FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 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 office)
(Zip Code)
(508) 855-1000
(Registrant's telephone number, including area code)
_____________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 54,419,422
shares of common stock outstanding, as of May 1, 1999.
31
Total Number of Pages Included in This Document
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Interim Consolidated Financial Statements 8 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14 - 28
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions, except per
share data) 1999 1998
<S> <C> <C>
REVENUES
Premiums $ 539.3 $ 577.5
Universal life and investment
product policy fees 82.9 69.5
Net investment income 159.1 155.1
Net realized investment gains 131.4 29.2
Other income 40.9 32.6
------- -------
Total revenues 953.6 863.9
------- -------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 502.0 506.8
Policy acquisition expenses 93.4 117.2
Other operating expenses 150.7 140.6
------- -------
Total benefits, losses and expenses 746.1 764.6
------- -------
Income before federal income taxes 207.5 99.3
------- -------
Federal income tax expense(benefit)
Current 55.7 29.8
Deferred (6.3) (5.6)
------- --------
Total federal income tax expense 49.4 24.2
------- --------
Income before minority interest 158.1 75.1
Minority interest:
Distributions on mandatorily
redeemable preferred
securities of a subsidiary
trust holding solely junior
subordinated debentures
of the Company (4.0) (4.0)
Equity in earnings 0.0 (4.3)
------- -------
(4.0) (8.3)
------- -------
Net income $154.1 $ 66.8
======= =======
PER SHARE DATA
Basic
Net income $ 2.69 $ 1.11
======= =======
Weighted average shares
outstanding 57.3 59.9
======= =======
Diluted
Net income $ 2.67 $ 1.11
======= =======
Weighted average shares
outstanding 57.7 60.3
======= =======
Dividends declared to shareholders $ 0.00 $ 0.05
======= =======
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 3
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
(In millions, except per share data) 1999 1998
<S> <C> <C>
ASSETS
Investments:
Fixed maturities-at fair value (amortized
cost of $8,086.2 and $7,618.2) $ 8,203.8 $ 7,780.8
Equity securities-at fair value (cost of
$85.6 and $253.1) 98.5 397.1
Mortgage loans 538.5 562.3
Policy loans 157.1 154.3
Real estate and other long-term investments 165.2 163.1
--------- ---------
Total investments 9,163.1 9,057.6
--------- ---------
Cash and cash equivalents 495.1 550.3
Accrued investment income 139.1 142.3
Deferred policy acquisition costs 1,224.3 1,161.2
Reinsurance receivable on paid and unpaid
losses, benefits and unearned premiums 1,203.7 1,136.0
Deferred federal income taxes 81.0 19.8
Premiums, accounts and notes receivable, net 536.6 510.5
Other assets 483.6 529.4
Closed Block assets 805.3 803.1
Separate account assets 14,329.4 13,697.7
--------- ---------
Total assets $28,461.2 $27,607.9
========= =========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,816.9 $ 2,802.2
Outstanding claims, losses and loss
adjustment expenses 2,834.7 2,816.3
Unearned premiums 861.1 843.2
Contractholder deposit funds and other
policy liabilities 2,907.9 2,637.0
--------- ---------
Total policy liabilities and accruals 9,420.6 9,098.7
--------- ---------
Expenses and taxes payable 803.5 716.1
Reinsurance premiums payable 68.7 50.2
Short-term debt 84.7 221.3
Long-term debt 199.5 199.5
Closed Block liabilities 874.1 872.0
Separate account liabilities 14,322.6 13,691.5
--------- ---------
Total liabilities 25,773.7 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 10)
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 1,770.2 1,768.8
Accumulated other comprehensive income 75.3 180.5
Retained earnings 754.0 599.9
Treasury stock at cost (4.0 million and 1.8
million shares) (212.6) (91.2)
--------- ---------
Total shareholders' equity 2,387.5 2,458.6
--------- ---------
Total liabilities and shareholders' equity $28,461.2 $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)
Three Months Ended
March 31,
(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 1.4 8.4
-------- --------
Balance at end of period 1,770.2 1,763.4
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 180.5 217.9
Net(depreciation) appreciation on
available-for-sale securities (161.6) 25.1
Benefit (provision) for deferred federal
income taxes 56.4 (9.0)
Minority interest 0.0 (0.7)
-------- --------
Other comprehensive income (105.2) 15.4
-------- --------
Balance at end of period 75.3 233.3
-------- --------
RETAINED EARNINGS
Balance at beginning of period 599.9 407.8
Net income 154.1 66.8
Dividends to shareholders 0.0 (3.1)
------- --------
Balance at end of period 754.0 471.5
-------- --------
TREASURY STOCK
Balance at beginning of period (91.2) 0.0
Shares purchased at cost (121.4) 0.0
-------- --------
Balance at end of period (212.6) 0.0
-------- --------
Total shareholders' equity $2,387.5 $2,468.8
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 5
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Net income $154.1 $ 66.8
Other comprehensive income
Net(depreciation) appreciation on
available-for-sale securities (161.6) 25.1
Benefit (provision) for deferred federal
income taxes 56.4 (9.0)
Minority interest 0.0 (0.7)
------- --------
Other comprehensive income (105.2) 15.4
------- --------
Comprehensive income $ 48.9 $ 82.2
======= ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 6
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $154.1 $ 66.8
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Minority interest 0.0 4.3
Net realized gains (132.2) (29.2)
Net amortization and depreciation 8.8 7.7
Deferred federal income taxes (6.3) (5.6)
Change in deferred acquisition costs (52.8) (33.9)
Change in premiums and notes receivable,
net of reinsurance payable (7.5) 2.3
Change in accrued investment income 2.6 5.5
Change in policy liabilities and
accruals, net 46.7 3.1
Change in reinsurance receivable (67.6) (54.6)
Change in expenses and taxes payable 48.6 (53.0)
Separate account activity, net 47.4 1.1
Other, net (3.8) 9.7
------- --------
Net cash provided by (used in)
operating activities 38.0 (75.8)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities of
available-for-sale fixed maturities 630.5 568.8
Proceeds from disposals of equity securities 352.6 45.5
Proceeds from disposals of other
investments 14.9 37.0
Proceeds from mortgages matured or collected 29.7 62.8
Purchase of available-for-sale fixed maturities (1,078.1) (829.1)
Purchase of equity securities (48.1) (32.7)
Purchase of other investments (16.3) (50.7)
Capital expenditures (8.7) (1.7)
------- -------
Net cash used in investing activities (123.5) (200.1)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 697.3 443.5
Withdrawals from contractholder deposit funds (418.1) (207.9)
Change in short-term debt (136.5) 7.1
Proceeds from issuance of common stock 0.5 8.4
Purchase of treasury shares (121.4) 0.0
Dividends paid to shareholders 0.0 (3.3)
-------- --------
Net cash provided by financing activities 21.8 247.8
-------- --------
Net change in cash and cash equivalents (63.7) (28.1)
Net change in cash held in the Closed Block 8.5 25.1
Cash and cash equivalents, beginning of period 550.3 215.1
-------- --------
Cash and cash equivalents, end of period $495.1 $212.1
-------- --------
</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 subsidiaries), Allmerica Property &
Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance
holding company), The Hanover Insurance Company ("Hanover", a wholly-owned
subsidiary of Allmerica P&C), Citizens Corporation (a wholly-owned non-
insurance holding company 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 3).
