
The Company's segment income before taxes and minority interest increased
$36.2 million, or 60.3%, to $96.2 million in the third quarter of 1999. This
increase is primarily attributable to increased income of $24.9 million from
the Risk Management segment and $15.6 million from the Allmerica Financial
Services segment. The increase in the Risk Management segment was primarily
attributable to a $20.6 million increase in favorable development on prior
years' reserves and decreased catastrophe losses of $8.3 million. The
increase in the Allmerica Financial Services segment is primarily attributable
to higher asset-based fee income driven by growth and market appreciation
principally in the variable annuity product line, as well as in the variable
universal life product line, net of related expenses. These increases were
partially offset by a decrease of $1.2 million in the Allmerica Asset
Management segment primarily due to the absence, in 1999, of a $2.6 million
equity participation payment from a mortgage loan in 1998, partially offset by
increased interest margins on GICs. Additionally, the operating loss in the
Corporate segment increased primarily due to a reduction in net investment
income.
The effective tax rate for segment income was 17.0% for the third quarter
of 1999 compared to 17.6% for the third quarter of 1998. The decrease in the
tax rate was primarily a result of a change in reserves for prior years tax
liabilities.
Net realized losses on investments after taxes were $16.7 million in the third
quarter of 1999, resulting primarily from net realized losses on fixed
maturities and equity securities of $11.0 million and $5.9 million,
respectively. During the third quarter of 1998, net realized gains on
investments after taxes and minority interest of $1.1 million resulted
primarily from net realized gains on equity securities of $32.4 million,
partially offset by net realized losses of $16.9 million and $12.0 million on
fixed maturities and hedge fund partnerships, respectively.
Page 17
<PAGE>
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
The Company's segment income before taxes and minority interest increased
$56.8 million, or 27.8%, to $260.9 million in the first nine months of 1999.
This increase is attributable to increased income of $37.4 million from the
Risk Management segment, $25.8 million from the Allmerica Financial
Services segment and $1.2 million from the Allmerica Asset Management segment,
partially offset by additional losses of $7.6 million in the Corporate
segment. Risk Management segment income for the first nine months of 1999 is
primarily attributable to a $49.0 million increase in favorable development
on prior year reserves and a $16.9 million favorable impact related to the
whole account aggregate excess of loss reinsurance treaty ("aggregate excess
of loss reinsurance treaty") entered into during the first quarter of 1999.
Partially offsetting these favorable impacts is a $27.1 million increase in
current year claim activity, primarily in the commercial lines. The increase
in the Allmerica Financial Services segment of $25.8 million was primarily
attributable to higher asset-based fee income resulting from growth and market
appreciation principally in the variable annuity product line, as well as in
the variable universal life product line, net of related expenses. The
increase in the Allmerica Asset Management segment of $1.2 million is
principally due to increased interest margins on GICs and growth in income
from assets under management, partially offset by the aforementioned mortgage
loan equity participation interest received in 1998. The operating loss in
the Corporate segment increased primarily due to a reduction in net investment
income.
The effective tax rate for segment income was 18.7% for the first nine months
of 1999 compared to 19.3% for the first nine months of 1998. The decrease in
the tax rate was primarily a result of a change in reserves for prior
years tax liabilities.
Net realized gains on investments after taxes were $76.6 million in the first
nine months of 1999, resulting primarily from net realized gains on equity
securities and partnership investments of $93.2 million and $4.0 million,
respectively, partially offset by $22.2 million of after-tax realized losses
from impairments recognized on fixed maturities. The increase in net realized
gains on equity securities relates principally to the sale of $310.0 million
of appreciated equities in the property and casualty investment portfolio.
During the first nine months of 1998, net realized gains on investments after
taxes and minority interest of $22.4 million resulted primarily from net
realized gains from sales of appreciated equity securities of $45.4 million,
partially offset by $12.0 million and $8.6 million of losses from hedge fund
partnerships and fixed maturities, respectively.
During the second quarter of 1999, the Company approved a plan to exit its
group life and health insurance business, consisting of its EBS business, its
AGU business and its reinsurance pool business. During the third quarter of
1998, the Company ceased writing new premium in the reinsurance pool business,
subject to certain contractual obligations. Prior to 1999, these businesses
comprised substantially all of the former Corporate Risk Management Services
segment. Accordingly, the operating results of the discontinued segment,
including its reinsurance pool business, have been reported in the
Consolidated Statements of Income as discontinued operations in accordance
with Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions"
("APB Opinion No. 30"). In the third quarter of 1999, the operating results
from the discontinued segment were adjusted to reflect the recording of
additional reserves related to accident claims from prior years. On October 6,
1999, the Company entered into an agreement with Great-West Life and Annuity
Insurance Company of Denver, which provides for the sale of the Company's EBS
business effective March 1, 2000. The Company has recorded a $30.5 million
loss, net of taxes, on the disposal of its group life and health business.
Segment Results
The following is management's discussion and analysis of the Company's results
of operations by business segment. The segment results are presented before
taxes and minority interest and other items which management believes are not
indicative of overall operating trends, including realized gains and losses.
Page 18
<PAGE>
Risk Management
The following table summarizes the results of operations for the Risk
Management segment:
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net premiums written $ 522.9 $ 510.1 $1,505.3 $1,501.1
------ ------ ------- -------
Net premiums earned $ 499.6 $ 487.5 $1,451.8 $1,477.6
------ ------ ------- -------
Underwriting loss $ (5.7) $ (32.3) $ (37.4) $ (77.4)
Net investment and other
income 55.2 56.9 172.0 174.6
------ ------ ------- -------
Segment income before taxes
and minority interest $ 49.5 $ 24.6 $ 134.6 $ 97.2
====== ====== ======= =======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Premium
Risk Management's net premiums written increased $12.8 million, or 2.5%, to
$522.9 million for the quarter ended September 30, 1999, compared to $510.1
million for the same period in 1998. This increase is primarily attributable
to an increase in net premiums written in the workers' compensation line of
$8.0 million, or 18.3%, in addition to an increase in net premiums written in
the commercial automobile line of $5.1 million, or 10.9%. These increases in
net premiums written are primarily due to increases in policies in force of
12.6% in the workers' compensation line and 5.6% in the commercial automobile
line since September 30, 1998.
Risk Management's net premiums earned increased $12.1 million, or 2.5%, to
$499.6 million for the quarter ended September 30, 1999, compared to $487.5
million for the same period in 1998. This increase is primarily attributable
to an increase in net premiums earned in the workers' compensation line of
$5.8 million, or 13.2%, in addition to an increase in net premiums earned in
the commercial multiple peril line of $6.0 million, or 8.6%. The increase in
the workers' compensation line is primarily attributed to the aforementioned
increase in policies in force of 12.6% since September 30, 1998. The increase
in the commercial multiple peril line is the result of an increase in policies
in force of 2.8% since September 30, 1998, and an average rate increase of
2.6% since September 30, 1998.
Underwriting results
Risk Management's underwriting loss decreased $26.6 million to $5.7 million
for the quarter ended September 30, 1999, compared to $32.3 million for the
same period in 1998. The decrease is primarily attributable to a $20.6 million
increase in favorable development on prior years' reserves. Catastrophe
losses decreased $8.3 million to $20.2 million for the quarter ended September
30, 1999. In addition, homeowners' current accident year losses excluding
catastrophes improved due to decreased frequency and severity. Policy
acquisition and other underwriting expenses increased $7.1 million to $141.1
million for the quarter ended September 30, 1999, compared to $134.0 million
for the same period in 1998. This increase is primarily due to an increase in
net earned premiums and expenses associated with a business technology project
to automate the commercial lines underwriting process.
