-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q3igVGVfOjSxoDE2UTvX0YSXpg83CjMTqAhtxAcAGSPF2O/jY3mGznKQGxae5RJZ GXRIlRIWeYJeDvY9OjfQgQ== 0000927016-01-001663.txt : 20010409 0000927016-01-001663.hdr.sgml : 20010409 ACCESSION NUMBER: 0000927016-01-001663 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLMERICA FINANCIAL CORP CENTRAL INDEX KEY: 0000944695 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 043263626 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13754 FILM NUMBER: 1590013 BUSINESS ADDRESS: STREET 1: 440 LINCOLN ST CITY: WORCESTER STATE: MA ZIP: 01653 BUSINESS PHONE: 5088551000 MAIL ADDRESS: STREET 1: 440 LINCOLN ST CITY: WORCESTER STATE: MA ZIP: 01653 10-K 1 0001.txt FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2000 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, 01653 Massachusetts (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (508) 855-1000 Securities registered pursuant to Section 12(b) of the Act: Title of each class of securities Name of Exchange on which Registered --------------------------------- ------------------------------------ Common Stock, $.01 par value, together with Stock Purchase Rights New York Stock Exchange 7 5/8% Senior Debentures due 2025 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE 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 [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] Based on the closing sales price of March 21, 2001 the aggregate market value of the voting and non-voting stock held by nonaffiliates of the registrant was $2,512,119,235. The number of shares outstanding of the registrant's common stock, $.01 par value, was 53,157,780 shares outstanding as of March 21, 2001. DOCUMENTS INCORPORATED BY REFERENCE Portions of Allmerica Financial Corporation's Annual Report to Shareholders for 2000 are incorporated by reference in Parts I, II, and IV. Portions of Allmerica Financial Corporation's Proxy Statement of Annual Meeting of Shareholders to be held May 15, 2001 are incorporated by reference in Part III. Total number of pages, including cover page: 43 Exhibit Index is on pages 27-30 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART I ITEM 1 BUSINESS Organization Allmerica Financial Corporation ("AFC" or the "Company") is a non-insurance holding company organized as a Delaware corporation in 1995. The consolidated financial statements of AFC include the accounts of AFC; First Allmerica Financial Life Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); Allmerica Asset Management, Inc. ("AAM", a wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance subsidiary of AAM through December 31, 2000); The Hanover Insurance Company ("Hanover", a wholly-owned subsidiary of Allmerica P&C through December 31, 2000); Citizens Corporation (a wholly-owned non-insurance subsidiary of Hanover through December 31, 2000); Citizens Insurance Company of America ("Citizens", a wholly-owned subsidiary of Citizens Corporation through December 31, 2000) and certain other insurance and non-insurance subsidiaries. On December 31, 2000, the Company dissolved Allmerica P&C and Citizens Corporation and transferred subsidiaries of Allmerica P&C to AAM and transferred subsidiaries of Citizens Corporation to Hanover. Financial Information About 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. 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, technology, finance, human resources and legal. Information with respect to each of the Company's segments is included in "Results of Operations" on pages 22-34 in Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 15 on pages 73-74 of the Notes to the Consolidated Financial Statements included in the 2000 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference. Description of Business by Segment Following is a discussion of each of the Company's operating segments. Risk Management General The Company's Risk Management segment consists primarily of its property and casualty operations, which are principally generated through The Hanover Insurance Company and Citizens Insurance Company of America. For the year ended December 31, 2000, the Risk Management segment accounted for approximately $2,307.7 million, or 71.5%, of consolidated segment revenues and approximately $190.0 million, or 50.7%, of consolidated segment income before federal income taxes and minority interest. The Company underwrites personal and commercial property and casualty insurance primarily through specialized, regionally based, distribution channels. The majority of business is placed through an independent agent network concentrated in the Northeast, Midwest and Southeast United States. The Company strives to maintain a focus on the core disciplines of underwriting, pricing, claims adjusting, investing, marketing and sales. The Company's overall strategy is to improve profitability through operating efficiencies and to pursue measured growth in markets which are anticipated to be profitable. The Company, in 2 its Risk Management segment, continues to have strong regional focus and places heavy emphasis on underwriting profitability and loss reserve adequacy in each major product line. The Risk Management segment of AFC was the 25th largest property and casualty insurance group in the United States based on 1999 net premiums written, according to A.M. Best. The 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, extracontractual liability and the size of jury awards, fluctuations in interest rates and other factors that may affect investment returns and other general economic conditions and trends, such as inflationary pressures, that may affect the adequacy of reserves. Lines of Business The Company underwrites personal and commercial property and casualty insurance coverage. The personal lines principally include personal automobile and homeowners coverage. The commercial lines principally include commercial automobile, workers' compensation and commercial multiple peril coverage. Personal automobile coverage insures individuals against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle, and property damage to other vehicles and other property. Homeowners coverage insures individuals for losses to their residences and personal property, such as those caused by fire, wind, hail, water damage (except for flooding), theft and vandalism, and against third party liability claims. Commercial automobile coverage insures businesses against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle, and property damage to other vehicles and other property. Workers' compensation coverage insures employers against employee medical and indemnity claims resulting from injuries related to work. Workers' compensation policies are often written in conjunction with other commercial policies. Commercial multiple peril coverage insures businesses against third party liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold. It also insures business property for damage, such as that caused by fire, wind, hail, water damage (except for flooding), theft and vandalism. Customers, Marketing and Distribution AFC pursues measured growth in its existing markets through local operations that apply extensive knowledge of markets to offer competitive products and services and through the establishment of long-term relationships with larger, well-established independent agencies. The Company believes that the selection of markets in which to pursue profitable growth is dependent upon maintaining its local market presence to enhance underwriting results and identify favorable markets. The Company is committed to maintaining the local market presence afforded by its eighteen branch sales and underwriting offices. Regional business centers provide processing support and are located in Atlanta, Georgia; Howell, Michigan; and Worcester, Massachusetts. Administrative functions are centralized in its headquarters in Worcester, Massachusetts. During 1999, AFC introduced a new businessowner policy ("BOP") called Dimension 2000+(SM). The Company expanded the distribution of this product to additional agents in 2000. The new product is designed to replace the traditional BOP product for certain classes of customers. This product is targeted toward small business, providing broadened coverage and enabling ease of conducting business. Dimension 2000+(SM) is sold 3 through agents and regional business centers utilizing an internet based point-of-sale system which provides full quote-to-issue capabilities. Commercial automobile policies will also be sold through this point-of-sale system. The Company believes that these investments in technology will significantly improve the service provided to agents and the timing of policy issuance. The Risk Management segment of the Company is not dependent on a single customer or even a few customers, for which the loss of any one or more would have an adverse effect upon the segment's insurance operations. Risk Management focuses on three target areas: standard, or traditional markets, sponsored program and specialty business. Standard Markets The Company markets property and casualty products primarily in the Northeast, Midwest and Southeast United States through the Standard Markets distribution channel, which at December 31, 2000 provided for more than $1,500 million of Risk Management's written premium. This channel predominantly markets property and casualty insurance products through more than 2,500 independent insurance agencies and seeks to establish long-term relationships with larger, well-established agencies. In selecting agencies for new appointments, the Company considers the following criteria: a record of profitability and financial stability, an experienced and professional staff, a marketing plan for future growth and a succession plan for management. Once appointed, each agency's performance is carefully monitored. Independent agents provide specialized knowledge of property and casualty products, local market conditions and targeted customer characteristics. Since the Company offers property and casualty insurance products mainly through independent agents, fostering a close, supportive relationship with each agency is critical to the continued growth of the business. The Company, in the Risk Management segment, compensates agents based on profitability, in addition to regular commission. This practice is intended to motivate its agents to write policies for customers with above-average profit characteristics. By offering its independent agents a consistent source of products demanded by the agents' customers, the Company believes that an increasing number of its agents will rely on it as their principal supplier of insurance products. The Risk Management segment sponsors an Agents Advisory Council as a forum to enhance relationships between AFC and its agents. The Council seeks to work together with the Company to provide products and services that help clients better manage the risks they face and to coordinate marketing efforts, support implementation of the Company's strategies, and enhance local market presence. In Michigan, AFC is a principal provider with many of its agencies, averaging more than $1 million of written premiums per agent in 2000. Sponsored Markets Over the past few years, the Company has begun to focus on the benefits of worksite marketing as a distribution channel for personal property and casualty lines through its Sponsored Markets channel. This distribution channel offers discounted insurance products that are individually written to employees and members of organizations which have established a marketing agreement with the Company, as well as franchise programs that are tailored for members of associations and organizations, including programs for senior citizens. For example, the Company has developed and marketed groups in both the personal and commercial segments that are tailored for members of associations, financial institutions and employers in Michigan, Indiana and Ohio. The organizations may choose to make the programs available to their members or employees based on an evaluation of rates, service and regulation, but each risk is individually underwritten and each customer is issued a separate policy. Associations and organizations receive no payment for making franchise programs available to their members or employees. Management believes that advantages of competitive pricing, effective consumer awareness campaigns targeted at sponsoring organizations, the convenience of payroll deducted premiums and word of mouth advertising will contribute to the effectiveness of worksite and affinity sales through this channel, as well as provide for lower distribution expenses. The Company, through the Risk Management segment, is also exploring sales through banks and electronic commerce. 4 As of December 31, 2000, written premium in the Sponsored Markets distribution channel was more than $600 million. Specialty Markets The Specialty Markets distribution channel offers niche property and casualty products in selected markets. This channel concentrates on commercial market segments which require specialized expertise and products, and can be marketed to on a group basis. The Company continually assesses the profitability of each individual program and seeks to exit programs that do not meet established Company underwriting guidelines. In 2000, Specialty Markets produced more than $35 million of written premium. Residual Markets and Pooling Arrangements As a condition of its license to do business in various states, the Company is 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. For example, since most states compel the purchase of a minimal level of automobile liability insurance, states have developed shared market mechanisms to provide the required coverages and in many cases, optional coverages, to those drivers who, because of their driving records or other factors, cannot find insurers who will write them voluntarily. The Company's participation in such shared markets or pooling mechanisms is generally proportional to the Risk Management segment's direct writings for the type of coverage written by the specific pooling mechanism in the applicable state. The Company incurred an underwriting loss from participation in such mechanisms, mandatory pools and underwriting associations of $26.1 million, $24.2 million and $14.7 million in 2000, 1999 and 1998, respectively, relating primarily to coverages for personal and commercial automobile, personal and commercial property, and workers' compensation. The increase in the underwriting loss since 1998 is primarily related to Hanover's participation in the Massachusetts Commonwealth Automobile Reinsurers ("CAR") pool which is consistent with an increase in the participation ratio and higher actual loss activity experienced in the overall Massachusetts automobile market. Assigned Risk Plans Assigned risk plans are the most common type of shared market mechanism. Many states, including Illinois, New Jersey and New York operate assigned risk plans. The plan assigns applications from drivers who are unable to obtain insurance in the voluntary market to insurers licensed in the applicant's state. Each insurer is required to accept a specific percentage of applications based on its market share of voluntary business in the state. Once an application has been assigned to an insurer, the insurer issues a policy under its own name and retains premiums and pays losses as if the policy was voluntarily written. Reinsurance Facilities and Pools Reinsurance facilities are currently in operation in various states that require an insurer to write all applications submitted by an agent. As a result, an insurer could be writing policies for applicants with a higher risk of loss than it would normally accept. The reinsurance facility allows the insurer to cede this high risk business to the reinsurance facility, thus sharing the underwriting experience with all other insurers in the state. If a claim is paid on a policy issued in this market, the facility will reimburse the insurer. Typically, reinsurance facilities operate at a deficit, which is then recouped by levying assessments against the same insurers. As a servicing carrier in Massachusetts, the Company cedes a significant portion of its private passenger and commercial automobile premiums to the Massachusetts Commonwealth Automobile Reinsurers. Net premiums earned and losses and loss adjustment expenses ("LAE") ceded to CAR were $37.3 million and $44.5 million in 2000, $42.8 million and $42.6 million in 1999, and $34.3 million and $38.1 million in 1998. At December 31, 2000, CAR represented 10% or more of the Company's reinsurance business. 5 A reinsurance mechanism that exists in Michigan, the Michigan Catastrophic Claims Association ("MCCA"), covers no-fault first party medical losses of retentions in excess of $250,000. All automobile insurers in this state are required to participate in this reinsurance mechanism. Insurers are reimbursed for their covered losses in excess of the $250,000 threshold. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the state's automobile liability insurance market. The Company ceded to the MCCA premiums earned and losses and LAE of $3.7 million and $31.1 million in 2000, $3.7 million and $75.3 million in 1999, and $3.7 million and $18.0 million in 1998. At December 31, 2000, the MCCA represented 10% or more of the Company's reinsurance business. On June 2, 1998, the Company recorded a $124.2 million one-time reduction of direct and ceded written premiums as a result of a return of excess surplus from the MCCA. This transaction is not reflected in the ceded premium and loss amounts above and had no impact on the total net premiums recorded by the Company in 1998. At December 31, 2000 and 1999, the Company, in the Risk Management segment, had reinsurance recoverables on paid and unpaid losses from CAR of $56.4 million and $44.6 million, respectively, and from MCCA of $298.4 million and $285.6 million, respectively. Management believes that in the current regulatory climate, the Company, in the Risk Management segment, is unlikely to incur any material loss or become unable to pay claims as a result of nonpayment of amounts owed to it by CAR, because CAR is a mandated pool supported by all insurance companies licensed to write automobile insurance in the Commonwealth of Massachusetts. In addition, with respect to MCCA (i) it is currently in a surplus position, (ii) the payment obligations of the MCCA are extended over many years, resulting in relatively small current payment obligations in terms of MCCA total assets, (iii) all amounts owed to the Company by the MCCA have been paid when due, and (iv) the MCCA is supported by assessments permitted by statute. A type of reinsurance mechanism that exists in New Jersey, The New Jersey Unsatisfied Claim and Judgment Fund ("NJUCJF"), covers no-fault first party medical losses of retentions in excess of $75,000 up to $175,000. All automobile insurers in this state are required to participate in the reinsurance mechanism. Insurers are reimbursed for their covered losses in excess of the threshold. Funding for this fund comes from assessments against automobile insurers based upon their proportionate market share of the state's automobile liability insurance market. The NJUCJF currently has an unfunded liability for future payment years. It calculates assessments against insurers on the basis of a two-year cash flow analysis. Reference is made to Note 17 on pages 74 and 75 and Note 21 on page 77 of the Notes to Consolidated Financial Statements of the 2000 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference. Joint Underwriting Associations A joint underwriting association ("JUA") is similar to a reinsurance pool. Generally, a JUA allows an insurer to share with other insurers the underwriting experience of drivers that reflect a higher risk of loss than the insurer would normally accept. Under a JUA, a limited number of insurers are designated as "servicing carriers." The servicing carrier is responsible for collecting premiums and paying claims for the policies issued in the JUA, and such insurers receive a fee for these administrative services. The underwriting results of the servicing carrier are then shared with all insurers in the state. Like reinsurance facilities, JUA's typically operate at a deficit, and fund that deficit by levying assessments on insurers. Other Mechanisms The principal shared market mechanisms for property insurance are the Fair Access to Insurance Requirements Plans ("FAIR Plans"), the formation of which was required by the federal government as a condition to an insurer's ability to obtain federal riot reinsurance coverage following the riots and civil disorder that occurred during the 1960's. These plans, created as mechanisms similar to automobile assigned risk plans, 6 were designed to increase the availability of property insurance in urban areas. The federal government reinsures those insurers participating in FAIR Plans against excess losses sustained from riots and civil disorders. The individual state FAIR Plans are created pursuant to statute or regulation. The property shared market mechanisms provide basic fire insurance and extended coverage protection for dwellings and certain commercial properties that could not be insured in the voluntary market. A few states also include a basic homeowners form of coverage in their shared market mechanism. Approximately 30 states have FAIR Plans including Massachusetts, New York and New Jersey. With respect to commercial automobile coverage, another pooling mechanism, a Commercial Auto Insurance Plan ("CAIP"), uses a limited number of servicing carriers to handle assignments from other insurers. The CAIP servicing carrier is paid a fee by the insurer who otherwise would be assigned the responsibility of handling the commercial automobile policy and paying claims. Approximately 40 states have CAIP mechanisms, including Connecticut, Illinois, New Hampshire, Maine, New Jersey and Rhode Island. Competition The property and casualty industry is highly competitive among national agency companies, direct writers, and regional and local insurers on the basis of both price and service. National agency companies sell insurance through independent agents and usually concentrate on commercial lines of property and casualty insurance. Direct writers, including those with exclusive agent representation, dominate the personal lines of property and casualty insurance and operate on a national, regional or single state basis. Regional and local companies sell through independent agents in one or several states in the same region and usually compete in both personal and commercial lines. The Company, through its Standard Markets and Sponsored Markets distribution channels, markets through independent agents and, therefore, competes with other independent agency companies for business in each of the agencies representing them. The Company is licensed to sell property and casualty insurance in all fifty states in the United States, as well as the District of Columbia. As of December 31, 2000, approximately 36% and 18% of AFC's written premium is generated in the states of Michigan and Massachusetts, respectively. The Company's other primary markets include New York, New Jersey, Maine and Indiana. In Michigan, the Company competes in personal lines with a number of national direct writers and regional and local companies. According to A.M. Best, as of December 31, 1999, the Company is the largest writer of property and casualty insurance in Michigan through independent agents based upon direct written premiums. About half of the Company's Michigan business is in the personal automobile line. In Michigan personal lines, AFC ranked fourth with 9.5% of the market. AFC's principal personal lines competition is from Auto Club of Michigan and State Farm Group. The personal lines market has seen intense competition in recent years, with many of the Company's competitors seeking to grow market share which has resulted in pricing competition in the automobile line. In Michigan, AFC's commercial lines competition is principally from national agency companies, and regional and local companies. AFC is the largest commercial lines writer in Michigan with approximately 7% of the market. Premium rate levels are related to the availability of insurance coverage, which varies according to the level of excess capacity in the industry. The insurance industry, including the Company, initiated commercial lines rate increases in 2000, as compared to rate decreases in prior years due primarily to price competition. In Massachusetts, the Company faces competition in personal lines primarily from direct writers and regional and local companies. In its commercial lines, the Company faces competition primarily from national agency companies and regional and local companies. Management believes that its emphasis on maintaining a local presence in its markets, through the use of the Standard Markets distribution channel, coupled with investments in operating and client technologies, will enable it to compete effectively. 7 During the past few years, the competitive environment in Massachusetts has increased substantially. Approximately 25% of Allmerica's personal automobile business is written in Massachusetts. The Massachusetts Division of Insurance sets the rates for personal automobile business in the state. Effective January 1, 2001, rates decreased 8.3%, reversing the previous trend of 0.7% increases that occurred in both 2000 and 1999. The Massachusetts Division of Insurance allows companies to offer discounts for sponsoring organizations and safe drivers. The Company has modified some of these discounts concurrent with the rate change. In 2000, the Company offered a 6% discount on automobile insurance for its safest drivers. In 2001, the discount for safe drivers will be 2%. In addition, the Company's Sponsored Markets unit currently offers more than 150 group programs throughout the state, including a large group plan with approximately 425,000 eligible members. Management believes that rate reductions net of lower discount may unfavorably impact premiums in Massachusetts. Additionally, lower discounts could negatively impact the Company's ability to maintain market share in Massachusetts with safe drivers and Sponsored Markets. Because there is no one, dominant competitor in any of the markets in which the Risk Management segment competes, management believes there is opportunity for future growth. Underwriting Pricing The manner in which the Company prices products takes into consideration the expected frequency and severity of losses, the costs of providing the necessary coverage (including the cost of administering policy benefits, sales and other administrative and overhead costs) and a margin for profit. The Company, in the Risk Management segment, seeks to achieve a target combined ratio in each of its product lines regardless of market conditions. This strategy is intended to better enable the Company to achieve measured growth and consistent profitability. The Company concentrates on its established major product lines, and accordingly, does not typically pursue the development of products with relatively unpredictable risk profiles. In addition, the Company seeks to utilize its extensive knowledge of local markets, including knowledge of regulatory requirements, to achieve superior underwriting results. AFC relies on information provided by its local agents and on the knowledge of its staff in the local branch offices. Since the Risk Management segment maintains a strong regional focus and a significant market share in a number of states, the Company can apply its extensive knowledge and experience in making underwriting and rate setting decisions. Claims The Company employs experienced claims adjusters, appraisers, medical specialists, managers and attorneys in order to manage its claims. The Risk Management segment has field claims adjusters strategically located throughout its operating territories. All claims staff members work closely with the agents and seek to settle claims rapidly and in a cost-effective manner. Claims office adjusting staff are supported by general adjusters for large property loss claims, by automobile and heavy equipment damage appraisers for automobile material damage losses, and by medical specialists whose principal concentration is on workers' compensation and no-fault automobile injury cases. In addition, the claims offices are supported by staff attorneys who specialize in litigation defense and claim settlements. The Risk Management segment also maintains a special investigative unit which investigates suspected insurance fraud and abuse. The Company, in the Risk Management segment, utilizes claims processing technology which allows most of the smaller and more routine personal lines claims to be processed at centralized locations. The centralization helps to increase efficiency and reduce operating costs. The Risk Management segment has a program under which participating agents have settlement authority for many property loss claims. Based upon the program's experience, the Company believes that this program 8 contributes to lower loss adjustment expense experience and to higher customer satisfaction ratings by permitting the early and direct settlement of these small claims. Approximately one-third of the total number of paid claims reported to the Midwest distribution channel were settled under this program. 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 Risk Management segment 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 snow, ice storms, hurricanes, earthquakes, tornadoes, wind, hail, fires and explosions, and the incidence and severity of catastrophes are inherently unpredictable. Although catastrophes can cause losses in a variety of property and casualty lines, homeowners and business property insurance have in the past generated the vast majority of catastrophe-related claims. Reserve for Unpaid Losses and Loss Adjustment Expenses Reference is made to "Reserve for Losses and Loss Adjustment Expenses" on pages 29, 30 and 31 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the 2000 Annual Report to Shareholders, which is incorporated herein by reference. The Company's actuaries, in the Risk Management segment, review the reserves each quarter and certify the reserves annually as required for statutory filings. Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company's settlement and payment of that loss. To recognize liabilities for unpaid losses, the Company establishes reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and LAE. The Risk Management segment 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 Risk Management segment 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. The Company, in the Risk Management segment, does not use discounting techniques in establishing reserves for losses and LAE, nor has it participated in any loss portfolio transfers or other similar transactions. The following table reconciles reserves determined in accordance with accounting principles and practices prescribed or permitted by insurance statutory authorities ("Statutory Reserve") to reserves determined in accordance with generally accepted accounting principles ("GAAP Reserve") at December 31, as follows:
2000 1999 1998 -------- -------- -------- (In millions) Statutory reserve for losses and LAE.............. $1,906.5 $1,926.6 $2,011.7 GAAP adjustments: Reinsurance recoverable on unpaid losses........ 816.9 694.2 591.7 Other(*)........................................ (4.3) (2.1) (6.1) -------- -------- -------- GAAP reserve for losses and LAE................... $2,719.1 $2,618.7 $2,597.3 ======== ======== ========
- -------- (*) Primarily represents other statutory liabilities reclassified as loss adjustment expense reserves for GAAP reporting and purchase accounting adjustments. 9 Analysis of Losses and Loss Adjustment Expenses Reserve Development The following table sets forth the development of net reserves for unpaid losses and LAE from 1990 through 2000 for the Company.
