FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: _________to __________
Commission file number: 1-13754
ALLMERICA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3263626
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
440 Lincoln Street, Worcester, Massachusetts 01653
(Address of principal executive offices)
(Zip Code)
(508) 855-1000
(Registrant's telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of the latest practicable date: 54,202,576
shares of common stock outstanding, as of August 1, 1999.
39
Total Number of Pages Included in This Document
Exhibit Index is on Page 40
Page 1
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Interim Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 6. Exhibits and Reports on Form 8-K 38
SIGNATURES 39
Page 2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions, except per share data) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 494.7 $ 499.0 $ 953.0 $ 991.1
Universal life and investment
product policy fees 88.6 72.7 171.5 142.2
Net investment income 158.2 149.3 312.5 298.7
Net realized investment
(losses) gains (5.5) 11.3 126.3 40.2
Other income 28.8 25.1 57.7 47.9
------- ------- ------- -------
Total revenues 764.8 757.4 1,621.0 1,520.1
------- ------- ------- -------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 440.2 456.0 883.4 900.7
Policy acquisition expenses 111.9 114.0 204.6 230.4
Other operating expenses 119.9 104.8 237.7 212.0
------- ------- ------- -------
Total benefits, losses and
expenses 672.0 674.8 1,325.7 1,343.1
------- ------- ------- -------
Income from continuing operations
before federal income taxes 92.8 82.6 295.3 177.0
------- ------- ------- -------
Federal income tax expense (benefit)
Current 19.0 14.2 73.2 42.3
Deferred 3.0 3.4 (3.5) (2.1)
------- ------- ------- -------
Total federal income tax expense 22.0 17.6 69.7 40.2
------- ------- ------- -------
Income from continuing operations
before minority interest 70.8 65.0 225.6 136.8
------- ------- ------- -------
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.0) (4.0) (8.0) (8.0)
Equity in earnings 0.0 (1.8) 0.0 (6.1)
------- ------- ------- -------
(4.0) (5.8) (8.0) (14.1)
Income from continuing operations 66.8 59.2 217.6 122.7
(Loss) income from operations of
discontinued business (less
applicable income taxes (benefit)
of $(3.5) and $0.7 for the quarters
ended June 30, 1999 and 1998 and
$(1.8) and $2.4 for the six months
ended June 30, 1999 and 1998 (6.6) 1.1 (3.3) 4.4
------- ------- ------- -------
Net income $ 60.2 $ 60.3 $ 214.3 $ 127.1
======= ======= ======= =======
PER SHARE DATA
Basic
Income from continuing
operations $ 1.22 $ 0.98 $ 3.89 $ 2.05
(Loss) income from
discontinued operations (0.12) 0.02 (0.06) 0.07
------- ------- ------- -------
$ 1.10 $ 1.00 $ 3.83 $ 2.12
======= ======= ======= =======
Weighted average shares
outstanding 54.5 60.0 55.9 59.9
======= ======= ======= =======
Diluted
Income from continuing
operations $ 1.21 $ 0.98 $ 3.86 $ 2.03
(Loss) income from
discontinued operations (0.12) 0.02 (0.06) 0.07
------- ------- ------- -------
Net income $ 1.09 $ 1.00 $ 3.80 $ 2.10
======= ======= ======= =======
Weighted average shares
outstanding 55.1 60.5 56.4 60.4
======= ======= ======= =======
Dividends declared to
shareholders $ 0.0 $ 0.05 $ 0.0 $ 0.10
======= ======= ======= =======
</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)
June 30, December 31,
(In millions, except per share data) 1999 1998
<S> <C> <C>
ASSETS
Investments:
Fixed maturities-at fair value (amortized
cost of $8,056.2 and $7,618.2) $ 8,044.3 $ 7,780.8
Equity securities-at fair value (cost of
$87.4 and $253.1) 106.4 397.1
Mortgage loans 555.7 562.3
Policy loans 160.5 154.3
Real estate and other long-term
investments 176.8 163.1
---------- ----------
Total investments 9,043.7 9,057.6
---------- ----------
Cash and cash equivalents 578.0 550.3
Accrued investment income 140.8 142.3
Deferred policy acquisition costs 1,284.5 1,161.2
Reinsurance receivable on paid and unpaid
losses, benefits and unearned premiums 1,152.6 1,136.0
Deferred federal income taxes 112.8 19.8
Premiums, accounts and notes receivable, net 611.6 510.5
Other assets 483.5 529.4
Closed Block assets 783.0 803.1
Separate account assets 15,635.9 13,697.7
---------- ----------
Total assets $ 29,826.4 $ 27,607.9
========== ==========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,870.0 $ 2,802.2
Outstanding claims, losses and loss
adjustment expenses 2,793.0 2,816.3
Unearned premiums 871.2 843.2
Contractholder deposit funds and other
policy liabilities 3,200.7 2,637.0
---------- ----------
Total policy liabilities and accruals 9,734.9 9,098.7
---------- ----------
Expenses and taxes payable 707.6 716.1
Reinsurance premiums payable 95.1 50.2
Short-term debt 50.2 221.3
Long-term debt 199.5 199.5
Closed Block liabilities 855.2 872.0
Separate account liabilities 15,635.2 13,691.5
---------- ----------
Total liabilities 27,277.7 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 11)
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 20.0
million shares authorized, none issued 0.0 0.0
Common stock, $0.01 par value, 300.0
million shares authorized, 60.4 million
shares issued 0.6 0.6
Additional paid-in capital 1,771.1 1,768.8
Accumulated other comprehensive income 2.3 180.5
Retained earnings 814.2 599.9
Treasury stock at cost (6.2 million and 1.8
million shares) (339.5) (91.2)
---------- ----------
Total shareholders' equity 2,248.7 2,458.6
---------- ----------
Total liabilities and shareholders'
equity $ 29,826.4 $ 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)
Six Months Ended
June 30,
(In millions) 1999 1998
<S> <C> <C>
PREFERRED STOCK
Balance at beginning and end of period $ 0.0 $ 0.0
---------- ----------
COMMON STOCK
Balance at beginning and end of period 0.6 0.6
---------- ----------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,768.8 1,755.0
Issuance of common stock 2.3 11.3
---------- ----------
Balance at end of period 1,771.1 1,766.3
---------- ----------
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 (274.0) 44.1
Benefit (provision) for deferred federal
income taxes 95.8 (15.7)
Minority interest 0.0 (2.7)
---------- ----------
Other comprehensive (loss) income (178.2) 25.7
---------- ----------
Balance at end of period 2.3 243.6
---------- ----------
RETAINED EARNINGS
Balance at beginning of period 599.9 407.8
Net income 214.3 127.1
Dividends to shareholders 0.0 (6.0)
---------- ----------
Balance at end of period 814.2 528.9
---------- ----------
TREASURY STOCK
Balance at beginning of period (91.2) 0.0
Shares purchased at cost (250.2) 0.0
Shares reissued at cost 1.9 0.0
---------- ----------
Balance at end of period (339.5) 0.0
---------- ----------
Total shareholders' equity $ 2,248.7 $ 2,539.4
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page 5
<PAGE>
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net income $ 60.2 $ 60.3 $ 214.3 $ 127.1
Other comprehensive income:
Net (depreciation) appreciation on
available-for-sale securities (112.4) 19.0 (274.0) 44.1
Benefit (provision) for deferred
federal income taxes 39.4 (6.7) 95.8 (15.7)
Minority interest 0.0 (2.0) 0.0 (2.7)
------- ------- ------- -------
Other comprehensive (loss) income (73.0) 10.3 (178.2) 25.7
------- ------- ------- -------
Comprehensive (loss) income $ (12.8) $ 70.6 $ 36.1 $ 152.8
======= ======= ======= =======
</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)
Six Months Ended
June 30,
(In millions) 1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 214.3 $ 127.1
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Minority interest 0.0 6.1
Net realized gains (126.9) (42.6)
Net amortization and depreciation 17.8 16.1
Deferred federal income taxes (0.3) (1.4)
Change in deferred acquisition costs (97.4) (86.8)
Change in premiums and notes receivable,
net of reinsurance payable (55.9) (4.0)
Change in accrued investment income 1.3 (3.5)
Change in policy liabilities and
accruals, net 63.8 23.9
Change in reinsurance receivable (16.6) (63.3)
Change in expenses and taxes payable (10.9) (54.9)
Separate account activity, net 53.5 1.1
Other, net (10.2) (8.3)
--------- ---------
Net cash provided by (used in)
operating activities 32.5 (90.5)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities of
available-for-sale fixed maturities 1,390.5 1,263.5
Proceeds from disposals of equity securities 371.4 61.1
Proceeds from disposals of other investments 20.6 49.9
Proceeds from mortgages matured or collected 49.3 92.2
Purchase of available-for-sale fixed maturities (1,854.7) (1,770.3)
Purchase of equity securities (67.1) (90.6)
Purchase of other investments (71.8) (110.6)
Capital expenditures (15.9) (11.7)
Other investing activities, net 0.0 11.4
--------- ---------
Net cash used in investing activities (177.7) (505.1)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 1,246.6 844.8
Withdrawals from contractholder deposit funds (668.5) (259.4)
Change in short-term debt (171.1) 13.6
Change in long-term debt 0.0 (2.6)
Proceeds from issuance of common stock 0.2 9.8
Purchase of treasury shares (250.2) 0.0
Reissuance of treasury shares 1.9 0.0
Dividends paid to shareholders 0.0 (6.6)
-------- -------
Net cash provided by financing activities 158.9 599.6
-------- -------
Net change in cash and cash equivalents 13.7 4.0
Net change in cash held in the Closed Block 14.0 16.9
Cash and cash equivalents, beginning of period 550.3 215.1
-------- -------
Cash and cash equivalents, end of period $ 578.0 $ 236.0
======== =======
</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 subsidiary of
Hanover), and Citizens Insurance Company of America ("Citizens", a
wholly-owned subsidiary of Citizens Corporation). The Closed Block
assets and liabilities and its results of operations are presented in
the consolidated financial statements as single line items. Unless
specifically stated, all disclosures contained herein supporting the
consolidated financial statements exclude the Closed Block related
amounts. All significant intercompany accounts and transactions have
been eliminated.
In December 1998, the Company acquired all of the outstanding common
stock of Citizens Corporation that it did not already own. Prior to
this acquisition, the financial statements reflect minority interest
in Citizens Corporation and its wholly-owned subsidiary, Citizens, of
17.5% (see Note 4).
The accompanying interim consolidated financial statements reflect, in
the opinion of the Company's management, all adjustments, 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 six months ended June 30, 1999, are not
necessarily indicative of the results to be expected for the full
year. These financial statements should be read in conjunction with
the Company's 1998 Annual Report to Shareholders, as filed on Form
10-K with the Securities and Exchange Commission.
2. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("Statement No. 133"),
which establishes accounting and reporting standards for derivative
instruments. Statement No. 133 requires that an entity recognize all
derivatives as either assets or liabilities at fair value in the
statement of financial position, and establishes special accounting
for the following three types of hedges: fair value hedges, cash flow
hedges, and hedges of foreign currency exposures. This statement is
effective for fiscal years beginning after June 15, 2000. The Company
is currently assessing the impact of the adoption of Statement No.
133.
In December 1997, the AICPA issued Statement of Position 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" ("SoP No. 97-3"). SoP No. 97-3 provides guidance on when
a liability should be recognized for guaranty fund and other
assessments and how to measure the liability. This statement allows
for the discounting of the liability if the amount and timing of the
cash payments are fixed and determinable. In addition, it provides
criteria for when an asset may be recognized for a portion or all of
the assessment liability or paid assessment that can be recovered
through premium tax offsets or policy surcharges. This statement is
effective for fiscal years beginning after December 15, 1998. The
adoption of SoP No. 97-3 had no effect on the results of operations or
financial position of the Company.
Page 8
<PAGE>
3. Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit
its group life and health insurance business, consisting of its
Employee Benefit Services ("EBS") business and its accident and health
assumed reinsurance pool business ("reinsurance pool business"). The
Company is pursuing a sale of its EBS business during the second half
of 1999. During the third quarter of 1998, the Company ceased writing
new premium in the reinsurance pool business, subject to certain
contractual obligations. Prior to 1999, these businesses comprised
substantially all of the former Corporate Risk Management Services
segment. Accordingly, the operating results of the Company's group life
and health insurance business, including its reinsurance pool business,
have been reported in the Consolidated Statements of Income as
discontinued operations in accordance with Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions"
("APB No. 30").As permitted by APB No. 30, the Consolidated Balance Sheet
has not been segregated between continuing and discontinued operations.
At June 30, 1999, the businesses had assets of approximately $469.3
million consisting primarily of invested assets, premiums and fees
receivable, and reinsurance recoverables, and liabilities of
approximately $445.2 million consisting primarily of policy liabilities.
Revenues for the discontinued operations were $89.7 million and $99.3
million for the quarters ended June 30, 1999 and 1998, respectively, and
$187.1 million and $200.5 million for the six months ended June 30, 1999
and 1998, respectively.
4. Acquisition of Minority Interest of Citizens Corporation
On December 3, 1998, Citizens Acquisition Corporation, a wholly-owned
subsidiary of the Company, completed a cash tender offer to acquire
the outstanding shares of Citizens Corporation common stock that AFC
or its subsidiaries did not already own at a price of $33.25 per
share. Approximately 99.8% of publicly held shares of Citizens
Corporation common stock were tendered. On December 14, 1998, the
Company completed a short-form merger, acquiring all shares of common
stock of Citizens Corporation not purchased in its tender offer,
through the merger of its wholly-owned subsidiary, Citizens
Acquisition Corporation, with Citizens Corporation at a price of $33.25
per share. Total consideration for the transactions amounted to
$195.9 million. The acquisition has been recognized as a purchase.
The minority interest acquired totaled $158.5 million. A total of
$40.8 million representing the excess of the purchase price over the
fair values of the net assets acquired, net of deferred taxes, has
been allocated to goodwill and is being amortized over a 40-year
period.
The Company's consolidated results of operations include minority
interest in Citizens Corporation prior to December 3, 1998. The
unaudited proforma information below presents consolidated results of
operations as if the acquisition had occurred at the beginning of
1998.