The accompanying interim consolidated financial statements reflect, in the
opinion of the Company's management, all adjustments, consisting of only
normal and recurring adjustments, necessary for a fair presentation of
the financial position and results of operations. The results of
operations for the three months ended March 31, 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 ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("Statement No. 133"),
which establishes accounting and reporting standards for derivative
instruments. Statement No. 133 requires that an entity recognize all
derivatives as either assets or liabilities at fair value in the statement
of financial position, and establishes special accounting for the
following three types of hedges: fair value hedges, cash flow hedges, and
hedges of foreign currency exposures. This statement is effective for
fiscal years beginning after June 15, 1999. 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.
3. 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.
Page 8
<PAGE>
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.
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)
Three Months Ended
March 31,
(In millions) 1998
<S> <C>
Revenue $860.2
=======
Net realized capital gains included in revenue $ 28.6
=======
Income before taxes and minority interest $ 95.3
Income taxes (22.9)
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary trust
holding solely junior subordinated
debentures of the Company (4.0)
-------
Net income $ 68.4
=======
Net income per common share (basic and diluted) $ 1.14
=======
Weighted average shares outstanding(basic and diluted) 60.3
=======
</TABLE>
4. 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 50-67.5% depending on the size of the loss, and increased by a
ceding commission of 20% 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 a net benefit of $19.9 million,
based on annual and quarterly 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 March 31, 1999, under this
additional program the Company had repurchased an additional $4.0 million
of its issued common stock.
5. Federal Income Taxes
Federal income tax expense for the three months ended March 31, 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 9
<PAGE>
6. Other Comprehensive Income
The following table provides a reconciliation of gross unrealized (losses)
gains to the net balance shown in the Statement of Comprehensive Income:
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Unrealized (losses) gains on securities:
Unrealized holding (losses) gains
arising during period (net of taxes
and minority interest of $(26.2) million and
$16.1 million in 1999 and 1998) $ (11.3) $ 30.8
Less: reclassification adjustment
for gains included in net income
(net of taxes and minority interest
of $30.2 million and $6.4 million in
1999 and 1998) 93.9 15.4
-------- -------
Other comprehensive income $(105.2) $ 15.4
======== =======
</TABLE>
7. Closed Block
Included in other income in the Consolidated Statements of Income in the
first three months of 1999 and 1998 is a net pre-tax contribution from
the Closed Block of $4.6 million and $2.4 million, respectively.
Summarized financial information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
(In millions) 1999 1998
<S> <C> <C>
ASSETS
Fixed maturities-at fair value
(amortized cost of $410.0 and $399.1) $416.3 $414.2
Mortgage loans 134.4 136.0
Policy loans 208.3 210.9
Cash and cash equivalents 0.9 9.4
Accrued investment income 14.6 14.1
Deferred policy acquisition costs 14.6 15.6
Other assets 16.2 2.9
------ ------
Total assets $805.3 $803.1
====== ======
LIABILITIES
Policy liabilities and accruals $854.3 $862.9
Other liabilities 19.8 9.1
------ ------
Total liabilities $874.1 $872.0
====== ======
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
REVENUES
Premiums $27.2 $28.2
Net investment income 13.1 13.2
Net realized investment gains 0.8 0.0
----- -----
Total revenues 41.1 41.4
----- -----
BENEFITS AND EXPENSES
Policy benefits 35.5 37.7
Policy acquisition expenses 0.5 0.7
Other operating expenses 0.5 0.6
----- -----
Total benefits and expenses 36.5 39.0
----- -----
Contribution from the Closed Block $ 4.6 $ 2.4
===== =====
</TABLE>
Page 10
<PAGE>
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.
8. 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. 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.
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. This distribution channel
also offers products to members of affinity groups and other organizations
including the affinity group life and health business. During the first
two quarters of 1999, Allmerica Voluntary Benefits will include only the
Company's worksite group property and casualty business and affinity group
life and health business. Beginning in the third quarter of 1999,
Allmerica Voluntary Benefits will also include affinity group property and
casualty business which is currently included in Citizens Midwest,
Hanover North and Hanover South. Allmerica Specialty offers group life
and health products, as well as special niche property and casualty
products in selected markets. In addition, the Allmerica Specialty
distribution channel provides self-insurance administrative services
for individual and group risks and writes excess reinsurance coverage for
the self-insurance program. Previously, group life and health
business, affinity group life and health business and self-insurance
administrative services were included in the Corporate Risk Management
Services segment while all other Risk Management business was reflected
in the Property and Casualty segment.