Year ended December 31, -------------------------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (In millions) Net reserve for losses and LAE(1).......... $1,902.2 $1,924.5 $2,005.5 $2,038.7 $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9 $1,772.4 $1,550.6 Cumulative amount paid as of(2): One year later... -- 703.8 638.0 643.0 732.1 627.6 614.3 566.9 564.3 569.0 561.5 Two years later.. -- -- 996.0 967.4 1,054.3 1,008.3 940.7 884.4 862.7 888.0 874.5 Three years later........... -- -- -- 1,180.7 1,235.0 1,217.8 1,172.8 1,078.1 1,068.4 1,077.1 1,074.3 Four years later........... -- -- -- -- 1,365.9 1,325.9 1,300.4 1,210.9 1,184.1 1,207.1 1,186.4 Five years later........... -- -- -- -- -- 1,408.8 1,369.9 1,289.5 1,267.5 1,279.4 1,265.4 Six years later.. -- -- -- -- -- -- 1,427.6 1,353.3 1,323.1 1,337.2 1,314.2 Seven years later........... -- -- -- -- -- -- -- 1,377.2 1,355.8 1,377.3 1,355.3 Eight years later........... -- -- -- -- -- -- -- -- 1,387.7 1,404.1 1,385.9 Nine years later........... -- -- -- -- -- -- -- -- -- 1,431.6 1,409.2 Ten years later.. -- -- -- -- -- -- -- -- -- -- 1,433.8 Net reserve re- estimated as of(3): End of year...... 1,902.2 1,924.5 2,005.5 2,038.7 2,117.2 2,132.5 2,109.3 2,019.6 1,936.9 1,772.4 1,550.6 One year later... -- 1,837.1 1,822.1 1,911.5 1,989.3 1,991.1 1,971.7 1,891.5 1,868.1 1,755.0 1,601.5 Two years later.. -- -- 1,781.4 1,796.8 1,902.8 1,874.3 1,859.4 1,767.4 1,762.8 1,717.7 1,601.9 Three years later........... -- -- -- 1,734.9 1,832.5 1,826.8 1,780.3 1,691.5 1,703.3 1,670.8 1,614.3 Four years later........... -- -- -- -- 1,783.7 1,780.7 1,766.2 1,676.3 1,658.9 1,654.1 1,597.6 Five years later........... -- -- -- -- -- 1,740.1 1,735.6 1,653.7 1,637.3 1,634.6 1,594.3 Six years later.. -- -- -- -- -- -- 1,699.2 1,630.3 1,650.5 1,630.6 1,588.7 Seven years later........... -- -- -- -- -- -- -- 1,603.9 1,627.2 1,644.2 1,593.1 Eight years later........... -- -- -- -- -- -- -- -- 1,607.4 1,626.1 1,621.9 Nine years later........... -- -- -- -- -- -- -- -- -- 1,611.8 1,593.4 Ten years later.. -- -- -- -- -- -- -- -- -- -- 1,581.6 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (Deficiency) Redundancy, net(4,5)........ $ -- $ 87.4 $ 224.1 $ 303.8 $ 333.4 $ 392.4 $ 410.0 $ 415.6 $ 329.5 $ 160.6 $ (31.0) ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
- ------- (1) Sets forth the estimated net liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years; represents the estimated amount of net losses and LAE for claims arising in the current and all prior years that are unpaid at the balance sheet date, including incurred but not reported ("IBNR") reserves. (2) Cumulative loss and LAE payments made in succeeding years for losses incurred prior to the balance sheet date. (3) Re-estimated amount of the previously recorded liability based on experience for each succeeding year; increased or decreased as payments are made and more information becomes known about the severity of remaining unpaid claims. (4) Cumulative deficiency or redundancy at December 31, 2000 of the net reserve amounts shown on the top line of the corresponding column. A redundancy in reserves means the reserves established in prior years exceeded actual losses and LAE or were reevaluated at less than the original reserved amount. A deficiency in reserves means the reserves established in prior years were less than actual losses and LAE or were reevaluated at more than the original reserved amount. (5) The following table sets forth the development of gross reserve for unpaid losses and LAE from 1992 through 2000 for the Company: 10
Year ended December 31, -------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- -------- -------- -------- -------- (In millions) Reserve for losses and LAE: Gross liability........ $2,719.1 $2,618.7 $2,597.2 $2,615.4 $2,744.1 $2,896.0 $2,821.7 $2,717.3 $2,598.9 Reinsurance recoverable........... 816.9 694.2 591.7 576.7 626.9 763.5 712.4 697.7 662.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- Net liability.......... $1,902.2 $1,924.5 $2,005.5 $2,038.7 $2,117.2 $2,132.5 $2,109.3 $2,019.6 $1,936.9 ======== ======== ======== ======== ======== ======== ======== ======== ======== One year later: Gross re-estimated liability............. $2,553.4 $2,432.9 $2,472.6 $2,541.9 $2,587.8 $2,593.5 $2,500.5 $2,460.5 Re-estimated recoverable........... 716.3 610.8 561.1 552.6 596.7 621.8 609.0 592.4 -------- -------- -------- -------- -------- -------- -------- -------- Net re-estimated liability............. $1,837.1 $1,822.1 $1,911.5 $1,989.3 $1,991.1 $1,971.7 $1,891.5 $1,868.1 ======== ======== ======== ======== ======== ======== ======== ======== Two years later: Gross re-estimated liability............. $2,379.6 $2,379.3 $2,424.5 $2,427.7 $2,339.2 $2,333.3 $2,341.9 Re-estimated recoverable........... 598.2 582.5 521.7 553.4 479.8 565.9 579.1 -------- -------- -------- -------- -------- -------- -------- Net re-estimated liability............. $1,781.4 $1,796.8 $1,902.8 $1,874.3 $1,859.4 $1,767.4 $1,762.8 ======== ======== ======== ======== ======== ======== ======== Three years later: Gross re-estimated liability............. $2,305.2 $2,395.3 $2,358.6 $2,227.0 $2,145.5 $2,257.3 Re-estimated recoverable........... 570.2 562.8 531.8 446.7 454.0 554.0 -------- -------- -------- -------- -------- -------- Net re-estimated liability............. $1,734.9 $1,832.5 $1,826.8 $1,780.3 $1,691.5 $1,703.3 ======== ======== ======== ======== ======== ======== Four years later: Gross re-estimated liability............. $2,336.3 $2,359.5 $2,220.9 $2,102.0 $2,168.2 Re-estimated recoverable........... 552.6 578.8 454.7 425.7 509.3 -------- -------- -------- -------- -------- Net re-estimated liability............. $1,783.7 $1,780.7 $1,766.2 $1,676.3 $1,658.9 ======== ======== ======== ======== ======== Five years later: Gross re-estimated liability............. $2,299.8 $2,215.2 $2,091.7 $2,027.3 Re-estimated recoverable........... 559.7 479.6 438.0 390.0 -------- -------- -------- -------- Net re-estimated liability............. $1,740.1 $1,735.6 $1,653.7 $1,637.3 ======== ======== ======== ======== Six years later: Gross re-estimated liability............. $2,158.9 $2,096.6 $2,022.6 Re-estimated recoverable........... 459.7 466.3 372.1 -------- -------- -------- Net re-estimated liability............. $1,699.2 $1,630.3 $1,650.5 ======== ======== ======== Seven years later: Gross re-estimated liability............. $2,050.3 $2,050.1 Re-estimated recoverable........... 446.4 422.9 -------- -------- Net re-estimated liability............. $1,603.9 $1,627.2 ======== ======== Eight years later: Gross re-estimated liability............. $2,013.6 Re-estimated recoverable........... 406.2 -------- Net re-estimated liability............. $1,607.4 ========
Reinsurance The Company, in the Risk Management segment, maintains a reinsurance program designed to protect against large or unusual losses and LAE activity. This includes both excess of loss reinsurance and catastrophe reinsurance. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as snow, ice storms, windstorm, hail, hurricane, tornado, riot or other extraordinary events. In addition, the Company, in the Risk Management segment, has reinsurance for casualty business. 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. Under the Company's 2000 catastrophe reinsurance program, AFC retains $45.0 million of loss per hurricane occurrence and $25.0 million of loss per occurrence for all other exposures, 10% of all loss amounts 11 in excess of $45.0 million or $25.0 million for non-hurricane losses, up to $65.0 million, 20% of all loss amounts in excess of $65.0 million up to $230.0 million and all amounts in excess of $230.0 million. As a result of this program, the Company ceded $16.8 million of catastrophe losses in 2000. Effective January 1, 2001, the Company modified its catastrophe reinsurance program. Under this new program, AFC retains $45.0 million of loss per hurricane occurrence and $25.0 million of loss per occurrence for all other exposures, 15% of all loss amounts in excess of $45.0 million, or $25.0 million for non-hurricane losses, up to $230.0 million, and all amounts in excess of $230.0 million. Effective January 1, 2000, the Company purchased a property catastrophe aggregate treaty which provides for annual aggregate coverage totaling 80% of catastrophe losses in excess of $60.0 million up to $110.0 million. The Company's retention is calculated cumulatively, in the aggregate, on a quarterly basis with the aggregate losses comprised of all catastrophe losses that exceed $0.5 million per each loss occurrence. The maximum contribution from the Company for any one-loss occurrence for the purposes of calculating the aggregate retention will be $25.0 million. As a result of this agreement, the Company ceded $18.4 million of catastrophe losses in 2000. Effective January 1, 2001, the Company modified its property catastrophe aggregate treaty. This new treaty provides for annual aggregate coverage totaling 90% of catastrophe losses in excess of $65.0 million up to $115.0 million. The Company's retention will be calculated cumulatively, in the aggregate, on a quarterly basis with the aggregate losses comprised of all catastrophe losses that exceed $0.5 million per each loss occurrence. The maximum contribution from the Company for any one-loss occurrence for the purposes of calculating the aggregate retention will be $25.0 million. Effective July 1, 1999, the Company maintains a property reinsurance program in which the reinsurers are responsible for 100% of each loss in excess of $0.5 million per occurrence up to $19.5 million for inland marine and commercial auto physical damage. All other property business is 100% covered by reinsurers for each loss in excess of $1.5 million per occurrence up to $18.5 million. Amounts in excess of $19.5 million for inland marine and commercial auto physical damage are 100% retained by the Company while amounts in excess of $18.5 million in all other property lines are retained by the Company. Under the 2000 casualty reinsurance program, the reinsurers are responsible for 40% of the amount of each loss in excess of $0.5 million per occurrence up to $1.0 million and 100% of the amount of each loss in excess of $1.0 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. The Company is subject to a whole account aggregate excess of loss reinsurance agreement, which provides coverage for the 1999 accident year for the Company's property and casualty business. The program covered losses and allocated LAE, including those incurred but not yet reported, in excess of a specified whole account loss and allocated LAE ratio. The annual coverage limit for losses and allocated LAE is $150.0 million. The effect of this agreement on results of operations in each reporting period is based on losses and allocated LAE ceded, reduced by a sliding scale premium of 50-67.5% depending on the size of the loss, and increased by a ceding commission of 20% of ceded premium. In addition, net investment income is reduced for amounts credited to the reinsurer. As a result of this agreement, the Company recognized net benefits of $9.8 million and $15.9 million for the years ended December 31, 2000 and 1999, respectively, based on estimates of losses and allocated LAE for accident year 1999. During 2000, premiums, and losses and LAE ceded under this treaty were $25.0 million and $34.1 million, respectively. In addition, the Company realized an additional $4.8 million benefit from commissions ceded under this contract, partially offset by $4.1 million of interest costs. Premiums, and losses and LAE ceded under this treaty in 1999 were $21.9 million and $35.0 million, respectively. In 1999, the Company realized an additional $4.3 million benefit from commissions ceded under this contract, partially offset by $1.5 million of interest costs. 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 for accident year 1999. The Company, in the Risk Management segment, cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve 12 the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company 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. 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 CAR and MCCA. Reference is made to "Reinsurance" in Note 17 on pages 74 and 75 of the Notes to Consolidated Financial Statements of the 2000 Annual Report to Shareholders, which is incorporated herein by reference. Reference is also made to "Reinsurance Facilities and Pools" on pages 5, 6 and 7 of this Form 10-K which is incorporated herein by reference. Asset Accumulation Allmerica Financial Services General The Allmerica Financial Services segment includes the individual financial products and the group retirement products and services businesses of FAFLIC and its wholly-owned subsidiary, AFLIAC, as well as the Company's registered investment advisor and broker-dealer affiliates. Through this segment, the Company is a leading provider of investment-oriented life insurance and annuities to upper income individuals and small businesses throughout the United States. These products are marketed through the Company's career agency force of 692 agents, to mutual fund providers for their variable annuity customers, and on a wholesale basis to financial planners and broker-dealers. For the year ended December 31, 2000, the Allmerica Financial Services segment accounted for $772.4 million, or 23.9%, of consolidated segment operating revenues and $222.8 million, or 59.5%, of consolidated segment income before taxes and minority interest. The Company offers a diverse line of products tailored to its customer market, including variable annuities, variable universal life, and universal life. The main components of the Company's current strategy in this segment are to: (i) emphasize investment-oriented insurance products, particularly variable annuities and variable universal life insurance, (ii) continue to expand existing and develop additional distribution channels, (iii) leverage the Company's technological resources to support marketing and client service initiatives, (iv) improve the productivity of and expand the career agency distribution system and (v) implement a targeted marketing approach emphasizing value-added service. The Company has also utilized its technological resources to support its marketing and client service initiatives in this segment. The Company has developed automated portfolio re-balancing capabilities and graphical quarterly report statements, which are used to establish and monitor the desired mix of investments by individual contract and policyholders. According to 2000 A.M Best's Policy Reports, the Company is among the twenty largest writers of individual variable annuity contracts and individual variable universal life insurance policies in the United States in 1999, based on statutory premiums and deposits. Sales of variable products represented approximately 96.7%, 95.9% and 98.0% of this segment's statutory premiums and deposits in 2000, 1999 and 1998, respectively. Statutory premiums and deposits, a common industry benchmark for sales achievement, totaled $3,938.6 million, $3,609.5 million and $4,101.9 million in 2000, 1999 and 1998, respectively. 13 Currently, under the Internal Revenue 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. Several legislative proposals are currently under consideration by Congress that could modify or repeal the existing estate tax laws. If these or similar proposals were enacted, the market demand for some of the Company's life products could be adversely affected. The Company cannot predict the impact of such changes in tax law. 14 Products The following table reflects premiums and deposits on a statutory accounting practices ("SAP") basis, including universal life and investment-oriented contract deposits, for the segment's major product lines, including the Closed Block, for the years ended December 31, 2000, 1999 and 1998. Receipts from various products are treated differently under GAAP and SAP. Under GAAP, universal life, variable universal life and annuity deposits are not included in revenues but are recorded directly to policyholder account balances.