Distribution channel results
The following table summarizes the results of operations for the distribution
channels of the Risk Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended September 30, 1999
(In millions, Hanover Hanover Citizens Voluntary Allmerica Other
except ratios) North South Midwest Benefits Specialty <FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $164.8 $ 49.4 $142.4 $153.3 $ 10.0 $ 3.0 $522.9
Underwriting
(loss)
profit $ (6.9) $ (1.5) $ 5.1 $ 0.7 $ (3.4) $ 0.3 $
(5.7)
Statutory
combined
ratio <FN1> 103.8 103.3 101.1 97.9 117.1 N/M 101.3
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the results
of property and casualty insurance underwriting. This ratio is the sum of the
ratio of incurred claims and claim expenses to premiums earned and the
ratio of underwriting expenses incurred to premiums written. Federal
income taxes, net investment income and other non-underwriting expenses are
not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
Page 19
<PAGE>
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended September 30, 1998
(In millions, Hanover Hanover Citizens Voluntary Allmerica Other
except ratios) North South Midwest Benefits Specialty <FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $159.3 $ 51.8 $145.3 $139.2 $ 12.7 $ 1.8 $510.1
Underwriting
(loss) $ (8.9) $ (4.8) $(14.8) $ (1.2) $ (0.1) $ (2.5)
$(32.3)
Statutory
combined
ratio <FN1> 104.7 105.1 110.2 102.6 102.4 N/M
106.1
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the results
of property and casualty insurance underwriting. This ratio is the sum of the
ratio of incurred claims and claim expenses to premiums earned and the
ratio of underwriting expenses incurred to premiums written. Federal
income taxes, net investment income and other non-underwriting expenses are
not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
Hanover North
Hanover North's net premiums written increased $5.5 million, or 3.5%, to
$164.8 million for the quarter ended September 30, 1999, compared to $159.3
million for the same period in 1998. This increase is primarily attributable
to a $6.9 million increase in net premiums written in the commercial lines due
to an aggregate increase in policies in force of 8.6% since September 30,
1998. This was partially offset by a decrease of $0.9 million, or 3.3%, in
the homeowners' line.
Hanover North's underwriting results improved $2.0 million to an underwriting
loss of $6.9 million for the quarter ended September 30, 1999, compared to an
underwriting loss of $8.9 million for the same period in 1998. This
improvement in underwriting results is driven by a decrease of $8.1 million in
non-catastrophe claim activity primarily in the workers' compensation and
homeowners' lines. This is partially offset by a $1.5 million increase in
catastrophes and an increase in policy acquisition and other underwriting
expenses.
Hanover South
Hanover South's net premiums written decreased $2.4 million, or 4.6%, to $49.4
million for the quarter ended September 30, 1999, compared to $51.8 million
for the same period in 1998. The decrease is primarily due to a $3.3 million,
or 24.3%, decrease in personal automobile net premiums written due to the exit
from certain states in the South.
Underwriting results improved $3.3 million to an underwriting loss of $1.5
million for the quarter ended September 30, 1999, compared to $4.8 million for
the same period in 1998. The improvement in underwriting results is primarily
attributable to a $3.2 million decrease in policy acquisition and other
underwriting expenses due to consolidation of operations in the southern
region.
Citizens Midwest
Citizens Midwest's net premiums written decreased $2.9 million, or 2.0%, to
$142.4 million for the quarter ended September 30, 1999, compared to $145.3
million for the same period in 1998. This decrease is primarily attributable
to a decrease in the personal automobile line of $7.1 million, or 15.1%, to
$39.8 million, for the quarter ended September 30, 1999. This decrease is
attributable to rate decreases in the Michigan personal automobile line of
3.6% and 3.7% in the first quarter and third quarter of 1999, respectively,
due to continued competitive conditions in Michigan. In addition, homeowners'
net premiums written decreased $2.8 million due to a 9.7% decrease in policies
in force since September 30, 1998. These decreases are significantly offset
by increases of $3.8 million and $2.9 million in the workers' compensation and
commercial multiple peril lines, respectively, for the quarter ended September
30, 1999.
Citizens Midwest's underwriting results improved $19.9 million to an
underwriting profit of $5.1 million for the quarter ended September 30, 1999,
compared to an underwriting loss of $14.8 million for the same period in 1998.
The improvement in underwriting results is primarily the result of favorable
claims activity in the homeowners' and workers' compensation lines, and a $3.4
million decrease in catastrophe losses to $3.4 million for the quarter ended
September 30, 1999. Policy acquisition and other underwriting expenses
decreased $4.8 million primarily due to consolidation of regional operations.
Page 20
<PAGE>
Voluntary Benefits
Voluntary Benefits' net premiums written increased $14.1 million, or 10.1%, to
$153.3 million for the quarter ended September 30, 1999, compared to $139.2
million for the same period in 1998. This increase is primarily due to growth
of $8.9 million, or 8.4%, in the personal automobile line attributable to a
3.9% increase in policies in force since September 30, 1998. In addition,
homeowners' net written premium increased $3.3 million, or 10.7%, primarily
due to an increase in policies in force of 4.8%. Net premiums earned were
$140.0 million and $130.7 million for the quarters ended September 30, 1999
and 1998, respectively.
Underwriting results improved $1.9 million to an underwriting profit of $0.7
million for the quarter ended September 30, 1999, compared to an underwriting
loss of $1.2 million for the same period in 1998. The improvement in
underwriting results is attributable to a $5.9 million decrease in catastrophe
losses, and to improved severity in the personal automobile line. This is
partially offset by a $5.6 million increase in policy acquisition and other
underwriting expenses primarily attributed to premium growth and increased
marketing initiatives.
Specialty Markets
Specialty Markets' net premiums written decreased $2.7 million, or 21.3%, to
$10.0 million for the quarter ended September 30, 1999, compared to
$12.7 million for the same period in 1998. Net premiums earned were $13.3
million and $11.4 million for the quarters ended September 30, 1999 and 1998,
respectively.
Underwriting results deteriorated $3.3 million to a loss of $3.4 million for
the quarter ended September 30, 1999, compared to an underwriting loss of $0.1
million for same period in 1998. This deterioration in the underwriting loss
is primarily attributable to unfavorable claims activity.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Premium
Risk Management's net premiums written increased $4.2 million, or 0.3%, to
$1,505.3 million for the nine months ended September 30, 1999, compared to
$1,501.1 million in 1998. Net premiums written include ceded premiums of
$21.9 million for the aggregate excess of loss reinsurance treaty entered into
during the first quarter of 1999. Excluding the impact of this reinsurance
treaty, net premiums written increased $26.1 million, or 1.7%, primarily due
to increases of $17.2 million and $7.0 million in the workers' compensation
and commercial automobile lines, respectively. The increase in the workers'
compensation line is primarily attributable to an increase in policies in
force of 12.6% since September 30, 1998. The increase in the commercial
automobile line is principally due to a 3.0% rate increase and an increase in
policies in force of 5.6% since September 30, 1998.
Risk Management's net premiums earned decreased $25.8 million primarily as a
result of a $21.9 million decrease due to the aforementioned aggregate excess
of loss reinsurance treaty. In addition, net premiums earned decreased $13.8
million in the personal automobile line due to a 3.3% rate decrease and to a
0.9% decrease in policies in force since September 30, 1998. These decreases
are partially offset by increases of $6.6 million and $4.5 million in the
workers' compensation and commercial automobile lines, respectively.
Underwriting results
Risk Management's underwriting loss decreased $40.0 million, to $37.4 million,
for the nine months ended September 30, 1999, compared to an underwriting loss
of $77.4 million for the same period in 1998. The improvement in underwriting
results is primarily attributable to a $49.0 million increase in favorable
development on prior year reserves and a $16.9 million favorable impact from
the aggregate excess of loss reinsurance treaty. In addition, catastrophe
losses decreased $9.3 million for the nine months ended September 30, 1999.
Partially offsetting these favorable impacts is a $27.1 million increase in
current year claim activity, primarily in the commercial lines, and an $8.1
million deterioration in involuntary pool underwriting results.