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 traditional GICs, synthetic GICs 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, 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 its 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.
Page 11
<PAGE>
Summarized below is financial information with respect to business
segments for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Segment revenues:
Risk Management $619.1 $658.6
------- -------
Asset Accumulation
Allmerica Financial Services 204.7 191.2
Allmerica Asset Management 34.3 23.9
------- -------
Subtotal 239.0 215.1
------- -------
Corporate 1.2 2.0
Intersegment revenues (1.4) (2.1)
------- -------
Total segment revenues including Closed Block 857.9 873.6
Adjustments to segment revenues:
Adjustment for Closed Block (35.7) (38.9)
Net realized gains 131.4 29.2
------- -------
Total revenues $953.6 $863.9
======= =======
Segment income (loss) before income taxes
and minority interest:
Risk Management $ 35.2 $ 42.3
------- -------
Asset Accumulation
Allmerica Financial Services 48.9 42.2
Allmerica Asset Management 5.7 3.9
------- -------
Subtotal 54.6 46.1
------- -------
Corporate (16.0) (12.3)
------- -------
Segment income before income taxes and
minority interest 73.8 76.1
Adjustments to segment income:
Net realized investment gains,
net of amortization 133.7 23.9
Other items 0.0 (0.7)
------- -------
Income before taxes and minority interest $207.5 $ 99.3
======= =======
</TABLE>
<TABLE>
<CAPTION>
Identifiable Assets Deferred Acquisition Costs
(Unaudited) (Unaudited)
March 31, December 31, March 31, December 31,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Risk Management $ 6,215.2 $ 6,219.0 $ 166.9 $ 167.5
--------- --------- -------- --------
Asset Accumulation
Allmerica Financial
Services 19,978.9 19,416.6 1,056.9 993.1
Allmerica Asset
Management 2,237.6 1,810.9 0.5 0.6
--------- --------- --------- --------
Subtotal 22,216.5 21,227.5 1,057.4 993.7
Corporate 29.5 161.4 0.0 0.0
--------- --------- --------- --------
Total $28,461.2 $27,607.9 $1,224.3 $1,161.2
========= ========= ======== ========
</TABLE>
9. Earnings Per Share
The weighted average number of shares of common stock and equivalents
which were utilized in the calculation of basic earnings per share were
57.3 million and 59.9 million for the three months ended March 31, 1999
and 1998, respectively. This differs from the weighted average shares
outstanding used in the calculation of diluted earnings per share due to
the 0.3 million share effect of dilutive employee stock options and the
0.1 million share effect of non-vested stock grants for the periods ended
March 31, 1999 and 1998. This difference in weighted average shares
outstanding causes a $0.02 per share difference between basic and diluted
earnings per share for the period ended March 31, 1999 and was of
insufficient magnitude to cause any difference between basic and diluted
earnings per share for the period ended March 31, 1998.
Page 12
<PAGE>
10. 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, and following a hearing on March 19, 1999, the judge took the
matter under advisement pending his final determination. Accordingly,
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 13
<PAGE>
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations and
financial condition of the Company should be read in conjunction with the
interim Consolidated Financial Statements and related footnotes included
elsewhere herein.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
Subsidiaries ("AFC" or "the Company") include the accounts of AFC, First
Allmerica Financial Life Insurance Company ("FAFLIC") its wholly-owned
life insurance subsidiary, Allmerica Financial Life Insurance and Annuity
Company ("AFLIAC"), Allmerica Property & Casualty Companies, Inc.
("Allmerica P&C," a wholly-owned non-insurance holding company), The
Hanover Insurance Company ("Hanover," a wholly-owned subsidiary of Allmerica
P&C), Citizens Corporation (a wholly-owned non-insurance holding company 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.
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. This distribution channel also offers products
to members of affinity groups and other organizations including the affinity
group life and health business. During the first two quarters of 1999,
Allmerica Voluntary Benefits will include only the Company's worksite group
property and casualty business and affinity group life and health business.
Beginning in the third quarter of 1999, Allmerica Voluntary Benefits will
also include affinity group property and casualty business which is
currently included in Citizens Midwest, Hanover North and Hanover South.
Allmerica Specialty offers group life and health products, as well as
special niche property and casualty products in selected markets. In
addition, the Allmerica Specialty distribution channel provides
self-insurance administrative services for individual and group risks and
writes excess reinsurance coverage for the self-insurance program.
Previously, group life and health business, affinity group life and health
business and self-insurance administrative services were included in the
Corporate Risk Management Services segment while all other Risk Management
business was reflected in the Property and Casualty segment.
Page 14
<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 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
Quarter Ended March 31, 1999 Compared to Quarter Ended March 31, 1998
The Company's consolidated net income for the first quarter increased $87.3
million, or 130.7%, to $154.1 million, compared to the same period in 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,
extraordinary items, the cumulative effect of accounting changes and
certain other items. While these items may be significant components in
understanding and assessing the Company's financial performance, management
believes that the presentation of adjusted net income enhances its
understanding of the Company's results of operations by highlighting net
income attributable to the normal, recurring operations of the business.
However, adjusted net income should not be construed as a substitute for
net income determined in accordance with generally accepted accounting
principles.
Page 15
<PAGE>
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.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Segment income (loss) before income taxes
and minority interest:
Risk Management $ 35.2 $ 42.3
------- -------
Asset Accumulation
Allmerica Financial Services 48.9 42.2
Allmerica Asset Management 5.7 3.9
------- -------
Subtotal 54.6 46.1
Corporate (16.0) (12.3)
------- -------
Segment income before income taxes
and minority interest 73.8 76.1
Federal income taxes on segment income (15.0) (17.9)
Minority interest on preferred dividends (4.0) (4.0)
Minority interest on segment income 0.0 (3.8)
------- -------
Adjusted net income 54.8 50.4
Adjustments (net of taxes, minority interest
and amortization, as applicable):
Net realized investment gains 99.3 17.0
Other items 0.0 (0.6)
------- -------
Net income $ 154.1 $ 66.8
======= =======
</TABLE>
The Company's segment income before taxes and minority interest decreased
$2.3 million, or 3.0%, to $73.8 million in the first quarter of 1999. This
decrease is attributable to reduced income of $7.1 million from the Risk
Management segment and an increased loss of $3.7 million in the Corporate
segment, partially offset by increased income from the Asset Accumulation
group of $8.5 million. The decrease in the Risk Management segment was
primarily attributable to a $33.6 million increase in catastrophe losses,
partially offset by a benefit of $19.9 million resulting from a Whole
Account Aggregate Excess of Loss reinsurance treaty ("aggregate excess of
loss reinsurance treaty") entered into during the first quarter of 1999.