2000 1999 1998 -------- -------- -------- (In millions) Statutory Premiums and Deposits Variable universal life........................ $ 209.1 $ 187.0 $ 158.7 Group variable universal life.................. 47.7 94.9 73.3 Separate account annuities..................... 2,555.1 1,922.2 2,583.6 General account annuities(1)................... 524.7 830.2 622.2 Retirement investment account annuities........ 9.3 16.4 20.1 Group annuities................................ 463.1 409.3 563.9 Universal life................................. 59.2 71.8 23.6 Traditional life............................... 70.2 77.4 55.9 Individual health.............................. 0.2 0.3 0.6 -------- -------- -------- Total statutory premiums and deposits............ $3,938.6 $3,609.5 $4,101.9 ======== ======== ========
- -------- (1) The general account includes approximately $145.7 million in 2000 and $590.5 million in 1999 of deposits made in association with an annuity program which provides, for a limited time, enhanced crediting rates on deposits made into the Company's general account and transferred ratably, over a period of time, into the Company's separate accounts. While the Company continues to offer certain traditional insurance products, its current focus for new business in this segment is on the sale of variable products. Variable Products The Company's variable products offered through this segment include variable universal life insurance and variable annuities. The Company's variable universal life insurance products combine the flexible terms of the Company's universal life insurance policy with separate account investment opportunities. The Company also offers a variable joint life product through this segment. The Company's variable annuities offer the investment opportunities of the Company's separate accounts and provide a vehicle for tax-deferred savings. These products are sold pursuant to registration statements under the Securities Act or exemptions from registration thereunder. The Company seeks to achieve product distinction with respect to its variable products on the basis of quality and diversity of the separate account investment options underlying these products. The Company's variable universal life and annuity products offer a variety of account investment options with choices ranging from money market funds to international equity funds. The number of these investment options has increased from 98 in 1998 to more than 150 in 2000, including those underlying the products sold through alternative distribution channels. For management of these separate accounts, the Company supplements its in-house expertise in managing fixed income assets with the equity management expertise of well-known mutual fund advisors, such as Fidelity Investments, as well as other independent management firms who specialize in the management of institutional assets. Additionally, the Company utilizes the services of an experienced investment consultant to the pension industry to assist it in the selection of these institutional managers and in the ongoing monitoring of their performance. Retirement Products In addition to the above, the Company provides consulting and investment services to defined benefit and defined contribution retirement plans of corporate employers. The Company also offers participant recordkeeping 15 and administrative services to defined benefit and defined contribution retirement plans. Currently, the Company provides administration and recordkeeping for approximately 337 qualified pension and profit sharing plans, which have assets totaling $2.2 billion, and cover approximately 57,729 participants. In 2001, the Company has agreed to sell the defined contribution business to Minnesota Life Insurance Company in a transaction scheduled to close in 2001. This sale is based on the Company's conclusion that this business lacked scale to compete effectively in the 401(k) market with an annuity based product. In addition, the Company does not plan to continue marketing efforts for its defined benefit business. It expects to continue to administer its defined benefit business which, in recent years, has not experienced new sales. Traditional Products The Company's primary insurance products contained in this segment are traditional life insurance products, including whole life and universal life, as well as fixed annuities and retirement plan funding products. The Company's universal life insurance product is an interest-sensitive product which offers flexibility in arranging the amount of insurance coverage, the premium level and the premium payment period. The Company also offers joint life products through this segment designed to meet estate planning needs. These products offer flexible premiums and benefits and cover two lives, with benefits paid at the first or second death, depending on the policy. Distribution The Company's life insurance and annuity products are distributed primarily through three distribution channels; (1) "Agency", which consists of the Company's career agency force; (2) "Select", which consists of a network of third party broker-dealers; and (3) "Partners", which includes distributors of the mutual funds advised by Zurich Scudder Investments (formerly "Scudder Kemper Investments, Inc.") ("Zurich-Scudder"), Pioneer Investment Management, Inc ("Pioneer"), and Delaware Management company ("Delaware"). The Company's national career agency sales force consists of 692 agents, housed in 19 general agencies located in or adjacent to most of the major metropolitan centers in the United States. Virtually all of these agents are licensed both as insurance agents and securities broker-dealers by the National Association of Securities Dealers ("NASD"), qualifying them to sell the full range of the Company's products. The Company has focused on improving the productivity and reducing the cost of its career agency system through performance-based compensation, higher performance standards for agency retention and agency training programs. The Company also regularly conducts comprehensive financial planning seminars and fact-to-face presentations to address different investment objectives of clients. During 2000, total statutory premiums and deposits from sales of variable annuities through the agency sales force totaled $885.7 million, compared to $930.1 million and $871.3 million in 1999 and 1998, respectively. Total statutory premiums from sales of variable life insurance through the agency sales force totaled $66.3 million in 2000, compared to $97.6 million and $48.7 million in 1999 and 1998, respectively. In addition, both the Select and Partners distribution channels have made significant contributions to the overall growth of variable product sales in this segment. Products sold through these channels include Allmerica Select life and annuity products, which are distributed through independent broker- dealers and financial planners, as well as annuity products sold through alliances with mutual fund partners. The Company's strategy is to increase sales under its existing distribution channels and to continue to pursue additional relationships in these markets. Through these distribution channels, the Company has obtained access to over 531 distribution firms employing over 81,892 sales personnel. In addition, establishment of these channels has enabled the Company to offer a broader range of investment options through alliances with Zurich-Scudder, Pioneer, and Delaware mutual funds as well as other financial institutions. During 2000, total statutory premiums and deposits from sales of variable annuities through additional distribution channels totaled $2,194.1 million, compared to $1,822.3 million and $2,334.5 million in 1999 and 1998, respectively. In addition, total statutory premiums from sales of variable life insurance through additional distribution channels totaled $62.1 million in 2000, compared to $55.4 million and $32.8 million in 1999 and 1998, respectively. 16 The Company has developed a number of new marketing and client service initiatives in order to encourage sales of its products and improve customer satisfaction. As part of its focus on the sale of investment-oriented insurance products, the Company has emphasized a financial planning approach utilizing face-to-face presentations and seminar programs to address different client needs. In order to identify a favorable prospective client base, the Company has developed a system utilizing advanced demographic screening and telemarketing techniques. The Company also regularly delivers seminars focused on retirement planning to these prospective clients. During 2000, the Company delivered 878 seminars nationally with a total of 26,040 attendees. While developed for and primarily utilized by the agency channel, these programs are being extended to the Company's other distribution channels. Underwriting Life insurance underwriting involves a determination of the type and amount of risk which an insurer is willing to accept and the price charged to do so. The Company's insurance underwriting standards for this segment attempt to produce mortality results consistent with the assumptions used in product pricing. Underwriting also determines the amount and type of reinsurance levels appropriate for a particular risk profile and thereby allows competitive risk selection. Underwriting rules and guidelines are based on the mortality experience of the Company, as well as of the insurance industry and the general population. The Company also uses a variety of medical tests to evaluate certain policy applications, based on the size of the policy, the age of the applicant and other factors. The Company's product specifications are designed to prevent anti-selection. Mortality assumptions are thoroughly communicated and monitored. The underwriting department tracks the profitability indicators of business by each distribution channel, including the mix of business, percentage of substandard and declined cases and placement ratio. Ongoing internal underwriting audits, conducted at multiple levels, monitor consistency of underwriting requirements and philosophy. Routine independent underwriting audits conducted by its reinsurers have supported the Company's underwriting policies and procedures. Insurance Reserves The Company has established liabilities for policyholders' account balances and future policy benefits in the Consolidated Balance Sheets included in the 2000 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference, to meet obligations on various policies and contracts. Policyholders' account balances for universal life and investment- type policies are equal to cumulative account balances: deposits plus credited interest, less expense and mortality charges and withdrawals. The Company holds a separate reserve for annuity minimum death benefits. Future policy benefits for traditional products are computed on the basis of assumed investment yields, mortality, persistency, morbidity and expenses (including a margin for adverse deviation), which are established at the time of issuance of a policy and generally vary by product, year of issue and policy duration. The Company periodically reviews both reserve assumptions and policyholder liabilities. Reinsurance Consistent with the general practice in the life insurance industry, the Company has reinsured portions of the coverage provided by this segment's insurance products with other insurance companies. Insurance is ceded principally to reduce net liability on individual risks, to provide protection against large losses and to obtain a greater diversification of risk. Although reinsurance does not legally discharge the ceding insurer from its primary liability for the full amount of policies reinsured, it does make the reinsurers liable to the insurer to the extent of the reinsurance ceded. The Company maintains a gross reserve for reinsurance liabilities. The Company ceded approximately 5.2% of this segment's total statutory life insurance premiums in 2000. With respect to life policies of the Allmerica Financial Services segment, the Company has reinsurance agreements in place, established on an annual term, for both automatic and facultative reinsurance. Under automatic reinsurance, the Company's retention is currently $2.0 million per life. The reinsurer is automatically 17 bound for up to three times the Company's retention, or $6.0 million, with certain restrictions that determine the binding authority with the various reinsurers. For life policies greater than $8.0 million, the Company obtains facultative reinsurance. Under facultative reinsurance, the facultative reinsurer reviews all of the underwriting information relating to the policies prior to issuing the reinsurance and reinsures on a policy by policy basis. Depending on the nature of the risk and the size of the policy, the facultative reinsurance could be provided by one company or several. The Company sometimes facultatively reinsures certain policies under $2.0 million which do not satisfy the Company's underwriting guidelines. The Company seeks to enter into reinsurance treaties with highly rated reinsurers. All of the reinsurers utilized by this segment have received an A.M. Best rating of "A- (Excellent)" or better (Best's Insurance Reports, 1999 edition). The Company believes that it has established appropriate reinsurance coverage for this segment based upon its net retained insured liabilities compared to its surplus. Based on its review of its reinsurers' financial positions and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound. The Company also obtains catastrophe reinsurance for life insurance in this segment through a catastrophe accident pool. The maximum pool reinsurance available per company is $50.0 million and the maximum pool reinsurance available for a single event is $125.0 million. Any amounts in excess of these limits are the responsibility of the company suffering the loss. Each participant in the pool pays a premium based on the share of claims paid by the pool. The Company's share of pool losses is approximately 0.7%. There have been three claims for which the Company's share was approximately $94,000 since the Company entered the pool on January 1, 1989. Approximately 121 companies currently participate in this pool. Effective January 1, 1998, the Company entered into an agreement with a highly rated reinsurer to reinsure the mortality risk on the universal life and variable universal life lines of business. In addition, the Company maintains coinsurance agreements to reinsure substantially all of its individual disability income and yearly renewable term business. Competition There is strong competition among insurance companies seeking clients for the types of insurance, annuities and investment products sold by the Company in this segment. As of December 31, 2000, there were approximately 1,500 companies that offer life insurance in the United States, most of which offer one or more products similar to those offered by the Company. In some cases these products are offered through similar marketing techniques. In addition, the Company may face additional competition from banks and other financial institutions since prior regulatory restrictions on the sale of insurance and securities by these institutions have been repealed. The Company believes that, based upon its extensive experience in the market, the principal competitive factors affecting the sale of its life insurance and related investment products are price, financial strength and claims-paying ratings, size and strength of distribution force, range of product lines, product quality, reputation and name recognition, value-added service and, with respect to variable insurance and annuity products, investment management performance of the underlying separate accounts. Allmerica Asset Management General Through the Allmerica Asset Management segment, the Company offers Stable Value Products, such as Guaranteed Investment Contracts ("GICs") and funding agreements, to ERISA-qualified retirement plans as well as other non-ERISA institutional buyers, such as money market funds and securities lending collateral reinvestment programs. Also, Euro-GICs, a type of funding agreement, were issued in conjunction with a new European Medium Term Note program. In addition, this segment includes a Registered Investment Advisor, which provides investment advisory services to affiliates and to other institutions, such as insurance companies, retirement plans and mutual funds. For the year ended December 31, 2000, this segment accounted for approximately $149.2 million, or 4.6%, of consolidated segment revenues, and income of $22.5 million, or 6.0%, of consolidated segment income before federal income taxes and minority interest. 18 Products and Services Stable Value Products The Company offers its customers the option of investing in Stable Value Products such as the traditional GIC and the non-qualified GIC, often referred to as funding agreements. The traditional GIC is issued to ERISA-qualified retirement plans, and provides a fixed guaranteed interest rate and fixed maturity for each contract. Some traditional GICs provide for a specific lump sum deposit and no withdrawals prior to maturity. Other traditional GICs allow for window deposits and/or benefit-sensitive withdrawals prior to maturity, for which the Company builds an additional risk charge into the guaranteed interest rate. The funding agreement is similar to the traditional GIC, except that it is issued to non-ERISA institutional buyers, such as money market funds and securities lending collateral reinvestment programs. This market tends to prefer short duration instruments, so it is typical for the funding agreements sold in this market to have short maturities and periodic interest rate resets, based on an index such as LIBOR. Some buyers prefer to invest in instruments with longer maturities and either fixed or floating rate characteristics. The Company is able to structure its funding agreements to accommodate these buyers. Funding agreements sold through the Euro-GIC program tend to have longer maturities, from 3-10 years, and may utilize either fixed or variable interest rates also based on an index such as LIBOR, and be denominated in either U.S. dollars or foreign currencies. Deposits from customers in 2000 were invested primarily in these longer-term funding agreements. During 2000, funding agreement deposits were approximately $1.1 billion, as compared to $1.0 billion and $1.1 billion in 1999 and 1998, respectively. During 2000, deposits of approximately $305 million were short maturity floating rate products, while $764 million were longer maturity products, including Euro-GIC deposits of approximately $564 million. In addition, traditional GIC deposits totaled approximately $2.0 million, $3.0 million, and $0.3 million in 2000, 1999, and 1998, respectively. The continued low volume of traditional GIC deposits reflects the Company's decision to sell these products only when the profit margins meet the Company's standards. The Company expects to continue its sales of funding agreements in 2001. Investment Advisory Services Through its registered investment advisor, Allmerica Asset Management, Inc., the Company provides investment advisory services to affiliates and to other institutions, including unaffiliated insurance companies, retirement plans, foundations and mutual funds. At December 31, 2000, Allmerica Asset Management had assets under management of approximately $14.0 billion, of which approximately $2.2 billion represented assets managed for third party clients (i.e. entities unaffiliated with the Company). Assets under management for third party clients grew by approximately $112.5 million during 2000. Distribution The Company distributes Stable Value Products through brokers, investment bankers, GIC investment managers and directly from the Home Office. Investment advisory services are marketed directly. Competition Prior to 1997, GIC deposits consisted primarily of traditional GICs. The Company introduced its funding agreement product in the latter part of 1997. There are approximately two dozen insurance companies that compete in the funding agreement market. Funding agreements are one of a variety of instruments being purchased by the buyers in this market, and the Company views these other instruments as comprising the primary competition. Short- term commercial paper issued by corporations is the most common of these competing instruments. The primary factors affecting the ability to sell are the yields offered, short term ratings (and to a lesser extent, claims paying ratings) and product structure. By utilizing asset/liability management techniques, the Company is able to offer yields and product structures that are very competitive with comparably rated instruments, while earning an attractive return on capital. During the third quarter of 1999, uncertainties in the short maturity floating rate funding agreement market prompted a number of investors to terminate their funding agreements with the Company and request the return of their funds. These termination requests received 19 by the Company were paid in a timely manner. Management does not expect significant deposits in short-term funding agreements to continue due to a diminished market for this product. The Company introduced its Euro-GIC product in the latter part of 1999. Currently, there are approximately a dozen insurance companies that compete in this market. Euro-GICs are one of a variety of instruments being purchased by institutional investors in a competitive European market. The Company considers these other instruments as comprising the primary competition, of which medium term notes issued by corporations are the most common form of these competing instruments. The primary factors affecting the ability to sell Euro-GICs are the yields offered, the credit ratings assigned to the program, and the familiarity of the Company name among investors in Europe. As such, the Company periodically sends representatives to Europe to meet with potential investors and has established new relationships with