Page 9
<PAGE>
The following unaudited pro forma information is not necessarily
indicative of the consolidated results of operations of the combined
Company had the acquisition occurred at the beginning of 1998, nor is
it necessarily indicative of future results.
<TABLE>
<CAPTION>
(Unaudited)
Six Months Ended
(In millions, except per share data) June 30, 1998
<S> <C>
Revenue $1,513.2
=========
Net realized capital gains included in revenue $ 39.4
=========
Income before taxes and minority interest $ 169.6
Income taxes (37.8)
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary
trust holding solely junior subordinated
debentures of the Company (8.0)
---------
Income from continuing operations 123.8
Income from operations of discontinued business 4.4
---------
Net income $ 128.2
=========
PER SHARE DATA
Basic
Income from continuing operations $ 2.07
=========
Weighted average shares outstanding 59.9
=========
Diluted
Income form continuing operations $ 2.05
=========
Weighted average shares outstanding 60.4
=========
</TABLE>
5. Significant Transactions
Effective January 1, 1999, the Company entered into a whole account
aggregate excess of loss reinsurance agreement with a highly rated
reinsurer. The reinsurance agreement provides accident year coverage
for the three years 1999 to 2001 for the Company's property and
casualty business, and is subject to cancellation or commutation
annually at the Company's option. The program covers losses and
allocated loss adjustment expenses ("LAE"), including those incurred
but not yet reported, in excess of a specified whole account loss and
allocated LAE ratio. The annual and aggregate coverage limits for
losses and allocated LAE are $150.0 million and $300.0 million,
respectively. The effect of this agreement on results of operations
in each reporting period is based on losses and allocated LAE ceded,
reduced by a sliding scale premium of 50.0-67.0% depending on the size
of the loss, and increased by a ceding commission of 20.0% of ceded
premium. In addition, net investment income is reduced for amounts
credited to the reinsurer. As a result of this agreement, the Company
recognized a net (expense) benefit of $(3.0) million and $16.9 million,
for the quarter and six months ended June 30, 1999, based on year-to-date
and annual estimates of losses and allocated loss adjustment expenses for
accident year 1999.
During March 1999, the Company completed the repurchase of $200.0
million of its common stock under its October, 1998 repurchase program
authorized by the Board of Directors of AFC. On March 23, 1999, the
Board of Directors of AFC authorized the repurchase of up to an
additional $200.0 million of its issued common stock. As of June 30,
1999, under this additional program, the Company had repurchased an
additional $132.6 million of its issued common stock.
6. Federal Income Taxes
Federal income tax expense for the six months ended June 30, 1999 and
1998, has been computed using estimated effective tax rates. These
rates are revised, if necessary, at the end of each successive interim
period to reflect the current estimates of the annual effective tax
rates.
Page 10
<PAGE>
7. Other Comprehensive Income
The following table provides a reconciliation of gross unrealized
(losses) gains to the net balance shown in the Statement of
Comprehensive Income:
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Unrealized (losses) gains on
securities:
Unrealized holding (losses)
gains arising during period
(net of taxes and minority
interest of $(34.8) million
and $13.1 million for the
quarters ended June 30, 1999
and 1998 and $(61.0) million
and $29.2 million for the six
months ended June 30, 1999
and 1998) $ (77.7) $ 13.3 $ (89.0) $ 44.1
Less: reclassification
adjustment for gains included
in net income (net of taxes
and minority interest of $(4.6)
million and $4.4 million for
the quarters ended June 30,
1999 and 1998 and $34.8
million and $10.8 million for
the six months ended June 30,
1999 and 1998) (4.7) 3.0 89.2 18.4
------ ------ ------- ------
Other comprehensive (loss) income $ (73.0) $ 10.3 $(178.2) $ 25.7
====== ====== ======= ======
</TABLE>
8. Closed Block
Included in other income in the Consolidated Statements of Income is a
net pre-tax contribution from the Closed Block of $2.5 million and
$7.1 million for the second quarter and six months ended June 30,
1999, respectively, compared to $3.6 million and $6.0 million for the
second quarter and six months ended June 30, 1998, respectively.
Summarized financial information of the Closed Block is as follows:
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
(In millions) 1999 1998
<S> <C> <C>
ASSETS
Fixed maturities-at fair value
(amortized cost of $415.0 and $399.1) $410.7 $414.2
Mortgage loans 133.0 136.0
Policy loans 205.0 210.9
Cash and cash equivalents 0.0 9.4
Accrued investment income 14.2 14.1
Deferred policy acquisition costs 14.1 15.6
Other assets 6.0 2.9
------ ------
Total assets $783.0 $803.1
====== ======
LIABILITIES
Policy liabilities and accruals $843.6 $862.9
Other liabilities 11.6 9.1
------ ------
Total liabilities $855.2 $872.0
====== ======
</TABLE>
Page 11
<PAGE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
REVENUES
Premiums $ 8.4 $ 9.0 $35.6 $37.2
Net investment income 13.5 13.2 26.6 26.4
Net realized investment (losses)
gains (0.3) 1.6 0.5 1.6
------ ------ ------ ------
Total revenues 21.6 23.8 62.7 65.2
------ ------ ------ ------
BENEFITS AND EXPENSES
Policy benefits 18.9 19.7 54.4 57.4
Policy acquisition expenses 0.6 0.6 1.1 1.3
Other operating expenses (0.4) (0.1) 0.1 0.5
------ ------ ------ ------
Total benefits and expenses 19.1 20.2 55.6 59.2
------ ------ ------ ------
Contribution from the
Closed Block $ 2.5 $ 3.6 $ 7.1 $ 6.0
====== ====== ====== ======
</TABLE>
Many expenses related to Closed Block operations are charged to
operations outside the Closed Block; accordingly, the contribution
from the Closed Block does not represent the actual profitability of
the Closed Block operations. Operating costs and expenses outside of
the Closed Block are, therefore, disproportionate to the business
outside the Closed Block.
9. Segment Information
The Company offers financial products and services in two major areas:
Risk Management and Asset Accumulation. Within these broad areas, the
Company conducts business principally in three operating segments. These
segments are Risk Management, Allmerica Financial Services, and Allmerica
Asset Management. The separate financial information of each segment is
presented consistent with the way results are regularly evaluated by the
chief operating decision maker in deciding how to allocate resources and
in assessing performance. A summary of the Company's reportable segments
is included below.
In 1999, the Company reorganized its Property and Casualty and Corporate
Risk Management Services operations within the Risk Management segment.
Under the new structure, the Risk Management segment manages its business
through five distribution channels identified as Hanover North, Hanover
South, Citizens Midwest, Allmerica Voluntary Benefits, and Allmerica
Specialty. During the second quarter of 1999, the Company approved a plan
to exit its group life and health business, consisting of its EBS business
and its reinsurance pool business. Results of operations from this
business, relating to both the current and the prior periods, have been
segregated and reported as a component of discontinued operations in the
Consolidated Statements of Income. Operating results from this business
were previously reported in the Allmerica Voluntary Benefits and Allmerica
Specialty distribution channels. Prior to 1999, results of the group
life and health business were included in the Corporate Risk Management
Services segment, while all other Risk Management business was reflected
in the Property and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States,
maintaining a strong regional focus. Allmerica Voluntary Benefits
focuses on worksite distribution, which offers discounted property and
casualty products through employer sponsored programs. In addition, the
affinity group property and casualty business, which was included in
Citizens Midwest, Hanover North and Hanover South in the first quarter
of 1999, is now included in the Allmerica Voluntary Benefits distribution
channel. This change is consistent with the resegmentation which was
presented in the first quarter of 1999 and with the way results are
regularly evaluated by the chief operating decision maker. Accordingly,
results for all periods presented have been restated to reflect this
change. Allmerica Specialty offers special niche property and casualty
products in selected markets.
Page 12
<PAGE>
The Asset Accumulation group includes two segments: Allmerica Financial
Services and Allmerica Asset Management. The Allmerica Financial Services
segment includes variable annuities, variable universal life and
traditional life insurance products distributed via retail channels as
well as group retirement products, such as defined benefit and 401(k)
plans and tax-sheltered annuities distributed to institutions. Through
its Allmerica Asset Management segment, the Company offers its customers
the option of investing in Guaranteed Investment Contracts ("GICs") such
as traditional GIC, synthetic GIC and other funding agreements. Funding
agreements are investment contracts issued to institutional buyers, such
as money market funds, corporate cash management programs and securities
lending collateral programs, which typically have short maturities and
periodic interest rate resets based on an index such as LIBOR. This
segment is also a Registered Investment Advisor providing investment
advisory services, primarily to affiliates, and to other institutions,
such as insurance companies and pension plans.
In addition to the three operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Capital Securities and corporate overhead expenses. Corporate overhead
expenses reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the Legal department.
Management evaluates the results of the aforementioned segments based on
a pre-tax and minority interest basis. Segment income is determined by
adjusting net income for net realized investment gains and losses, net
gains and losses on disposals of businesses, dicontinued operations,
extraordinary items, the cumulative effect of accounting changes and
certain other items which management believes are not indicative of
overall operating trends. While these items may be significant
components in understanding and assessing the Company's financial
performance, management believes that the presentation of segment income
enhances 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.
Summarized below is financial information with respect to business
segments for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues:
Risk Management $554.5 $560.4 $1,075.8 $1,118.1
------- ------- -------- --------
Asset Accumulation
Allmerica Financial Services 193.9 172.4 398.6 363.6
Allmerica Asset Management 40.5 29.9 74.8 53.8
------- ------- -------- --------
Subtotal 234.4 202.3 473.4 417.4
------- ------- -------- --------
Corporate 2.4 4.1 3.6 6.1
Intersegment revenues (1.9) (0.5) (2.5) (2.5)
------- ------- -------- --------
Total segment revenues
including Closed Block 789.4 766.3 1,550.3 1,539.1
Adjustments to segment revenues:
Adjustment for Closed Block (19.1) (20.2) (55.6) (59.2)
Net realized (losses) gains (5.5) 11.3 126.3 40.2
------- ------- -------- --------
Total revenues $764.8 $757.4 $1,621.0 $1,520.1
======= ======= ======== ========
Segment income (loss) before income
taxes and minority interest:
Risk Management $ 55.3 $ 34.9 $ 85.1 $ 72.6
------- ------- -------- --------
Asset Accumulation
Allmerica Financial Services 47.7 44.2 96.6 86.4
Allmerica Asset Management 6.8 6.2 12.5 10.1
------- ------- -------- --------
Subtotal 54.5 50.4 109.1 96.5
------- ------- -------- --------
Corporate (13.5) (12.7) (29.5) (25.0)
------- ------- -------- --------
Segment income before income
taxes and minority interest 96.3 72.6 164.7 144.1
Adjustments to segment income:
Net realized investment (losses)
gains, net of amortization (3.5) 10.1 130.6 33.7
Other items 0.0 (0.1) 0.0 (0.8)
------- ------- -------- --------
Income from continuing operations
before taxes and minority interest $ 92.8 $ 82.6 $ 295.3 $177.0
======= ======= ======== ========
</TABLE>
Page 13
<PAGE>
<TABLE>
<CAPTION>
Identifiable Assets Deferred Acquisition Costs
(Unaudited) (Unaudited)
June 30, December 31, June 30, December 31
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Risk Management $ 5,810.6 $ 6,219.0 $ 169.2 $ 167.5
--------- --------- -------- --------
Asset Accumulation
Allmerica Financial
Services 21,306.0 19,416.6 1,114.8 993.1
Allmerica Asset
Management 2,482.9 1,810.9 0.5 0.6
--------- --------- -------- --------
Subtotal 23,788.9 21,227.5 1,115.3 993.7
Corporate 226.9 161.4 0.0 0.0
--------- --------- -------- --------
Total $29,826.4 $27,607.9 $1,284.5 $1,161.2
========= ========= ======== ========
</TABLE>
10. Earnings Per Share
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions, except per share data) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Basic shares used in the
calculation of earnings per share 54.5 60.0 55.9 59.9
Dilutive effect of securities:
Employee stock options 0.4 0.4 0.3 0.4
Non-vested stock grants 0.2 0.1 0.2 0.1
---- ---- ---- ----
Diluted shares used in the
calculation of earnings per share 55.1 60.5 56.4 60.4
==== ==== ==== ====
Per share effect of dilutive
securities on net income and
income from continuing operations $0.01 $ 0.0 $0.03 $0.02
==== ==== ==== ====
</TABLE>
11. Commitments and Contingencies
Litigation
In July 1997, a lawsuit on behalf of a putative class was instituted in
Louisiana against AFC and certain of its subsidiaries by individual
plaintiffs alleging fraud, unfair or deceptive acts, breach of contract,
misrepresentation, and related claims in the sale of life insurance
policies. In October 1997, the plaintiffs voluntarily dismissed the
Louisiana suit and filed a substantially similar action in Federal
District Court in Worcester, Massachusetts. In early November 1998, the
Company and the plaintiffs entered into a settlement agreement. The
court granted preliminary approval of the settlement on December 4,
1998. On May 19, 1999, the court issued an order certifying the class
for settlement purposes and granting final approval of the settlement
agreement. AFC recognized a $31.0 million pre-tax expense during the
third quarter of 1998 related to this litigation. Although the Company
believes that this expense reflects appropriate recognition of its
obligation under the settlement, this estimate assumes the availability
of insurance coverage for certain claims, and the estimate may be revised
based on the amount of reimbursement actually tendered by AFC's
insurance carriers, if any, and based on changes in the Company's
estimate of the ultimate cost of the benefits to be provided to members
of the class.
Year 2000
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar
normal business activities.
Although the Company does not believe that there is a material
contingency associated with the Year 2000 project, there can be no
assurance that exposure for material contingencies will not arise.
Page 14
<PAGE>
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations and
financial condition of the Company should be read in conjunction with the
interim Consolidated Financial Statements and related footnotes included
elsewhere herein.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
subsidiaries ("AFC" or "the Company") include the accounts of AFC, First
Allmerica Financial Life Insurance Company ("FAFLIC"), its wholly-owned life
insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company
("AFLIAC"), Allmerica 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 subsidiary of Hanover), Citizens
Insurance Company of America ("Citizens," a wholly-owned subsidiary of
Citizens Corporation) and certain other insurance and non-insurance
subsidiaries.