In addition, policy acquisition and other underwriting expenses decreased
$7.2 million reflecting a decrease in earned premium and declining
information systems costs. The operating loss in the Corporate segment
increased primarily due to higher technology costs, as well as a slight
reduction in net investment income. These items were partially offset by
an increase in the Allmerica Financial Services segment of $6.7 million,
principally due to higher asset-based fee income resulting from growth in
the variable annuity and variable universal life product lines, net of
related expenses. Additionally, Allmerica Asset Management segment income
increased $1.8 million due to growth in income from assets under management
and increased interest margins on GICs.
The effective tax rate for segment income was 20.3% for the first quarter
of 1999 compared to 23.5% for the first quarter of 1998. The decrease in
the tax rate was principally driven by a change in reserves for prior year
tax liability and an increase in low income housing tax credits.
Net realized gains on investments after taxes were $99.3 million in the
first quarter of 1999, resulting primarily from net realized gains on equity
securities of $101.9 million, partially offset by net realized losses on
fixed maturities of $9.1 million. This increase in net realized gains
relates principally to the sale of $310.0 million of appreciated equities
in the property and casualty investment portfolio. During the first
quarter of 1998, net realized gains on investments after taxes and minority
interest of $17.0 million resulted primarily from net realized gains on
equity securities and fixed maturities of $10.7 million and $6.5 million,
respectively.
Page 16
<PAGE>
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.
Risk Management
The following table summarizes the results of operations for the Risk
Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Net premiums written $ 558.2 $ 574.6
------- -------
Net premiums earned $ 538.6 $ 576.8
------- -------
Underwriting loss <F1> (31.1) (28.6)
Net investment and other income 66.3 70.9
------- -------
Segment income before taxes $ 35.2 $ 42.3
======= =======
<FN>
<F1> Includes gross profit on administrative services in addition to
underwriting results.
</FN>
</TABLE>
Three Months Ended March 31, 1999 Compared to Three Months Ended
March 31, 1998
Premium
Risk Management's net premiums written decreased $16.4 million, or 2.9%, to
$558.2 million during the first quarter of 1999, compared to $574.6 million
in the first quarter of 1998. The decrease is primarily attributable to an
aggregate excess of loss reinsurance treaty entered into during the first
quarter of 1999, resulting in additional ceded premiums written of $25.4
million. Excluding the impact of the reinsurance treaty, net premiums
written increased $9.0 million or 1.6%, attributable to increases of $11.7
million, and $1.9 million in the property & casualty commercial and personal
lines, respectively. The increase in commercial lines is driven by a 2.4%
increase in policies in force since March 31, 1998 and a 2.5% rate increase
in Michigan commercial policies. These increases are partially offset by a
$4.6 million decrease in group life and health net premiums written.
Risk Management net premiums earned decreased $38.2 million primarily
resulting from a $25.4 million decrease in net premiums earned due to the
aforementioned aggregate excess of loss reinsurance treaty. In addition,
net premiums earned decreased $4.6 million for group life and health and
$4.2 million in the personal auto line. Group life and health's decrease is
attributable to the Company's decision to exit its accident and health
assumed reinsurance pool business. The decrease in the personal auto line
is primarily attributable to rate decreases in the state of Michigan of
2.0% and 3.6% in the third quarter of 1998 and first quarter of 1999,
respectively, as well as a decrease in personal auto policies in force of
3.2% since March 31, 1998, primarily in Hanover South and Citizens Midwest.
Underwriting results
Risk Management's underwriting loss increased $2.5 million to $31.1 million
in the first quarter of 1999, compared to $28.6 million in the first quarter
of 1998. The decline in underwriting results is primarily attributable to a
$33.6 million increase in catastrophe losses to $43.7 million in the first
quarter of 1999, compared to $10.1 million for the same period in 1998.
This increase is partially offset by a net increase in underwriting results
of $19.6 million as a result of the aggregate excess of loss reinsurance
treaty. Policy acquisition and other underwriting expenses, excluding a
$5.1 million favorable impact from the aforementioned aggregate excess of
loss treaty, decreased $7.2 million or 4.0% in 1999, to $173.2 million
primarily reflecting the decrease in net premiums earned and declining
information systems costs.
Page 17
<PAGE>
The following table summarizes the results of operations for the
distribution channels of the Risk Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended March 31, 1999
Hanover Hanover Citizens Voluntary Allmerica
(In millions) North South Midwest Benefits Specialty Other Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $194.4 $50.6 $206.7 $18.6 $87.6 $ 0.3 $558.2
Underwriting (loss)
profit <F1> $ (9.9) $(3.1) $(14.0) $(4.2) $ 1.4 $(1.3) $(31.1)
Statutory combined
ratio <F2> 106.3% 107.7% 118.4% 108.9% 99.0% N/M 105.1%
<FN>
<F1> Includes gross profit on administrative services in addition to
underwriting results.
<F2> 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.
</FN>
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended March 31, 1998
Hanover Hanover Citizens Voluntary Allmerica
(In millions) North South Midwest Benefits Specialty Other Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $172.3 $53.4 $234.7 $16.9 $87.3 $10.0 $574.6
Underwriting (loss)
profit <F1> $(23.0) $ 1.0 $ 1.9 $(4.4) $(7.6) $ 3.5 $(28.6)
Statutory combined
ratio <F2> 113.9% 99.4% 99.4% 148.9% 134.6% N/M 104.8%
<FN>
<F1> Includes gross profit on administrative services in addition to
underwriting results.