several investment banking firms who manage the distribution of this product. Investment Portfolio General At December 31, 2000, the Company held $9.7 billion of investment assets, including $736.0 million of investment assets in the Closed Block. These investments are generally of high quality and broadly diversified across asset classes and individual investment risks. The major categories of investment assets are: fixed maturities, which includes both investment grade and below investment grade public and private debt securities; equity securities; mortgage loans, principally on commercial properties; policy loans and other long-term investments. The remainder of the investment assets is comprised of cash and cash equivalents. Management has an integrated approach to developing an investment strategy for the Company that maximizes income, while incorporating overall asset allocation, business segment objectives, and asset/liability management tailored to specific insurance or investment product requirements. The Company's integrated approach and the execution of the investment strategy are founded upon a value orientation. The Company's investment professionals seek to identify undervalued securities in the markets through extensive fundamental research and credit analysis. Management believes this research- driven, value orientation is a key to achieving the overall investment objectives of producing superior rates of return, preserving capital and meeting the financial goals of the Company's business segments. The appropriate asset allocation for the Company (the selection of broad investment categories such as fixed maturities, equity securities and mortgages) is determined by management initially through a process that focuses overall on the types of businesses in each segment that the Company engages in and the level of surplus (net worth) required to support these businesses. At the segment level, the Company has developed an asset/liability management approach tailored to specific insurance, investment product and income objectives. The investment assets of the Company are then managed in over 20 portfolio segments consistent with specific products or groups of products having similar liability characteristics. As part of this approach, management develops investment guidelines for each portfolio consistent with the return objectives, risk tolerance, liquidity, time horizon, tax and regulatory requirements of the related product or business segment. Specific investments frequently meet the requirements of, and are acquired by, more than one investment portfolio (or investment segment of the general account of FAFLIC or AFLIAC, with each investment segment holding a pro rata interest in such investments and the cash flows therefrom). Management has a general policy of diversifying investments both within and across all portfolios. The Company monitors the credit quality of its investments and its exposure to individual borrowers, industries, sectors and, in the case of mortgages, property types and geographic locations. All investments held by the Company's insurance subsidiaries are subject to diversification requirements under insurance laws. Consistent with this management approach, portfolio managers maintain close working relationships with the managers of related product lines within the Risk Management, Allmerica Financial Services and Allmerica Asset Management segments. 20 Rating Agencies Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers meaningful information on specific insurance companies. Higher ratings generally indicate financial stability and a stronger ability to pay claims. As of February 28, 2001, A.M. Best affirmed FAFLIC's, AFLIAC's, Hanover's and Citizens' financial condition rating of A (Ecxcellent). As of February 28, 2001, Standard & Poor's affirmed FAFLIC's, AFLIAC's and Hanover's, together with its subsidiaries, including Citizens Insurance, claims-paying ability rating of AA- (Excellent). As of February 28, 2001, Moody's affirmed FAFLIC's, AFLIAC's and Hanover's financial strength rating of A1 (Good). 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 protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. Employees The Company has approximately 5,700 employees located throughout the country. Management believes relations with employees and agents are good. ITEM 2 PROPERTIES The Company's headquarters are located at 440 Lincoln Street, Worcester, Massachusetts, and consist primarily of approximately 758,000 rentable square feet of office and conference space owned in fee and includes the headquarters of Hanover. Citizens owns its home office, located at 645 W. Grand River, Howell, Michigan, which is approximately 137,000 rentable square feet. Citizens also owns a three-building complex located at 808 North Highlander Way, Howell, Michigan, with approximately 207,000 rentable square feet, where various business operations are conducted. The Company leases office space for its sales force throughout the United States. The leased property houses agency offices and group insurance sales offices. Hanover and Citizens also lease offices throughout the country for its field employees. The Company believes that its facilities are adequate for its present needs in all material respects. ITEM 3 LEGAL PROCEEDINGS Reference is made to Note 21 on page 77 of the Notes to Consolidated Financial Statements of the 2000 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K. 21 PART II ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Common Stock and Shareholder Ownership The common stock of Allmerica Financial Corporation is traded on the New York Stock Exchange under the symbol "AFC". On March 21, 2001, the Company had 42,167 shareholders of record and 53.2 million shares outstanding. On the same date, the trading price of the Company's common stock was $48.91 per share. Common Stock Prices and Dividends
High Low Dividends ------ ------ --------- 2000 First Quarter......................................... $53.50 $35.31 -- Second Quarter........................................ $60.13 $46.31 -- Third Quarter......................................... $65.44 $54.00 $0.25 Fourth Quarter........................................ $72.50 $58.13 -- 1999 First Quarter......................................... $57.88 $50.19 -- Second Quarter........................................ $62.25 $54.50 -- Third Quarter......................................... $64.44 $47.56 $0.25 Fourth Quarter........................................ $59.69 $46.50 --
2000 Dividend Schedule Allmerica Financial Corporation declared an annual cash dividend of $0.25 per share on July 25, 2000, which was paid on November 15, 2000. The record date for such dividend was November 1, 2000. The payment of future dividends, if any, on the Company's Common Stock will be a business decision made by the Board of Directors from time to time based upon the results of operations and financial condition of the Company and such other factors as the Board of Directors considers relevant. Dividends paid by the Company may be funded from dividends paid to the Company from its subsidiaries. Dividends from insurance subsidiaries are subject to restrictions imposed by state insurance laws and regulations. Reference is made to "Liquidity and Capital Resources" on pages 43 and 44 of Management's Discussion and Analysis of Financial Condition and Results of Operations and to Note 14 on pages 72 and 73 of the Notes to Consolidated Financial Statements of the 2000 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference. ITEM 6 SELECTED FINANCIAL DATA Reference is made to the "Five Year Summary of Selected Financial Highlights" on page 21 of the 2000 Annual Report to Shareholders, which is incorporated herein by reference. ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Reference is made to "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 22-45 of the 2000 Annual Report to Shareholders, which is incorporated herein by reference. 22 ITEM 7A QUANTATATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Reference is made to "Market Risk and Risk Management Policies" on pages 36- 42 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the 2000 Annual Report to Shareholders, which is incorporated herein by reference. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Consolidated Financial Statements on pages 48-52 and the accompanying Notes to Consolidated Financial Statements on pages 53-78 of the 2000 Annual Report to Shareholders which meet the requirements of Regulation S-X, and which include a summary of quarterly results of consolidated operations (see Note 23 of Notes to Consolidated Financial Statements--page 78), which is incorporated herein by reference. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 23 PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS OF THE REGISTRANT Information regarding Directors of the Company is incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 15, 2001, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below is biographical information concerning the executive officers of the Company. John F. O'Brien, 57 Director, Chief Executive Officer and President of the Company since February 1995 See biography under "Directors of the Registrant" above. Bruce C. Anderson, 56 Vice President of the Company since February 1995 Mr. Anderson has been Vice President of AFC since February 1995. Mr. Anderson has been employed by FAFLIC since 1967 and has been Vice President and Director of FAFLIC since October 1984 and April 1996, respectively. Mark R. Colborn, 52 Vice President of the Company since March 2000 Mr. Colborn has been Vice President of AFC since March 2000. In addition, Mr. Colborn has served as Vice President of FAFLIC since June 1992. J. Kendall Huber, 46 Vice President and General Counsel of the Company since March 2000 Mr. Huber has been Vice President, General Counsel and Assistant Secretary of AFC and FAFLIC since March 2000. Prior to joining AFC, Mr. Huber was Executive Vice President, General Counsel, and Secretary of Promus Hotel Corporation from February 1999 to January 2000. Previously, Mr. Huber was Vice President and Deputy General Counsel of Legg Mason, Inc., from November 1998 to January 1999. He has also served as Vice President and Deputy General Counsel of USF&G Corporation, where he was employed from March 1990 to August 1998. John P. Kavanaugh, 46 Vice President and Chief Investment Officer of the Company since September 1996 Mr. Kavanaugh has been Vice President and Chief Investment Officer of AFC since September 1996, has been employed by FAFLIC since 1983, and has been Vice President of FAFLIC since December 1991. 24 Edward J. Parry, III, 41 Vice President of the Company since February 1995 Chief Financial Officer of the Company since December 1996 Mr. Parry has been Chief Financial Officer of AFC and FAFLIC since December 1996. He has also been Vice President of AFC since February 1995 and was Treasurer from February 1995 to March 2000. He has been a Vice President of FAFLIC since February 1993 and was Treasurer from February 1993 until March 2000. Richard M. Reilly, 62 Vice President of the Company since February 1997 Mr. Reilly has been Vice President of AFC and FAFLIC since February 1997 and November 1990, respectively. He has also been a Director and Vice President of AFLIAC since November 1990 and President and Chief Executive Officer of AFLIAC since August 1995. Mr. Reilly was Vice President of AFC from February 1995 through December 1995. Additionally, Mr. Reilly has been the President of Allmerica Investment Trust, and Allmerica Securities Trust, each a registered investment company, since February 1991. Robert P. Restrepo, Jr., 50 Vice President of the Company since May 1998 Mr. Restrepo has been Vice President of AFC and FAFLIC since May 1998. He was President, Chief Executive Officer and Director of Allmerica P&C from May 1998 to December 2000. Prior to joining AFC, Mr. Restrepo was Chief Executive Officer, Personal Lines at Travelers Property and Casualty, a member of the Travelers Group from January 1996 to May 1998. Additionally, Mr. Restrepo was the Senior Vice President, Personal Lines at Aetna Life & Casualty Company from March 1991 to January 1996. Eric A. Simonsen, 55 Vice President of the Company since February 1995 Mr. Simonsen has been Vice President of AFC since February 1995. In addition, he has served as Vice President and as a Director of FAFLIC since September 1990 and April 1996, respectively. Mr. Simonsen was Chief Financial Officer of AFC from February 1995 to December 1996 and of FAFLIC from September 1990 to December 1996. Gregory D. Tranter, 44 Vice President and Chief Information Officer of the Company since October 2000 Mr. Tranter has been Vice President and Chief Information Officer of AFC since October 2000. Mr. Tranter has been Vice President and Chief Information Officer of AFC's insurance subsidiaries since August 1998. Prior to joining AFC, Mr. Tranter was Vice President, Automation Strategy of Travelers Property & Casualty Company from April 1996 to July 1998. Mr. Tranter was employed by Aetna Life & Casualty Company from 1983 to 1996. ITEM 11 EXECUTIVE COMPENSATION Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 15, 2001, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. 25 ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 15, 2001, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference from the Proxy Statement for the Annual Meeting of Shareholders to be held May 15, 2001, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. 26 PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements The consolidated financial statements and accompanying notes thereto on pages 48 through 78 of the 2000 Annual Report to Shareholders have been incorporated herein by reference in their entirety.
Annual Report Page(s) ------- Report of Independent Accountants..................................... 46 Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998.................................................. 48 Consolidated Balance Sheets as of December 31, 2000 and 1999.......... 49 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998..................................... 50 Consolidated Statements of Comprehensive Income for the years ended December 31, 2000, 1999 and 1998..................................... 51 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998.................................................. 52 Notes to Consolidated Financial Statements............................ 53-78
(a)(2) Financial Statement Schedules
Page No. in Schedule this Report -------- ----------- Report of Independent Accountants on Financial Statement Schedules.................................... 33 I Summary of Investments--Other than Investments in Related Parties........................................ 34 II Condensed Financial Information of Registrant.......... 35-37 III Supplementary Insurance Information.................... 38-40 IV Reinsurance............................................ 41 V Valuation and Qualifying Accounts...................... 42 VI Supplemental Information concerning Property/Casualty Insurance Operations................................... 43
(a)(3) Exhibit Index Exhibits filed as part of this Form 10-K are as follows: 2.1 Plan of Reorganization.+ 2.2 Stock and Asset Purchase Agreement by an among State Mutual Life Assurance Company of America, 440 Financial Group of Worcester, Inc., and The Shareholder Services Group, Inc. dated as of March 9, 1995.+ 3.1 Certificate of Incorporation of AFC.+ 3.2 By-Laws of AFC.+ 4 Specimen Certificate of Common Stock.+ 4.1 Form of Indenture relating to the Debentures between the Registrant and State Street Bank & Trust Company, as trustee.++ 4.2 Form of Global Debenture.++ 4.3 Amended and Restated Declaration of Trust of AFC Capital Trust I dated February 3, 1997.+++++ 4.4 Indenture dated February 3, 1997 relating to the Junior Subordinated Debentures of AFC.+++++ 4.5 Series A Capital Securities Guarantee Agreement dated February 3, 1997.+++++ 4.6 Common Securities Guarantee Agreement dated February 3, 1997.+++++
27 4.8 Rights Agreement dated as of December 16, 1997, between the Registrant and First Chicago Trust Company of New York as Rights Agent, filed as Exhibit 1 to the Company's Form 8-A dated December 17, 1997 is incorporated herein by reference. 10.3 Administrative Services Agreement between State Mutual Life Assurance Company of America and The Hanover Insurance Company, dated July 19, 1989.+ 10.4 First Allmerica Financial Life Insurance Company Employees' 401(k) Matched Savings Plan incorporated by reference to Exhibit 10.1 to the Allmerica Financial Corporation Registration Statement on Form 8-K (No. 333-576) and incorporated herein by reference originally filed with the Commission on January 24, 1996. 10.5 State Mutual Life Assurance Company of America Excess Benefit Retirement Plan.+ 10.6 State Mutual Life Assurance Company of America Supplemental Executive Retirement Plan.+ 10.7 State Mutual Incentive Compensation Plan.+ 10.8 State Mutual Companies Long-Term Performance Unit Plan.+ 10.9 Indenture of Lease between State Mutual Life Assurance Company of America and the Hanover Insurance Company dated July 3, 1984 and corrected First Amendment to Indenture of Lease dated December 20, 1993.+ 10.12 Lease dated March 23, 1993 by and between Aetna Life Insurance Company and State Mutual Life Assurance Company of America, including amendments thereto, relating to property in Atlanta, Georgia.+ 10.13 Stockholder Services Agreement dated as of January 1, 1992 between Private Healthcare Systems, Inc. and State Mutual Life Assurance Company of America, the successor to its wholly-owned subsidiary, Group Healthcare Network, Inc.+ 10.14 Lease dated January 26, 1995 by and between Citizens Insurance and Upper Peninsula Commission for Area Progress, Inc., including amendments thereto, relating to property in Escanaba, Michigan.+ 10.16 Trust Indenture for the State Mutual Life Assurance Company of America Employees' 401(k) Matched Savings Plan between State Mutual Life Assurance Company of America and Bank of Boston/Worcester.+ 10.17 State Mutual Life Assurance Company of America Non-Qualified Executive Retirement Plan.+ 10.18 State Mutual Life Assurance Company of America Non-Qualified Executive Deferred Compensation Plan.+ 10.19 The Allmerica Financial Cash Balance Pension Plan incorporated by reference to Exhibit 10.19 to the Allmerica Financial Corporation September 30, 1995 report on Form 10-Q and incorporated herein by reference. 10.20 The Allmerica Financial Corporation Employment Continuity Plan.++++++ 10.21 Amended and Restated Form of Non-Solicitation Agreement executed by substantially all of the executive officers of AFC incorporated by reference to Exhibit 10.21 to the Allmerica Financial Corporation June 30, 1997 report on Form 10-Q and incorporated herein by reference. 10.23 Amended Allmerica Financial Corporation Long-Term Stock Incentive Plan.+++++++ 10.24 The Allmerica Financial Corporation Director Stock Ownership Plan incorporated by reference to Exhibit 10.21 to the Allmerica Financial Corporation June 30, 1996 report on Form 10-Q and incorporated herein by reference. 10.25 Reinsurance Agreement dated September 29, 1997 between First Allmerica Financial Life Insurance Company and Metropolitan Life Insurance Company.+++++++ 10.26 Consolidated Service Agreement between Allmerica Financial Corporation and its subsidiaries, dated January 1, 1998.+++++++ 10.27 Deferral Agreement, dated April 4, 1997, between Allmerica Financial Corporation and John F. O'Brien.+++++++ 10.28 Severance Agreement, dated September 25, 1997, between First Allmerica Financial Life Insurance Company and Larry C. Renfro.+++++++ 10.29 Credit agreement dated as of June 17, 1998 between the Registrant and the Chase Manhattan Bank.++++++++
28 10.30 Form of Deferral Agreement executed by substantially all of the executive officers of AFC dated January 30, 1998.++++++++ 10.31 Form of Restricted Stock Agreement, dated January 30, 1998 and executed by substantially all of the executive officers of AFC.++++++++ 10.32 Form of Converted Stock Agreement, dated January 30, 1998 and executed by substantially all of the executive officers of AFC.++++++++ 10.33 Employment Arrangement, dated May 13, 1998 between First Allmerica Financial Life Insurance Company and Robert P. Restrepo, Jr.++++++++ 10.34 Restricted Stock Agreement, dated May 26, 1998, between Allmerica Financial Corporation and Robert P. Restrepo, Jr.++++++++ 10.35 Credit agreement dated as of December 1, 1998 between the Registrant and the Chase Manhattan Bank.++++++++ 10.36 Amendment to the Credit Agreement dated as of June 17, 1998 between the Registrant and the Chase Manhattan Bank incorporated by reference to Exhibit 10.36 to the Allmerica Financial Corporation June 30, 1999 report on Form 10-Q and incorporated herein by reference. 10.37 Allmerica Financial Corporation Short-Term Incentive Compensation Plan incorporated herein by reference to Exhibit A contained in the Registrant's Proxy Statement (Commission File No. 001-13754) originally filed with the Commission on March 31, 1999. 13 The following sections of the Annual Report to Shareholders for 2000 ("2000 Annual Report") which are expressly incorporated by reference into this Annual Report on Form 10-K: .Management's Discussion and Analysis of Financial Condition and Results of Operations at pages 22 through 45 of the 2000 Annual Report. .Consolidated Financial Statements and Notes thereto at pages 48 through 78 of the 2000 Annual Report. .Report of Independent Accountants at page 46 of the 2000 Annual Report. .The information appearing under the caption "Five Year Summary of Selected Financial Highlights" at page 21 of the 2000 Annual Report. .The information appearing under the caption "Shareholder Information" at page 80 of the 2000 Annual Report. 21 Subsidiaries of AFC. 23 Consent of Independent Accountants 24 Power of Attorney. 27 Financial Data Schedule. 99.1 Internal Revenue Service Ruling dated April 15, 1995.+ 99.2 Important Factors Regarding Forward Looking Statements.