In December 1998, the Company acquired all of the outstanding common stock
of Citizens Corporation that it did not already own. Prior to this
acquisition, the results of operations reflect minority interest in Citizens
Corporation and its wholly owned subsidiary, Citizens, of 17.5%.
Description of Operating Segments
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments
are Risk Management, Allmerica Financial Services, and Allmerica Asset
Management. The separate financial information of each segment is presented
consistent with the way results are regularly evaluated by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. A summary of the Company's reportable segments is
included below.
In 1999, the Company reorganized its Property and Casualty and Corporate
Risk Management Services operations within the Risk Management segment.
Under the new structure, the Risk Management segment manages its business
through five distribution channels identified as Hanover North, Hanover
South, Citizens Midwest, Allmerica Voluntary Benefits, and Allmerica
Specialty. During the second quarter of 1999, the Company approved a plan
to exit its group life and health business, consisting of its Employee
Benefit Services ("EBS") business and its accident and health assumed
reinsurance pool business ("reinsurance pool business"). Results of
operations from this business, relating to both the current and the prior
periods, have been segregated and reported as a component of discontinued
operations in the Consolidated Statements of Income. Operating results from
this business were previously reported in the Allmerica Voluntary Benefits
and Allmerica Specialty distribution channels. Prior to 1999, results of
the group life and health business were included in the Corporate Risk
Management Services segment, while all other Risk Management business
was reflected in the Property and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States, maintaining
a strong regional focus. Allmerica Voluntary Benefits focuses on worksite
distribution, which offers discounted property and casualty products through
employer sponsored programs. In addition, the affinity group property and
casualty business, which was included in Citizens Midwest, Hanover North and
Hanover South in the first quarter of 1999, is also included in the
Allmerica Voluntary Benefits distribution channel. This change is
consistent with the resegmentation which was presented in the first quarter
of 1999 and with the way results are regularly evaluated by the chief
operating decision maker. Accordingly, results for all periods presented
have been restated to reflect this change. Allmerica Specialty offers
special niche property and casualty products in selected markets.
Page 15
<PAGE>
The Asset Accumulation group includes two segments: Allmerica Financial
Services and Allmerica Asset Management. The Allmerica Financial
Services segment includes variable annuities, variable universal life
and traditional life insurance products distributed via retail channels
as well as group retirement products, such as defined benefit and 401(k)
plans and tax-sheltered annuities distributed to institutions. Through
its Allmerica Asset Management segment, the Company offers its customers
the option of investing in Guaranteed Investment Contracts ("GICs") such
as traditional GIC, synthetic GIC and other funding agreements. Funding
agreements are investment contracts issued to institutional buyers, such
as money market funds, corporate cash management programs and securities
lending collateral programs, which typically have short maturities and
periodic interest rate resets based on an index such as LIBOR. This
segment is also a Registered Investment Advisor providing investment
advisory services, primarily to affiliates, and to other institutions,
such as insurance companies and pension plans.
In addition to the three operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Capital Securities and corporate overhead expenses. Corporate overhead
expenses reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the Legal department.
Results of Operations
Consolidated Overview
The Company's consolidated net income for the second quarter decreased
$0.1 million, or 0.2%, to $60.2 million, compared to $60.3 million for
the same period in 1998. Consolidated net income for the first six months
increased $87.2 million, or 68.6%, to $214.3 million, compared to $127.1
million for the first six months of 1998. Net income includes certain
items which management believes are not indicative of overall operating
trends, such as net realized investment gains and losses, net gains and
losses on disposals of businesses, discontinued operations, extraordinary
items, the cumulative effect of accounting changes and certain other
items. While these items may be significant components in understanding and
assessing the Company's financial performance, management believes that
the presentation of adjusted net income enhances its understanding of the
Company's results of operations by highlighting net income attributable
to the normal, recurring operations of the business. However, adjusted
net income should not be construed as a substitute for net income
determined in accordance with generally accepted accounting principles.
For purposes of assessing each segment's contribution to adjusted net
income, management evaluates the results of these segments on a pre-tax
and minority interest basis. The following table reflects each segment's
contribution to adjusted net income and reconciliation to consolidated
net income as adjusted for these items.
Page 16
</PAGE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment income (loss) before income
taxes and minority interest:
Risk Management $ 55.3 $ 34.9 $ 85.1 $ 72.6
------ ------ ------ ------
Asset Accumulation
Allmerica Financial Services 47.7 44.2 96.6 86.4
Allmerica Asset Management 6.8 6.2 12.5 10.1
------ ------ ------ ------
Subtotal 54.5 50.4 109.1 96.5
Corporate (13.5) (12.7) (29.5) (25.0)
------ ------ ------ ------
Segment income before income
taxes and minority interest 96.3 72.6 164.7 144.1
Federal income taxes on segment
income (19.3) (12.2) (32.4) (28.6)
Minority interest on preferred
dividends (4.0) (4.0) (8.0) (8.0)
Minority interest on segment
income 0.0 (1.7) 0.0 (5.5)
------ ------ ------ ------
Adjusted net income 73.0 54.7 124.3 102.0
Adjustments (net of taxes,
minority interest and
amortization, as applicable):
Net realized investment
(losses) gains (6.2) 4.5 93.3 21.3
Other items 0.0 0.0 0.0 (0.6)
------ ------ ------ ------
Net income from continuing
operations 66.8 59.2 217.6 122.7
Discontinued operations:
(Loss) income from operations
of discontinued group life and
health business (net of
applicable taxes) (6.6) 1.1 (3.3) 4.4
------ ------ ------ ------
Net income $ 60.2 $ 60.3 $214.3 $127.1
====== ====== ====== ======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
The Company's segment income before taxes and minority interest increased
$23.7 million, or 32.6%, to $96.3 million in the second quarter of 1999.
This increase is attributable to increased income of $20.4 million from
the Risk Management segment and $4.1 million from the Asset Accumulation
group. The increase in the Risk Management segment was primarily
attributable to a $34.6 million decrease in catastrophe losses, partially
offset by unfavorable current year claims activity in both the commercial
multiple peril and homeowners' lines. The increase in the Allmerica
Financial Services segment is primarily attributable to higher
asset-based fee income driven by growth and market appreciation in the
variable annuity and variable universal life product lines, net of related
expenses. Additionally, Allmerica Asset Management segment income
increased $0.6 million primarily due to growth in income from assets
under management.
The effective tax rate for segment income was 20.2% for the second
quarter of 1999 compared to 16.8% for the second quarter of 1998. The
increase in the tax rate was principally driven by the decrease in the
proportion of tax-exempt income to pre-tax operating income.
Net realized losses on investments after taxes were $6.2 million in the
second quarter of 1999, resulting primarily from net realized losses on
fixed maturities of $7.4 million. During the second quarter of 1998, net
realized gains on investments after taxes and minority interest of $4.5
million resulted primarily from net realized gains on fixed maturities
and equity securities of $3.5 million and $1.4 million, respectively.
Page 17
<PAGE>
During the second quarter of 1999, the Company approved a plan to exit
its group life and health insurance business, consisting of its EBS
business and its reinsurance pool business . The Company is pursuing a
sale of its EBS business during the second half of 1999. During the
third quarter of 1998, the Company ceased writing new premium in the
reinsurance pool business, subject to certain contractual obligations.
Prior to 1999, these businesses comprised substantially all of the former
Corporate Risk Management Services segment. Accordingly, the operating
results of the Company's group life and health insurance business,
including its reinsurance pool business, have been reported in the
Consolidated Statements of Income as discontinued operations in
accordance with Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" ("APB No. 30").
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
The Company's segment income before taxes and minority interest increased
$20.6 million, or 14.3%, to $164.7 million in the first six months of
1999. This increase is attributable to increased income of $12.6 million
from the Asset Accumulation group and $12.5 million from the Risk
Management segment, partially offset by additional losses of $4.5 million
in the Corporate segment. The increase in the Allmerica Financial
Services segment of $10.2 million was primarily attributable to higher
asset-based fee income resulting from growth and market appreciation in
the variable annuity and variable universal life product lines, net of
related expenses. The increase in the Allmerica Asset Management segment
of $2.4 million is principally due to growth in income from assets under
management and increased interest margins on GICs. Risk Management
segment income for the first six months of 1999 resulted primarily from
a $16.9 million favorable impact related to the whole account aggregate
excess of loss reinsurance treaty ("aggregate excess of loss reinsurance
treaty") entered into during the first quarter of 1999. The operating
loss in the Corporate segment increased primarily due to a reduction in
net investment income as well as higher technology costs.
The effective tax rate for segment income was 19.7% for the first six
months of 1999 compared to 19.8% for the first six months of 1998. The
decrease in the tax rate was principally driven by a change in reserves
for prior year tax liability, partially offset by a decrease in the
proportion of tax-exempt income to pre-tax operating income.
Net realized gains on investments after taxes were $93.3 million in the
first six months of 1999, resulting primarily from net realized gains on
equity securities and partnership investments of $99.1 million and $4.1
million, respectively, partially offset by $16.4 million of after-tax
realized losses from impairments recognized on fixed maturities. The
increase in net realized gains on equity securities relates principally
to the sale of $310.0 million of appreciated equities in the property
and casualty investment portfolio. During the first six months of 1998,
net realized gains on investments after taxes and minority interest of
$21.3 million resulted primarily from net realized gains on equity
securities and fixed maturities of $12.3 million and $9.6 million,
respectively.
Segment Results
The following is management's discussion and analysis of the Company's
results of operations by business segment. The segment results are
presented before taxes and minority interest and other items which
management believes are not indicative of overall operating trends,
including realized gains and losses.
Page 18
<PAGE>
Risk Management
The following table summarizes the results of operations for the Risk
Management segment:
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net premiums written $505.2 $501.8 $982.4 $991.0
------ ------ ------ ------
Net premiums earned $494.6 $498.7 $952.2 $990.1
------ ------ ------ ------
Underwriting loss $ (1.2) $(20.7) $(31.7) $(45.1)
Net investment and other income 56.5 55.6 116.8 117.7
------ ------ ------ ------
Segment income before taxes and
minority interest $ 55.3 $ 34.9 $ 85.1 $ 72.6
====== ====== ====== ======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Premium
Risk Management's net premiums written increased $3.4 million, or 0.7%,
to $505.2 million for the quarter ended June 30, 1999, compared to
$501.8 million for the same period in 1998. This is primarily
attributable to an increase in net premiums written in the workers'
compensation line of $6.8 million, or 15.5%, primarily due to an increase
in policies in force of 7.2% since June 30, 1998, and to a decrease of
$3.7 million in ceded premium under the aggregate excess of loss
reinsurance treaty. These increases in net premiums written are
partially offset by a $5.2 million decrease in personal automobile net
premiums written primarily attributed to an average rate decrease of 3.6%
and a 1.8% decline of policies in force since June 30, 1998.
Risk Management's net premiums earned decreased $4.1 million, or 0.8%, to
$494.6 million for the quarter ended June 30, 1999, compared to $498.7
million for the same period in 1998. This decrease is primarily
attributable to an $8.4 million decrease in the personal automobile line,
to $224.3 million for the quarter ended June 30, 1999, from $232.7
million for the same quarter in 1998. The decrease in the personal
automobile line's net premiums earned is primarily attributable to an
average rate decrease of 3.6% since June 30, 1998, as well as to a
decrease in policies in force of 1.8% since June 30, 1998. This was
partially offset by increased net premiums earned of $3.7 million from
the aforementioned aggregate excess of loss reinsurance treaty.
Management believes that competitive conditions in the personal
automobile line may continue to impact future growth in net premiums
earned.
Underwriting results
Risk Management's underwriting loss decreased $19.5 million to $1.2
million for the quarter ended June 30, 1999, compared to $20.7 million
for the same period in 1998. The decrease is primarily attributable to a
$34.6 million decrease in catastrophe losses, to $9.2 million for the
quarter ended June 30, 1999, from $43.8 million for the same period in
1998. In addition, there was improved severity of $16.0 million in the
personal automobile line, partially offset by unfavorable current year
claims activity in both the commercial multiple peril and homeowners
lines. Policy acquisition and other underwriting expenses increased
$4.0 million to $144.0 million for the quarter ended June 30, 1999,
compared to $140.0 million for the same period in 1998. Underwriting
results were also unfavorably impacted by a $3.0 million reduction in
net recoverability on the aforementioned aggregate excess of loss
reinsurance treaty.
Page 19
<PAGE>
Distribution channel results
The following table summarizes the results of operations for the
distribution channels of the Risk Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended June 30,1999
(In millions, Hanover Hanover Citizens Voluntary Allmerica
except ratios) North South Midwest Benefits Specialty Other<FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $168.0 $ 49.9 $138.9 $138.5 $ 10.0 $(0.1) $505.2
Underwriting
profit
(loss) $ 7.0 $ (2.6) $ (0.8) $ 1.0 $ (3.5) $(2.3) $ (1.2)
Statutory
combined
ratio <FN1> 97.3 103.4 100.9 98.2 140.8 N/M 100.1
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the
results of property and casualty insurance underwriting. This ratio is
the sum of the ratio of incurred claims and claim expenses to premiums
earned and the ratio of underwriting expenses incurred to premiums
written. Federal income taxes, net investment income and other non-
underwriting expenses are not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which
the Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Quarter Ended June 30,1998
(In millions, Hanover Hanover Citizens Voluntary Allmerica
except ratios) North South Midwest Benefits Specialty Other<FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $159.4 $ 52.4 $140.2 $134.0 $ 14.8 $ 1.0 $501.8
Underwriting
(loss)
profit $ (1.9) $(2.4) $(14.9) $ (1.3) $ 0.9 $(1.1) $(20.7)
Statutory
combined
ratio <FN1> 102.3 105.4 110.0 103.8 91.4 N/M 105.0
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the
results of property and casualty insurance underwriting. This ratio is
the sum of the ratio of incurred claims and claim expenses to premiums
earned and the ratio of underwriting expenses incurred to premiums
written. Federal income taxes, net investment income and other non-
underwriting expenses are not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which
the Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
Hanover North
Hanover North's net premiums written increased $8.6 million, or 5.4%, to
$168.0 million for the quarter ended June 30, 1999, compared to $159.4
million for the same period in 1998. This increase is primarily
attributable to a $6.9 million increase in net premiums written in the
commercial lines. In addition, there was a $1.7 million increase in the
personal lines.