<F2> 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.
</FN>
</TABLE>
Hanover North
Hanover North net premiums written increased $22.1 million, or 12.8% to
$194.4 million in the first quarter of 1999. This increase is primarily
due to an $11.5 million increase in net premiums written in the personal
auto line primarily driven by a 6.4% rate increase in Massachusetts
resulting from the Company's decision to reduce group and safe driver
discounts. In addition, Hanover North commercial lines net premiums
written increased $11.2 million in the first quarter of 1999 over the same
period in 1998. These increases are partially offset by a $3.7 million
decrease in net premiums written resulting from the aforementioned
aggregate excess of loss reinsurance treaty.
Hanover North's underwriting results improved $13.1 million from an
underwriting loss of $23.0 million for the first quarter of 1998, to a
loss of $9.9 million in 1999. The decrease in underwriting loss is
attributable to improved severity per claim in personal lines resulting
in a decrease in the statutory loss ratio for all lines to 63.1% in the
first quarter of 1999, from 69.6% for the same period in 1998. In
addition, net premiums earned increased $2.7 million, or 1.6%, to $176.7
million in the first quarter of 1999. This growth is attributed to the
6.4% rate increase in Massachusetts, noted above, and a 2.7% increase in
policies in force for all lines.
Hanover South
Hanover South had a decrease in net premiums written of 5.2% to $50.6
million in the first quarter of 1999. The decrease is primarily due to
a $3.4 million, or 22.7% decrease in the personal automobile lines net
premiums written, driven by a 27.5% decrease in policies in force since
March 31, 1998.
Underwriting results deteriorated $4.1 million from an underwriting gain of
$1.0 million for the first quarter of 1998, to a loss of $3.1 million
in 1999. The decrease in underwriting results is attributable to an $8.3
million decrease in net premiums earned to $49.4 million in the first
quarter of 1999 and a $3.6 million increase in catastrophe losses to
$5.8 million in the first quarter of 1999 compared to $2.2 million
in 1998. The decrease in net premiums earned is due to the
aforementioned decrease in personal auto policies in force, as well as
a 20.1% decrease in homeowners policies in force. These declines in
policies in force are attributable to the Company's decision to exit
certain markets in the South. Partially offsetting these unfavorable
impacts to underwriting results is a decline in personal auto claims
activity.
Page 18
<PAGE>
Citizens Midwest
Citizens Midwest net premiums written decreased 11.9% to $206.7 million
in the first quarter of 1999, primarily due to the $20.4 million decrease
in net premiums written from the aggregate excess of loss reinsurance
treaty. In addition, Citizens Midwest personal auto net premiums written
decreased $6.0 million to $120.2 million for the first quarter of 1999,
compared to the first quarter of 1998, due to rate decreases of 2.0% and
3.6% in the third quarter of 1998 and first quarter of 1999, respectively,
in the Michigan personal auto line.
Citizens Midwest's underwriting results deteriorated $15.9 million from an
underwriting gain of $1.9 million for the first quarter of 1998, to a loss
of $14.0 million in 1999. The increase in underwriting loss is
attributable to a $32.0 million increase in catastrophe losses to $31.7
million in the first quarter of 1999 compared to $(0.3) million in 1998.
In addition, net premiums earned were $206.4 million for the three months
ended March 31, 1999, a decrease of $27.1 million from the same period
in 1998. This decrease is primarily due to the $20.4 million decrease in
net premiums earned from the aggregate excess of loss reinsurance treaty.
In addition, personal auto net premiums earned decreased $4.9 million as a
result of the rate decreases noted above and a 1.5% decrease in policies
in force. Management believes that continued competitive conditions in
Michigan in the personal auto line may continue to impact future growth in
net premiums earned. These unfavorable factors were partially offset by a
$16.1 million favorable underwriting impact in Citizens Midwest from the
aggregate excess of loss reinsurance treaty.
Voluntary Benefits
Voluntary Benefit net premiums written, increased 10.1% to $18.6 million
in the first quarter of 1999 compared to $16.9 million for the same period
in 1998. The increase is primarily due to a decrease in group discounts
in the personal auto line. In addition, policies in force have increased
5.5% since March 31, 1998. Net premiums earned were $13.7 million and
$12.4 million for the three months ended March 31, 1999 and 1998,
respectively. Underwriting results improved $0.2 million from an
underwriting loss of $4.4 million for the first quarter of 1998, to a
loss of $4.2 million in 1999. The decrease in underwriting loss is
attributable to favorable claim activity and improved severity per
claim in the personal auto line of business.
Specialty Markets
Specialty Markets net premiums written increased 0.3% to $87.6 million in
the first quarter of 1999, compared to $87.3 million for the same period
in 1998. Net premiums earned were $89.7 million and $84.8 million for the
periods ended March 31, 1999 and 1998, respectively. Underwriting results
improved $9.0 million from an underwriting loss of $7.6 million for the
first quarter of 1998, to a gain of $1.4 million in 1999. The improvement
in underwriting results is attributable to a $2.4 million increase in
administrative service fee income and favorable current year claim activity
in the group life and health and special niche property & casualty
products.
Investment Results
Net investment income before tax was $63.2 million and $65.0 million in
the first quarter of 1999 and 1998, respectively. This primarily reflects
a reduction in average invested assets as a result of a $117.1 million
transfer of assets to the Corporate segment in April 1998. Average
pre-tax yields on debt securities decreased to 6.7% in 1999 compared to
6.8% for 1998. Average invested assets decreased $219.7 million, or 5.1%,
to $4,057.7 million in 1999 compared to $4,277.4 million 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.