- -------- + Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's Registration Statement on Form S- 1 (No. 33-91766) originally filed with the Commission on May 1, 1995. ++ Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's Registration Statement on Form S- 1 (No. 33-96764) originally filed with the Commission on September 11, 1995. +++ Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's 1995 Annual Report on Form 10-K originally filed with the Commission on March 28, 1996. ++++ Incorporated by herein by reference to Exhibit I of the Current Report of the Registrant (Commission File No. 1-13754) filed February 20, 1997. +++++ Incorporated herein by reference to Exhibits 2, 3, 4, 5 and 6, respectively, contained in the Registrant's Current Report on Form 8-K filed on February 5, 1997. ++++++ Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's 1996 Annual Report on Form 10-K originally filed with the Commission on March 24, 1997. 29 +++++++ Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's 1997 Annual Report on Form 10-K originally filed with the Commission on March 27, 1998 ++++++++ Incorporated herein by reference to the correspondingly numbered exhibit contained in the Registrant's 1998 Annual Report Form 10-K originally filed with the Commission on March 29, 1999. (b) Reports on Form 8-K None 30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and 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 Date: March 23, 2001 /s/ John F. O'Brien By: _________________________________ John F. O'Brien, Chairman of the Board, Chief Executive Officer and President Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: March 23, 2001 /s/ John F. O'Brien By: _________________________________ John F. O'Brien, Chairman of the Board, Chief Executive Officer and President Date: March 23, 2001 /s/ Edward J. Parry, III By: _________________________________ Edward J. Parry III, Vice President, Chief Financial Officer and Principal Accounting Officer Date: March 23, 2001 * By: _________________________________ Michael P. Angelini, Director Date: March 23, 2001 * By: _________________________________ E. Gordon Gee, Director Date: March 23, 2001 * By: _________________________________ Samuel J. Gerson, Director Date: March 23, 2001 * By: _________________________________ Gail L. Harrison, Director 31 Date: March 23, 2001 * By: _________________________________ Robert P. Henderson, Director Date: March 23, 2001 * By: _________________________________ M Howard Jacobson, Director Date: March 23, 2001 * By: _________________________________ Wendell J. Knox, Director Date: March 23, 2001 * By: _________________________________ Robert J. Murray, Director Date: March 23, 2001 * By: _________________________________ Terrence Murray, Director Date: March 23, 2001 * By: _________________________________ John R. Towers, Director Date: March 23, 2001 * By: _________________________________ Herbert M. Varnum, Director /s/ Edward J. Parry *By: ________________________________ Edward J. Parry, Attorney-in-fact 32 Report of Independent Accountants on Financial Statement Schedules To the Board of Directors of Allmerica Financial Corporation Our audits of the consolidated financial statements referred to in our report dated February 1, 2001, appearing in the 2000 Annual Report to Shareholders of Allmerica Financial Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP _____________________________________ PricewaterhouseCoopers LLP Boston, Massachusetts February 1, 2001 33 Schedule I ALLMERICA FINANCIAL CORPORATION Summary of Investments--Other than Investments in Related Parties December 31, 2000
Amount at which shown in the balance Type of Investment Cost(1) Value sheet - ------------------ -------- ------- -------------- (In millions) Fixed maturities: Bonds: United States Government and government agencies and authorities.................. $ 86.7 $ 89.2 $ 89.2 States, municipalities and political subdivisions.............................. 1,966.7 2,018.5 2,018.5 Foreign governments........................ 52.1 53.9 53.9 Public utilities........................... 466.6 457.4 457.4 All other corporate bonds.................. 4,892.7 4,816.4 4,816.4 Redeemable preferred stocks.................. 288.5 285.1 285.1 -------- ------- -------- Total fixed maturities..................... 7,753.3 7,720.5 7,720.5 -------- ------- -------- Equity securities: Common stocks: Public utilities........................... 0.1 0.2 0.2 Banks, trust and insurance companies....... 0.1 3.0 3.0 Industrial, miscellaneous and all other.... 44.8 67.1 67.1 Nonredeemable preferred stocks............... 15.0 15.2 15.2 -------- ------- -------- Total equity securities.................... 60.0 85.5 85.5 -------- ------- -------- Mortgage loans on real estate.................. 472.7 XXXXXX 472.7 Policy loans................................... 189.6 XXXXXX 189.6 Other long-term investments.................... 207.0 XXXXXX 193.2 -------- ------- -------- Total investments.......................... $8,682.6 XXXXXX $8,661.5 ======== ======= ========
- -------- (1) Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums and accretion of discounts. 34 Schedule II ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Statements of Income for the Years Ended December 31,
2000 1999 1998 ------ ------ ------ (In millions) Revenues Net investment income............................... $ 3.6 $ 5.3 $ 7.1 Net realized investment gains (losses).............. 2.6 (0.4) 1.7 ------ ------ ------ Total revenues.................................... 6.2 4.9 8.8 ------ ------ ------ Expenses Interest expense.................................... 40.6 40.6 40.5 Operating expenses.................................. 2.7 2.3 2.5 ------ ------ ------ Total expenses.................................... 43.3 42.9 43.0 ------ ------ ------ Net loss before federal income taxes and equity in net income of unconsolidated subsidiaries................ (37.1) (38.0) (34.2) Income tax benefit: Federal............................................. 13.2 14.2 12.4 State............................................... -- 0.3 0.5 Equity in net income of unconsolidated subsidiaries... 223.8 319.3 222.5 ------ ------ ------ Net income............................................ $199.9 $295.8 $201.2 ====== ====== ======
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 35 Schedule II (continued) ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Balance Sheets
December 31, ------------------ 2000 1999 -------- -------- (In millions, except share and per share data) Assets Cash and cash equivalents................................ $ 26.6 $ 5.6 Investment in unconsolidated subsidiaries................ 2,922.6 2,761.5 Receivable from subsidiaries............................. 65.3 47.2 Other assets............................................. 8.7 7.4 -------- -------- Total assets........................................... $3,023.2 $2,821.7 ======== ======== Liabilities Expenses and taxes payable............................... $ 35.6 $ 14.8 Interest and dividends payable........................... 13.6 13.3 Short-term debt.......................................... 56.1 44.6 Long-term debt........................................... 508.8 508.8 -------- -------- Total liabilities...................................... 614.1 581.5 -------- -------- Shareholders' Equity Preferred stock, par value $0.01 per share, 20.0 million shares authorized, none issued.......................... -- -- Common stock, par value $0.01 per share, 300.0 million shares authorized, 60.4 million shares issued at both December 31, 2000 and December 31, 1999................. 0.6 0.6 Additional paid-in capital............................... 1,765.3 1,770.5 Accumulated other comprehensive income................... (5.2) (75.3) Retained earnings........................................ 1,068.7 882.2 Treasury stock at cost (7.7 and 6.2 million shares)...... (420.3) (337.8) -------- -------- Total shareholders' equity............................. 2,409.1 2,240.2 -------- -------- Total liabilities and shareholders' equity............. $3,023.2 $2,821.7 ======== ========
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 36 Schedule II (continued) ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Statement of Cash Flows for the Years Ended December 31,
2000 1999 1998 ------- ------- ------- (In millions) Cash flows from operating activities Net income......................................... $ 199.9 $ 295.8 $ 201.2 Adjustments to reconcile net income to net cash used in operating activities: Equity in undistributed income of subsidiaries.... (223.8) (319.3) (222.5) Net realized investment (gains) losses............ (2.6) 0.4 (1.7) Change in expenses and taxes payable.............. 22.5 (2.8) 24.7 Change in interest and dividends payable.......... 0.3 0.3 (2.8) Change in receivable from subsidiaries............ (18.1) 3.3 (43.9) Other, net........................................ (1.5) 1.7 8.0 ------- ------- ------- Net cash used in operating activities............... (23.3) (20.6) (37.0) ------- ------- ------- Cash flows from investing activities Capital contributed to unconsolidated subsidiaries...................................... (16.9) (54.1) (95.7) Proceeds from disposals and maturities of available-for-sale fixed maturities............... 33.5 84.6 123.9 Purchase of available-for-sale fixed maturities.... -- (41.4) -- Proceeds from sale of common stock of subsidiary... -- 247.6 -- ------- ------- ------- Net cash provided by investing activities........... 16.6 236.7 28.2 ------- ------- ------- Cash flow from financing activities Dividend received from unconsolidated subsidiaries...................................... 109.8 39.5 50.0 Net proceeds from issuance of commercial paper..... 11.5 3.5 41.1 Net proceeds from issuance of common stock......... 0.6 1.1 11.4 Treasury stock purchased at cost................... (104.1) (250.2) (82.7) Treasury stock reissued at cost.................... 23.3 6.2 -- Dividends paid to shareholders..................... (13.4) (13.5) (9.0) ------- ------- ------- Net cash provided by (used in) financing activities......................................... 27.7 (213.4) 10.8 ------- ------- ------- Net change in cash and cash equivalents............. 21.0 2.7 2.0 Cash and cash equivalents at beginning of the period............................................. 5.6 2.9 0.9 ------- ------- ------- Cash and cash equivalents at end of the period...... $ 26.6 $ 5.6 $ 2.9 ======= ======= =======
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 37 Schedule III ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 2000
Future policy Amortization benefits, Other Benefits, of Deferred losses, policy claims, deferred policy claims and claims and Net losses and policy Other acquisition loss Unearned benefits Premium investment settlement acquisition operating Premiums costs expenses premiums payable revenue income expenses costs expenses written ----------- ---------- -------- ---------- -------- ---------- ---------- ------------ --------- -------- (In millions) Risk Management.. $ 187.2 $3,017.5 $978.8 $ 25.1 $2,066.7 $218.4 $1,563.0 $373.2 $184.9 $2,153.4 Asset Accumulation Allmerica Financial Services........ 1,409.8 2,764.9 2.8 418.5 2.2 230.0 222.6 81.1 242.3 -- Allmerica Asset Management...... 0.2 -- -- 1,636.5 -- 138.1 103.7 0.2 23.0 -- Corporate........ -- -- -- -- -- 6.3 -- -- 82.3 -- Eliminations..... -- -- -- -- -- (0.9) -- -- (7.0) -- -------- -------- ------ -------- -------- ------ -------- ------ ------ -------- Total........... $1,597.2 $5,782.4 $981.6 $2,080.1 $2,068.9 $591.9 $1,889.3 $454.5 $525.5 $2,153.4 ======== ======== ====== ======== ======== ====== ======== ====== ====== ========
38 Schedule III (continued) ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 1999
Future policy Amortization benefits, Other Benefits, of Deferred losses, policy claims, deferred policy claims and claims and Net losses and policy Other acquisition loss Unearned benefits Premium investment settlement acquisition operating Premiums costs expenses premiums payable revenue income expenses costs expenses written ----------- ---------- -------- ---------- -------- ---------- ---------- ------------ --------- -------- (In millions) Risk Management.. $ 173.3 $3,003.8 $887.2 $ 24.8 $1,948.2 $221.4 $1,420.3 $370.6 $197.0 $1,977.0 Asset Accumulation Allmerica Financial Services........ 1,213.1 2,659.8 3.0 700.2 2.3 251.1 232.1 59.1 211.7 -- Allmerica Asset Management...... 0.4 -- -- 1,316.0 -- 138.2 118.3 0.2 8.5 -- Corporate........ -- -- -- -- -- 6.0 -- -- 65.3 -- Eliminations..... -- -- -- -- -- (1.0) -- -- (5.9) -- -------- -------- ------ -------- -------- ------ -------- ------ ------ -------- Total........... $1,386.8 $5,663.6 $890.2 $2,041.0 $1,950.5 $615.7 $1,770.7 $429.9 $476.6 $1,977.0 ======== ======== ====== ======== ======== ====== ======== ====== ====== ========
39 Schedule III (continued) ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 1998
Future policy Amortization benefits, Other Benefits, of Deferred losses, policy claims, deferred policy claims and claims and Net losses and policy Other acquisition loss Unearned benefits Premium investment settlement acquisition operating Premiums costs expenses premiums payable revenue income expenses costs expenses written ----------- ---------- -------- ---------- -------- ---------- ---------- ------------ --------- -------- (In millions) Risk Management.. $ 167.5 $2,955.4 $840.1 $ 21.4 $1,967.9 $229.8 $1,495.4 $379.7 $206.4 $1,956.7 Asset Accumulation Allmerica Financial Services........ 993.1 2,663.1 3.1 823.8 2.7 253.1 219.3 69.6 209.3 -- Allmerica Asset Management...... 0.6 -- -- 1,791.8 -- 111.4 89.3 0.3 8.4 -- Corporate........ -- -- -- -- -- 11.9 -- -- 63.8 -- Eliminations..... -- -- -- -- -- (1.8) -- -- (7.6) -- -------- -------- ------ -------- -------- ------ -------- ------ ------ -------- Total........... $1,161.2 $5,618.5 $843.2 $2,637.0 $1,970.6 $604.4 $1,804.0 $449.6 $480.3 $1,956.7 ======== ======== ====== ======== ======== ====== ======== ====== ====== ========
40 Schedule IV ALLMERICA FINANCIAL CORPORATION Reinsurance December 31,
Assumed Percentage Ceded to from of amount Gross other other Net assumed to amount companies companies amount net --------- --------- --------- --------- ---------- (In millions) 2000 Life insurance in force..... $30,999.4 $19,329.9 $488.3 $12,157.8 4.02% ========= ========= ====== ========= ===== Premiums: Life insurance............ $ 13.9 $ 10.7 $ 0.7 $ 3.9 17.95% Accident and health insurance................ 29.8 29.6 -- 0.2 -- Property and casualty insurance................ 2,297.8 299.8 66.8 2,064.8 3.24% --------- --------- ------ --------- Total premiums.............. $ 2,341.5 $ 340.1 $ 67.5 $ 2,068.9 3.26% ========= ========= ====== ========= ===== 1999 Life insurance in force..... $41,393.1 $21,251.5 $374.2 $20,515.8 1.82% ========= ========= ====== ========= ===== Premiums: Life insurance............ $ 21.3 $ 18.6 $ 0.7 $ 3.4 20.59% Accident and health insurance................ 32.2 31.4 -- 0.8 -- Property and casualty insurance................ 2,135.0 261.7 73.0 1,946.3 3.75% --------- --------- ------ --------- Total premiums.............. $ 2,188.5 $ 311.7 $ 73.7 $ 1,950.5 3.78% ========= ========= ====== ========= ===== 1998 Life insurance in force..... $44,790.9 $23,886.9 $555.4 $21,459.4 2.59% ========= ========= ====== ========= ===== Premiums: Life insurance............ $ 15.8 $ 13.3 $ 0.7 $ 3.2 21.88% Accident and health insurance................ 35.6 34.5 -- 1.1 -- Property and casualty insurance................ 1,967.9 66.1 64.5 1,966.3 3.28% --------- --------- ------ --------- Total premiums.............. $ 2,019.3 $ 113.9 $ 65.2 $ 1,970.6 3.31% ========= ========= ====== ========= =====
41 Schedule V ALLMERICA FINANCIAL CORPORATION Valuation and Qualifying Accounts December 31,
Additions --------------------- Deductions Balance at Charged to Charged to from Balance at beginning of costs and other allowance end of period expense accounts account period ------------ ---------- ---------- ---------- ---------- (In millions) 2000 Mortgage loans.......... $ 5.8 $(1.3) $-- $0.1 $ 4.4 Allowance for doubtful accounts............... 5.8 8.4 -- 7.3 6.9 ----- ----- ---- ---- ----- $11.6 $ 7.1 $-- $7.4 $11.3 ===== ===== ==== ==== ===== 1999 Mortgage loans.......... $11.5 $(2.4) $-- $3.3 $ 5.8 Allowance for doubtful accounts............... 5.4 5.6 -- 5.2 5.8 ----- ----- ---- ---- ----- $16.9 $ 3.2 $-- $8.5 $11.6 ===== ===== ==== ==== ===== 1998 Mortgage loans.......... $20.7 $(6.8) $-- $2.4 $11.5 Allowance for doubtful accounts............... 6.1 4.4 -- 5.1 5.4 ----- ----- ---- ---- ----- $26.8 $(2.4) $-- $7.5 $16.9 ===== ===== ==== ==== =====
42 Schedule VI ALLMERICA FINANCIAL CORPORATION Supplemental Information Concerning Property and Casualty Insurance Operations For the Years Ended December 31,
Reserves Discount, for if any, Deferred losses and deducted policy loss from Net Net Affiliation with acquisition adjustment previous Unearned premiums investment Registrant costs expenses(2) column(1) premiums(2) earned income ---------------- ----------- ----------- --------- ----------- -------- ---------- (In millions) Consolidated Property and Casualty Subsidiaries 2000.................. $183.9 $2,719.1 $-- $975.9 $2,064.8 $217.9 ====== ======== ==== ====== ======== ====== 1999.................. $167.3 $2,618.7 $-- $883.3 $1,946.3 $220.5 ====== ======== ==== ====== ======== ====== 1998.................. $164.9 $2,597.3 $-- $834.9 $1,966.3 $228.9 ====== ======== ==== ====== ======== ======
Amortization Losses and loss of deferred Paid losses adjustment expenses policy and loss Net ------------------------ acquisition adjustment premiums Current Year Prior Years expenses expenses written ------------ ----------- ------------ ----------- -------- 2000.............. $1,634.9 $ (87.4) $373.2 $1,574.0 $2,151.6 ======== ======= ====== ======== ======== 1999.............. $1,601.4 $(183.4) $370.6 $1,499.1 $1,975.4 ======== ======= ====== ======== ======== 1998.............. $1,609.0 $(127.2) $379.7 $1,514.9 $1,955.1 ======== ======= ====== ======== ========
- -------- (1) The Company does not employ any discounting techniques. (2) Reserves for losses and loss adjustment expenses are shown gross of $816.9 million, $694.2 million and $591.7 million of reinsurance recoverable on unpaid losses in 2000, 1999 and 1998, respectively. Unearned premiums are shown gross of prepaid premiums of $63.2 million, $57.4 million and $37.9 million in 2000, 1999 and 1998, respectively. 43 EX-13 2 0002.txt SECTIONS OF THE ANNUAL REPORT - -------------------------------------------------------------------------------- FIVE YEAR SUMMARY OF SELECTED FINANCIAL HIGHLIGHTS - --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS, EXCEPT PER SHARE DATA) Statements of Income Revenues Premiums $ 2,068.9 $ 1,950.5 $ 1,970.6 $ 1,980.5 $ 1,937.1 Universal life and investment product policy fees 421.1 359.3 296.6 237.3 197.2 Net investment income 591.9 615.7 604.4 631.1 651.2 Net realized investment (losses) gains (135.3) 91.0 59.2 76.0 65.6 Other income 141.3 128.7 103.2 81.5 77.7 - ------------------------------------------------------------------------------------------------------------------------------------ Total revenues 3,087.9 3,145.2 3,034.0 3,006.4 2,928.8 - ------------------------------------------------------------------------------------------------------------------------------------ Benefits, Losses and Expenses Policy benefits, claims, losses and loss adjustment expenses 1,889.3 1,770.7 1,804.0 1,764.0 1,747.8 Policy acquisition expenses 454.5 429.9 449.6 408.5 454.4 Sales practice litigation expense -- -- 31.0 -- -- Loss from cession of disability income business -- -- -- 53.9 -- Restructuring costs 20.7 (1.9) 9.0 -- -- Other operating expenses 504.8 478.5 440.3 440.0 421.4 - ------------------------------------------------------------------------------------------------------------------------------------ Total benefits, losses and expenses 2,869.3 2,677.2 2,733.9 2,666.4 2,623.6 - ------------------------------------------------------------------------------------------------------------------------------------ Income from continuing operations before federal income taxes 218.6 468.0 300.1 340.0 305.2 Federal income tax expense 2.7 106.9 56.1 84.7 66.2 - ------------------------------------------------------------------------------------------------------------------------------------ Income from continuing operations before minority interest 215.9 361.1 244.0 255.3 239.0 Minority interest (16.0) (16.0) (29.3) (62.7) (74.6) - ------------------------------------------------------------------------------------------------------------------------------------ Income from continuing operations 199.9 345.1 214.7 192.6 164.4 Discontinued operations: (Loss) income from operations of discontinued group life and health business, net of taxes -- (18.8) (13.5) 16.6 17.5 Loss from disposal of group life and health business, net of taxes -- (30.5) -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 199.9 $ 295.8 $ 201.2 $ 209.2 $ 181.9 ==================================================================================================================================== Earnings per common share (diluted) $ 3.70 $ 5.33 $ 3.33 $ 3.82 $ 3.63 Dividends declared per common share (diluted) $ 0.25 $ 0.25 $ 0.15 $ 0.20 $ 0.20 - ------------------------------------------------------------------------------------------------------------------------------------ Adjusted net income (1) $ 301.2 $ 280.9 $ 212.5 $ 164.3 $ 121.1 - ------------------------------------------------------------------------------------------------------------------------------------ Balance Sheet (at December 31) Total assets $ 31,588.0 $ 30,769.6 $ 27,653.1 $ 22,549.0 $ 18,970.3 Long-term debt 199.5 199.5 199.5 202.1 202.2 Total liabilities 28,878.9 28,229.4 24,894.5 19,714.8 16,461.6 Minority interest 300.0 300.0 300.0 452.9 784.0 Shareholders' equity 2,409.1 2,240.2 2,458.6 2,381.3 1,724.7