Hanover North's underwriting results improved $8.9 million to an
underwriting profit of $7.0 million for the quarter ended June 30, 1999,
compared to an underwriting loss of $1.9 million for the same period in
1998. This improvement in underwriting results is primarily attributable
to an increase in net premiums earned of $13.8 million, or 8.9%, to $169.5
million for the quarter ended June 30, 1999, compared to $155.7 million
for the same period in 1998, reflecting growth in all of the major lines.
Also contributing to the improvement in underwriting results is a $5.1
million decrease in catastrophes, which is partially offset by unfavorable
claims activity, primarily in the workers' compensation and commercial
multiple peril lines.
Hanover South
Hanover South's net premiums written decreased $2.5 million, or 4.8%, to
$49.9 million for the quarter ended June 30, 1999, compared to $52.4
million for the same period in 1998. The decrease is primarily due to a
$2.2 million, or 16.8%, decrease in personal automobile net premiums
written due to the exit of certain states in the South.
Underwriting results deteriorated $0.2 million to an underwriting loss of
$2.6 million for the quarter ended June 30, 1999, compared to $2.4
million for the same period in 1998. The decrease in underwriting
results is primarily attributable to a $2.7 million and a $0.5 million
deterioration in the commercial multiple peril and workers' compensation
lines, respectively, offset by a $3.2 million decrease in catastrophe
losses.
Citizens Midwest
Citizens Midwest's net premiums written decreased $1.3 million, or 0.9%,
to $138.9 million for the quarter ended June 30, 1999, compared to
$140.2 million for the same period in 1998. This decrease is primarily
attributable to a decrease in the personal automobile line of $4.8
million, to $37.8 million, for the quarter ended June 30, 1999, compared
to $42.6 million for the same period in 1998. This decrease is
attributable to rate decreases in the Michigan personal automobile line
of 2.0% and 3.6% in the third quarter of 1998 and first quarter of 1999,
respectively. This is significantly offset by increases of $2.5 million
and $2.0 million in the workers' compensation and homeowners lines,
respectively, for the quarter ended June 30, 1999.
Page 20
<PAGE>
Citizens Midwest's underwriting results improved $14.1 million to an
underwriting loss of $0.8 million for the quarter ended June 30, 1999,
compared to an underwriting loss of $14.9 million for the same period in
1998. The improvement in underwriting results is primarily attributable
to an $18.5 million decrease in catastrophe losses to $0.7 million for the
quarter ended June 30, 1999, compared to $19.2 million for the same period
in 1998. The decrease in catastrophes is partially offset by unfavorable
claims activity in the commercial lines.
Voluntary Benefits
Voluntary Benefits' net premiums written increased $4.5 million, or 3.4%,
to $138.5 million for the quarter ended June 30, 1999, compared to $134.0
million for the same period in 1998. The increase is primarily due to
increases in policies in force in the homeowners line and a decrease in
group discounts in the personal automobile line. Net premiums earned
were $129.4 million and $131.5 million for the quarters ended June 30,
1999 and 1998, respectively.
Underwriting results improved $2.3 million to an underwriting profit of
$1.0 million for the quarter ended June 30, 1999, compared to an
underwriting loss of $1.3 million for the same period in 1998. The
improvement in underwriting results is attributable to a $7.8 million
decrease in catastrophe losses, and to improved severity in the personal
automobile line. This is partially offset by a $2.4 million increase in
policy acquisition and other underwriting expenses and to a $2.1 million
decrease in net premiums earned.
Specialty Markets
Specialty Markets' net premiums written decreased $4.8 million, or 32.4%,
to $10.0 million for the second quarter ended June 30, 1999, compared to
$14.8 million for the same period in 1998. Net premiums earned were
$12.3 million and $9.5 million for the quarters ended June 30, 1999 and
1998, respectively.
Underwriting results deteriorated $4.4 million to a loss of $3.5 million
for the quarter ended June 30, 1999, compared to an underwriting gain of
$0.9 million for same period in 1998.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Premium
Risk Management's net premiums written decreased $8.6 million, or 0.9%,
to $982.4 million during the six months ended June 30, 1999, compared to
$991.0 million in 1998. This 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 $21.9
million. Excluding the impact of the reinsurance treaty, net premiums
written increased $13.3 million, or 1.3%, primarily due to increases of
$9.2 million and $5.9 million in the workers' compensation and commercial
multiple peril lines, respectively, during 1999. The increase in the
workers' compensation line is primarily attributable to an increase in
policies in force of 7.2% since June 30, 1998. The increase in the
commercial multiple peril line is principally due to a 1.3% rate increase
and an increase in policies in force of 1.2% since June 30, 1998.
Risk Management's net premiums earned decreased $37.9 million primarily
attributable to a $21.9 million decrease due to the aforementioned
aggregate excess of loss reinsurance treaty. In addition, net premiums
earned decreased $12.6 million in the personal automobile line due to a
3.6% rate decrease and to a 1.8% decrease in policies in force since June
30, 1998.
Underwriting results
Risk Management's underwriting loss decreased $13.4 million, to $31.7
million, for the six months ended June 30, 1999, compared to an
underwriting loss of $45.1 million for the same period in 1998. The
improvement in underwriting results is primarily attributable to a $16.9
million favorable impact from the aggregate excess of loss reinsurance
treaty. Excluding the impact of the aggregate excess of loss reinsurance
treaty, underwriting results decreased $3.5 million. This decrease is
due to a deterioration in current year commercial lines' claim activity,
partially offset by a decrease in policy acquisition and other
underwriting expenses. This decline in policy acquisition and other
underwriting expenses primarily reflects a decrease in net premiums
earned and declining information systems costs, relating to the year 2000
issue
Page 21
<PAGE>
Distribution channel results
The following table summarizes the results of operations for the
distribution channels of the Risk Management segment:
<TABLE>
<CAPTION>
(Unaudited)
Six Months Ended June 30,1999
(In millions, Hanover Hanover Citizens Voluntary Allmerica
except ratios) North South Midwest Benefits Specialty Other<FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $331.7 $100.5 $262.4 $266.2 $ 21.4 $ 0.2 $982.4
Underwriting
profit
(loss) $ (1.7) $ (5.7) $(12.7) $ (2.5) $ (3.9) $(5.2) $(31.7)
Statutory
combined
ratio <FN1> 100.1 103.8 105.2 99.5 123.5 N/M 102.5
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the
results of property and casualty insurance underwriting. This ratio is
the sum of the ratio of incurred claims and claim expenses to premiums
earned and the ratio of underwriting expenses incurred to premiums
written. Federal income taxes, net investment income and other non-
underwriting expenses are not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which
the Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
Six Months Ended June 30,1998
(In millions, Hanover Hanover Citizens Voluntary Allmerica
except ratios) North South Midwest Benefits Specialty Other<FN2> Total
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written $307.0 $105.8 $280.9 $268.0 $ 22.4 $ 6.9 $991.0
Underwriting
profit
(loss) $(27.7) $ (1.4) $(21.0) $ 6.3 $ (1.8) $ 0.5 $(45.1)
Statutory
combined
ratio <FN1> 109.6 102.5 107.0 99.4 104.3 N/M 104.8
<FN>
<FN1> Statutory combined ratio is a common industry measurement of the
results of property and casualty insurance underwriting. This ratio is
the sum of the ratio of incurred claims and claim expenses to premiums
earned and the ratio of underwriting expenses incurred to premiums
written. Federal income taxes, net investment income and other non-
underwriting expenses are not reflected in the statutory combined ratio.
<FN2> Includes results from certain property and casualty business which
the Company has exited, as well as purchase accounting adjustments.
</FN>
</TABLE>
Hanover North
Hanover North's net premiums written increased $24.7 million, or 8.0%, to
$331.7 million for the six months ended June 30, 1999, compared to $307.0
million for the same period in 1998. Net premiums written in the
commercial lines increased $16.5 million, or 12.2%, to $151.6 million for
the six months ended June 30, 1999, primarily due to an increase in
policies in force. Personal lines' net premiums written increased $8.2
million to $180.1 million, primarily driven by a 5.8% rate increase in
the Massachusetts personal automobile line resulting from the Company's
decision to reduce safe driver discounts.
Hanover North's underwriting results improved $26.0 million to a loss of
$1.7 million for the six months ended June 30, 1999, compared to an
underwriting loss of $27.7 million for the same period in 1998. The
improvement in underwriting results is primarily attributable to improved
current year severity in the personal lines, as well as additional
favorable development on prior year's loss reserves in the personal
automobile line. In addition, catastrophe losses decreased $7.1 million
for the six months ended June 30, 1999, compared to the same period in
1998.
Hanover South
Hanover South's net premiums written decreased $5.3 million, or 5.0%, to
$100.5 million for the six months ended June 30, 1999, compared to $105.8
million for the same period in 1998. The decrease is primarily due to a
$5.6 million, or 19.9%, decrease in the personal automobile line's net
premiums written driven by a 24.1% decrease in policies in force. This
decline is attributable to the Company's decision to exit certain markets
in the South.
Underwriting results deteriorated $4.3 million from an underwriting loss
of $1.4 million for the six months ended June 30, 1998, to a loss of $5.7
million for the same period in 1999. The decrease in underwriting
results is primarily attributable to a $5.9 million deterioration in
commercial lines' claim activity. In addition, loss activity in the
homeowners line increased $1.2 million for the six months ended June 30,
1999, compared to the same period in 1998. Partially offsetting these
unfavorable factors is a $3.5 million increase in underwriting results as
a result of the aggregate excess of loss reinsurance treaty.
Page 22
<PAGE>
Citizens Midwest
Citizens Midwest's net premiums written decreased $18.5 million, or 6.6%,
to $262.4 million for the six months ended June 30, 1999. This decrease
is primarily attributable to a $10.3 million decrease in the personal
automobile line's net premiums written to $81.3 million for the period
ended June 30, 1999, compared to $91.6 million in the same period in
1998. This decline is due to rate decreases in the Michigan personal
automobile line of 2.0% and 3.6% in the third quarter of 1998 and first
quarter of 1999, respectively. In addition, Citizens Midwest's net
premiums written decreased $4.9 million as a result of additional
premiums ceded under the aggregate excess of loss reinsurance treaty.
Citizens Midwest's underwriting results improved $8.3 million to an
underwriting loss of $12.7 million for the six months ended June 30,
1999, from an underwriting loss of $21.0 million for the same period in
1998. The improvement in the underwriting results is attributable to a
$5.5 million decrease in catastrophe losses to $13.2 million in 1999,
compared to $18.7 million in 1998. In addition, underwriting results
were favorably impacted $3.9 million due to the aforementioned aggregate
excess of loss reinsurance treaty.
Voluntary Benefits
Voluntary Benefits' net premiums written decreased $1.8 million, or 0.7%,
to $266.2 million for the six months ended June 30, 1999, compared to
$268.0 million for the same period in 1998. This decrease is primarily
due to a $12.6 million decrease in net premiums written from the
aggregate excess of loss reinsurance treaty. Excluding the impact of
this reinsurance treaty, net premiums written increased $10.8 million,
or 4.0%, attributable to the Company's decision to reduce group and safe
driver discounts offered in Massachusetts.
Underwriting results deteriorated $8.8 million to a loss of $2.5 million
for the six months ended June 30, 1999, from an underwriting gain of $6.3
million for the for the same period in 1998. The deterioration in
underwriting results is primarily attributable to an $11.2 million
increase in catastrophe losses to $23.9 million in 1999, compared to
$12.7 million in 1998. In addition, underwriting results are adversely
impacted by increased loss activity in the personal automobile line.
Partially offsetting these unfavorable factors is a $10.1 million
increase in underwriting results due to the aggregate excess of loss
reinsurance treaty.
Specialty Markets
Specialty Markets' net premiums written decreased slightly to
$21.4 million for the six months ended June 30, 1999, compared to $22.4
million for the same period in 1998. Net premiums earned increased $11.5
million to $26.1 million for the six months ended June 30, 1999, from
$14.6 million for the same period in 1998.
Underwriting results deteriorated $2.1 million to an underwriting loss of
$3.9 million for the six months ended June 30, 1999, compared to an
underwriting loss of $1.8 million for the period ended June 30, 1998.
The deterioration in underwriting results is primarily attributable to
case reserve strengthening and an increase in underwriting expenses.
Investment Results
Net investment income before tax was $113.5 million and $115.3 million in
the first six months of 1999 and 1998, respectively. This primarily
reflects a reduction in average invested assets of $317.5 million, or
7.5%, to $3,900.5 million in 1999, compared to $4,218.0 million in 1998.
This reduction in average invested assets is due to transfers of cash
and securities of $350.0 million to the Corporate segment during the
second quarter of 1999. Average pre-tax yields on debt securities were
6.7% in 1999 and 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 23
<PAGE>
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE as follows:
<TABLE>
<CAPTION>
(Unaudited)
Six Months Ended
June 30,
(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 795.6 812.5
Decrease in provision for
insured events of prior years (96.1) (68.1)
--------- ---------
Total incurred losses and LAE $ 699.5 $ 744.4
--------- ---------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to
insured events of current year 342.1 335.2
Losses and LAE attributable to
insured events of prior years 424.2 433.6
--------- ---------
Total payments $ 766.3 $ 768.8
--------- ---------
Change in reinsurance recoverable on
unpaid losses 44.3 (11.3)
--------- ---------
Reserve for losses and LAE, end of year $2,574.8 $2,579.7
========= =========
</TABLE>
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $96.1 million and $68.1 million
for the six months ended June 30, 1999 and 1998, respectively, reflecting
increased favorable development on reserves for both losses and loss
adjustment expenses.
Favorable development on prior years' loss reserves was $52.0 million and
$29.5 million for the six months ended June 30, 1999 and 1998, respectively.