Page 21
<PAGE>
Distribution channel results
The following table summarizes the results of operations for the distribution
channels of the Risk Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended September 30, 1999
(In millions, Hanover Hanover Citizens Voluntary Allmerica Other
except ratios) North South Midwest Benefits Specialty <FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $496.5 $149.9 $404.8 $419.5 $ 31.4 $ 3.2 $1,505.3
Underwriting
loss $ (9.1) $ (8.0) $ (3.6) $ (7.4) $ (2.0) $ (7.3) $
(37.4)
Statutory
combined
ratio<FN1> 103.9 107.1 105.2 106.7 104.4 N/M 102.0
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the results
of property and casualty insurance underwriting. This ratio is the sum of the
ratio of incurred claims and claim expenses to premiums earned and the
ratio of underwriting expenses incurred to premiums written. Federal
income taxes, net investment income and other non-underwriting expenses are
not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended September 30, 1998
(In millions, Hanover Hanover Citizens Voluntary Allmerica Other
except ratios) North South Midwest Benefits Specialty <FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $466.3 $157.6 $426.2 $407.2 $ 35.1 $ 8.7 $1,501.1
Underwriting
(loss)
profit $(36.6) $ (6.2) $(35.8) $ 5.1 $ (1.9) $ (2.0) $
(77.4)
Statutory
combined
ratio<FN1> 107.6 103.0 108.5 100.7 101.9 N/M 105.4
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the results
of property and casualty insurance underwriting. This ratio is the sum of the
ratio of incurred claims and claim expenses to premiums earned and the
ratio of underwriting expenses incurred to premiums written. Federal
income taxes, net investment income and other non-underwriting expenses are
not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
Hanover North
Hanover North's net premiums written increased $30.2 million, or 6.5%, to
$496.5 million for the nine months ended September 30, 1999, compared to
$466.3 million for the same period in 1998. Net premiums written in the
commercial lines increased $21.7 million, or 12.6%, for the nine months ended
September 30, 1999, primarily due to an increase in policies in force of 8.6%
since September 30, 1998. Personal automobile net premiums written increased
$6.1 million to $203.7 million, primarily driven by a 5.8% rate increase in
the Massachusetts personal automobile line resulting from the Company's
decision to reduce safe driver discounts.
Hanover North's underwriting results improved $27.5 million to an underwriting
loss of $9.1 million for the nine months ended September 30, 1999, compared to
an underwriting loss of $36.6 million for the same period in 1998. The
improvement in underwriting results is primarily attributable to improved
current year severity in the personal lines, as well as an increase in
favorable development on prior years' loss reserves in the personal automobile
line. In addition, catastrophe losses decreased $5.6 million.
Page 22
<PAGE>
Hanover South
Hanover South's net premiums written decreased $7.7 million, or 4.9%, to
$149.9 million for the nine months ended September 30, 1999, compared to
$157.6 million for the same period in 1998. The decrease is primarily due to
an $8.9 million, or 21.3%, decrease in the personal automobile line's net
premiums written, driven by a 21.0% decrease in policies in force since
September 30, 1998. This decline is attributable to the Company's decision to
exit certain markets in the South.
Underwriting results deteriorated $1.8 million from an underwriting loss of
$6.2 million for the nine months ended September 30, 1998, to a loss of $8.0
million for the same period in 1999. The decrease in underwriting results is
primarily attributable to a $2.8 million deterioration in workers'
compensation claims activity. This increase is partially offset by a decrease
in loss activity in the personal automobile line.
Citizens Midwest
Citizens Midwest's net premiums written decreased $21.4 million, or 5.0%, to
$404.8 million for the nine months ended September 30, 1999. This decrease is
primarily attributable to a $17.4 million decrease in the personal automobile
line's net premiums written to $121.1 million for the period ended September
30, 1999, compared to $138.5 million in the same period in 1998. This decline
is due to rate decreases in the Michigan personal automobile line of
3.6% and 3.7% in the and first quarter and third quarter of 1999,
respectively, due to continued competitive conditions in Michigan. In
addition, Citizens Midwest's net premiums written decreased $4.9 million as a
result of additional premiums ceded under the aggregate excess of loss
reinsurance treaty.
Citizens Midwest's underwriting results improved $32.2 million to an
underwriting loss of $3.6 million for the nine months ended September 30,
1999, from an underwriting loss of $35.8 million for the same period in 1998.
The improvement in underwriting results is attributable to an $8.9 million
decrease in catastrophe losses to $16.6 million in 1999, compared to $25.5
million in 1998. In addition, reductions in homeowners' and workers'
compensation non-catastrophe claims activity totaling $7.3 million and $8.3
million, respectively, also contributed to this improvement. Results were also
favorably impacted by $3.9 million due to the aforementioned aggregate excess
of loss reinsurance treaty.
Voluntary Benefits
Voluntary Benefits' net premiums written increased $12.3 million, or 3.0%, to
$419.5 million for the nine months ended September 30, 1999, compared to
$407.2 million for the same period in 1998. This increase is primarily
attributed to an increase in policies in force of 4.8%. This increase is
partially offset by a $12.6 million increase in ceded premiums written under
the aggregate excess of loss reinsurance treaty.
Underwriting results deteriorated $12.5 million to a loss of $7.4 million for
the nine months ended September 30, 1999, from an underwriting gain of $5.1
million for the same period in 1998. The deterioration in underwriting
results is primarily attributable to a $5.3 million increase in
catastrophe losses to $31.1 million in 1999, and increased non-catastrophe
claims activity in the homeowners' line. The deterioration in underwriting
results is also attributed to a $5.7 million increase in policy acquisition
and other underwriting expenses. Partially offsetting these unfavorable
factors is a $10.1 million increase in underwriting results due to the
aggregate excess of loss reinsurance treaty.
Specialty Markets
Specialty Markets' net premiums written decreased to $31.4 million
for the nine months ended September 30, 1999, compared to $35.1 million for
the same period in 1998. Net premiums earned increased $13.4 million to $39.4
million for the nine months ended September 30, 1999, from $26.0 million for
the same period in 1998.
Underwriting results for the nine months ended September 30, 1999 remained
consistent with the prior year.
Page 23
<PAGE>
Investment Results
Net investment income was $167.8 million and $171.5 million in the
first nine months of 1999 and 1998, respectively. This primarily reflects a
reduction in average fixed maturity assets of $90.9 million, or 2.5%, to
$3,581.0 million in 1999 compared to $3,671.9 million in 1998. The reduction
in average fixed maturities is due to transfers of securities to the Corporate
segment during the second quarter of 1999. Average pre-tax yields on debt
securities were 6.6% in 1999 and 6.7% in 1998.
Reserve for Losses and Loss Adjustment Expenses
The Risk Management segment maintains reserves for its property & casualty
products to provide for the Company's ultimate liability for losses and loss
adjustment expenses ("LAE") with respect to reported and unreported claims
incurred as of the end of each accounting period. These reserves are
estimates, involving actuarial projections at a given point in time, of what
management expects the ultimate settlement and administration of claims will
cost based on facts and circumstances then known, predictions of future
events, estimates of future trends in claim severity and judicial theories of
liability and other factors. The inherent uncertainty of estimating insurance
reserves is greater for certain types of property and casualty insurance
lines, particularly workers' compensation and other liability lines, where a
longer period of time may elapse before a definitive determination of ultimate
liability may be made, and where the technological, judicial and political
climates involving these types of claims are changing.
The Company regularly updates its reserve estimates as new information becomes
available and further events occur which may impact the resolution of
unsettled claims. Changes in prior reserve estimates are reflected in results
of operations in the year such changes are determined to be needed and
recorded.