Page 19
<PAGE>
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE as follows:
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Reserve for losses and LAE, beginning of year $2,597.3 $2,615.4
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events of
current year 397.0 396.0
Decrease in provision for insured
events of prior years (46.7) (28.5)
-------- --------
Total incurred losses and LAE 350.3 367.5
-------- --------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured
events of current year 139.3 116.2
Losses and LAE attributable to
insured events of prior years 229.5 260.2
-------- --------
Total payments 368.8 376.4
Change in reinsurance recoverable
on unpaid losses 34.6 (1.1)
-------- --------
Reserve for losses and LAE, end of year $2,613.4 $2,605.4
======== ========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $46.7 million and $28.5 million
for the first three months ended March 31, 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 $27.8 million and
$10.4 million for the three months ended March 31, 1999 and 1998,
respectively. This increase of $17.4 million is primarily due to improved
personal auto results in Hanover North and commercial auto results in
Citizens Midwest. Favorable development on prior year's loss adjustment
expense reserves was $18.9 million and $18.1 million for the first quarters
in 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.
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.
Page 20
<PAGE>
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 50-67.5% depending on the
size of the loss, and increased by a ceding commission of 20% 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 a net benefit of $19.9 million, based on annual and quarterly
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 arrangement include the Commonwealth
Automobile Reinsurers (CAR) and the Michigan Catastrophic Claims
Association (MCCA).
As part of the strategy of exiting the accident and health assumed
reinsurance pool business, the Company entered into an agreement that
cedes the underwriting loss from this business from July 1, 1998 to
December 31, 2000 up to an aggregate of $40.0 million. All amounts in
excess of $40.0 million will be 100% retained by the Company.
Page 21
<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)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Segment revenues
Premiums $ 27.9 $ 28.9
Fees 82.9 69.5
Investment and other income 93.9 92.8
----- -----
Total segment revenues 204.7 191.2
Policy benefits, claims and losses 98.4 93.5
Policy acquisition and other operating expenses 57.4 55.5
----- -----
Segment income before taxes $ 48.9 $ 42.2
===== =====
</TABLE>
Three Months Ended March 31, 1999 Compared to Three Months Ended
March 31, 1998
Segment income before taxes increased $6.7 million, or 15.9%, to $48.9
million in the first quarter of 1999. This increase is primarily
attributable to higher asset-based fee income driven by growth in the
variable annuity and variable universal life product lines, partially
offset by higher policy benefits and other operating expenses incurred
as a result of this growth.
Segment revenues increased $13.5 million, or 7.1%, in 1999 primarily due
to increased fees and other income, partially offset by a decrease in net
investment income. Fee income from annuities and individual variable
universal life policies increased $15.3 million, or 34.4%, in the first
quarter of 1999 due to additional deposits and market appreciation. In
addition, other income increased $5.1 million due primarily to higher
investment management fees resulting from growth and appreciation in
variable product assets under management. These increases were partially
offset by reduced income from mortgage loans. Additionally, decreases in
net investment income resulted from a reduction in average invested assets
due to the run-off of non-variable universal life business and cancellation
of certain accounts in the group retirement business, as well as an ongoing
shift in assets from the general account to the separate accounts.
Policy benefits, claims and losses increased $4.9 million, or 5.2%, to $98.4
million in the first quarter of 1999. This increase is primarily due to the
Company's establishment of a $7.4 million mortality reserve related to the
variable annuity line of business, additional growth in this line, and the
introduction in the second quarter of 1998 of a new annuity program which
provides, for a limited time, enhanced crediting rates on deposits made into
the Company's general account. Partially offsetting these increases were
more favorable mortality experience in the Closed Block and non-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 $1.9 million, or
3.4%, in the first quarter of 1999. This increase primarily results from
ongoing growth in the variable product lines, as well as increased
operating expenses related to the Company's investment management
business. In addition, other operating expenses related to claims
handling costs in the individual disability line of business and trail
commissions in the annuity line of business increased $2.0 million and
$1.6 million, respectively. Partially offsetting these increases is an
$11.0 million net decrease in deferred policy acquisition expenses related
to the implementation of a new valuation system for the variable annuity
line of business.
Page 22
<PAGE>
Interest Margins
The results of the Allmerica Financial Services segment depend, in part, on
the maintenance of profitable margins between investment results from
investment assets supporting universal life and general account annuity
products and the interest credited on those products.
The following table sets forth interest earned, interest credited and the
related interest margin.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Net investment income $28.3 $32.9
Less: Interest credited 23.5 23.1
---- ----
Interest margins <F1> $ 4.8 $ 9.8
==== ====
<FN>
<F1> Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal
life and general account annuity policies. Earnings on surplus
assets are excluded from net investment income in the calculation
of the above interest margins.
</FN>
</TABLE>
Interest margins decreased in the first three months of 1999 due to reduced
income from mortgage loans, a shift in assets to other product lines, and
to the introduction of the aforementioned annuity program with enhanced
crediting rates.
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica
Asset Management segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Interest margins on GICs
Net investment income $31.4 $21.6
Interest credited 26.6 17.5
---- ----
Net interest margin 4.8 4.1
---- ----
Other income and expenses
External fees and other income 1.4 0.6
Internal fees and other income 1.5 1.7
Other operating expenses 2.0 2.5
---- ----
Segment income before taxes $ 5.7 $ 3.9
==== ====
</TABLE>
Three Months Ended March 31, 1999 compared to Three Months Ended
March 31, 1998
Segment income before taxes increased $1.8 million, or 46.2%, to $5.7
million. This increase is attributable to growth in income from assets
under management and increased interest margins on GICs. External fees
increased as a result of new deposits from money market fund and other
fixed income fund clients. Interest margins on GICs increased slightly
since the first quarter of 1998, primarily as a result of continued sales
of funding agreements.