This increase of $22.5 million is primarily due to improved personal
automobile results in the Northeast. Favorable development on prior year's
loss adjustment expense reserves was $44.1 million and $38.6 million for
the six months ended June 30, 1999 and 1998, respectively. This favorable
development in both periods is primarily attributable to claims process
improvement initiatives taken by the Company over the past two years.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future.
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 24
<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 50.0-67.0% depending on the size of the loss, and increased by a ceding
commission of 20.0% of ceded premium. In addition, net investment income is
reduced for amounts credited to the reinsurer. As a result of this agreement,
the Company recognized a net (expense) benefit of $(3.0) and $16.9 million
for the quarter and six months ended June 30, 1999, based on year-to-date
and annual estimates of losses and allocated loss adjustment expenses for
accident year 1999. The effect of this agreement on the results of operations
in future periods is not currently determinable, as it will be based both on
future losses and allocated LAE, and on the possible cancellation or
commutation of the agreement. The agreement may increase or decrease income
in future periods.
The Company, in the Risk Management segment, is subject to concentration of
risk with respect to reinsurance ceded to various residual market mechanisms.
As a condition to the ability to conduct certain business in various states,
the Company is required to participate in various residual market mechanisms
and pooling arrangements which provide various insurance coverages to
individuals or other entities that are otherwise unable to purchase such
coverage voluntarily provided by private insurers. These market mechanisms
and pooling arrangements include the Commonwealth Automobile Reinsurers and
the Michigan Catastrophic Claims Association.
Page 25
<PAGE>
Asset Accumulation
Allmerica Financial Services
The following table summarizes the results of operations, including the
Closed Block, for the Allmerica Financial Services segment for the periods
indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues
Premiums $ 8.5 $ 9.3 $ 36.4 $ 38.2
Fees 88.6 72.7 171.5 142.2
Investment and other income 96.8 90.4 190.7 183.2
------- ------- ------- -------
Total segment revenues 193.9 172.4 398.6 363.6
Policy benefits, claims and losses 75.8 74.4 174.2 167.9
Policy acquisition and
other operating expenses 70.4 53.8 127.8 109.3
------- ------- ------- -------
Segment income before taxes $ 47.7 $ 44.2 $ 96.6 $ 86.4
======= ======= ======= =======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Segment income before taxes increased $3.5 million, or 7.9%, to $47.7 million
during the second quarter of 1999. This increase is primarily attributable
to higher asset-based fee income driven by growth and market appreciation in
the variable annuity and variable universal life product lines, partially
offset by higher policy benefits and other operating expenses.
Segment revenues increased $21.5 million, or 12.5%, in 1999 primarily due to
increased fees and other income. Fee income from annuities and individual
variable universal life policies increased $16.2 million, or 32.5%, in the
second quarter of 1999 due to additional deposits and market appreciation.
In addition, other income increased $4.6 million due primarily to higher
investment management fees resulting from growth and appreciation in
variable product assets under management. Financial Profiles, a third
quarter 1998 acquisition, contributed $1.9 million of this $4.6 million
increase.
Policy benefits, claims and losses increased $1.4 million, or 1.9%, to $75.8
million in the second quarter of 1999. This increase was primarily due to a
$1.9 million increase in the mortality reserve related to the variable
annuity line of business, additional growth in this line, and the
introduction in 1998 of a new annuity program which provides, for a limited
time, enhanced crediting rates on deposits made into the Company's general
account. These increases were offset by more favorable mortality experience
in the Closed Block and individual variable universal life lines 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 $16.6 million, or
30.9%, in the second quarter of 1999. This increase primarily results from
ongoing growth in the variable product lines. Also, policy acquisition
expenses increased $2.5 million related to the implementation of an enhanced
valuation system for the annuity line of business earlier in 1999. In
addition, other operating expenses relating to Financial Profiles and trail
commissions in the annuity line of business increased $2.3 million and
$2.2 million, respectively.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Segment income before taxes increased $10.2 million, or 11.8%, to $96.6
million in the first half of 1999. This increase is primarily attributable
to higher asset-based fee income driven by growth and market appreciation
in the variable annuity and variable universal life product lines, partially
offset by higher policy benefits and operating expenses.
Page 26
<PAGE>
Segment revenues increased $35.0 million, or 9.6%, in 1999 primarily due to
increased fees and other income. Fee income from annuities and individual
variable universal life policies increased $31.5 million, or 33.4%, in the
first six months of 1999 compared to the same period in 1998 due to
additional deposits and market appreciation. In addition, investment and
other income increased $7.5 million due primarily to higher investment
management fees resulting from growth and appreciation in variable product
assets under management and the aforementioned acquisition of Financial
Profiles. These increases were partially offset by a decrease in premiums
of $1.8 million and a decline in fees of $1.4 million primarily from the
Company's continued shift in focus from traditional and non-variable
universal life insurance products to variable life insurance and annuity
products.
Policy benefits, claims and losses increased $6.3 million, or 3.8%, to
$174.2 million during the first half of 1999. This increase was primarily
due to the Company's establishment of a $7.4 million mortality reserve in
the first quarter of 1999 related to the variable annuity line of business,
a second quarter increase in this reserve of $1.9 million, and additional
growth in this line. In addition, annuity reserves increased $5.4 million
due to the introduction of the aforementioned new annuity program, with
enhanced crediting rates. These increases were offset by more favorable
mortality experience in the universal life, Closed Block and individual
variable universal life lines 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 $18.5 million, or
16.9%, in the six months ended June 30, 1999. This increase was primarily
due to growth in the variable product lines. In addition, Financial Profiles,
which was acquired in the third quarter of 1998, generated $4.2 million of
expenses during the first half of 1999. Partially offsetting these increases
is an $8.5 million decline in policy acquisition expenses resulting from
the implementation of an enhanced valuation system for the annuity line
of business in the first quarter of 1999. This decline consists of a
one-time increase in the deferred acquisition asset of $13.5 million,
partially offset by increased ongoing deferred acquisition expenses of
approximately $5.0 million.
Interest Margins
The results of the Allmerica Financial Services segment depend, in part, on
the maintenance of profitable margins between investment results from
investment assets supporting universal life and general account annuity
products and the interest credited on those products.
The following table sets forth interest earned, interest credited and the
related interest margin.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net investment income $ 30.9 $ 34.6 $ 59.2 $ 67.5
Less: Interest credited 23.9 20.7 47.4 43.8
------- ------- ------- -------
Interest margins <FN1> $ 7.0 $ 13.9 $ 11.8 $ 23.7
======= ======= ======= =======
<FN>
<FN1> Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal life and
general account annuity policies. Earnings on surplus assets are excluded
from net investment income in the calculation of the above interest margins.
</FN>
</TABLE>
Interest margins decreased in the first six months of 1999 due to reduced
income from mortgage loans, a shift in assets to the variable product lines,
and to the introduction of the aforementioned annuity program with enhanced
crediting rates.
Page 27
<PAGE>
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica
Asset Management segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Interest margins
Net investment income $ 36.9 $ 27.6 $ 68.3 $ 49.2
Interest credited 31.5 21.9 58.1 39.4
------- ------- ------- -------
Net interest margin 5.4 5.7 10.2 9.8
------- ------- ------- -------
Other income and expenses
External investment advisory
fees and other income 1.6 0.6 3.0 1.2
Internal investment advisory
fees and other income 2.0 1.7 3.5 3.4
Other operating expenses 2.2 1.8 4.2 4.3
------- ------- ------- -------
Segment income before taxes $ 6.8 $ 6.2 $ 12.5 $ 10.1
======= ======= ======= =======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Income in the Allmerica Asset Management segment is generated by interest
margins earned on the Company's GICs and funding agreements, as well as
investment advisory fees earned on assets under management. Investment
advisory services are provided to affiliates and third parties, such as
money market and other fixed income clients. Related fees are based upon
asset balances under the Company's management. Segment income before taxes
increased $0.6 million, or 9.7%, to $6.8 million. This increase is
primarily attributable to increased investment advisory fees resulting from
increased assets under management from new and existing money market and
other external fixed income fund clients. These increases were partially
offset by a slight decrease in interest margins due to the absence, in 1999,
of approximately $0.4 million of mortgage prepayment fees received in 1998.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Segment income before taxes increased $2.4 million, or 23.8%, to $12.5
million. This increase is primarily attributable to growth in investment
advisory fees on assets under management and improved interest margins.
Assets under management grew in the first half of 1999 as a result of
increased business from new and existing money market and other external
fixed income fund clients. Interest margins on GICs increased slightly since
the first half of 1998, due to continued sales of funding agreements,
partially offset by withdrawals of traditional GICs and to the absence, in
1999, of approximately $0.8 million of mortgage prepayyment fees received in
1998. Funding agreement deposits in the first six months of 1999 increased
approximately $252.2 million.
Page 28
<PAGE>
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Segment revenues
Investment and other income $ 2.4 $ 4.1 $ 3.6 $ 6.1
Interest expense 3.8 3.8 7.6 7.6
Other operating expenses 12.1 13.0 25.5 23.5
------- ------- ------- -------
Segment loss before taxes
and minority interest $ (13.5) $ (12.7) $ (29.5) $ (25.0)
======= ======= ======= =======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Segment loss before taxes and minority interest increased $0.8 million, or
6.3 %, to $13.5 million in the second quarter of 1999 primarily due to a
$1.7 million decrease in investment and other income, partially offset by a
$0.9 million decrease in other operating expenses. Investment income
declined $1.5 million during the second quarter of 1999 due to lower average
invested assets. This decline primarily reflects the sale of investments
which were used to fund the Company's stock repurchase program, partially
offset by assets transferred from the Risk Management segment of $125.0
million and $225.0 million in April and May of 1999, respectively.
Interest expense for both periods relates solely to the interest paid on the
Senior Debentures of the Company.
Other operating expenses for the quarter ended June 30, 1999 decreased $0.9
million, or 6.9%. This expense category consists primarily of corporate
overhead expenses, which reflect costs not attributable to a particular
segment, such as those generated by certain officers and directors,
Corporate Technology, Corporate Finance, Human Resources and the Legal
department. The decrease in other operating expenses primarily reflects
the Company's exit from certain non-insurance businesses during 1998.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Segment loss before taxes and minority interest increased $4.5 million, or
18.0%, to $29.5 million for the six months ended June 30, 1999. Investment
and other income decreased $2.5 million in 1999 primarily from lower
average invested assets. This decline primarily resulted from the sale of
investments used to fund the Company's stock repurchase program, partially
offset by the aforementioned transfers of assets from the Risk Management
segment.
Interest expense for both periods relates solely to the interest paid on
the Senior Debentures of the Company.
Other operating expenses increased $2.0 million, or 8.5%, primarily due to
$3.2 million of higher corporate technology and overhead costs, partially
offset by decreased expenses resulting from the Company's exit from certain
non-insurance businesses in 1998.
Page 29
<PAGE>
Discontinued Operations
On June 30, 1999, the Company approved a plan to exit its group life and
health insurance business, consisting of its EBS business and its accident
and health assumed reinsurance pool business. The Company is pursuing a
sale of its EBS business during the second half of 1999. During the third
quarter of 1998, the Company ceased writing new premium in the reinsurance
pool business, subject to certain contractual obligations. Prior to 1999,
these businesses comprised substantially all of the former Corporate Risk
Management Services segment. Accordingly, the operating results of the
Company's group life and health insurance business, including its
reinsurance pool business, have been reported in the Consolidated Statements
of Income as discontinued operations in accordance with APB No. 30.
The following table summarizes the results of operations for the
discontinued group life and health insurance business for the periods
indicated.
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Revenues
Premiums $ 74.3 $ 83.1 $ 155.3 $ 168.5
Net investment and other income 15.4 16.2 31.8 32.0
------- ------- ------- -------
Total revenues 89.7 99.3 187.1 200.5
Policy benefits, claims and losses 69.0 62.6 127.8 124.7
Policy acquisition and other
operating expenses 30.8 34.7 64.4 69.0
------- ------- ------- -------
(Loss) income from operations of
discontinued group life and
health business before federal
income taxes (10.1) 1.8 (5.1) 6.8
Federal income tax (benefit)
expense (3.5) 0.7 (1.8) 2.4
------- ------- ------- -------
(Loss) income from operations of
discontinued group life and
health business, net of taxes $ (6.6) $ 1.1 $ (3.3) $ 4.4
======= ======= ======= =======
</TABLE>
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Income from operations before federal income taxes decreased $11.9 million
to a loss of $10.1 million during the second quarter of 1999. Losses in the
assumed reinsurance pool business totaled $13.0 million in the current
quarter as compared to income of $0.9 million in the prior year. This was
partially offset by a $2.0 million increase in income from the EBS business
to $3.3 million in 1999.
Premiums declined $8.8 million, or 10.6%, in 1999, primarily resulting from
a $10.8 million charge related to unrecoverable receivables in the accident
and health assumed reinsurance pool business. In addition, premiums
declined $1.6 million in the fully insured medical product line, due to the
Company's decision, in 1998, to cancel several large, unprofitable accounts.
These decreases were partially offset by an increase in assumed premiums
of $4.0 million in the accident and health assumed reinsurance pool
business, as well as $1.7 million of growth in the affinity group life
and health business.
Policy benefits, claims and losses increased $6.4 million, or 10.2% in 1999,
primarily due to $8.6 million in reserve increases in the accident and
health assumed reinsurance pool business, net of applicable reinsurance. In
addition, losses increased $1.9 million and $1.7 million in the risk sharing
and affinity group life and health lines of business, respectively, due to
growth and unfavorable loss experience. Partially offsetting these
increases was favorable loss experience in the fully insured medical, dental
and disability product lines totaling $5.9 million.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Income from operations before federal income taxes decreased $11.9 million
to a loss of $5.1 million during the first six months of 1999. Losses in
the assumed reinsurance pool business totaled $11.8 million in the period
ended June 30, 1999 as compared to income of $2.0 million in the prior year.
This was partially offset by a $3.5 million increase in income from the EBS
business to $8.2 million in 1999.
Page 30
<PAGE>
Premiums declined $13.2 million, or 7.8%, in 1999, primarily resulting
from the aforementioned charge related to unrecoverable receivables in
the accident and health assumed reinsurance business. In addition,
premiums declined $6.3 million in the fully insured medical and dental
product lines due to the Company's decision, in 1998, to cancel several
large, unprofitable accounts. These decreases were partially offset by
an increase of $3.6 million in the risk sharing line of business due to
growth.