The table below provides a reconciliation of the beginning and ending reserve
for unpaid losses and LAE as follows:
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
(In millions) 1999 1998
<S> <C> <C>
Reserve for losses and LAE, beginning of period $ 2,597.3 $ 2,615.4
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events of
current year 1,208.3 1,220.3
Decrease in provision for insured
events of prior years (141.9) (92.9)
--------- ---------
Total incurred losses and LAE 1,066.4 1,127.4
--------- ---------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to
insured events of current year 587.2 558.8
Losses and LAE attributable to
insured events of prior years 517.2 587.9
--------- ---------
Total payments 1,104.4 1,146.7
--------- ---------
Change in reinsurance recoverable
on unpaid losses 62.2 (9.7)
--------- ---------
Reserve for losses and LAE, end of period $ 2,621.5 $ 2,586.4
========= =========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $141.9 million and $92.9 million
for the nine months ended September 30, 1999 and 1998, respectively,
reflecting increased favorable development on reserves for both losses and
loss adjustment expenses.
Favorable development on prior years' loss reserves was $76.8 million and
$35.6 million for the nine months ended September 30, 1999 and 1998,
respectively. This increase of $41.2 million is primarily due to improved
personal automobile results in the Northeast and increased reinsurance
recoverables in the commercial multiple peril line. Favorable development on
prior year's loss adjustment expense reserves was $65.1 million and $57.3
million for the nine months ended September 30, 1999 and 1998, respectively.
This favorable development in both periods is primarily attributable to claims
process improvement initiatives taken by the Company over the past two years.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future.
Page 24
<PAGE>
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the Company varies by product.
Property and casualty insurance premiums are established before the amount of
losses and LAE, and the extent to which inflation may affect such expenses,
are known. Consequently, the Company attempts, in establishing rates, to
anticipate the potential impact of inflation in the projection of ultimate
costs. The impact of inflation has been relatively insignificant in recent
years. However, inflation could contribute to increased losses and LAE in the
future.
The Company regularly reviews its reserving techniques, its overall reserving
position and its reinsurance. Based on (i) review of historical data,
legislative enactments, judicial decisions, legal developments in impositions
of damages, changes in political attitudes and trends in general economic
conditions, (ii) review of per claim information, (iii) historical loss
experience of the Company and the industry, (iv) the relatively short-term
nature of most policies and (v) internal estimates of required reserves,
management believes that adequate provision has been made for loss reserves.
However, establishment of appropriate reserves is an inherently uncertain
process and there can be no certainty that current established reserves will
prove adequate in light of subsequent actual experience. A significant change
to the estimated reserves could have a material impact on the results of
operations.
Reinsurance
The Risk Management segment maintains a reinsurance program designed to
protect against large or unusual losses and allocated LAE activity. This
includes excess of loss reinsurance and catastrophe reinsurance. The Company
determines the appropriate amount of reinsurance based on the Company's
evaluation of the risks accepted and analyses prepared by consultants and
reinsurers and on market conditions including the availability and pricing of
reinsurance. Reinsurance contracts do not relieve the Company from its
obligations to policyholders. Failure of reinsurers to honor their
obligations could result in losses to the Company. The Company also believes
that the terms of its reinsurance contracts are consistent with industry
practice in that they contain standard terms with respect to lines of business
covered, limit and retention, arbitration and occurrence. Based on its review
of its reinsurers' financial statements and reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially sound.
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. Effective January 1,
1999, the Company retains $45.0 million of loss per occurrence, 10% of all
aggregate loss amounts in excess of $45.0 million up to $230.0 million and all
amounts in excess of $230.0 million under its catastrophe reinsurance program.
Under the Company'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, in the workers' compensation line, are retained 100%
by the Company, while amounts in excess of $30.5 million, in the general
liability line, are retained 100% by the Company.
Effective January 1, 1999, the Company entered into a whole account aggregate
excess of loss reinsurance agreement with a highly rated reinsurer. The
reinsurance agreement provides accident year coverage for the three years 1999
to 2001 for the Company's property and casualty business, and is subject to
cancellation or commutation annually at the Company's option. The program
covers losses and allocated loss adjustment expenses, including those incurred
but not yet reported, in excess of a specified whole account loss and
allocated LAE ratio. The annual and aggregate coverage limits for losses and
allocated LAE are $150.0 million and $300.0 million, respectively. The effect
of this agreement on results of operations in each reporting period is based
on losses and allocated LAE ceded, reduced by a sliding scale premium of 50.0-
67.0% depending on the size of the loss, and increased by a ceding commission
of 20.0% of ceded premium. In addition, net investment income is reduced for
amounts credited to the reinsurer. As a result of this agreement, the Company
recognized no benefit for the third quarter and a net benefit of $16.9 million
for the nine months ended September 30, 1999, based on year-to-date and annual
estimates of losses and allocated loss adjustment expenses for accident year
1999. The effect of this agreement on the results of operations in future
periods is not currently determinable, as it will be based both on future
losses and allocated LAE, and on the possible cancellation or commutation of
the agreement. The agreement may increase or decrease income in future
periods.
The Company, in the Risk Management segment, is subject to concentration of
risk with respect to reinsurance ceded to various residual market mechanisms.
As a condition to the ability to conduct certain business in various states,
the Company is required to participate in various residual market mechanisms
and pooling arrangements which provide various insurance coverages to
individuals or other entities that are otherwise unable to purchase such
coverage voluntarily provided by private insurers. These market mechanisms
and pooling arrangements include the Commonwealth Automobile Reinsurers and
the Michigan Catastrophic Claims Association.
Page 25
<PAGE>
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) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues
Premiums $ 8.3 $ 9.5 $ 44.7 $ 47.7
Fees 91.4 75.0 262.9 217.2
Investment and other income 100.5 89.9 291.2 273.1
------ ------ ------ ------
Total segment revenues 200.2 174.4 598.8 538.0
Policy benefits, claims and losses 71.2 73.6 245.4 241.5
Policy acquisition and
other operating expenses 74.3 61.7 202.1 171.0
------ ------ ------ ------
Segment income before taxes $ 54.7 $ 39.1 $ 151.3 $ 125.5
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Segment income before taxes increased $15.6 million, or 39.9%, to $54.7
million during the third quarter of 1999. This increase is primarily
attributable to higher asset-based fee income driven by growth and market
appreciation principally in the variable annuity product, line as well as in
the variable universal life product line, partially offset by higher policy
acquisition and other operating expenses. In addition, segment income in 1998
was negatively impacted by losses incurred on hedge fund partnership
investments.
Segment revenues increased $25.8 million, or 14.8%, in 1999 primarily due to
increased fees and other income. Fee income from annuities and individual
variable universal life policies increased $17.9 million, or 35.0%, in the
third quarter of 1999 due to additional deposits and market appreciation. In
addition, other income increased $6.1 million due primarily to higher
investment management fees resulting from growth and appreciation in variable
product assets under management. Financial Profiles, a financial software
company acquired during the third quarter of 1998, contributed $1.5 million of
this $6.1 million increase. Net investment income increased $4.5 million
quarter over quarter primarily due to the absence of hedge fund losses which
were incurred in 1998.
Policy benefits, claims and losses decreased $2.4 million, or 3.3%, to $71.2
million in the third quarter of 1999. This decrease was primarily due to more
favorable mortality experience in the traditional life line of business, as
well as decreased interest credited due to cancellations of certain accounts
in the group retirement business and asset transfers to the separate accounts.
These decreases were partially offset by an increase in the mortality reserve
related to the variable annuity line of business, additional growth in this
line, and the introduction in 1998 of a new annuity program which provides,
for a limited time, enhanced crediting rates on deposits made into the
Company's general account.
Policy acquisition and other operating expenses increased $12.6 million, or
20.4%, in the third quarter of 1999. This increase primarily results from
ongoing growth in the variable product lines. In addition, other operating
expenses relating to trail commissions in the annuity line of business and to
Financial Profiles increased $2.7 million and $1.6 million, respectively.