Page 23
<PAGE>
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended
March 31,
(In millions) 1999 1998
<S> <C> <C>
Segment revenues
Investment and other income $ 1.2 $ 2.0
Interest expense 3.8 3.8
Other operating expenses 13.4 10.5
------- -------
Segment loss before taxes and
minority interest $ (16.0) $ (12.3)
======= =======
</TABLE>
Three Months Ended March 31, 1999 compared to Three Months Ended
March 31,1998
Segment loss before taxes and minority interest increased $3.7 million, or
30.1%, to $16.0 million in the first quarter of 1999 primarily due to an
increase in expenses and a reduction in investment income. Other operating
expenses consist 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 $2.9 million increase in other
operating expenses is primarily the result of increased corporate technology
costs. Additionally, investment income decreased primarily due to the sale of
fixed maturity investments to fund the Company's stock repurchase program.
Interest expense for both periods relates solely to the interest paid on the
Senior Debentures of the Company.
Investment Portfolio
The Company had investment assets diversified across several asset classes,
as follows:
<TABLE>
<CAPTION>
March 31, 1999<F1> December 31,1998<F1>
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
<S> <C> <C> <C> <C>
Fixed maturities<F2> $ 8,620.1 82.7% $ 8,195.0 79.0%
Equity securities<F2> 98.5 0.9 397.1 3.8
Mortgages 672.9 6.5 698.3 6.7
Policy loans 365.4 3.5 365.2 3.5
Cash and cash
equivalents 496.0 4.8 559.7 5.4
Real estate and other
invested assets 165.2 1.6 163.1 1.6
----------- ------- ----------- -------
Total $10,418.1 100.0% $10,378.4 100.0%
=========== ======= =========== =======
<FN>
<F1> Includes Closed Block invested assets with a carrying value of
$759.9 million and $770.5 million at March 31, 1999 and
December 31, 1998, respectively.
<F2> The Company carries the fixed maturities and equity securities in
its investment portfolio at market value.
</FN>
</TABLE>
Total investment assets increased $39.7 million, or 0.4%, to $10.4 billion
during the first quarter of 1999. This increase results primarily from
increased fixed maturities of $425.1 million, partially offset by a decrease
of $298.6 million of equity securities. The increase in fixed maturities is
principally due to new funding agreement deposits. In January 1999, sales of
equity securities resulted in proceeds of $310.0 million and realized gains
of $116.0 million. In addition, mortgages decreased $25.4 million
principally due to loan repayments.
Proceeds from the equity sales were used, in part, to repay the loan used to
fund the acquisition of minority interest of Citizens Corporation. In
addition, the decrease in cash and cash equivalents was due, in part, to the
repurchase of AFC common stock under the stock repurchase program. The
cancellation of certain accounts in the group retirement business and the
maturation of several traditional GICs also reduced the cash balances.
Page 24
<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 85.5% and 84.7% of the Company's total fixed maturity
portfolio at March 31, 1999 and December 31, 1998, respectively. The average
yield on debt securities was 7.1% and 7.4% for the three months ended March
31, 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 <F1> (2.4)
----------
Ending balance $ 11.5
Valuation allowance as a
percentage of carrying value
before reserves 1.6%
Three months ended March 31, 1999
Ending balance $ 11.5
==========
Valuation allowance as a
percentage of carrying value
before reserves 1.7%
<FN>
<F1> 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.
Provision for federal income taxes before minority interest was $49.4 million
during the first quarter of 1999 compared to $24.2 million during the same
period in 1998. These provisions resulted in consolidated effective federal
tax rates of 23.8% and 24.4%, respectively. The effective tax rates for
AFLIAC and FAFLIC and its non-insurance subsidiaries were 29.8% and 31.6%
during the first quarter of 1999 and 1998, respectively. The effective tax
rates for Allmerica P&C and its subsidiaries were 20.7% and 13.7% during the
first quarter of 1999 and 1998, respectively. The increase in the rate for
the Allmerica P&C subsidiaries primarily reflects a larger proportion of
pre-tax income from realized capital gains in 1999.
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. On March 12, 1999, Hanover declared
a dividend to Allmerica P&C of $125.0 million, which was paid April 1, 1999.
These funds were subsequently used to repurchase certain shares of Allmerica
P&C's common stock held by AFC.
Sources of cash for the Company's insurance subsidiaries are from premiums
and fees collected, investment income and maturing investments. Primary cash
outflows are paid benefits, claims, losses and loss adjustment expenses,
policy acquisition expenses, other underwriting expenses and investment
purchases. Cash outflows related to benefits, claims, losses and loss
adjustment expenses can be variable because of uncertainties surrounding
settlement dates for liabilities for unpaid losses and because of the
potential for large losses either individually or in the aggregate. The
Company periodically adjusts its investment policy to respond to changes in
short-term and long-term cash requirements.
Page 25
<PAGE>
Net cash provided by operating activities was $38.0 million during the first
quarter of 1999, compared to cash used in operating activities of $75.8
million for the same period of 1998. The change in 1999 was primarily due to
the timing of settlements related to receivable balances with the Company's
Separate Accounts. This receipt of cash was partially offset by cash used to
fund increased commissions and other deferrable expenses related to continued
growth in the variable annuity product lines of the Allmerica Financial
Services segment.
Net cash used in investing activities was $123.5 million during the first
three months of 1999, compared to $200.1 million during the same period in
1998. This change is primarily due to the $310.0 million sale of equity
securities in January 1999, partially offset by increased net purchases of
fixed maturities. Fixed maturity purchases totaling $187.3 million resulted
from an increase in funds available from funding agreement sales. In
addition, net proceeds from real estate and other long-term investments
decreased $26.2 million.
Net cash provided by financing activities was $21.8 million during the first
three months of 1999, as compared to $247.8 million during the comparable
prior year period. In 1999, cash was used to repay $150.0 million in short
term debt used to finance the acquisition of the minority interest of
Citizens Corporation, and to repurchase AFC common stock with an aggregate
cost of $121.4 million. These uses of cash were partially offset by an
increase in net GIC deposits of $43.6 million during the first quarter as
compared to the same period in 1998.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C to meet its obligations to pay
interest on the Senior Debentures, Capital Securities and dividends, when
and if declared by the Board of Directors, on the common stock. Whether the
Company will pay dividends in the future depends upon the costs of
administering a dividend program as compared to the benefits conferred, and
upon the earnings and financial condition of AFC.