Policy benefits, claims and losses increased $3.1 million, or 2.5%, in 1999,
primarily due to the aforementioned reserve increases in the accident and
health assumed reinsurance business. In addition, losses increased $5.1
million due to growth and unfavorable experience in the risk sharing
lines of business. Partially offsetting these increases were decreased
losses in the fully
insured medical, dental and disability product lines totaling $10.0
million resulting from favorable experience through the first six months
of 1999.
The Company believes that its current reserves for the accident and health
assumed reinsurance pool business appropriately reflect both current claims
and unreported losses. However, due to the inherent volatility in this
business, possible issues related to the enforceability of reinsurance
treaties in the industry, and to its recent history of increased losses,
there can be no assurance that either current reserves are adequate or that
future losses will not arise. Although the Company has discontinued its
participation in these reinsurance pools, claims related to prior years may
occur and/or develop unfavorably.
Investment Portfolio
The Company had investment assets diversified across several asset classes,
as follows:
<TABLE>
<CAPTION>
June 30, 1999 <FN1> December 31, 1998 <FN1>
% of Total % of Total
Carrying Carrying Carrying Carrying
(Dollars in millions) Value Value Value Value
<S> <C> <C> <C> <C>
Fixed maturities <FN2> $ 8,455.0 81.6% $ 8,195.0 79.0%
Equity securities <FN2> 106.4 1.0 397.1 3.8
Mortgages 688.7 6.7 698.3 6.7
Policy loans 365.5 3.5 365.2 3.5
Cash and cash equivalents 573.3 5.5 559.7 5.4
Real estate and other
invested assets 176.8 1.7 163.1 1.6
----------------- -----------------
Total $10,365.7 100.0% $10,378.4 100.0%
================= =================
<FN>
<FN1> Includes Closed Block invested assets with a carrying value of
$744.0 million and $770.5 million at June 30, 1999 and December 31, 1998,
respectively.
<FN2> The Company carries the fixed maturities and equity securities in
its investment portfolio at market value.
</FN>
</TABLE>
Total investment assets decreased $12.7 million, or 0.1%, to $10.4 billion
during the first six months of 1999. This decrease resulted primarily from
decreased equity securities of $290.7 million, partially offset by an
increase of $260.0 million of fixed maturities. In January 1999, sales of
equity securities resulted in proceeds of $310.0 million and realized gains
of $116.0 million. Proceeds from the equity securities were used, in part,
to repay the loan used to fund the acquisition of minority interest of
Citizens Corporation. The increase in fixed maturities is principally due
to new funding agreement deposits, partially offset by sales used for the
repurchase of AFC common stock under the stock repurchase program. In
addition, real estate and other long-term investments increased $13.7
million, primarily due to the investment in new partnerships.
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 85.4% and 84.7% of the Company's total fixed maturity
portfolio at June 30, 1999 and December 31, 1998, respectively. The average
yield on debt securities was 7.1% and 7.3% for the six months ended June 30,
1999 and 1998, respectively. Although management expects that a substantial
portion of new funds will be invested in investment grade fixed maturities,
the Company may invest a portion of new funds in below investment grade
fixed maturities or equity interests.
Page 31
<PAGE>
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 (1) (2.4)
--------
Ending balance $ 11.5
Valuation allowance as a percentage of
carrying value before reserves 1.6 %
Six months ended June 30, 1999
Provision 0.0
Write-offs <FN1> (0.1)
--------
Ending balance $ 11.4
========
Valuation allowance as a percentage of
carrying value before reserves 1.6 %
<FN>
<FN1> Write-offs reflect asset sales, foreclosures and forgiveness of debt
upon restructurings.
</FN>
</TABLE>
Income Taxes
AFC and its domestic subsidiaries (including certain non-insurance
operations) file a consolidated United States federal income tax return.
Entities included within the consolidated group are segregated into either a
life insurance or a non-life insurance company subgroup. The consolidation
of these subgroups is subject to certain statutory restrictions on the
percentage of eligible non-life tax losses that can be applied to offset
life company taxable income.
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998
Provision for federal income taxes before minority interest and discontinued
operations was $22.0 million during the second quarter of 1999 compared to
$17.6 million during the same period in 1998. These provisions resulted in
consolidated effective federal tax rates of 23.9% and 21.4%, respectively.
The effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 22.1% and 32.7% during the second quarter of 1999 and 1998,
respectively. The effective tax rates for Allmerica P&C and its subsidiaries
were 25.6% and 9.1% during the second quarter of 1999 and 1998, respectively.
The decrease in the rate for AFLIAC and FAFLIC and its subsidiaries is
primarily the result of a smaller proportion of pre-tax income from realized
capital gains in 1999. The increase in the rate for the Allmerica P&C
subsidiaries is primarily the result of a decrease in the proportion of tax
exempt income to pre-tax income.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
The provision for federal income taxes before minority interest and
discontinued operations was $69.7 million during the first six months of
1999 compared to $40.2 million during the same period in 1998. These
provisions resulted in consolidated effective federal tax rates of 23.6% and
22.7%, respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 26.4% and 31.8% during the first six months
of 1999 and 1998, respectively. The effective tax rates for Allmerica P&C
and its subsidiaries were 22.0% and 11.4% during the first six months of
1999 and 1998, respectively. The decrease in the rate for AFLIAC and FAFLIC
and its subsidiaries is primarily the result of a smaller proportion of
pre-tax income from realized capital gains in 1999. The increase in the rate
for the Allmerica P&C subsidiaries is primarily the result of a decrease in
the proportion of tax exempt income to pre-tax income, as well as a larger
proportion of pre-tax income from realized capital gains in 1999.
Page 32
<PAGE>
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash
flows to meet the cash requirements of business operations. As a holding
company, AFC's primary source of cash is dividends from its insurance
subsidiaries. However, dividend payments to AFC by its insurance
subsidiaries are subject to limitations imposed by state regulators, such
as the requirement that cash dividends be paid out of unreserved and
unrestricted earned surplus and restrictions on the payment of
"extraordinary" dividends, as defined.
During 1999, AFC received $350.0 million in extraordinary dividends from
its property and casualty businesses. These funds were principally used to
repurchase $250.2 million of AFC common stock and pay $20.3 million of
interest expense on the Senior Debentures and Capital Securities. During the
third quarter of 1999, the Company expects to use the remaining funds from
the aforementioned dividends, as well as anticipated proceeds from sales of
AFC holding company investments, to fund a $125.0 million capital
contribution from AFC to FAFLIC. As of July 1, 1999, FAFLIC's ownership of
Allmerica P&C, as well as several non-insurance subsidiaries, were
transferred from FAFLIC to AFC. Under an agreement with the Commonwealth of
Massachusetts Insurance Commissioner ("the Commissioner"), AFC will
contribute the aforementioned $125.0 million and maintain FAFLIC's statutory
surplus at specified levels during the following six years. Future capital
contributions from AFC to FAFLIC may be required. In addition, any dividend
from FAFLIC to AFC during the years 2000 and 2001 would require the prior
approval of the Commissioner.
During the first six months of 1998, Hanover and FAFLIC declared dividends
to AFC of $125.0 million and $50.0 million, respectively. These funds were
transferred to the holding company in anticipation of the fourth quarter
1998 acquisition of the minority interest of Citizens and were temporarily
invested in short-term securities. In addition, AFC paid $20.3 million of
interest expense during the first half of 1998 on the Senior Debentures and
Capital Securities.
Sources of cash for the Company's insurance subsidiaries are from premiums
and fees collected, investment income and maturing investments. Primary
cash outflows are paid benefits, claims, losses and loss adjustment expenses,
policy acquisition expenses, other underwriting expenses and investment
purchases. Cash outflows related to benefits, claims, losses and loss
adjustment expenses can be variable because of uncertainties surrounding
settlement dates for liabilities for unpaid losses and because of the
potential for large losses either individually or in the aggregate. The
Company periodically adjusts its investment policy to respond to changes in
short-term and long-term cash requirements.
Net cash provided by operating activities was $32.5 million during the first
six months of 1999, compared to cash used in operating activities of $90.5
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 declined $327.4 million, to $177.7
million, during the first six months of 1999. This change is primarily due
to $310.0 million of sales of equity securities in January 1999.
Net cash provided by financing activities decreased $440.7 million to $158.9
million during the first six months of 1999, as compared to $599.6 million
during the same period in 1998. In 1999, the Company repurchased AFC common
stock with an aggregate cost of $250.2 million. In addition, cash was used
to repay $150.0 million in short term debt used to finance the acquisition
of the minority interest of Citizens Corporation.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C to meet its obligations to pay
interest on the Senior Debentures, Capital Securities and dividends, when
and if declared by the Board of Directors, on the common stock. Whether
the Company will pay dividends in the future depends upon the costs of
administering a dividend program as compared to the benefits conferred, and
upon the earnings and financial condition of AFC. On July 27, 1999, the
Board of Directors declared an annual dividend of $0.25 per share on the
issued and outstanding common stock of the Company, payable November 15, 1999
to shareholders of record at the close of business November 1, 1999.
Page 33
<PAGE>
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and long-term cash
requirements. The Company maintains a high degree of liquidity within the
investment portfolio in fixed maturity investments, common stock and short-
term investments. AFC has $150.0 million available under a committed
syndicated credit agreement which expires on May 28, 2000. Borrowings under
this agreement are unsecured and incur interest at a rate per annum equal
to, at the Company's option, a designated base rate or the eurodollar rate
plus applicable margin. At June 30, 1999, no amounts were outstanding under
this agreement. The Company had $50.2 million of commercial paper
borrowings outstanding at June 30, 1999.
Contingencies
In July 1997, a lawsuit on behalf of a putative class was instituted in
Louisiana against AFC and certain of its subsidiaries by individual
plaintiffs alleging fraud, unfair or deceptive acts, breach of contract,
misrepresentation, and related claims in the sale of life insurance policies.
In October 1997, the plaintiffs voluntarily dismissed the Louisiana suit and
filed a substantially similar action in Federal District Court in Worcester,
Massachusetts. In early November 1998, the Company and the plaintiffs
entered into a settlement agreement. The court granted preliminary approval
of the settlement on December 4, 1998. On May 19, 1999, the court issued an
order certifying the class for settlement purposes and granting final
approval of the settlement agreement. AFC recognized a $31.0 million
pre-tax expense during the third quarter of 1998 related to this litigation.
Although the Company believes that this expense reflects appropriate
recognition of its obligation under the settlement, this estimate assumes
the availability of insurance coverage for certain claims, and the estimate
may be revised based on the amount of reimbursement actually tendered by
AFC's insurance carriers, if any, and based on changes in the Company's
estimate of the ultimate cost of the benefits to be provided to members of
the class.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the Company's opinion, the
ultimate resolution of these proceedings will not have a material effect on
the Company's consolidated financial statements. However, liabilities
related to these proceedings could be established in the near term if
estimates of the ultimate resolution of these proceedings are revised.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
Based on a third party assessment, the Company determined that significant
portions of its software require modification or replacement to enable its
computer systems to process dates beyond December 31, 1999. The Company is
presently completing the process of modifying or replacing existing
software and believes that this action will resolve the Year 2000 issue.
However, if such modifications and conversions are not made, or are not
completed timely, or should there be serious unanticipated interruptions
from unknown sources, the Year 2000 issue could have a material adverse
impact on the operations of the Company. Specifically, the Company could
experience, among other things, an interruption in its ability to collect
and process premiums, process claim payments, safeguard and manage its
invested assets, accurately maintain policyholder information, accurately
maintain accounting records, and perform customer service. Any of these
specific events, depending on duration, could have a material adverse impact
on the results of operations and the financial position of the Company.
The Company has initiated formal communications with all of its suppliers
to determine the extent to which the Company is vulnerable to those third
parties' failure to remediate their own Year 2000 issue. The Company's
total Year 2000 project cost and estimates to complete the project include
the estimated costs and time associated with the Company's involvement on a
third party's Year 2000 program, and are based on presently available
information. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted, or
that a failure to convert by another company, or a conversion that is
incompatible with the Company's systems, would not have material adverse
effect on the Company. The Company does not believe that it has material
exposure to contingencies related to the Year 2000 issue for the products it
has sold. Although the Company does not believe that there is a material
contingency associated with the Year 2000 issue, there can be no assurance
that exposure for material contingencies will not arise.
Page 34
<PAGE>
The cost of the Year 2000 project will be expensed as incurred and is being
funded primarily through a reallocation of resources from discretionary
projects and a reduction in systems maintenance and support costs.
Therefore, the Year 2000 project is not expected to result in any
significant incremental technology cost, except as described above, and is
not expected to have a material effect on the results of operations. The
Company has incurred and expensed approximately $59 million related to the
assessment plan development and substantial completion of the Year 2000
project, through June 30, 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
All of the 613 AFC systems inventoried have been corrected, tested for
year 2000 dates, and returned to production.
Desktop Systems
The Company has verified that all desktop computers are capable of correctly
processing year 2000 dates. Additionally, over 99% of the third party
software installed on the Company's desktop machines has been confirmed
capable of processing year 2000 dates properly. Any remaining desktop
systems will be upgraded, eliminated, or replaced prior to year end.
External Partners
The Company has tested and verified that 97% of its electronic interfaces
will process year 2000 dates correctly. Ninety-two percent of the property
and casualty agents have confirmed that they are capable of properly
processing year 2000 dates. In addition, the Company has verified, through
a process that included, where appropriate, testing, written disclosure and
personal contact, that 86% 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 in the third quarter of 1999, however,
external partner compliance is not under the Company's control. As such,
the Company has initiated a proactive program to track these remaining
external partners. Action plans are being developed to mitigate the risk
of interruption of essential business processes should it be determined
that the Company's year 2000 readiness criteria for external partners
will not be met by September 30, 1999.
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.
Page 35
<PAGE>
Forward-Looking Statements
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected and in the future could affect,
the Company's actual results and could cause the Company's actual results for
1999 and beyond to differ materially from those expressed in any forward-
looking statements made by, or on behalf of, the Company. When used in the
MD&A discussion, the words "believes", "anticipates", "expects" and similar
expressions are intended to identify forward looking statements. See
"Important Factors Regarding Forward-Looking Statements" filed as Exhibit
99-2.