Also, policy acquisition expenses increased $2.5 million related to the
implementation of an enhanced valuation system for the annuity line of
business earlier in 1999.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Segment income before taxes increased $25.8 million, or 20.6%, to $151.3
million in the first nine months of 1999. This increase is primarily
attributable to higher asset-based fee income driven by growth and market
appreciation principally in the variable annuity product line, as well as in
the universal life product line, partially offset by higher policy benefits
and operating expenses. In addition, segment income in 1998 was negatively
impacted by losses incurred on hedge fund partnership investments.
Page 26
<PAGE>
Segment revenues increased $60.8 million, or 11.3%, in 1999 primarily due to
increased fees and other income. Fee income from annuities and individual
variable universal life policies increased $49.4 million, or 33.9%, in the
first nine months of 1999 compared to the same period in 1998 due to
additional deposits and market appreciation. In addition, investment and other
income increased $18.1 million due primarily to higher investment management
fees resulting from growth and appreciation in variable product assets under
management and the aforementioned acquisition of Financial Profiles. Also, net
investment income increased $2.3 million over the prior year principally due
to the absence of hedge fund losses which were incurred in 1998. These
increases were partially offset by a decrease in premiums of $3.0 million and
a decline in fees of $2.4 million primarily from the Company's continued shift
in focus from traditional and non-variable universal life insurance products
to variable life insurance and annuity products.
Policy benefits, claims and losses increased $3.9 million, or 1.6%, to $245.4
million during the first nine months of 1999. This increase was primarily due
to the Company's establishment of a $7.4 million mortality reserve in the
first quarter of 1999 related to the variable annuity line of business,
subsequent increases in this reserve of $3.5 million, and additional growth
in this line. In addition, annuity reserves increased $6.7 million due to the
introduction of the aforementioned new annuity program with enhanced crediting
rates. These increases were partially offset by more favorable mortality
experience in the Closed Block and individual variable universal life line of
business, as well as decreased interest credited due to cancellations of
certain accounts in the group retirement business.
Policy acquisition and other operating expenses increased $31.1 million, or
18.2%, in the nine months ended September 30, 1999. This increase was
primarily due to growth in the variable product lines. In addition, other
operating expenses relating to trail commissions in the annuity line of
business and to Financial Profiles increased $6.5 million and $5.9 million,
respectively. Partially offsetting these increases is a $6.0 million decline
in policy acquisition expenses resulting from the implementation of an
enhanced valuation system for the annuity line of business in the first
quarter of 1999. This decline consists of a one-time increase in the deferred
acquisition cost asset of $13.5 million, partially offset by increased ongoing
deferred acquisition expenses of approximately $7.5 million.
Statutory Premiums and Deposits
The following table sets forth statutory premiums and deposits by product for
the Allmerica Financial Services segment.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Insurance:
Traditional life $ 13.8 $ 9.8 $ 62.5 $ 45.5
Universal life 21.5 5.5 54.1 19.8
Variable universal life 45.7 39.2 134.8 115.8
Individual health 0.1 0.1 0.2 0.5
Group variable universal life 13.0 12.1 30.6 23.2
------- ------- ------- -------
Total Insurance 94.1 66.7 282.2 204.8
------- ------- ------- -------
Annuities:
Separate account annuities 429.9 652.9 1,439.0 2,120.0
General account annuities 201.5 207.4 663.3 382.5
Retirement investment accounts 4.0 4.2 13.5 16.4
------- ------- ------- -------
Total individual annuities 635.4 864.5 2,115.8 2,518.9
Group annuities 107.9 125.3 302.2 402.0
------- ------- ------- -------
Total annuities 743.3 989.8 2,418.0 2,920.9
------- ------- ------- -------
Total premiums and deposits $ 837.4 $1,056.5 $2,700.2 $3,125.7
======= ======= ======= =======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Total premiums and deposits decreased by $219.1 million, or 20.7%, in the
third quarter of 1999. This decrease is due primarily to lower individual
and group annuity deposits, partially offset by increased universal and
variable universal life insurance premiums. The decrease in individual
annuity deposits was caused by a sharp decrease in sales among third party
mutual fund advisors within the broker-dealer and financial planner
distribution channels. Decreases in sales at three specific advisors are
responsible for $220.2 million of the $229.1 million overall contraction
within this line. The decrease of $17.4 million in group annuity deposits is
due primarily to cancellations of certain accounts within the group
retirement business.
Page 27
<PAGE>
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
For the nine months ended September 30, 1999, total premiums and deposits
decreased $425.5 million, or 13.6 %, to $2,700.2 million. This decrease is
due primarily to the aforementioned decline in third party mutual fund
advisor sales, which through the nine months ended September 30, 1999, have
decreased $421.5 million over the same period in the prior year. In addition,
group annuity deposits are down slightly due primarily to cancellations of
certain accounts within the group retirement business.
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) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Interest margins:
Net investment income $ 38.7 $ 30.2 $ 107.0 $ 79.4
Interest credited 33.6 23.8 91.7 63.2
------ ------ ------ ------
Net interest margin 5.1 6.4 15.3 16.2
------ ------ ------ ------
Other income and expenses:
External investment advisory
fees and other income 1.4 1.1 4.4 2.3
Internal investment advisory
fees and other income 1.4 1.5 4.9 4.9
Other operating expenses 2.2 2.1 6.4 6.4
------ ------ ------ ------
Segment income before taxes $ 5.7 $ 6.9 $ 18.2 $ 17.0
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Income in the Allmerica Asset Management segment is generated by interest
margins earned on the Company's GICs and funding agreements, as well as
investment advisory fees earned on assets under management. Investment
advisory services are provided to affiliates and third parties, such as money
market and other fixed income clients. Related fees are based upon asset
balances under the Company's management. Segment income before taxes
decreased $1.2 million, or 17.4%, to $5.7 million. This decrease is primarily
attributable to a one-time $2.6 million mortgage loan equity participation
interest received in 1998. In addition, a slight decrease in segment income
is attributable to the sale of income producing securities in anticipation of
funding agreement withdrawals in the fourth quarter of 1999. Management
expects income from the GIC product line to be unfavorably impacted in future
periods due to the anticipated funding agreement withdrawals. These decreases
were partially offset by increased margins on GICs due to growth in the
funding agreement business, as well as increased investment advisory fees
resulting from increased assets under management from new and existing money
market and other external fixed income fund clients.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Segment income before taxes increased $1.2 million, or 7.1%, to $18.2 million.
This increase is primarily attributable to improved interest margins on GICs
and to growth in investment advisory fees on assets under management.
Excluding the 1998 effect of approximately $3.9 million, relating primarily to
the aforementioned mortgage loan equity participation interest and mortgage
prepayment fees, interest margins on GICs increased $3.0 million in 1999.
This increase is due to continued sales of funding agreements, partially
offset by withdrawals of traditional GICs. Outstanding GIC deposits increased
approximately $460.1 million as compared to the prior year. In addition,
income from assets under management grew $2.1 million in 1999 as a result of
increased business from new and existing money market and other external fixed
income fund clients.
Page 28
<PAGE>
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) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues
Investment and other income $ 1.3 $ 3.8 $ 4.9 $ 9.9
Interest expense 3.9 3.8 11.5 11.4
Other operating expenses 11.1 10.6 36.6 34.1
------ ------ ------ ------
Segment loss before taxes
and minority interest $ (13.7) $ (10.6) $ (43.2) $ (35.6)
====== ====== ====== ======
</TABLE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Segment loss before taxes and minority interest increased $3.1 million, or
29.2%, to $13.7 million in the third quarter of 1999 primarily due to a $2.5
million decrease in investment and other income and a $0.5 million increase in
other operating expenses. Investment income declined $2.1 million during the
third quarter of 1999 due to lower average invested assets. This decline
primarily reflects the sale of investments used to fund the Company's stock
repurchase program and the transfer of $125.0 million of assets from AFC to
FAFLIC as part of a 1999 capital contribution. These decreases were partially
offset by assets transferred from the Risk Management segment totaling $125.0
million and $225.0 million in April and May of 1999, respectively.