(1) Represents net income adjusted for certain items which management believes are not indicative of overall operating trends, including net realized investment gains (losses), net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes, restructuring costs, differential earnings tax adjustments, and certain other items. While these items may be significant components in understanding and assessing the Company's financial performance, management believes adjusted net income enhances an investor's 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. 21 - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements included elsewhere herein. INTRODUCTION - -------------------------------------------------------------------------------- The results of operations for Allmerica Financial Corporation and subsidiaries ("AFC" or "the Company") include the accounts of AFC; First Allmerica Financial Life Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); Allmerica Asset Management, Inc. ("AAM," a wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C," a wholly-owned non-insurance subsidiary of AAM through December 31, 2000); The Hanover Insurance Company ("Hanover," a wholly-owned subsidiary of Allmerica P&C through December 31, 2000); Citizens Corporation (a wholly-owned non-insurance subsidiary of Hanover through December 31, 2000); Citizens Insurance Company of America ("Citizens," a wholly-owned subsidiary of Citizens Corporation through December 31, 2000) and certain other insurance and non-insurance subsidiaries. On December 31, 2000, the Company dissolved Allmerica P&C and Citizens Corporation and transferred subsidiaries of Allmerica P&C to AAM and transferred subsidiaries of Citizens Corporation to Hanover. The results of operations also reflect minority interest in Citizens Corporation, prior to the acquisition of minority interest on or about December 3, 1998, of approximately 16.8%. 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. The Risk Management Segment manages its products through three distribution channels identified as Standard Markets, Sponsored Markets, and Specialty Markets. Standard Markets consists of the aggregate operating results for the three channels previously characterized as Hanover North, Hanover South and Citizens Midwest. Maintaining a strong regional focus, Standard Markets sells property and casualty insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. Sponsored Markets offers property and casualty products to members of affinity groups and other organizations. This distribution channel also focuses on worksite distribution, which offers discounted property and casualty (automobile and homeowners) insurance through employer sponsored programs. Specialty Markets offers specialty or program property and casualty business nationwide. This channel focuses on niche classes of risks and leverages specific underwriting processes. 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, as well as group retirement products, such as defined benefit and 401(k) plans and tax-sheltered annuities. Allmerica Financial Services also includes brokerage and non-institutional investment advisory services. Through its Allmerica Asset Management segment, the Company offers its customers the option of investing in Guaranteed Investment Contracts ("GICs"), such as short-term and long-term funding agreements. Short-term 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. Long-term funding agreements are investment contracts issued to various business or charitable trusts, which are used to support debt issued by the trust to foreign and domestic institutional buyers, such as banks, insurance companies, and pension plans. These funding agreements have long maturities and may be issued with a fixed or variable interest rate based on an index such as LIBOR. This segment is also a Registered Investment Advisor providing investment advisory services, primarily to affiliates and to third parties, such as money market and other fixed income clients. 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, technology, finance, human resources and legal. 22 RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Consolidated Overview Consolidated net income includes the results of each segment of the Company, which management evaluates on a pre-tax and pre-minority interest basis. In addition, net income also 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", which excludes these items, enhances understanding of the Company's results of operations by highlighting net income attributable to the normal, recurring operations of the business. However, adjusted net income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles. The Company's consolidated net income decreased $95.9 million, or 32.4%, to $199.9 million, compared to $295.8 million in 1999. The reduction in net income resulted primarily from a $150.8 million decline in net realized investment gains and $13.5 million of restructuring charges in 2000, partially offset by a lower federal income tax rate. In addition, 2000 results do not include a $49.3 million after-tax loss resulting from the discontinuation of the Company's group life and health business in 1999. In 1999, the Company's consolidated net income increased $94.6 million, or 47.0%, to $295.8 million, compared to $201.2 million in 1998. The increase in 1999 primarily reflected an increase in adjusted net income of $68.4 million, increased net realized investment gains of $34.2 million and the absence, in 1999, of sales practice litigation expenses totaling $20.2 million, net of taxes. These items were partially offset by the aforementioned discontinuation of the Company's group life and health business. The following table reflects adjusted net income and a reconciliation to consolidated net income. Adjusted net income consists of segment income (loss), federal income taxes on segment income and minority interest on preferred dividends. FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Segment income (loss) before federal income taxes and minority interest: Risk Management $190.0 $199.6 $149.6 Asset Accumulation Allmerica Financial Services 222.8 205.5 169.0 Allmerica Asset Management 22.5 23.5 23.7 - -------------------------------------------------------------------------------- Subtotal 245.3 229.0 192.7 Corporate (60.8) (59.3) (50.9) - -------------------------------------------------------------------------------- Segment income before federal income taxes and minority interest 374.5 369.3 291.4 - -------------------------------------------------------------------------------- Federal income taxes on segment income (57.3) (72.4) (53.1) Minority interest on preferred dividends (16.0) (16.0) (16.0) Minority interest on segment income -- -- (9.8) - -------------------------------------------------------------------------------- Adjusted net income 301.2 280.9 212.5 Adjustments (net of taxes, minority interest and amortization, as applicable): Net realized investment (losses) gains (87.8) 63.0 28.8 Sales practice litigation expense -- -- (20.2) Restructuring costs (13.5) 1.2 (5.8) Other items -- -- (0.6) - -------------------------------------------------------------------------------- Income from continuing operations 199.9 345.1 214.7 Discontinued operations: Loss from operations of discontinued group life and health business (net of applicable taxes) -- (18.8) (13.5) Loss on disposal of group life and health business (net of applicable taxes) -- (30.5) -- - -------------------------------------------------------------------------------- Net income $199.9 $295.8 $201.2 ================================================================================ 2000 Compared to 1999 The Company's segment income before taxes and minority interest increased $5.2 million, or 1.4%, to $374.5 million during 2000. This increase is primarily attributable to increased income of $17.3 million from the Allmerica Financial Services segment, partially offset by a decrease of $9.6 million from the Risk Management segment. The increase in the Allmerica Financial Services segment income is primarily attributable to higher asset-based fee income driven by additional deposits and market appreciation in the variable product lines, partially offset by higher policy acquisition and other growth related operating expenses. The decrease in the Risk Management segment is primarily attributable to increased losses and loss adjustment expenses ("LAE") resulting from a $96.0 million decrease in favorable development on prior years' reserves, as well as increased current year claims activity, primarily in the workers' 23 compensation, commercial automobile and homeowners lines of business. Partially offsetting these items are rate increases, principally in the commercial lines, of approximately $66 million and decreased policy acquisition and other operating expenses of $14.8 million. The effective tax rate for segment income was 15.3% for 2000 as compared to 19.6% in 1999. The decrease in the tax rate was primarily due to the recognition of the dividend received deduction associated with the Company's variable products. Net realized losses on investments, after taxes and amortization, were $87.8 million during 2000, primarily attributable to after-tax realized losses of $54.7 million resulting from the sale of approximately $2.2 billion of fixed income securities, pursuant to the Company's strategy to maximize yields by investing the proceeds in higher yielding securities. In addition, the Company recognized $43.0 million in after-tax realized losses due to impairments of fixed maturities. During 1999, net realized gains on investments, after taxes and amortization, were $63.0 million, primarily due to after-tax net realized gains from sales of appreciated equity securities of $92.2 million. This was partially offset by $31.3 million of after-tax realized losses from impairments recognized on fixed maturities. During 2000, the Company recognized an after tax restructuring charge of $13.5 million. This charge is the result of a formal company-wide restructuring plan, intended to reduce expenses and enhance revenues. This plan consists of various initiatives, including a series of internal reorganizations, consolidations in home office operations, consolidations in field offices, changes in distribution channels and product changes. In the fourth quarter of 1999, the Company reduced its charge related to the 1998 restructuring of the Company's Risk Management segment by $1.2 million, net of taxes. During the second quarter of 1999, the Company approved a plan to exit its group life and health insurance business, consisting of its Employee Benefit Services ("EBS") business, its Affinity Group Underwriters ("AGU") business and its accident and health assumed reinsurance pool business ("reinsurance pool business"). Prior to 1999, these businesses comprised substantially all of the former Corporate Risk Management Services segment. Accordingly, the operating results of the discontinued segment have been reported in the Consolidated Statements of Income as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB Opinion No. 30"). In the third quarter of 1999, the operating results from the discontinued segment were adjusted to reflect the recording of additional reserves related to accident claims from prior years. In March 2000, the Company sold its EBS business to Great-West Life and Annuity Insurance Company of Denver. In 1999, the Company recorded a $30.5 million loss, net of taxes, on the disposal of its group life and health business. 1999 Compared to 1998 The Company's segment income before taxes and minority interest increased $77.9 million, or 26.7%, to $369.3 million during 1999. This increase is primarily attributable to increased income of $50.0 million from the Risk Management segment and an increase of $36.5 million from the Allmerica Financial Services segment. The increase in Risk Management segment income is primarily attributable to a $56.2 million increase in favorable development on prior years reserves, a $15.9 million favorable impact from a whole account aggregate excess of loss reinsurance agreement, and to decreased catastrophes of $13.4 million. Partially offsetting these favorable items are a $14.3 million increase in involuntary pool underwriting losses and a $13.9 million increase in current year claims activity, primarily in the commercial lines. The increase in the Allmerica Financial Services segment is primarily attributable to higher asset-based fee income resulting from market appreciation and additional deposits in the variable product lines. The increased fees were partially offset by higher policy acquisition and other operating expenses. Partially offsetting these increases were increased losses from the Corporate segment of $8.4 million, due to lower investment and other income and to higher corporate overhead costs. The effective tax rate for segment income was 19.6% for 1999 as compared to 18.2% in 1998. The increase in the tax rate was primarily due to improved underwriting results in the Risk Management segment, partially offset by changes in reserves for prior years' tax liabilities. Net realized gains on investments, after taxes and amortization, were $63.0 million during 1999, primarily due to after-tax net realized gains from sales of appreciated equity securities of $92.2 million, partially offset by $31.3 million of after-tax realized losses from impairments recognized on fixed maturities. During 1998, net realized gains on investments, after taxes, minority interest and amortization were $28.8 million, primarily due to after-tax net realized gains from sales of appreciated equity securities of $41.4 million and after-tax gains on real estate of $9.0 million. These were partially offset by $20.1 million of after-tax realized losses from impairments recognized on fixed maturities and $11.4 million of after-tax realized losses on partnership investments. 24 Minority interest on segment income decreased in the current period primarily due to the Company's acquisition of the outstanding common stock of Citizens Corporation on or about December 3, 1998. Prior to the acquisition, minority interest reflected approximately 16.8% of the results of operations from Citizens Corporation. Also, in 1998, AFC recognized a $20.2 million expense, net of taxes, related to a class action lawsuit. On October 28, 1998, the Company announced that it was restructuring its Risk Management segment. As part of the initiative, the segment consolidated its property and casualty field support activities from fourteen regional branches into three hub locations. As a result of this restructuring initiative, the Company recognized a loss of $5.8 million, net of taxes, in the fourth quarter of 1998. This loss was reduced by $1.2 million, net of taxes, in the fourth quarter of 1999. SEGMENT RESULTS - -------------------------------------------------------------------------------- The following is management's discussion and analysis of the Company's results of operations by business segment. The segment results are presented before taxes and minority interest and other items which management believes are not indicative of overall operating trends, including realized gains and losses. RISK MANAGEMENT - -------------------------------------------------------------------------------- The following table summarizes the results of operations for the Risk Management segment: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Segment revenues Net premiums written $2,153.4 $1,977.0 $1,956.7 ================================================================================ Net premiums earned $2,066.7 $1,948.2 $1,967.9 Net investment income 218.4 221.4 229.8 Other income 22.6 19.8 24.4 - -------------------------------------------------------------------------------- Total segment revenues 2,307.7 2,189.4 2,222.1 Losses and LAE (1) 1,563.0 1,420.3 1,495.4 Policy acquisition expenses 373.2 370.6 379.7 Other operating expenses 181.5 198.9 197.4 - -------------------------------------------------------------------------------- Segment income $ 190.0 $ 199.6 $ 149.6 (1) Includes policyholders' dividends of $13.8 million, $12.3 million and $11.9 million in 2000, 1999 and 1998, respectively. 2000 Compared to 1999 Risk Management's segment income decreased $9.6 million, or 4.8%, to $190.0 million for the year ended December 31, 2000, compared to $199.6 million in 1999. The decline in segment income is primarily attributable to increased losses and loss adjustment expenses resulting from a $96.0 million decrease in favorable development on prior years' reserves. In addition, increased current year claims activity primarily in the workers' compensation, commercial automobile, and homeowners lines contributed to the decline. Partially offsetting these items are approximately $66 million of rate increases, primarily in the commercial lines. Also, policy acquisition and other operating expenses decreased $14.8 million primarily as the result of continued efficiencies gained through consolidation of underwriting processes, which is substantially complete. Reflected in the aforementioned $14.8 million decrease is a $6.0 million reduction in premium tax reserves, recognized in the fourth quarter of 2000. Net catastrophe losses decreased $6.7 million, to $70.2 million for the year ended December 31, 2000, compared to $76.9 million in 1999. Net benefits of $9.8 million and $15.9 million are included in segment income as a result of the aforementioned aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. 1999 Compared to 1998 Risk Management's segment income increased $50.0 million, or 33.4%, to $199.6 million in 1999, compared to $149.6 million in 1998. The increase in segment income is primarily attributable to a $56.2 million increase in favorable development on prior years' loss and loss adjustment expense reserves and a $15.9 million favorable impact resulting from the aggregate excess of loss reinsurance treaty. Also, catastrophe losses decreased $13.4 million, to $76.9 million in 1999, compared to $90.3 million in 1998. Partially offsetting these items are a $14.3 million increase in involuntary pool underwriting losses and a $13.9 million increase in current year claims activity, primarily in the commercial lines. In addition, net investment income decreased $8.4 million, or 3.7%, to $221.4 million in 1999, compared to $229.8 million in 1998. The decrease in net investment income is primarily the result of a reduction in average invested assets. Other income decreased $4.6 million to $19.8 million in 1999, primarily as a result of management's decision to exit certain workers' compensation servicing carrier business. The decline in net premiums earned is primarily attributable to the aforementioned aggregate excess of loss reinsurance treaty. 25 DISTRIBUTION CHANNEL RESULTS - -------------------------------------------------------------------------------- Distribution channel results are reported using statutory accounting principles, which are prescribed by state insurance regulators. The primary difference between statutory accounting principles and generally accepted accounting principles ("GAAP") is the deferral of certain underwriting costs under GAAP that are amortized over the life of the policy. Under statutory accounting principles, theses costs are recognized when incurred or paid. Management reviews the operations of this business based upon statutory results. The following table summarizes the results of operations for the distribution channels of the Risk Management segment:
FOR THE YEAR ENDED DECEMBER 31, 2000 - ---------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT RATIOS) STANDARD SPONSORED SPECIALTY MARKETS MARKETS MARKETS OTHER (2) TOTAL Statutory net premiums written $1,505.7 $ 603.2 $ 38.2 $ 2.3 $2,149.4 ============================================================================================== Statutory combined ratio (1) 102.9 97.7 110.4 N/M 102.0 ============================================================================================== Statutory underwriting (loss) profit $ (58.1) $ 8.0 $ (4.2) $ (9.0) $ (63.3) Reconciliation to segment income: Net investment income 218.4 Other income and expenses, net 12.1 Other Statutory to GAAP adjustments 22.8 - ---------------------------------------------------------------------------------------------- Segment income $ 190.0 ============================================================================================== FOR THE YEAR ENDED DECEMBER 31, 1999 - ---------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT RATIOS) STANDARD SPONSORED SPECIALTY MARKETS MARKETS MARKETS OTHER (2) TOTAL Statutory net premiums written $1,391.9 $ 545.6 $ 39.7 $ 2.7 $1,979.9 ============================================================================================== Statutory combined ratio (1) 101.3 101.2 124.0 N/M 101.2 ============================================================================================== Statutory underwriting (loss) profit $ (14.7) $ (7.7) $ (8.1) $ 0.4 $ (30.1) Reconciliation to segment income: Net investment income 221.4 Other income and expenses, net 6.2 Other Statutory to GAAP adjustments 2.1 - ---------------------------------------------------------------------------------------------- Segment income $ 199.6 ==============================================================================================
(1) 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. (2) Includes results from certain property and casualty business which the Company has exited. The decline in underwriting results is primarily attributable to unprofitable business in California. N/M - Not meaningful 26 2000 Compared to 1999 Standard Markets Standard Markets' net premiums written increased $113.8 million, or 8.2%, to $1,505.7 million for the year ended December 31, 2000. The increase in net premiums written primarily resulted from increases of $29.7 million, or 6.4%, $26.3 million, or 13.4%, $25.9 million, or 9.1%, and $18.4 million, or 9.4%, in the personal automobile, commercial automobile, commercial multiple peril, and workers' compensation lines, respectively. The increase in the personal automobile line is primarily the result of a 6.9% increase in policies in force and a 1.0% rate increase in Massachusetts since December 31, 1999. Effective January 1, 2001 Massachusetts mandated an 8.3% personal automobile rate decrease. Management believes that net rate reductions may unfavorably impact future premiums in Massachusetts. The increase in commercial automobile net premiums written is primarily the result of rate increases of 6.8%, 10.3%, and 14.3% in Michigan, Massachusetts, and New York, respectively, partially offset by a 3.5% decrease in policies in force since December 31, 1999. In addition, the commercial multiple peril line experienced a 16.2% rate increase in Michigan and policies in force increased 3.3% since December 31, 1999. Workers' compensation net premiums written increased as a result of 36.8%, 8.0%, and 13.0% rate increases in Maine, Michigan and Indiana, respectively, since December 31, 1999. Also, net premiums written increased $11.2 million, or 7.3%, for the year ended December 31, 2000 in the homeowners line. This increase is primarily the result of a 7.2% Michigan rate increase and a 2.3% increase in policies in force over the prior year. Net premiums written reflected ceded premiums of $16.8 million and $9.3 million under the aforementioned aggregate excess of loss reinsurance treaty for 2000 and 1999, respectively. Standard Markets' underwriting results declined $43.4 million to an underwriting loss of $58.1 million for the year ended December 31, 2000, compared to an underwriting loss of $14.7 million in 1999. The decline in underwriting results is primarily attributable to a decrease in favorable development on prior years' loss and loss adjustment expense reserves in the workers' compensation, commercial multiple peril, and personal automobile lines. In addition, an increase in current year claims severity in the workers' compensation and commercial automobile lines contributed to the decline. Partially offsetting these unfavorable items is improved current year claims frequency in the commercial multiple peril line. Net benefits of $9.7 million and $7.5 million are included in underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. Sponsored Markets Sponsored Markets' net premiums written increased $57.6 million, or 10.6%, to $603.2 million for the year ended December 31, 2000. The increase in net premiums written is primarily attributable to a $42.3 million, or 9.7%, increase in the personal automobile line. This is primarily the result of a 4.8% increase in policies in force over the same period in 1999 and the aforementioned 1.0% rate increase in Massachusetts. In addition, homeowners' net premiums written increased $10.3 million, or 9.2%, primarily attributable to the aforementioned 7.2% Michigan rate increase and a 3.2% increase in policies in force since December 31, 1999. Net premiums written reflected ceded premiums of $7.8 million and $12.6 million under the aforementioned aggregate excess of loss reinsurance treaty for 2000 and 1999, respectively. Underwriting results improved $15.7 million to an underwriting profit of $8.0 million for the year ended December 31, 2000, compared to an underwriting loss of $7.7 million in 1999. The improvement in underwriting results is primarily attributable to a $7.3 million decrease in loss adjustment expenses resulting from a decrease in legal fees and employee related expenses in 2000. In addition, net catastrophe losses decreased $6.6 million to $25.9 million for the year ended December 31, 2000, compared to $32.5 million in 1999. Improved current year claims activity in the personal automobile line also contributed to this improvement. Partially offsetting these favorable items is a decrease in favorable development on prior years' loss reserves in the personal automobile line. Net benefits of $4.1 million and $9.9 million are included in underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. Specialty Markets Specialty Markets' net premiums written decreased $1.5 million, or 3.8%, to $38.2 million for the year ended December 31, 2000. This decrease is primarily attributable to a 6.4% decrease in policies in force since December 31, 1999. In addition, an increase in ceded premiums resulting from greater utilization of reinsurance in the general liability line contributed to the decrease in net premiums written. The Company continually assesses the profitability of each individual program and seeks to exit programs that do not meet established Company underwriting guidelines. Underwriting results improved $3.9 million, to a loss of $4.2 million for the year ended December 31, 2000, compared to a loss of $8.1 million in 1999. The improvement in underwriting results is primarily attributable to $4.3 million and $1.8 million decreases in policy acquisition and other underwriting expenses and loss adjustment expenses, respectively. Partially offsetting these favorable items is an increase in non-catastrophe claims activity in the commercial multiple peril line. 27