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; (xix) changes in the mix
of assets comprising the Company's investment portfolio and the fluctuation
of the market value of such assets; and (xx) losses resulting from the
Company's participation in certain reinsurance pools.
Page 36
<PAGE>
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This registrant's annual shareholder's meeting was held on May 11, 1999.
All four directors nominated for reelection by the Board of Directors were
named in proxies for the meeting, which proxies were solicited pursuant to
Regulations 14A of the Securities and Exchange Act of 1934. Messrs. Gerson
and Murray were elected to serve a three-year term. Mr. Henderson was
elected to serve a two-year term. Mr. Sprague was elected to serve a
one-year term. The following votes were cast:
<TABLE>
<CAPTION>
VOTES FOR WITHHELD
<S> <C> <C>
Samuel J. Gerson 41,356,558 474,962
Robert P. Henderson 41,534,971 476,549
Robert J. Murray 41,542,064 469,456
John L. Sprague 41,537,674 473,846
</TABLE>
The other directors whose terms were continued after the Annual Meeting
are Mr. Michael P. Angelini, Mr. E. Gordon Gee, Ms. Gail L. Harrison,
Mr. M Howard Jacobson, Mr. J. Terrence Murray, Mr. John F. O'Brien, Mr.
Robert G. Stachler and Mr. Herbert M. Varnum.
Shareholders ratified the appointment of PricewaterhouseCoopers LLP as the
Independent Public Accountants of the Company for 1999: for 41,733,083;
against 75,568; abstain 202,869.
Shareholders approved a Short-Term Incentive Compensation Plan: for
39,893,835; against 1,561,335; abstain 556,350.
Page 37
<PAGE>
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX - 10.36 Amendment to the Credit Agreement dated as of June 17,
1998 between the Registrant and the Chase Manhattan Bank.
EX - 10.37 Allmerica Financial Corporation Short-Term Incentive
Compensation Plan. +
EX - 27 Financial Data Schedule
EX - 99.2 Important Factors Regarding Forward Looking Statements
+ Incorporated herein by reference to Exhibit A contained
in the Registrants current Proxy Statement (Commission
File No. 001-13754) filed March 31, 1999.
(b) Reports on Form 8K
On April 29, 1999, Allmerica Financial Corporation announced its
financial results for the three months ended March 31, 1999.
On May 25, 1999, Allmerica Financial Corporation announced that a
settlement agreement in a class action lawsuit against the Company and three
of its subsidiaries received final approval in U.S. District Court in
Worcester. The class action lawsuit related to the sale of approximately
400,000 policies from 1978 to May 31, 1998.
Page 38
<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 August 12, 1999
/s/ John F. O'Brien
John F. O'Brien
President and Chief Executive Officer
Dated August 12, 1999
/s/ Edward J. Parry III
Edward J. Parry III
Vice President, Chief Financial
Officer, and Treasurer
Page 39
<PAGE>
EXHIBIT INDEX
Exhibit Number Exhibit
10.36 Amendment to the Credit Agreement dated as
of June 17, 1998 between the Registrant and
the Chase Manhattan Bank.
10.37 Allmerica Financial Corporation Short-term
Incentive Compensation Plan. +
27 Financial Data Schedule
99.2 Important Factors Regarding Forward Looking
Statements
+ Incorporated herein by reference to Exhibit
A contained in the Registrants current
Proxy Statement (Commission File No. 001-
13754) filed March 31, 1999.
Page 40
<PAGE>
AMENDMENT AND RESTATEMENT
dated as of May 28, 1999
of
364-DAY CREDIT AGREEMENT
dated as of May 29, 1998
among
ALLMERICA FINANCIAL CORPORATION
The LENDERS Party Hereto
and
THE CHASE MANHATTAN BANK,
as Administrative Agent
-------------------------------------
$150,000,000
-------------------------------------
CHASE SECURITIES INC.,
as Arranger and Book Manager
<PAGE>
AMENDMENT AND RESTATEMENT dated as of May 28, 1999 (this
"Amendment and Restatement") of the 364-DAY CREDIT AGREEMENT referred to
below, among: ALLMERICA FINANCIAL CORPORATION, a Delaware corporation (the
"Company"); the LENDERS party hereto; and THE CHASE MANHATTAN BANK, as
administrative agent to the Lenders (in such capacity, with any successors
in such capacity, the "Administrative Agent").
W I T N E S S E T H:
WHEREAS, the Borrower, the Lenders and the Administrative Agent
are parties to a 364-Day Credit Agreement dated as of May 29, 1998
immediately prior to the effectiveness of this Amendment and Restatement
pursuant to Section 4 hereof, the "Existing Credit Agreement") and desire
to amend and restate the Existing Credit Agreement to make certain
amendments and other modifications thereto; and
NOW, THEREFORE, in consideration of the foregoing premises and the
mutual agreements contained herein, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged,
the parties hereto agree to amend the Existing Credit Agreement as set forth
herein and to restate the Existing Credit Agreement to read in its entirety
as set forth in the Existing Credit Agreement, which is hereby incorporated
herein by reference, with the amendments thereto specified in Section 2 of
this Amendment and Restatement (the Existing Credit Agreement, as amended
and restated hereby, being herein called the "Amended and Restated Credit
Agreement"):
Section 1. Definitions. Terms defined in the Existing Credit
Agreement but not herein have the meanings given them in the Existing Credit
Agreement.
Section 2. Amendments. Effective on the date provided in Section
4 of this Amendment and Restatement, subject to satisfaction of the
conditions to effectiveness set forth therein, the Existing Credit
Agreement is hereby amended as follows:
2.01. General. References in the Existing Credit Agreement to
"this Agreement" or words of similar import (including indirect references
to the Existing Credit Agreement) shall be deemed to be references to the
Amended and Restated Credit Agreement.
2.02. Certain Definitions. Each of the following definitions in
Section 1.01 of the Credit Agreement shall be amended in its entirety to
read as follows:
"Applicable Loan Fee Percentage" shall mean 0.08% per annum.
"Applicable Margin" shall mean, with respect to Eurodollar Loans,
0.22% per annum.
"Commitment Termination Date" shall mean May 27, 2000, as such
date may be extended pursuant to Section 2.09 hereof.
Amendment and Restatement
-------------------------
Page 1 of 6
<PAGE>
2.03. Clause (f) of Section 8.04 of the Credit Agreement shall
be amended by inserting the following parenthetical immediately after the
word "thereto" in the ninth line thereof:
"(unless the aggregate purchase price for such acquisition
is less than $20,000,000 and such approval is not required by
applicable law, in which case such approval shall not be required
hereunder)".
2.04. Clause (l) of Section 8.05 of the Credit Agreement shall
be amended in its entirety to read as follows:
"(l) additional Liens upon real and/or personal Property
created after the date hereof, provided that the aggregate
Indebtedness secured thereby and incurred on and after the
date hereof shall not exceed $30,000,000 in the aggregate at
any one time outstanding; and".
2.05. Clause (f) of Section 8.06 of the Credit Agreement shall
be amended in its entirety to read as follows:
"(f) additional Indebtedness of the Company and its
Subsidiaries (including, without limitation, Capital Lease
Obligations and other Indebtedness secured by Liens permitted
under Sections 8.05(j) or 8.05(l) hereof) if on the date of the
incurrence of such Indebtedness (after giving pro forma effect
to such Indebtedness and the application of the net proceeds
therefrom) the (A) the sum of (i) Total Debt plus (ii) the
aggregate liquidation preference of all Special Preferred
Securities but only that portion of such aggregate liquidation
preference that is at such time equal to, or in excess of, 15%
of Total Capitalization on such date would not exceed (B) 25%
of Total Capitalization.
2.06. Section 8.08 of the Credit Agreement shall be amended by
(i) replacing the word "and" immediately prior to clause (y) thereof with
a comma and (ii) amending said clause (y) in its entirety, and inserting a
new clause (z) immediately following said clause (y), to read as follows:
"(y) the Company and its Subsidiaries may enter into transactions
in the ordinary course of business and upon terms no less
favorable to the Company or such Subsidiary than the Company or
such Subsidiary would obtain in a comparable arm's-length
transaction with a Person not an Affiliate and (z) the Company
and its Subsidiaries may make investment in Affiliates in an
aggregate amount not exceeding 10% of the Total Shareholders'
Equity."
Amendment and Restatement
-------------------------
Page 2 of 6
<PAGE>
Section 3. Representations and Warranties. The Borrower hereby
represents and warrants to the Lenders and the Administrative Agent that (a)
the representations and warranties set forth in Article III of the Existing
Credit Agreement as amended and restated hereby are true and correct as of
the Effective Date (as defined in Section 4 hereof) with the same force and
effect as if made on and as of such date (or, if any such representation or
warranty is expressly stated to have been made as of a specific date, as of
such specific date) and (b) no Default shall have occurred and be continuing
on the Effective Date both immediately before and after giving effect to the
amendments set forth in Section 2 of this Amendment and Restatement.
Section 4. Conditions Precedent. The amendment and restatement
of the Existing Credit Agreement contemplated hereby shall be effective as
of May 28, 1999 (the "Effective Date") upon the satisfaction of each of the
following conditions precedent:
(a) Amended and Restated Credit Agreement. This Amendment and
Restatement, duly executed and delivered by the Borrower, the Lenders
and the Administrative Agent.
(b) Payments. Evidence satisfactory to the Administrative Agent
of payment (or arrangements for payment) in full of all unpaid loan
fees under Section 2.04 of the Existing Credit Agreement, which shall
have accrued to but not including the Commitment Termination Date as
in effect immediately prior to the effectiveness of this Amendment
and Restatement.
(c) Other Documents. Receipt by the Administrative Agent of
such other documents as any Administrative Agent or any Lender or
special New York counsel to Chase may reasonably request.
Section 5. Miscellaneous. Except as herein provided, the
Existing Credit Agreement shall remain unchanged and in full force and
effect. This Amendment and Restatement may be executed in any number
of counterparts, all of which taken together shall constitute one and
the same amendatory instrument and any of the parties hereto may execute
this Amendment and Restatement by signing any such counterpart and sending
the same by telecopier, mail messenger or courier to the Administrative
Agent or special New York counsel to Chase. This Amendment and
Restatement shall be governed by, and construed in accordance with, the
law of the State of New York.
Amendment and Restatement
-------------------------
Page 3 of 6
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment and Restatement to be duly executed as of the day and year first
above written.
BORROWER
--------
ALLMERICA FINANCIAL CORPORATION
By: /s/ Edward J. Parry III
-------------------------
Name: Edward J. Parry III
Title: Vice President, Chief
Financial Officer, and
Treasurer
Amendment and Restatement
-------------------------
Page 4 of 6
<PAGE>
LENDERS
-------
Commitments
- -----------
(as of May 28, 1999)
$30,000,000 THE CHASE MANHATTAN BANK,
individually and as
Administrative Agent
By: /s/ Lawrence M. Karp
-------------------------
Name: Lawrence M. Karp
Title: Vice President
$30,000,000 BANKBOSTON, N.A.
By: /s/Stewart P. Neff
-------------------------
Name: Stewart P. Neff
Title: Managing Director
$30,000,000 THE FIRST NATIONAL BANK OF CHICAGO
By: /s/ Samuel W. Bridges
------------------------
Name: Samuel W. Bridges
Title: First Vice President
$45,000,000 FLEET NATIONAL BANK.
By: /s/ David A. Bosselait
------------------------
Name: David A. Bosselait
Title: Vice President
Page 5 of 6
<PAGE>
$15,000,000 THE BANK OF NEW YORK
By: /s/ Robert V. Masi
--------------------------
Name: Robert V. Masi
Title: Vice President
Amended and Restated Credit Agreement
NY3:#7208600v3
[EXECUTION COPY]
NY3:#7208600v3
Amendment and Restatement
NY3:#7208600v3
NY3:#7208600v3
Amendment and Restatement
-------------------------
Page 6 of 6
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This Schedule contains summary financial information extracted from the
Consolidated Financial Statements of Allmerica Financial Corporation as of
June 30, 1999 and for the period then ended, and is qualified in its
entirety reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 8044
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 106
<MORTGAGE> 556
<REAL-ESTATE> 18
<TOTAL-INVEST> 9044
<CASH> 578
<RECOVER-REINSURE> 1153
<DEFERRED-ACQUISITION> 1285
<TOTAL-ASSETS> 29826
<POLICY-LOSSES> 2870
<UNEARNED-PREMIUMS> 871
<POLICY-OTHER> 2793
<POLICY-HOLDER-FUNDS> 3201
<NOTES-PAYABLE> 250
300
0
<COMMON> 1
<OTHER-SE> 2248
<TOTAL-LIABILITY-AND-EQUITY> 29826
953
<INVESTMENT-INCOME> 313
<INVESTMENT-GAINS> 126
<OTHER-INCOME> 58
<BENEFITS> 883
<UNDERWRITING-AMORTIZATION> 204
<UNDERWRITING-OTHER> 238
<INCOME-PRETAX> 295
<INCOME-TAX> 70
<INCOME-CONTINUING> 218
<DISCONTINUED> (3)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 214
<EPS-BASIC> 3.83
<EPS-DILUTED> 3.80
<RESERVE-OPEN> 2597
<PROVISION-CURRENT> 796
<PROVISION-PRIOR> (96)
<PAYMENTS-CURRENT> 342
<PAYMENTS-PRIOR> 424
<RESERVE-CLOSE> 2575
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
EXHIBIT 99.2
ALLMERICA FINANCIAL CORPORATION
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that the following important
factors, among others, in some cases have affected the Company's results
and in the future could cause actual results and needs of the Company to
vary materially from forward-looking statements made from time to time by
the Company on the basis of management's then-current expectations, The
businesses in which the Company is engaged are in rapidly changing and
competitive markets and involve a high degree of risk, and accuracy with
respect to forward looking projections is difficult.