Interest expense for both periods relates primarily to the interest paid on
the Senior Debentures of the Company.
Other operating expenses for the quarter ended September 30, 1999 increased
$0.5 million, or 4.7%. This expense category consists primarily of corporate
overhead expenses, which reflect costs not attributable to a particular
segment, such as those generated by certain officers and directors, Corporate
Technology, Corporate Finance, Human Resources and the Legal department. The
increase in other operating expenses primarily reflects higher corporate
technology and overhead costs.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Segment loss before taxes and minority interest increased $7.6 million, or
21.3%, to $43.2 million for the nine months ended September 30, 1999.
Investment and other income decreased $5.0 million in 1999 primarily from
lower average invested assets. This decline primarily resulted from the sale
of investments used to fund the Company's stock repurchase program and the
aforementioned capital contribution to FAFLIC. These decreases were partially
offset by the aforementioned transfers of assets from the Risk Management
segment.
Interest expense for both periods relates primarily to the interest paid on
the Senior Debentures of the Company.
Other operating expenses increased $2.5 million, or 7.3%, primarily due to
$3.9 million of higher corporate technology and overhead costs, partially
offset by decreased expenses resulting from the Company's exit from certain
non-insurance businesses in 1998.
Page 29
<PAGE>
Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit its
group life and health insurance business, consisting of its EBS business, its
AGU business and its reinsurance pool business. Prior to 1999, these
businesses comprised substantially all of the former Corporate Risk Management
Services segment. The operating results of the discontinued segment have been
reported in the Consolidated Statements of Income as discontinued operations
in accordance with APB Opinion No. 30.
Reinsurance Pools
The reinsurance pools business consist primarily of assumed medical stop
loss business, the medical and disability portions of workers' compensation
risks, small group managed care pools, long-term disability and long-term care
pools, student accident and special risk business. During the third quarter
of 1998, the Company announced that it ceased writing new premium in the
reinsurance pool business, subject to certain contractual obligations.
Concurrent with the decision to exit the reinsurance pool business, the
Company entered into a reinsurance agreement that cedes current and future
underwriting losses, including unfavorable development of prior year reserves,
up to a $40.0 million maximum, relating to the reinsurance pool business. As
a result of this transaction, the Company recognized a $25.3 million loss in
the third quarter of 1998. In the third quarter of 1999, the Company
recognized estimated future losses future losses of $46.2 million.
EBS
The EBS business unit provides managed care products and offers group life,
medical, dental, and disability insurance to the middle market. On October 6,
1999, the Company entered into an agreement with Great-West Life and Annuity
Insurance Company of Denver, which provides for the sale of the Company's EBS
business effective March 1, 2000. The sales transaction effectively transfers
the business upon renewal subjecting the Company to losses on its existing
book during the runoff period. As required by APB Opinion No. 30, the loss
from disposal of the discontinued segment includes estimated net proceeds from
the aforementioned sale of the Company's EBS business of $26.1 million, as
well as an estimated future losses of $15.7 million, expected from the runoff
of EBS after the June 30,1999 measurement date. Accordingly, the Company
recognized a net gain from disposal of discontinued EBS business of $10.4
million. Net proceeds for the sale of $26.1 million are comprised of the
sales price, which is a function of persistency levels at March 1, 2000 and
2001, less estimated costs of sale, including severance, legal, and
retirement.
AGU
AGU operates as a Managing Group Underwriting unit offering members of
affinity groups medical, life and disability insurance. Estimated future
losses expected from runoff are $11.1 million.
The following table summarizes the loss from operations and disposal for the
discontinued group life and health insurance business for the periods
indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Loss from operations of
discontinued group life and
health business before
federal income taxes $ 23.9 $ 24.7 $ 28.9 $ 17.9
Federal income tax benefit (8.4) (8.6) (10.1) (6.2)
------ ------ ------ ------
Loss from operations of
discontinued group life
and health business, net
of taxes 15.5 16.1 18.8 11.7
------ ------ ------ ------
Loss from disposal of
discontinued group life and
health business before
federal income taxes 46.9 0.0 46.9 0.0
Federal income tax benefit (16.4) 0.0 (16.4) 0.0
------ ------ ------ ------
Loss income from disposal of
discontinued group life
and health business, net
of taxes 30.5 0.0 30.5 0.0
------ ------ ------ ------
Net loss from discontinued
segment $ 46.0 $ 16.1 $ 49.3 $ 11.7
====== ====== ====== ======
</TABLE>
Page 30
<PAGE>
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
The $23.9 million loss from operations for the quarter ended September 30,
1999 results from additional reserves provided for accident claims related to
prior years. The loss from operations for the quarter ended September 30,
1998 reflects primarily the $25.3 million loss recognized from the
aforementioned reinsurance agreement.
As required by APB Opinion No. 30, the loss from disposal of the discontinued
segment includes estimated proceeds from the aforementioned sale of the
Company's EBS business, as well as an estimate of future losses expected from
the runoff of the discontinued operations after the June 30, 1999 measurement
date. Accordingly, the Company recognized a loss from disposal of its group
life and health business of $46.9 million, which is comprised of the
following (in millions):
Proceeds from sale $ 26.1
Losses expected from runoff:
EBS (15.7)
Reinsurance pools (46.2)
AGU (11.1)
---------
$ (46.9)
=========
The provision for anticipated future losses on the runoff of discontinued
operations was established based on estimates of cash flows from the assets
supporting the discontinued products offset by estimates of cash flows
expected to meet the obligations of outstanding contracts and estimates of
cash flows expected to meet operational funding requirements. To the extent
that actual future losses differ from these estimates, the Company's reported
results from the disposal of the discontinued segment would be affected. The
Company believes the provision established appropriately reflects future
results. However, due to the inherent volatility in this segment, and to its
history of increased losses there can be no assurance that current reserves
are adequate and future losses will not arise.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
The $28.9 million loss from operations for the nine months ended September
30, 1999 results primarily from the aforementioned additional reserves
provided for accident claims related to prior years. The loss from operations
for the nine months ended September 30, 1998 of $17.9 million, reflects
primarily the $25.3 million loss recognized from the aforementioned
reinsurance agreement.
Investment Portfolio
The Company had investment assets diversified across several asset classes, as
follows:
<TABLE>
<CAPTION>
September 30, 1999<FN1> December 31, 1998<FN1>
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
<S> <C> <C> <C> <C>
Fixed maturities<FN2> $ 7,671.9 76.7% $ 8,195.0 79.0%
Equity securities<FN2> 100.9 1.0 397.1 3.8
Mortgages 683.9 6.8 698.3 6.7
Policy loans 367.9 3.7 365.2 3.5
Cash and cash equivalents 999.7 10.0 559.7 5.4
Real estate and other
invested assets 180.0 1.8 163.1 1.6
-------------------- --------------------
Total $10,004.3 100.0% $10,378.4 100.0%
==================== ====================
<FN>
<FN1> Includes Closed Block invested assets with a carrying value of $739.3
million and $770.5 million at September 30, 1999 and December 31, 1998,
respectively.