FOR THE YEAR ENDED DECEMBER 31, 1999 - ---------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT RATIOS) STANDARD SPONSORED SPECIALTY MARKETS MARKETS MARKETS OTHER (2) TOTAL Statutory net premiums written $1,391.9 $ 545.6 $ 39.7 $ 2.7 $1,979.9 ============================================================================================== Statutory combined ratio (1) 101.3 101.2 124.0 N/M 101.2 ============================================================================================== Statutory underwriting (loss) profit $ (14.7) $ (7.7) $ (8.1) $ 0.4 $ (30.1) Reconciliation to segment income: Net investment income 221.4 Other income and expenses, net 6.2 Other Statutory to GAAP adjustments 2.1 - ---------------------------------------------------------------------------------------------- Segment income $ 199.6 ============================================================================================== FOR THE YEAR ENDED DECEMBER 31, 1998 - ---------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT RATIOS) STANDARD SPONSORED SPECIALTY MARKETS MARKETS MARKETS OTHER (2) TOTAL Statutory net premiums written $1,372.4 $ 527.5 $ 47.8 $ 8.9 $1,956.6 ============================================================================================== Statutory combined ratio (1) 106.7 99.4 98.2 N/M 104.6 ============================================================================================== Statutory underwriting (loss) profit $ (92.8) $ 3.2 $ (2.3) $ 4.0 $ (87.9) Reconciliation to segment income: Net investment income 229.8 Other income and expenses, net 3.7 Other Statutory to GAAP adjustments 4.0 - ---------------------------------------------------------------------------------------------- Segment income $ 149.6 ==============================================================================================
(1) 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. (2) Includes results from certain property and casualty business which the Company has exited. The decline in underwriting results is primarily attributable to unprofitable business in California. N/M - Not Meaningful 1999 Compared to 1998 Standard Markets Standard Markets' net premiums written increased $19.5 million, or 1.4%, to $1,391.9 million for the year ended December 31, 1999, compared to $1,372.4 million in 1998. 1999 results reflected ceded premiums of $9.3 million under the aforementioned aggregate excess of loss reinsurance treaty. Excluding the impact from this treaty, net premiums written increased $28.8 million, or 2.1% resulting from increases of $22.8 million, or 8.7%, $16.7 million, or 9.4%, and $13.7 million, or 7.5%, in the commercial multiple peril, workers' compensation, and commercial automobile lines, respectively. The increase in the commercial multiple peril line is the result of both a 2.7% increase in policies in force and a 5.9% Michigan rate increase since December 31, 1998. Workers' compensation's net premiums written increased primarily as the result of a 10.2% increase in policies in force partially offset by a 3.3% Michigan rate decrease compared to the prior year. The increase in commercial automobile's net premiums written is primarily the result of a 4.9% increase in policies in force and a 2.7% rate increase in Michigan. Partially offsetting these favorable items are decreases in personal automobile and homeowners' net premiums written of $19.7 million, or 4.0%, and $6.2 million, or 3.9%, respectively. The decrease in personal automobile's net premiums written is primarily the result of Michigan rate decreases of 3.6% and 3.7% in the first and third quarters of 1999, respectively, resulting from continued competitive conditions, in addition to a 2.8% decrease in policies in force. Homeowners' net premiums written decreased due to a 3.1% decrease in policies in force and a 5.7% Massachusetts rate decrease, partially offset by a 3.3% Michigan rate increase over the prior year. 28 Standard Markets' underwriting results improved $78.1 million to an underwriting loss of $14.7 million for the year ended December 31, 1999, compared to an underwriting loss of $92.8 million in 1998. A net benefit of $7.5 million is included in 1999 underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty. Excluding the impact from this treaty, the total improvement of $70.6 million in underwriting results is primarily attributable to an increase in favorable development on prior years' loss and loss adjustment expense reserves in the commercial multiple peril, personal automobile, and commercial automobile lines. Improved current year claims activity in the personal automobile and homeowners lines also contributed to this improvement. In addition, catastrophe losses decreased $14.7 million to $44.3 million in 1999, compared to $59.0 million in 1998. Sponsored Markets Sponsored Markets' net premiums written increased $18.1 million, or 3.4%, to $545.6 million for the year ended December 31, 1999, compared to $527.5 million for the same period in 1998. The 1999 results reflect ceded premiums of $12.6 million under the aforementioned aggregate excess of loss reinsurance treaty. Excluding the impact from this treaty, net premiums written increased $30.7 million, or 5.8%. This increase is primarily attributable to an increase in the personal automobile line of $16.6 million, or 4.0%, over the prior year primarily resulting from a 3.7% increase in policies in force. In addition, homeowners' net premiums written increased $12.6 million, or 12.7%, primarily due to a 5.1% increase in policies in force and the aforementioned Michigan rate increase. Underwriting results declined $10.9 million to a loss of $7.7 million for the year ended December 31, 1999, from an underwriting profit of $3.2 million in 1998. A net benefit of $9.9 million is included in 1999 underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty. Excluding the impact from this treaty, the total decline of $20.8 million is primarily attributable to a $10.8 million increase in policy acquisition and other underwriting expenses, to $130.5 million in 1999, compared to $119.7 million in 1998, resulting from increased marketing initiatives. In addition, an increase in non-catastrophe claims activity in the personal automobile and homeowners lines contributed to the decline. Specialty Markets Specialty Markets' net premiums written decreased $8.1 million to $39.7 million for the year ended December 31, 1999, compared to $47.8 million for 1998. This decrease is primarily attributable to an increase in ceded premiums resulting from greater utilization of reinsurance primarily in the commercial multiple peril line, and a 3.2% decrease in policies in force. Underwriting results declined $5.8 million to a loss of $8.1 million for the year ended December 31, 1999, compared to a loss of $2.3 million in 1998. The decline in underwriting results is primarily attributable to an increase in non-catastrophe claims activity in the commercial multiple peril line. INVESTMENT RESULTS - -------------------------------------------------------------------------------- Net investment income was $218.4 million, $221.4 million and $229.8 million for the years ended December 31, 2000, 1999 and 1998, respectively. The decrease in net investment income in 2000, compared to 1999, primarily reflects a reduction in average invested assets, partially offset by an increase in average pre-tax yields on debt securities. Average invested assets decreased $170.6 million, or 4.5%, to $3,634.9 million in 2000, compared to $3,805.5 million in 1999. This reduction is due to the transfer of cash and securities of $108.0 million and $350.0 million to the Corporate segment during the second quarters of 2000 and 1999, respectively. Average pre-tax yields on debt securities increased to 6.8% in 2000, compared to 6.7% in 1999, due to a shift in investment strategy providing for investments in taxable securities instead of tax exempt securities, to maximize after-tax investment yields. The decrease in net investment income in 1999, compared to 1998, primarily reflects a reduction in average fixed maturity assets of $122.1 million, or 3.3%, to $3,560.1 million in 1999 compared to $3,682.2 million in 1998. The reduction is due to the transfer of $350.0 million in cash and securities to the Corporate segment during the second quarter of 1999. Average pre-tax yields on debt securities remained stable at 6.7% for 1999 and 1998. Average invested assets decreased $385.9 million, or 9.2%, to $3,805.5 million in 1999, compared to $4,191.4 million in 1998. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES - -------------------------------------------------------------------------------- The Risk Management segment maintains reserves for its property and casualty products to provide for the Company's ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claim severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater 29 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 period such changes are determined to be needed and recorded. The table below provides a reconciliation of the beginning and ending reserve for unpaid losses and LAE as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Reserve for losses and LAE, beginning of year $2,618.7 $2,597.3 $2,615.4 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 1,634.9 1,601.4 1,609.0 Decrease in provision for insured events of prior years (87.4) (183.4) (127.2) - -------------------------------------------------------------------------------- Total incurred losses and LAE 1,547.5 1,418.0 1,481.8 - -------------------------------------------------------------------------------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 870.2 861.1 871.9 Losses and LAE attributable to insured events of prior years 703.8 638.0 643.0 - -------------------------------------------------------------------------------- Total payments 1,574.0 1,499.1 1,514.9 - -------------------------------------------------------------------------------- Change in reinsurance recoverable on unpaid losses 126.9 102.5 15.0 - -------------------------------------------------------------------------------- Reserve for losses and LAE, end of year $2,719.1 $2,618.7 $2,597.3 ================================================================================ As part of an ongoing process, the reserves have been reestimated for all prior accident years and were decreased by $87.4 million, $183.4 million and $127.2 million in 2000, 1999 and 1998, respectively, reflecting favorable development on reserves for both losses and loss adjustment expenses. Favorable development on prior years' loss reserves was $25.9 million, $93.1 million, and $58.9 million for the years ended December 31, 2000, 1999, and 1998, respectively. The decrease of $67.2 million in 2000 is primarily due to increased medical costs and severity in the workers' compensation line, as well as to less favorable development in the commercial multiple peril line and to a lesser degree, the personal automobile line. The increase of $34.2 million in 1999 is primarily due to improved personal automobile results in the Northeast and to payments received from reinsurers related to prior years' losses in the commercial multiple peril line. Favorable development on prior years' loss adjustment expense reserves was $61.5 million, $90.3 million, and $68.3 million for the years ended December 31, 2000, 1999, and 1998, respectively. The favorable development in these periods is primarily attributable to claims process improvement initiatives taken by the Company over the past three years. Since 1997, the Company has lowered claim settlement costs through increased utilization of in-house attorneys and consolidation of claim offices. These measures are substantially complete. Reserves established for current year losses and LAE consider the factors that resulted in the recent favorable development of prior years' loss and LAE reserves. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in prior years and the Company expects continued reductions in the amount of favorable development in future years. Due to the nature of the business written by the Risk Management segment, the exposure to environmental liabilities is relatively small and therefore its reserves are relatively small compared to other types of liabilities. Loss and LAE reserves related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $36.0 million, $47.3 million and $49.9 million, net of reinsurance of $15.9 million, $11.2 million and $14.2 million in 2000, 1999 and 1998, respectively. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company may be required to defend such claims. The Company estimated its ultimate liability for these claims based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not significant, their existence gives rise to uncertainty and are discussed because of the possibility, however remote, that they may become significant. The Company believes that, notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate. In addition, the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. 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 30 anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserving position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. Reinsurance The Risk Management segment maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes excess of loss reinsurance and catastrophe reinsurance. The Company determines the appropriate amount of reinsurance based on the Company's evaluation of the risks accepted and analyses prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company 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 losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. In 2000, the Company retained $45.0 million of loss per hurricane occurrence and $25.0 million of loss per occurrence for all other exposures, 10% of all loss amounts in excess of $45.0 million or $25.0 million for non-hurricane losses up to $65.0 million, 20% of all loss amounts in excess of $65.0 million up to $230.0 million and all amounts in excess of $230.0 million under its catastrophe reinsurance program. As a result of this agreement, the Company ceded $16.8 million of catastrophe losses in 2000. Additionally, effective January 1, 2000, the Company purchased a property catastrophe aggregate treaty which provides for annual aggregate coverage totaling 80% of catastrophe losses in excess of $60.0 million, up to $110.0 million. The Company's retention is calculated cumulatively, in the aggregate, on a quarterly basis with the aggregate losses comprised of all catastrophe losses that exceed $0.5 million for each loss occurrence. The maximum contribution from the Company for any one-loss occurrence for the purposes of calculating the aggregate retention is $25.0 million. As a result of this agreement, the Company ceded $18.4 million of catastrophe losses in 2000. The Company is subject to a whole account aggregate excess of loss reinsurance agreement, which provides coverage for the 1999 accident year for the Company's property and casualty business. The program covered losses and allocated LAE, including those incurred but not yet reported, in excess of a specified whole account loss and allocated LAE ratio. The annual coverage limit for losses and allocated LAE is $150.0 million. The effect of this agreement on results of operations in each reporting period is based on losses and allocated LAE ceded, reduced by a sliding scale premium of 50-67.5% depending on the size of the loss, and increased by a ceding commission of 20% of ceded premium. In addition, net investment income is reduced for amounts credited to the reinsurer. As a result of this agreement, the Company recognized net benefits of $9.8 million and $15.9 million for the years ended December 31, 2000 and 1999, respectively, based on estimates of losses and allocated LAE for accident year 1999. During 2000, premiums, and losses and LAE ceded under this treaty were $25.0 million and $34.1 million, respectively. In addition, the Company realized an additional $4.8 million benefit from commissions ceded under this contract, partially offset by $4.1 million of interest costs. Premiums, and losses and LAE ceded under this treaty in 1999 were $21.9 million and $35.0 million, respectively. In 1999, the Company realized an additional $4.3 million benefit from commissions ceded under this contract, partially offset by $1.5 million of interest costs. 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 for accident year 1999. 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 coverage to individuals or other entities that are otherwise unable to purchase such coverage. These market mechanisms and pooling arrangements include the Massachusetts Commonwealth Automobile Reinsurers and the Michigan Catastrophic Claims Association. 31 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 YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Segment revenues Premiums $ 52.1 $ 54.5 $ 58.1 Fees 421.1 359.3 296.6 Investment and other income 391.0 392.5 369.3 - -------------------------------------------------------------------------------- Total segment revenues 864.2 806.3 724.0 - -------------------------------------------------------------------------------- Policy benefits, claims and losses 312.1 321.0 314.3 Policy acquisition and other operating expenses 329.3 279.8 240.7 - -------------------------------------------------------------------------------- Segment income $222.8 $205.5 $169.0 ================================================================================ 2000 Compared to 1999 Segment income increased $17.3 million, or 8.4%, to $222.8 million in 2000. This increase is primarily attributable to higher asset-based fee income driven by additional deposits and market appreciation in the variable product lines, partially offset by higher policy acquisition and other operating expenses. Segment revenues increased $57.9 million, or 7.2%, in 2000 primarily due to increased fees and other income, partially offset by a decline in net investment income. Fee income from variable annuities and individual variable universal life policies increased $52.8 million, or 19.8%, in 2000, primarily due to additional deposits and market appreciation. New deposits generated approximately $26.6 million of this growth, while market appreciation generated approximately $26.2 million. The growth in annuity deposits resulted from the introduction of a "bonus" product in the fourth quarter of 1999. The bonus product provides for immediate benefits to annuitants upon depositing funds into an annuity issued by the Company. This product is distributed through third party mutual fund advisors and independent broker-dealer distribution channels. Sales of bonus annuities, which totaled approximately $1.3 billion in 2000, compared to approximately $157.6 million in 1999, were partially offset by decreases of approximately $857.8 million in sales of annuities that do not include the bonus feature. Although average separate account asset values in 2000 were higher than those in 1999, total separate account assets at December 31, 2000 are less than average separate account assets during 2000, reflecting the net market depreciation during the year. Accordingly, fee income in 2001 will be unfavorably affected by the lower asset levels. Investment and other income decreased $1.5 million, or 0.4%, in 2000. This decrease is primarily due to a $21.2 million decline in net investment income due to lower average invested assets resulting from transfers from the Company's general account to the separate accounts in the annuity and group retirement product lines. This decrease was partially offset by higher brokerage income of $16.0 million attributable to an increase in mutual fund and general securities transaction volumes and to increased investment management fees of $8.6 million resulting from appreciation and additional deposits in variable product assets under management. Policy benefits, claims and losses decreased $8.9 million, or 2.8%, to $312.1 million in 2000. This decrease is due principally to the absence of a $5.4 million mortality reserve established in the variable annuity lines of business during the first quarter of 1999, and lower participation in an annuity program introduced in 1998, which provides for a limited time, enhanced crediting rates on general account deposits. Under this program, general account deposits are transferred ratably over a period of time into the Company's separate accounts. Also contributing to this decrease is reduced interest credited on group retirement products due to the cancellations of certain accounts and asset transfers to the separate accounts. These reductions were partially offset by strengthening of universal life and Closed Block reserves in 2000, which resulted in approximately a $5.5 million increase in the current year, as well as less favorable mortality experience, primarily in the Closed Block. Policy acquisition and other operating expenses increased $49.5 million, or 17.7%, in 2000. Other operating expenses increased $28.8 million, primarily due to ongoing growth in the variable annuity and individual variable universal life product lines, and increases in technology and distribution costs. Also, brokerage commissions and administrative expenses increased due to the aforementioned growth in trading volumes for mutual fund and general securities transactions. These increases were partially offset by a $4.7 million net reduction in premium tax and guaranty fund reserves, recognized in the fourth quarter of 2000. Policy acquisition expenses increased $20.7 million, primarily due to continued growth in the annuity line of business. Included in policy acquisition expenses in 2000 were several unusual items, particularly approximately $36.3 million of reduced expenses related to a change in certain life products actuarial assumptions and an increase in policy acquisition expenses of approximately $25.0 million in the annuity line of business, resulting from an increase in assumed lapse rates. In 1999, policy acquisition expenses reflected an $18.4 million benefit resulting from the implementation and subsequent refinement of an enhanced valuation system for annuities. Absent the aforementioned items, policy acquisition expenses increased approximately $16.9 million. The Company expects deferred acquisition expenses to continue to increase as a result of ongoing growth in the annuity line. 1999 Compared to 1998 Segment income increased $36.5 million, or 21.6%, to $205.5 million in 1999. This increase is primarily attributable to higher asset-based fee income resulting from market appreciation and additional deposits in the variable annuity and variable universal 32 life product lines, partially offset by higher policy acquisition and other operating expenses. In addition, segment income in 1998 was negatively impacted by losses incurred on hedge fund partnership investments. Segment revenues increased $82.3 million, or 11.4% in 1999 primarily due to increased fees and other income. Fee income from variable annuities and individual variable universal life policies increased $66.1 million, or 32.8%, in 1999 due to market appreciation and additional deposits. In addition, investment and other income increased $23.2 million primarily due to higher investment management fees and brokerage income resulting from growth and appreciation in variable product assets under management. Financial Profiles, a financial planning software company acquired during the third quarter of 1998, contributed $6.5 million of this $23.2 million increase. Net investment income decreased $1.6 million in 1999 principally due to a reduction in average fixed maturities invested resulting from asset transfers to the separate accounts in the annuity and group retirement product lines, as well as cancellations of certain accounts in the group retirement business. These decreases were partially offset by the absence of losses incurred on hedge fund partnership investments in 1998. Premiums and fees from traditional and non-variable universal life insurance products declined $6.7 million primarily from the Company's