Geographic Concentration in the Property and Casualty Insurance Business
Substantially all of the Company's property and casualty insurance
subsidiaries net premiums written and earnings are generated in Michigan
and the Northeast (Connecticut, Massachusetts, New York, New Jersey, New
Hampshire, Rhode Island, Vermont and Maine). The revenues and
profitability of the Company's property and casualty insurance
subsidiaries are therefore subject to prevailing economic, regulatory,
demographic and other conditions, including adverse weather, in Michigan
and the Northeast.
Cyclicality in the Property and Casualty Insurance Industry
Historically, the property and casualty insurance industry has been
highly cyclical. The property and casualty industry's profitability can
be affected significantly by price competition, volatile and unpredictable
developments such as extreme weather conditions and natural disasters, legal
developments affecting insurer liability and the size of jury awards,
fluctuations in interest rates and other factors that affect investment
returns and other general economic conditions and trends that may affect
the adequacy of reserves.
Over the past several years, the property and casualty insurance
industry as a whole has been in a soft market. Competition for premiums
in the property and casualty insurance markets may continue to have an
adverse impact on the Company's rates and profitability.
Catastrophe Losses in the Property and Casualty Insurance Industry
Property and casualty insurers are subject to claims arising out of
catastrophes, which may have a significant impact on their results of
operations and financial condition. The Company may experience catastrophe
losses in the future which could have a material adverse impact on the
Company. Catastrophes can be caused by various events including hurricanes,
earthquakes, tornadoes, wind, hail, fires, severe winter weather and
explosions, and the frequency and severity of catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of two
factors: the total amount of insured exposure in the area affected by the
event and the severity of the event. Although catastrophes can cause losses
in a variety of property and casualty lines, homeowners and commercial
property insurance have in the past generated the vast majority of the
Company's catastrophe-related claims. The Company purchases catastrophe
reinsurance as protection against catastrophe losses. The Company believes,
based upon its review of its reinsurers' financial statements and
reputations in the reinsurance marketplace, that the financial condition of
its reinsurers is sound. However, there can be no assurance that
reinsurance will be adequate to protect the Company against such losses or
that such reinsurance will continue to be available to the Company in the
future at commercially reasonable rates.
Page 1 of 7
<PAGE>
Uncertainty Regarding Adequacy of Property and Casualty Loss Reserves
The Company's property and casualty insurance subsidiaries maintain
reserves to cover their estimated ultimate liability for losses and loss
adjustment expenses ("LAE") with respect to reported and unreported claims
incurred as of the end of each accounting period. These reserves are
estimates, involving actuarial projections at a given time, of what the
Company's property and casualty insurance subsidiaries expect the ultimate
settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claims severity and judicial theories of liability, legislative
activity and other factors. The inherent uncertainties of estimating
reserves are greater for certain types of property and casualty insurance
lines, particularly workers' compensation, where a longer period of time
may elapse before a definitive determination of ultimate liability may be
made, and environmental liability, where the technological, judicial and
political climates involving these types of claims are changing.
The Company's property and casualty insurance subsidiaries regularly
review reserving techniques, reinsurance and overall reserve adequacy.
Based upon (I) review of historical data, legislative enactments, judicial
decision, legal developments in imposition of damages, changes in
political attitudes and trends in general economic conditions; (ii) review
of per claim information; (iii) historical loss experience of the property
and casualty insurance subsidiaries and the industry; and (iv) the
relatively short-term nature of most of its property and casualty insurance
policies, management believes that adequate provision has been made for
reserves. However, establishment of appropriate reserves is an inherently
uncertain process involving estimates of future losses and there can be no
certainty that currently established reserves will prove adequate in light
of subsequent actual experience. The Company's property and casualty
insurance subsidiaries' reserves are annually certified as required by
insurance regulatory authorities.
Sensitivity to Interest Rates Relative to Life Insurance Subsidiaries
The Company's life insurance subsidiaries are exposed to risk of
disintermediation and reduction in interest spread or profit margins when
interest rates fluctuate. Bond calls, mortgage prepayments, contract
surrenders and withdrawals of life insurance policies, annuities and
guaranteed investment contracts are influenced by the interest rate
environment. Since the Company's life insurance subsidiaries' investment
portfolios consist primarily of fixed income assets, the investment
portfolio market value and the yields on newly invested and reinvested
assets vary depending on interest rates. Management attempts to mitigate
any negative impact of interest rate changes through asset/liability
management, product design (including an increased focus on variable
insurance products), management of crediting rates, use of hedging
techniques, relatively high surrender charges and management of mortality
charges and dividend scales with respect to its in force life insurance
policies.
Uncertainty Regarding Accident and Health Assumed Reinsurance Pool Business
The Company believes that notwithstanding the recent losses incurred
by the accident and health assumed reinsurance pool business, the Company's
current reserves appropriately reflect both current claims and unreported
losses. However, due to the inherent volatility in this business, possible
issues related to the enforceability of reinsurance treaties in the industry
and to its recent history of increased losses, we cannot assure you that
our current reserves are adequate or that we will not have losses in the
future. Although we have discontinued our participation in these
reinsurance pools, we may become subject to claims related to prior years.
We may be harmed from liabilities resulting from any such claims.
Page 2 of 7
<PAGE>
Regulatory, Surplus, Capital, Rating Agency and Related Matters
Insurance companies are subject to supervision and regulation by the
state insurance authority in each state in which they transact business.
Such supervision and regulation relate to numerous aspects of an insurance
company's business and financial condition, including limitations on the
authorization of lines of business, underwriting limitations, the setting
of premium rates, the establishment of standards of solvency, the licensing
of insurers and agents, concentration of investments, levels of reserves,
the payment of dividends, transactions with affiliates, changes of control
and the approval of policy forms. Such regulation is concerned primarily
with the protection of policyholders.
State regulatory oversight and various proposals at the federal level
(including the proposed adoption of a federal regulatory framework for
insurance companies) may in the future adversely affect the Company's
ability to sustain adequate returns in certain lines of business. In
recent years, the state insurance regulatory framework has come under
increased federal scrutiny, and certain state legislatures have considered
or enacted laws that alter and, in many cases, increase state authority to
regulate insurance companies and insurance holding company systems.
Further, the National Association of Insurance Commissioners ("NAIC") and
state insurance regulators are reexamining existing laws and regulations,
and as a condition to accreditation have required the adoption of certain
model laws which specifically focus on insurance company investments,
issues relating to the solvency of insurance companies, risk-based capital
("RBC") guidelines, interpretations of existing laws, the development of
new laws, and the definition of extraordinary dividends.
The capacity for an insurance company's growth in premiums is in part
a function of its statutory surplus. Maintaining appropriate levels of
statutory surplus, as measured by state insurance regulators, is considered
important by state insurance regulatory authorities and the private agencies
that rate insurers' claims-paying abilities and financial strength. Failure
to maintain certain levels of statutory surplus could result in increased
regulatory scrutiny, action by state regulatory authorities or a downgrade
by the private rating agencies.
The NAIC has created a new system for assessing the adequacy of
statutory capital for life and health insurers and property and casualty
insurers. The new system, known as risk-based capital, is in addition to
the states' fixed dollar minimum capital and other requirements. The new
system is based on risk-based formulas (separately defined for life and
health insurers and property and casualty insurers) that apply prescribed
factors to the various risk elements in an insurer's business to report a
minimum capital requirement proportional to the amount of risk assumed by
the insurer.
Because the investment of First Allmerica Financial Life Insurance
Company ("FAFLIC"), a life insurance subsidiary of the Company, in Allmerica
Property & Casualty Companies, Inc. ("Allmerica P&C") represents a
significant percentage of FAFLIC's surplus, the trading
In addition, in 1997, A.M. Best decided to no longer rate Citizens
independently from its majority parent, The Hanover Insurance Company, but
instead rated the two separate companies as a group. Consequently, Citizens
was assigned Best's "A (Excellent)" rating, despite its "A+ (Superior)"
qualifications. Management believes that its strong ratings are important
factors in marketing the products of its insurance companies to its agents
and customers, since rating information is broadly disseminated and
generally used throughout the industry. Insurance company ratings are
assigned to an insurer based upon factors relevant to policyholders and are
not directed toward protections of investors. Such ratings are neither a
rating of securities nor a recommendation to buy, hold or sell any
security. Further downgrades may have a material adverse effect on the
Company's business and prospects.
Page 3 of 7
<PAGE>
State Guaranty Funds, Shared Markets Mechanisms and Pooling Arrangements
All fifty states of the United Sates have insurance guaranty fund laws
requiring all life and health and property and casualty insurance companies
doing business within the state to participate in guaranty associations,
which are organized to pay contractual obligations under insurance policies
issued by impaired or insolvent insurance companies. These associations
levy assessments (up to prescribed limits) on all member insurers in a
particular state on the basis of the proportionate share of the premiums
written by member insurers in the lines of business in which the impaired
or insolvent insurer is engaged. Mandatory assessments by state guaranty
funds are used to cover losses to policyholders of insolvent or
rehabilitated companies and can be partially recovered through a reduction
in future premium taxes in many states. These assessments may increase in
the future depending upon the rate of insolvencies of insurance companies.
In addition, as a condition to the ability to conduct business in
various states, the Company's property and casualty insurance subsidiaries
are required to participate in mandatory property and casualty shared
market mechanisms or pooling arrangements, which provide various insurance
coverages to individuals or other entities that otherwise are unable to
purchase such coverage voluntarily provided by private insurers. The
Company cannot predict whether its participation in these shared market
mechanisms or pooling arrangements will provide underwriting profits or
losses to the Company.
Competition
The Company's business is composed of four principal segments:
Property and Casualty Insurance, Corporate Risk Management Services,
Allmerica Financial Services, and Allmerica Asset Management. Each of
these industry segments, in general, is highly competitive. The Company's
products and services compete not only with those offered by insurance
companies, but also with products offered by other financial institutions
and health maintenance organizations. In all of its segments, many of the
Company's competitors are larger and have greater financial, technical, and
operating resources than those of the Company. In addition, the Company may
face additional competition from banks and other financial institutions
should current regulatory restrictions on the sale of insurance and
securities by these institutions be repealed.
Retention of Key Executives
The future success of the Company will be affected by its continued
ability to attract and retain qualified executives. The Company's success
is dependent in large part on John F. O'Brien, the loss of whom could
adversely affect the Company's business. The Company does not have an
employment agreement with Mr. O'Brien.
FEDERAL INCOME TAX LEGISLATION
Currently, under the Code, holders of certain life insurance and
annuity products are entitled to tax-favored treatment on these products.
For example, income tax payable by policyholders on investment earnings
under certain life insurance and annuity products is deferred during the
product's accumulation period and is payable, if at all, only when the
insurance or annuity benefits are actually paid or to be paid. Also, for
example, interest on loans up to $50,000 secured by the cash value of
certain insurance policies owned by businesses is eligible for deduction
even though investment earnings during the accumulation period are
tax-deferred.
Page 4 of 7
<PAGE>
In the past, legislation has been proposed that would have curtailed
the tax-favored treatment of the life insurance and annuity products
offered by the Company. These proposals were not enacted, however; such
proposals or similar proposals are currently under consideration by
Congress. If these or similar proposals directed at limiting the
tax-favored treatment of life insurance policies and annuity contracts
were enacted, market demand for such products offered by the Company would
be adversely affected.
SALES PRACTICES
A number of civil jury verdicts have been returned against life and
health insurers in the jurisdictions in which the Company does business
involving the insurers' sales practices, alleged agent misconduct, failure
to properly supervise agents, and other matters. Some of the lawsuits have
resulted in the award of substantial judgements against the insurer,
including material amounts of punitive damages. In some states, juries
have substantial discretion in awarding punitive damages in these
circumstances. The Company and its subsidiaries, from time to time are
involved in such litigation. Although the outcome of any litigation cannot
be predicted with certainty, to date, no such lawsuit has resulted in the
award of any material amount of damages against the Company.
In December 1996, the Company received notice from the Securities and
Exchange Commission (the "Commission") that it would be conducting a limited
inspection concerning the Company's marketing and sales practices associated
with variable insurance products. The Commission requested that certain
information be provided to it by the Company, which the Company promptly
complied with. No litigation has been instituted, nor has the Commission
initiated any further action with respect to this matter.
HEALTH CARE REFORM LEGISLATION
There continue to be a number of legislative and regulatory proposals
introduced at the federal and state level to reform the current health care
system. At the federal level, recent proposals have focused on managed care
reform, and patient protection and advocacy. State and federal legislation
adopted over the past few years generally limits the flexibility of insurers
with respect to underwriting practices for small employer plans that contain
less than 50 employees, provides for crediting previous coverage for the
purposes of determining pre-existing conditions, and limits the ability to
medically underwrite individual risks in the group market. In addition,
several states have enacted managed care reform legislation which may change
managed care programs. While future legislative activity is unknown, it is
probable that limitations on insurers that utilize managed care programs or
market health insurance to small employers will continue. However, the
Company's rating, underwriting practices, and managed care programs are
consistent with the experience rate small cases, nor does it refuse coverage
to eligible individuals because of medical histories. Also, its managed
care programs provide for coverage outside of the preferred network and
allow for open communication between a doctor and his/her patient. Because
of its emphasis on managed care and risk sharing partnerships, management
believes that it will continue to be able to operate effectively in the
event of further reform, even if specified states expand the existing
limitations.
The Company believes that the proposed federal and state health care
reforms would, if enacted, substantially expand access to and mandate the
amounts of health care coverage while limiting or eliminating insurer's
flexibility and
Page 5 of 7
<PAGE>
Impact of the Year 2000 Issue
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of
the Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities.
Based on a third party assessment, the Company determined that
significant portions of its software required modification or replacement
to enable its computer systems to properly process dates beyond December
31, 1999. The Company is presently 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 and is not expected to have a
material effect on the results of operations. 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 98% 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 complete by
June 30, 1999.
Desktop Systems
The Company has verified that all desktop computers are capable of
correctly processing year 2000 dates. Additionally, over 98% 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.
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External Partners
The Company has verified that 50% of its electronic interfaces will
process year 2000 dates correctly. Eighty percent of the Property and
Casualty agents have confirmed that they are capable of properly processing
year 2000 dates. Sixty percent of the Company's non-electronic partners
have responded that they 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.
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.
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