<FN2> The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
</FN>
</TABLE>
Total investment assets decreased $374.1 million, or 3.6%, to $10.0 billion
during the first nine months of 1999. This decrease resulted primarily from
decreased fixed maturities of $523.1 million and equity securities of $296.2
million, partially offset by an increase of $440.0 million of cash and cash
equivalents. The change in fixed maturities is principally due to new funding
agreement deposits which are more than offset by sales of assets in
anticipation of funding agreement redemptions, sales used for the repurchase
of AFC common stock under the stock repurchase program and a shift in assets
from the general to the separate accounts. In January 1999, sales of equity
securities resulted in proceeds of $310.0 million and realized gains of $116.0
million. Proceeds from the equity securities were used, in part, to repay the
loan used to fund the acquisition of minority interest of Citizens
Corporation. In addition, cash and cash equivalents increased $440.0 million
in anticipation of the aforementioned funding agreement redemptions.
Page 31
<PAGE>
The Company's fixed maturity portfolio is comprised of primarily investment
grade corporate securities, tax-exempt issues of state and local governments,
U.S. government and agency securities and other issues. Based on ratings by
the National Association of Insurance Commissioners, investment grade
securities comprised 84.5% and 84.7% of the Company's total fixed maturity
portfolio at September 30, 1999 and December 31, 1998, respectively. The
average yield on debt securities was 7.2% and 7.3% for the nine months ended
September 30, 1999 and 1998, 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 the asset valuation allowance and additions to
or deductions from such allowance for the periods indicated.
<TABLE>
<CAPTION>
(Dollars in millions) Mortgages
<S> <C>
Year Ended December 31, 1998
Beginning balance $ 20.7
Benefit (6.8)
Write-offs<FN1> (2.4)
-------
Ending balance $ 11.5
Valuation allowance as a percentage
of carrying value before reserves 1.6 %
Nine months ended September 30, 1999
Provision (0.5)
Write-offs<FN1> (0.1)
-------
Ending balance $ 10.9
=======
Valuation allowance as a percentage
of carrying value before reserves 1.6 %
<FN>
<FN1> Write-offs reflect asset sales, foreclosures and forgiveness of debt
upon restructurings.
</FN>
</TABLE>
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.
Quarter Ended September 30, 1999 Compared to Quarter Ended September 30, 1998
Provision for federal income taxes before minority interest and discontinued
operations was $14.4 million during the third quarter of 1999 compared to a
benefit of $0.3 million during the same period in 1998. The provision and
benefit resulted in consolidated effective federal tax rates of 18.6% and
(0.9%), respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 25.0% and 40.0% during the third quarter of
1999 and 1998, respectively. The effective tax rates for Allmerica P&C and
its subsidiaries were 12.7% and 12.3% during the third quarter of 1999 and
1998, respectively. The tax rate for AFLIAC and FAFLIC and its non-insurance
subsidiaries for 1999 primarily reflects a change in the reserves for prior
years tax liabilities. In 1998, a tax benefit from AFLIAC and FAFLIC and its
non-insurance subsidiaries resulted from a net loss primarily related to the
Company's sales practice litigation expense. The increase in the rate
for the Allmerica P&C subsidiaries is primarily the result of a decrease in
the proportion of tax exempt income to pre-tax income.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
The provision for federal income taxes before minority interest and
discontinued operations was $84.1 million during the first nine months of 1999
compared to $39.9 million during the same period in 1998. These provisions
resulted in consolidated effective federal tax rates of 22.6% and 19.0%,
respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 26.0% and 30.3% during the first nine months
of 1999 and 1998, respectively. The effective tax rates for Allmerica P&C and
its subsidiaries were 20.3% and 11.8% during the first nine months of 1999 and
1998, respectively. The 1999 tax rate for AFLIAC and FAFLIC and its non-
insurance subsidiaries primarily reflects a change in the reserves for prior
years tax liabilities, whereas the 1998 tax rate primarily reflects lower pre-
tax income due to the aforementioned sales practice litigation expense. The
increase in the rate for the Allmerica P&C subsidiaries is primarily the
result of a larger proportion of pre-tax income from realized capital gains in
1999, as well as improved underwriting results.
Page 32
<PAGE>
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. As a holding company,
AFC's primary source of cash is dividends from its insurance subsidiaries.
However, dividend payments to AFC by its insurance subsidiaries are subject to
limitations imposed by state regulators, such as the requirement that cash
dividends be paid out of unreserved and unrestricted earned surplus and
restrictions on the payment of "extraordinary" dividends, as defined.
During 1999, AFC received $350.0 million in extraordinary dividends from its
property and casualty businesses. These funds were principally used to
repurchase $250.2 million of AFC common stock and pay $39.9 million of
interest expense on the Senior Debentures and Capital Securities. Any
additional dividends from the property and casualty insurance companies to AFC
prior to April 2000 would require regulatory approval. During the third
quarter of 1999, the Company used the remaining funds from the aforementioned
dividends, as well as proceeds from sales of AFC holding Company investments,
to fund a $125.0 million capital contribution from AFC to FAFLIC. As of July
1, 1999, FAFLIC's ownership of Allmerica P&C, as well as several non-insurance
subsidiaries, were transferred from FAFLIC to AFC. Under an agreement with
the Commonwealth of Massachusetts Insurance Commissioner ("the Commissioner"),
AFC contributed the aforementioned $125.0 million and agreed to maintain
FAFLIC's statutory surplus at specified levels during the following six years.
Future capital contributions from AFC to FAFLIC may be required. In addition,
any dividend from FAFLIC to AFC during the remainder of 1999 and the years
2000 and 2001 would require the prior approval of the Commissioner.
During the first nine months of 1998, Hanover and FAFLIC declared dividends to
AFC of $125.0 million and $50.0 million, respectively. These funds were
transferred to the holding company in anticipation of the fourth quarter 1998
acquisition of the minority interest of Citizens and were temporarily invested
in short-term securities. In addition, AFC paid $39.9 million of interest
expense during the first nine months of 1998 on the Senior Debentures and
Capital Securities.
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 provided by operating activities was $15.3 million during the first
nine months of 1999, as compared to $7.1 million for the same period of 1998.
The increase in 1999 primarily resulted from the timing of recoveries of
reinsurance related to the universal life and variable universal life
reinsurance agreement, partially offset by a change in timing of reinsurance
payments relating to the property and casualty segment.
Net cash provided by investing activities increased $1,056.3 million to $496.6
million during the first nine months of 1999, as compared to cash used in
investing activities of $559.7 for the same period of 1998. This change is
primarily due to $215.2 million in net sales and maturities of available-for-
sale securities in 1999 as compared to net purchases of $657.1 million during
1998. In addition, net sales of equity securities increased approximately
$188.4 million in 1999.
Net cash used in financing activities was $71.9 million during the first nine
months of 1999, as compared to cash provided by financing activities of $726.7
million during the same period in 1998. During 1999, the Company experienced
a reduction of $357.3 million in net deposits for funding agreements as
compared to the first nine months of 1998. Also during 1999, the Company
repurchased AFC common stock with an aggregate cost of $250.2 million. In
addition, cash was used to repay $150.0 million in short term debt used to
finance the acquisition of the minority interest of Citizens Corporation.
AFC has sufficient funds at the holding company or available through dividends
from FAFLIC and Allmerica P&C, or through available credit facilities to meet
its obligations to pay interest on the Senior Debentures, Capital Securities
and dividends, when and if declared by the Board of Directors, on the common
stock. Whether the Company will pay dividends in the future depends upon the
costs of administering a dividend program as compared to the benefits
conferred, and upon the earnings and financial condition of AFC. On July 27,
1999, the Board of Directors declared an annual dividend of $0.25 per share on
the issued and outstanding common stock of the Company, payable November 15,
1999 to shareholders of record at the close of business November 1, 1999.
Page 33
<PAGE>
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. AFC has $150.0 million available under a committed
syndicated credit agreement which expires on May 28, 2000. 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. At September 30, 1999, no amounts were outstanding under
this agreement. The Company had $43.8 million of commercial paper borrowings
outstanding at September 30, 1999.