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and long-term cash
requirements. The Company maintains a high degree of liquidity within the
investment portfolio in fixed maturity investments, common stock and short-
term investments. AFC has $150.0 million available under a committed
syndicated credit agreement which expires on May 28, 1999. Borrowings under
this agreement are unsecured and incur interest at a rate per annum equal to,
at the Company's option, as designated base rate or the eurodollar rate plus
applicable margin. At March 31, 1999, no amounts were outstanding under this
agreement. The Company had $84.7 million of commercial paper borrowings
outstanding at March 31, 1999. AFC had no repurchase agreements outstanding
as of March 31, 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, and following a hearing on March 19,
1999, the judge took the matter under advisement pending his final
determination. Accordingly, 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, based
on the advice of legal counsel, the ultimate resolution of these proceedings
will not have a material effect on the Company's consolidated financial
statements. However, liabilities related to these proceedings could be
established in the near term if estimates of the ultimate resolution of
these proceedings are revised.
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.
Page 26
<PAGE>
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.
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 $57 million related to the assessment
plan development and substantial completion of the Year 2000 project, through
March 31, 1999. The total remaining cost of the project is estimated at
between $10-20 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
Over 99% of the Company's internal systems have been corrected, tested for
year 2000 dates, and returned to production. The remaining systems, which
include relatively small systems waiting for vendor upgrade or scheduled for
elimination or replacement, are targeted to be completed by June 30, 1999.
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. The remaining desktop
systems are expected to be upgraded, eliminated, or replaced by June 30,
1999.
External Partners
The Company has verified that 85% of its electronic interfaces will process
year 2000 dates correctly. Eighty-four 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 that 84% 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 hopes for full compliance of external partners by July 1, 1999.
Page 27
<PAGE>
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.
It outlines responses to situations that may affect critical business
functions and also provides triage guidance, a documented order of actions
to respond to problems. During the triage process, business priorities are
established and "Critical Points of Failure" are identified as having a
significant impact on the business. The Company's contingency plans are
designed to keep business unit operations functioning in the event of a
failure or delay due to year 2000 record format and date calculation changes.
All plans, including individual plans by business segment, are scheduled to
be completed by September 30, 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, 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.
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", "anticipated", "expects" and similar
expressions are intended to identify forward looking statements. See
"Important Factors Regarding Forward-Looking Statements" filed as Exhibit
99-2 to the Company's Annual Report on Form 10-K for the period ended
December 31, 1998.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include among others, the following possibilities: (i)
adverse catastrophe experience and severe weather; (ii) adverse loss
development for events the Company insured in prior years or adverse trends
in mortality and morbidity; (iii) heightened competition, including the
intensification of price competition, the entry of new competitors, and the
introduction of new products by new and existing competitors; (iv) adverse
state and federal legislation or regulation, including decreases in rates,
limitations on premium levels, increases in minimum capital and reserve
requirements, benefit mandates, limitations on the ability to manage care and
utilization, and tax treatment of insurance and annuity products; (v) changes
in interest rates causing a reduction of investment income or in the market
value of interest rate sensitive investments; (vi) failure to obtain new
customers, retain existing customers or reductions in policies in force by
existing customers; (vii) higher service, administrative, or general expense
due to the need for additional advertising, marketing, administrative or
management information systems expenditures; (viii) loss or retirement of key
executives; (ix) increases in medical costs, including increases in
utilization, costs of medical services, pharmaceuticals, durable medical
equipment and other covered items; (x) termination of provider contracts or
renegotiations at less cost-effective rates or terms of payment; (xi) changes
in the Company's liquidity due to changes in asset and liability matching;
(xii) restrictions on insurance underwriting, based on genetic testing and
other criteria; (xiii) adverse changes in the ratings obtained from
independent rating agencies, such as Moody's, Standard and Poor's, A.M.
Best, and Duff & Phelps; (xiv) lower appreciation on and decline in value of
managed investments, resulting in reduced variable products, assets and
related fees; (xv) possible claims relating to sales practices for insurance
products; (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; and (xix) changes in the mix of assets comprising
the Company's investment portfolio and the fluctuation of the market value of
such assets.
Page 28
<PAGE>
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX - 27 Financial Data Schedule
(b) Reports on Form 8K
On February 5, 1999, Allmerica Financial Corporation announced its financial
results for the year ended December 31, 1998 and that first quarter
results will be negatively impacted by catastrophe losses resulting from
severe winter storms and adverse weather.
On March 24, 1999, Allmerica Financial Corporation announced that the
Company's board of directors has authorized the expenditure of up to an
additional $200 million to repurchase outstanding shares of its own common
stock in an ongoing stock repurchase program.
Page 29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
Registrant
Dated May 13, 1999
/s/ John F. O'Brien
John F. O'Brien
President and Chief
Executive Officer
Dated May 13, 1999
/s/ Edward J. Parry III
Edward J. Parry III
Vice President,
Chief Financial Officer,
and Treasurer
Page 30
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit Page
27 Financial Data Schedule -
Page 31
<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 March 31, 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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 8204
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 99
<MORTGAGE> 539
<REAL-ESTATE> 18
<TOTAL-INVEST> 9163
<CASH> 495
<RECOVER-REINSURE> 1204
<DEFERRED-ACQUISITION> 1224
<TOTAL-ASSETS> 28461
<POLICY-LOSSES> 2817
<UNEARNED-PREMIUMS> 861
<POLICY-OTHER> 2835
<POLICY-HOLDER-FUNDS> 2908
<NOTES-PAYABLE> 284
300
0
<COMMON> 1
<OTHER-SE> 2387
<TOTAL-LIABILITY-AND-EQUITY> 28461
539
<INVESTMENT-INCOME> 159
<INVESTMENT-GAINS> 131
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</TABLE>