Contingencies
In July 1997, a lawsuit on behalf of a putative 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, the plaintiffs voluntarily dismissed the Louisiana suit and
filed a substantially similar action in Federal District Court in Worcester,
Massachusetts. In early November 1998, the Company and the plaintiffs entered
into a settlement agreement. The court granted preliminary approval of the
settlement on December 4, 1998. On May 19, 1999, the court issued an order
certifying the class for settlement purposes and granting final approval of
the settlement agreement. AFC recognized a $31.0 million pre-tax expense
during the third quarter of 1998 related to this litigation. Although the
Company believes that this expense reflects appropriate recognition of its
obligation under the settlement, this estimate assumes the availability of
insurance coverage for certain claims, and the estimate may be revised based
on the amount of reimbursement actually tendered by AFC's insurance carriers,
and based on changes in the Company's estimate of the ultimate cost of
the benefits to be provided to members of the class.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the Company's opinion, the
ultimate resolution of these proceedings will not have a material effect on
the Company's consolidated financial statements. However, liabilities related
to these proceedings could be established in the near term if estimates of the
ultimate resolution of these proceedings are revised.
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 require modification or replacement to enable its
computer systems to process dates beyond December 31, 1999. The Company is
presently completing the process of modifying or replacing existing software
and believes that 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 suppliers 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 Company's involvement on a third
party's Year 2000 program, 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 issue, there can be no assurance that exposure for material
contingencies will not arise.
Page 34
<PAGE>
The cost of the Year 2000 project will be expensed as incurred and is being
funded primarily through a reallocation of resources from discretionary
projects and a reduction in systems maintenance and support costs. Therefore,
the Year 2000 project is not expected to result in any significant incremental
technology cost, except as described above, and is not expected to have a
material effect on the results of operations. The Company has incurred and
expensed approximately $61 million related to the assessment plan development
and substantial completion of the Year 2000 project, through September 30,
1999. The total remaining cost of the project is estimated at between $10-15
million.
Approximately 10% of the Company's Year 2000 resources to be utilized in 1999
have been allocated to the Company's remediation plan, which has three mission
critical elements: internal systems, desktop systems, and external partners.
Internal Systems
All of the 613 AFC systems inventoried have been corrected, tested for year
2000 dates, and returned to production.
Desktop Systems
The Company has verified that all desktop computers are capable of correctly
processing year 2000 dates. Additionally, over 99% of the third party
software installed on the Company's desktop machines has been confirmed
capable of processing year 2000 dates properly. Any remaining desktop systems
will be upgraded, eliminated, or replaced prior to year end.
External Partners
The Company has tested and verified that 99% of its electronic interfaces will
process year 2000 dates correctly. Ninety-seven percent of the property and
casualty agents have confirmed that they are capable of properly processing
year 2000 dates. In addition, the Company has verified, through a process
that included, where appropriate, testing, written disclosure and personal
contact, that 94% of its non-electronic partners are capable of properly
processing year 2000 dates. Most external partners have informed the Company
that they expect to be compliant. The Company expects full compliance of
external partners in the fourth quarter of 1999, however, external partner
compliance is not under the Company's control. As such, the Company has
initiated a proactive program to track these remaining external partners.
Action plans are under development for those external partners not verified as
ready.
In partnership with an outside consulting firm, the Company has completed an
enterprise-wide Year 2000 business risk identification and assessment. The
Continuity of Operations Plan (COOP) requirements have been identified for all
business units of the Company and applicable plans are currently being
developed. These plans will contain immediate steps needed to keep business
functions operating while unforeseen Year 2000 issues are being addressed.
They outline responses to situations that may affect critical business
functions and also provide 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 along
with specialized Rapid Response Teams are designed to keep business unit
operations functioning in the event of a failure or delay due to year 2000
record format and date calculation changes. As of September 30, 1999, 96% of
the Company's contingency plans are complete. The Company expects the
remainder will be completed during the fourth quarter of 1999. Contingency
planning will utilize approximately 15% of the Company's Year 2000 resources
in 1999.
The remaining 75% of the Company's Year 2000 resources will be utilized to
address on-going compliance issues. These include periodic reviews of
applications, implementation of system control guidelines which includes
procedures to limit the amount of change introduced to its production and
infrastructure systems environment, installation and testing of new hardware
and software packages, testing new software maintenance and testing internally
developed software.
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 responsiveness and
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, the Year 2000 readiness of suppliers and business partners,
and similar uncertainties.
Page 35
<PAGE>
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 1999
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", "anticipates", "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 June 30, 1999 Form 10-Q.
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; as well as
continued compliance with state and federal regulations; (v) changes
in interest rates causing a reduction of investment income or in the market
value of interest rate sensitive investments; (vi) failure to obtain new
customers, retain existing customers or reductions in policies in force by
existing customers; (vii) higher service, administrative, or general expense
due to the need for additional advertising, marketing, administrative or
management information systems expenditures; (viii) loss or retirement of key
executives; (ix) increases in medical costs, including increases in
utilization, costs of medical services, pharmaceuticals, durable medical
equipment and other covered items; (x) termination of provider contracts or
renegotiations at less cost-effective rates or terms of payment; (xi) changes
in the Company's liquidity due to changes in asset and liability matching;
(xii) restrictions on insurance underwriting, based on genetic testing and
other criteria; (xiii) adverse changes in the ratings obtained from
independent rating agencies, such as Moody's, Standard and Poor's, A.M. Best,
and Duff & Phelps; (xiv) lower appreciation on and decline in value of managed
investments, resulting in reduced variable products, assets and related fees;
(xv) possible claims relating to sales practices for insurance products; (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;
(xviii) earlier than expected withdrawals from the Company's general account
annuities, GICs (including funding agreements), and other insurance products;
(xix) changes in the mix of assets comprising the Company's investment
portfolio and the fluctuation of the market value of such assets; and (xx)
losses resulting from the Company's participation in certain reinsurance
pools.
Page 36
<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 July 29, 1999, Allmerica Financial Corporation announced its financial
results for second quarter 1999 and its intent to exit its group life and
health insurance business.
Page 37
<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 12, 1999
/s/ John F. O'Brien
-------------------------------------
John F. O'Brien
President and Chief Executive Officer
Dated November 12, 1999
/s/ Edward J. Parry III
-------------------------------------
Edward J. Parry III
Vice President, Chief Financial
Officer, and Treasurer
Page38
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit
27 Financial Data Schedule
Page 39
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This Schedule contains summary financial information extracted from the
Consolidated Financial Statements of Allmerica Financial Corporation as of
September 30, 1999 and for the period then ended, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 7274
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 101
<MORTGAGE> 546
<REAL-ESTATE> 18
<TOTAL-INVEST> 8266
<CASH> 999
<RECOVER-REINSURE> 1205
<DEFERRED-ACQUISITION> 1334
<TOTAL-ASSETS> 29080
<POLICY-LOSSES> 2863
<UNEARNED-PREMIUMS> 911
<POLICY-OTHER> 2856
<POLICY-HOLDER-FUNDS> 2973
<NOTES-PAYABLE> 243
300
0
<COMMON> 1
<OTHER-SE> 2212
<TOTAL-LIABILITY-AND-EQUITY> 29080
1453
<INVESTMENT-INCOME> 470
<INVESTMENT-GAINS> 107
<OTHER-INCOME> 91
<BENEFITS> 1335
<UNDERWRITING-AMORTIZATION> 317
<UNDERWRITING-OTHER> 358
<INCOME-PRETAX> 373
<INCOME-TAX> 84
<INCOME-CONTINUING> 277
<DISCONTINUED> (49)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 227
<EPS-BASIC> 4.11
<EPS-DILUTED> 4.07
<RESERVE-OPEN> 2597
<PROVISION-CURRENT> 1208
<PROVISION-PRIOR> (142)
<PAYMENTS-CURRENT> 587
<PAYMENTS-PRIOR> 517
<RESERVE-CLOSE> 2622
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