continued shift in focus to variable life insurance and annuity products. Policy benefits, claims and losses increased $6.7 million, or 2.1%, to $321.0 million in 1999. This increase is primarily due to the Company's establishment of a $7.4 million mortality reserve in the first quarter of 1999 related to the variable annuity line of business, subsequent increases in this reserve of $5.8 million, and to additional growth in this line. In addition, annuity reserves increased $5.5 million related to the aforementioned annuity program with enhanced crediting rates. These increases were partially offset by more favorable mortality experience in the traditional life line of business, lower policy benefits due to a reduction of policies in force in the universal life product line, as well as decreased interest credited due to the aforementioned cancellations in the group retirement business. Policy acquisition and other operating expenses increased $39.1 million, or 16.2%, to $279.8 million in 1999. This increase reflects growth in the individual variable annuity and variable universal life product lines. In addition, other operating expenses relating to trail commissions in the annuity line of business and to Financial Profiles increased $9.2 million and $8.1 million, respectively. Partially offsetting these increases is a $3.5 million decline in policy acquisition expenses resulting from the implementation of an enhanced valuation system for the annuity line of business in 1999. This decline consists of a one-time increase in the deferred acquisition cost asset of $13.5 million, partially offset by increased ongoing deferred acquisition expenses of approximately $10.0 million. Statutory Premiums and Deposits The following table sets forth statutory premiums and deposits by product for the Allmerica Financial Services segment. FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Insurance: Traditional life $ 70.2 $ 77.4 $ 55.9 Universal life 59.2 71.8 23.6 Variable universal life 209.1 187.0 158.7 Individual health 0.2 0.3 0.6 Group variable universal life 47.7 94.9 73.3 - -------------------------------------------------------------------------------- Total insurance 386.4 431.4 312.1 - -------------------------------------------------------------------------------- Annuities: Separate account annuities 2,555.1 1,922.2 2,583.6 General account annuities 524.7 830.2 622.2 Retirement investment accounts 9.3 16.4 20.1 - -------------------------------------------------------------------------------- Total individual annuities 3,089.1 2,768.8 3,225.9 Group annuities 463.1 409.3 563.9 - -------------------------------------------------------------------------------- Total annuities 3,552.2 3,178.1 3,789.8 - -------------------------------------------------------------------------------- Total premiums and deposits $3,938.6 $3,609.5 $4,101.9 ================================================================================ 2000 Compared to 1999 For the year ended December 31, 2000, total premiums and deposits increased $329.1 million, or 9.1%, to $3,938.6 million. This increase is primarily due to higher separate account annuity deposits, partially offset by a decline in general account annuity deposits. The growth in separate account annuity deposits results from the introduction of the aforementioned bonus annuity product in the fourth quarter of 1999. This was partially offset by a decrease in annuity sales that do not include the bonus feature. Lower general account annuity deposits resulted from decreased utilization of the aforementioned annuity program with enhanced crediting rates. Although group annuity deposits increased $53.8 million in 2000 over 1999, such deposits are expected to decline in future years since the Company has ceased marketing activities for new group retirement business. Annuity products are distributed primarily through three distribution channels: (1) "Agency", which consists of the Company's career agency force; (2) "Select", which consists of a network of third party broker-dealers; and (3) "Partners", which includes distributors of the mutual funds advised by Zurich Scudder Investments (formerly "Scudder Kemper Investments, Inc.") ("Zurich-Scudder"), Pioneer Investment Management, Inc. and Delaware Management Company ("Delaware"). Partners, Agency and Select represented, respectively, 45%, 29% and 25% of individual annuity deposits in 2000, and Zurich-Scudder represented 31% of all individual annuity deposits. The Company anticipates that sales through the Delaware distribution channel, which represented 6% of individual annuity deposits in 2000, will continue to decrease as Delaware emphasizes its proprietary products. 33 1999 Compared to 1998 For the year ended December 31, 1999, total premiums and deposits decreased $492.4 million, or 12.0%, to $3,609.5 million. This decrease is primarily due to lower separate account and group annuity deposits, partially offset by increased universal and variable universal life insurance premiums. The decrease in separate account annuity deposits was caused by a sharp decline in sales in the Partners channel, slightly offset by growth in the Agency and Select distribution channels. Decreases in sales in the Partners channel aggregating $538.0 million are responsible for the $457.1 million overall contraction within this line. These decreases were attributable to the Company not having available until the fourth quarter of 1999 a bonus annuity product to compete with similar products in the market and to the fact that the Partners' products used single managers (versus multi-manager products), and have a strong value bias in investment strategy. In addition, Delaware's shift in emphasis to its proprietary products contributed to the decline. The increase in general account annuities reflects the Company's aforementioned annuity program with enhanced crediting rates. In addition, group annuity deposits declined $154.6 million in 1999 primarily due to cancellations of certain accounts within the group retirement business. These decreases were partially offset by higher variable and non-variable universal life insurance premiums due to increased sales and renewals in 1999. Allmerica Asset Management The following table summarizes the results of operations for the Allmerica Asset Management segment. FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Interest margins on GICs: Net investment income $ 137.8 $ 137.9 $ 111.3 Interest credited 119.7 118.6 89.3 - -------------------------------------------------------------------------------- Net interest margin 18.1 19.3 22.0 Fees and other income: External 6.3 6.2 4.0 Internal 5.1 6.4 6.4 Other operating expenses (7.0) (8.4) (8.7) - -------------------------------------------------------------------------------- Segment income $ 22.5 $ 23.5 $ 23.7 ================================================================================ 2000 Compared to 1999 Segment income decreased $1.0 million, or 4.3%, to $22.5 million in 2000 primarily due to decreased earnings on GICs. Earnings on GICs decreased $1.2 million primarily due to short-term funding agreement withdrawals during the fourth quarter of 1999 and a shift to lower margin long-term funding agreements in 2000. The withdrawals in 1999 reflected uncertainties in the market resulting in greater redemptions for the industry overall. 1999 Compared to 1998 Segment income decreased $0.2 million, or 0.8%, to $23.5 million in 1999. This decrease is primarily attributable to the absence of a one-time $2.6 million mortgage loan equity participation interest received in 1998 and lower mortgage prepayment fees in 1999. Excluding the effect of these items, interest margins on GICs increased $3.8 million. This increase reflects continued sales of funding agreements during the first six months of 1999, partially offset by the aforementioned short-term funding agreement withdrawals during the fourth quarter of 1999. Income from assets under management grew $1.6 million in 1999 as a result of increased business from new and existing money market and other external fixed income fund clients. Corporate The following table summarizes the results of operations for the Corporate segment for the periods indicated. FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Segment revenues Investment and other income $ 6.3 $ 6.0 $ 12.9 Interest expense 15.3 15.4 16.0 Other operating expenses 51.8 49.9 47.8 - -------------------------------------------------------------------------------- Segment loss $ (60.8) $ (59.3) $ (50.9) ================================================================================ 2000 Compared to 1999 Segment loss increased $1.5 million, or 2.5%, to $60.8 million in 2000, primarily as a result of higher other operating expenses. Interest expense for both periods relates principally to the interest paid on the Senior Debentures of the Company. 1999 Compared to 1998 Segment loss increased $8.4 million, or 16.5%, to $59.3 million in 1999, primarily due to lower investment and other income and higher corporate overhead costs. Investment and other income decreased $6.9 million in 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 and the transfer of $125.0 million of assets from AFC to FAFLIC as part of a 1999 capital contribution. These decreases were partially offset by assets transferred from the Risk Management segment of $350.0 million in 1999. Interest expense for both periods relates principally to the interest paid on the Senior Debentures of the Company. In addition, interest expense in 1998 includes $0.7 million related to the Company's short term revolving credit loan associated with the acquisition of Citizens Corporation's minority interest. Other operating expenses increased $2.1 million, or 4.4%, to $49.9 million in 1999. The increase in other operating expenses is primarily due to higher corporate overhead costs, partially offset by a reduction in other corporate expenses. 34 DISCONTINUED OPERATIONS - -------------------------------------------------------------------------------- During the second quarter of 1999, the Company approved a plan to exit its group life and health insurance business, consisting of its EBS business, its AGU business and its reinsurance pool business. Prior to 1999, these businesses comprised substantially all of the former Corporate Risk Management Services segment. The operating results of the discontinued segment have been reported in the Consolidated Statements of Income as discontinued operations in accordance with APB Opinion No.30 with a June 30, 1999 measurement date. Reinsurance Pools The reinsurance pool business consists primarily of assumed medical stop loss business, the medical and disability portions of workers' compensation risks, small group managed care pools, long-term disability and long-term care pools, student accident and special risk business. EBS The EBS business provides managed care products and offers group life, medical, dental, and disability insurance to the middle market. On October 6, 1999, the Company entered into an agreement with Great-West Life and Annuity Insurance Company of Denver, which provided for the sale of the Company's EBS business effective March 1, 2000. The sales transaction effectively transfers the business upon renewal subjecting the Company to losses on its existing book during the runoff period. AGU AGU operates as a Managing Group Underwriting unit offering members of affinity groups medical, life and disability insurance. The following table summarizes the loss from operations and disposal for the discontinued group life and health insurance business for the periods indicated. There were no additional losses recognized in 2000 related to the Company's discontinued group life and health insurance business. FOR THE YEARS ENDED DECEMBER 31 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Loss from operations of discontinued group life and health business before federal income taxes $ (28.9) $ (20.5) Federal income tax benefit 10.1 7.0 - -------------------------------------------------------------------------------- Loss from operations of discontinued group life and health business, net of taxes (18.8) (13.5) - -------------------------------------------------------------------------------- Loss from disposal of discontinued group life and health business before federal income taxes (46.9) -- Federal income tax benefit 16.4 -- - -------------------------------------------------------------------------------- Loss from disposal of discontinued group life and health business, net of taxes (30.5) -- - -------------------------------------------------------------------------------- Net loss from discontinued segment $ (49.3) $ (13.5) ================================================================================ 1999 Compared to 1998 The $28.9 million loss from operations before federal income taxes for the year ended December 31, 1999 primarily results from additional reserves provided for accident claims related to prior years. The loss from operations before federal income taxes for the year ended December 31, 1998 of $20.5 million primarily reflects the $25.3 million loss recognized from the Company's agreement with a reinsurer to cede underwriting losses related to the reinsurance pool business. As required by APB Opinion No.30, the loss from disposal of the discontinued segment includes estimated proceeds from the aforementioned sale of the Company's EBS business, as well as an estimate of future losses expected from the runoff of the discontinued operations after the June 30, 1999 measurement date. Accordingly, the Company recognized a pre-tax loss from disposal of its group life and health insurance business of $46.9 million, which was comprised of the following (in millions): Proceeds from sale $25.3 Losses expected from runoff: EBS (15.7) Reinsurance pools (40.6) AGU (15.9) - -------------------------------------------------------------------------------- $(46.9) ================================================================================ The provision for anticipated future losses on the runoff of discontinued operations was established based on estimates of cash flows from the assets supporting the discontinued products offset by estimates of cash flows expected to meet the obligations of outstanding contracts and estimates of cash flows expected to meet operational funding requirements. These estimates are continually reviewed and adjusted as necessary. To the extent that actual future losses differ from these estimates, the Company's reported results from the disposal of the discontinued segment would be affected. The Company believes the provision established appropriately reflects expected future results. However, due to the inherent volatility in this segment, and to its history of increased losses, there can be no assurance that current reserves are adequate and future losses will not arise. 35 INVESTMENT PORTFOLIO - -------------------------------------------------------------------------------- The Company had investment assets diversified across several asset classes, as follows: DECEMBER 31 2000(1) 1999(1) - -------------------------------------------------------------------------------- (IN MILLIONS) % OF TOTAL % OF TOTAL CARRYING CARRYING CARRYING CARRYING VALUE VALUE VALUE VALUE Fixed maturities (2) $8,118.0 83.9% $7,306.7 80.6% Equity securities (2) 85.5 0.9 83.2 0.9 Mortgages 617.6 6.4 657.5 7.3 Policy loans 381.3 3.9 371.6 4.1 Cash and cash equivalents 281.1 2.9 464.8 5.1 Other long-term investments 193.2 2.0 180.0 2.0 - -------------------------------------------------------------------------------- Total $9,676.7 100.0% $9,063.8 100.0% ================================================================================ (1) Includes Closed Block invested assets with a carrying value of $736.0 million and $732.9 million at December 31, 2000 and 1999, respectively. (2) The Company carries the fixed maturities and equity securities in its investment portfolio at market value. Total investment assets increased $612.9 million, or 6.8%, to $9.7 billion during 2000. This increase resulted primarily from increased fixed maturities of $811.3 million, partially offset by a decline of $183.7 million in cash and cash equivalents. The increase in fixed maturities is principally due to the investment of funds received from the sale of the Company's new long-term funding agreements by the Allmerica Asset Management segment. The decrease in cash and cash equivalents is primarily due to the repurchase of AFC common stock under the stock repurchase program and to the timing of investment purchases. 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 88.1% and 84.4% of the Company's total fixed maturity portfolio at December 31, 2000 and 1999, respectively. The average yield on fixed maturities was 7.4% and 7.2% for 2000 and 1999, respectively. Although management expects that new funds will be invested primarily in investment grade fixed maturities, the Company may invest a portion of new funds in below investment grade fixed maturities or equity interests. MARKET RISK AND RISK MANAGEMENT POLICIES - -------------------------------------------------------------------------------- Interest Rate Sensitivity The operations of the Company are subject to risk resulting from interest rate fluctuations to the extent that there is a difference between the amount of the Company's interest-earning assets and the amount of interest-bearing liabilities that are paid, withdrawn, mature or re-price in specified periods. The principal objective of the Company's asset/liability management activities is to provide maximum levels of net investment income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Company. The Company has developed an asset/liability management approach tailored to specific insurance or investment product objectives. The investment assets of the Company are managed in over 20 portfolio segments consistent with specific products or groups of products having similar liability characteristics. As part of this approach, management develops investment guidelines for each portfolio consistent with the return objectives, risk tolerance, liquidity, time horizon, tax and regulatory requirements of the related product or business segment. Management has a general policy of diversifying investments both within and across all portfolios. The Company monitors the credit quality of its investments and its exposure to individual markets, borrowers, industries, sectors, and in the case of mortgages, property types and geographic locations. In addition, the Company carries long and short-term debt, as well as mandatory redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company. The Company uses derivative financial instruments, primarily interest rate swaps, with indices that correlate to on-balance sheet instruments to modify its indicated net interest sensitivity to levels deemed to be appropriate. Specifically, for floating rate GIC liabilities that are matched with fixed rate securities, the Company manages the interest rate risk by hedging with interest rate swap contracts designed to pay fixed and receive floating interest. Additionally, the Company uses exchange traded financial futures contracts to hedge against interest rate risk on anticipated GIC sales and other funding agreements, as well as the reinvestment of fixed maturities. The following tables for the years ended December 31, 2000 and 1999 provide information about the Company's financial instruments used for purposes other than trading that are sensitive to changes in interest rates. The tables present principal cash flows and related weighted-average interest rates by expected maturities. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or the Company may have the right to put or sell the obligations back to the issuers. Mortgage backed and asset backed securities 36 are included in the category representing their expected maturity. Available-for-sale securities include both U.S. and foreign-denominated fixed maturities, but exclude interest rate swap contracts and foreign currency swap contracts, which are disclosed in separate tables. Foreign-denominated fixed maturities are also shown separately in the table of financial instruments subject to foreign currency risk. For liabilities that have no contractual maturity, the tables present principal cash flows and related weighted-average interest rates based on the Company's historical experience, management's judgment, and statistical analysis, as applicable, concerning their most likely withdrawal behaviors. Additionally, the Company has assumed its available-for-sale securities are similar enough to aggregate those securities for presentation purposes. Specifically, variable rate available-for-sale securities and mortgage loans comprise an immaterial portion of the portfolio and do not have a significant impact on weighted average interest rates. Therefore, the variable rate investments are not presented separately; instead they are included in the tables at their current interest rate.
FAIR VALUE FOR THE YEAR ENDED DECEMBER 31, 2000 2001 2002 2003 2004 2005 THEREAFTER TOTAL 12/31/00 - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN MILLIONS) Rate Sensitive Assets: Available-for-sale securities $510.6 $690.7 $666.1 $644.7 $1,311.7 $4,236.4 $8,060.2 $8,166.1 Average interest rate 7.53% 7.16% 7.14% 7.48% 7.73% 7.25% 7.35% Mortgage loans $ 74.0 $ 47.4 $ 40.1 $ 75.9 $ 27.6 $ 357.5 $ 622.5 $ 640.4 Average interest rate 8.15% 8.50% 7.86% 7.70% 8.10% 7.73% 7.86% Policy loans $ -- $ -- $ -- $ -- $ -- $ 381.3 $ 381.3 $ 381.3 Average interest rate -- -- -- -- -- 6.97% 6.97% Company owned life insurance $ -- $ -- $ -- $ -- $ -- $ 65.6 $ 65.6 $ 65.6 Average interest rate -- -- -- -- -- 6.84% 6.84% Rate Sensitive Liabilities: Fixed interest rate GICs $ 29.8 $ 30.3 $ 2.1 $ -- $ -- $ 105.2 $ 167.4 $ 170.2 Average interest rate 7.05% 7.31% 7.20% -- -- 6.87% 6.98% Variable interest rate GICs $194.6 $251.7 $301.7 $368.3 $ 352.8 $ -- $1,469.1 $1,493.1 Average interest rate 6.85% 6.99% 6.79% 6.88% 6.85% -- 6.87% Supplemental contracts without life contingencies $ 17.8 $ 9.0 $ 5.5 $ 3.7 $ 0.2 $ 4.5 $ 40.7 $ 40.7 Average interest rate 4.04% 4.06% 4.09% 4.13% 4.21% 4.19% 4.08% Other individual contract deposit funds $ 12.1 $ 10.9 $ 9.8 $ 8.8 $ 7.8 $ 84.1 $ 133.5 $ 133.4 Average interest rate 4.96% 4.94% 4.92% 4.90% 4.88% 4.87% 4.92% Other group contract deposit funds $ 61.0 $ 56.1 $ 40.1 $ 24.8 $ 16.4 $ 124.7 $ 323.1 $ 319.0 Average interest rate 5.15% 5.61% 5.72% 5.83% 5.71% 5.85% 5.65% Individual fixed annuity contracts $ 67.5 $ 71.4 $ 73.9 $ 76.1 $ 75.6 $ 661.6 $1,026.1 $ 991.7 Average interest rate 4.83% 4.83% 4.81% 4.73% 4.50% 4.12% 4.67% Trust instruments supported by funding obligations $146.5 $ -- $ 88.8 $ -- $ 352.3 $ 33.9 $ 621.5 $ 620.5 Average interest rate 4.90% -- 3.71% -- 4.48% 5.82% 4.54% Long-term debt $ -- $ -- $ -- $ -- $ -- $ 199.5 $ 199.5 $ 194.7 Average interest rate -- -- -- -- -- 7.63% 7.63% Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company $ -- $ -- $ -- $ -- $ -- $ 300.0 $ 300.0 $ 280.2 Average interest rate -- -- -- -- -- 8.21% 8.21%
37
FAIR VALUE FOR THE YEAR ENDED DECEMBER 31, 1999 2000 2001 2002 2003 2004 THEREAFTER TOTAL 12/31/99 - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN MILLIONS) Rate Sensitive Assets: Available-for-sale securities $466.3 $553.5 $533.8 $587.0 $ 522.7 $4,563.9 $7,227.2 $7,260.5 Average interest rate 7.73% 7.46% 7.26% 6.89% 7.37% 7.30% 7.31% Mortgage loans $119.4 $ 61.1 $ 32.3 $ 41.7 $ 77.5 $ 331.4 $ 663.4 $ 656.5 Average interest rate 9.08% 8.27% 8.17% 7.33% 7.68% 7.65% 7.98% Policy loans $ -- $ -- $ -- $ -- $ -- $ 371.6 $ 371.6 $ 371.6 Average interest rate -- -- -- -- -- 6.81% 6.81% Rate Sensitive Liabilities: Fixed interest rate GICs $ 70.0 $ 27.6 $ 46.4 $ -- $ -- $ 105.0 $ 249.0 $ 253.8 Average interest rate 7.60% 7.10% 7.29% -- -- 6.86% 7.17% Variable interest rate GICs $107.8 $ 43.2 $ 50.1 $402.5 $ 463.4 $ -- $1,067.0 $1,087.6 Average interest rate 6.26% 6.24% 6.24% 6.28% 6.17% -- 6.23% Supplemental contracts without life contingencies $ 21.9 $ 11.2 $ 6.9 $ 4.7 $ 0.4 $ 3.7 $ 48.8 $ 48.8 Average interest rate 4.03% 4.04% 4.05% 4.08% 4.13% 4.10% 4.04% Other individual contract deposit funds $ 15.6 $ 13.7 $ 12.0 $ 10.4 $ 8.6 $ 76.2 $ 136.5 $ 136.3 Average interest rate 4.95% 4.92% 4.92% 4.77% 4.73% 4.64% 4.84% Other group contract deposit funds $107.9 $ 85.7 $ 49.8 $ 43.0 $ 35.8 $ 280.7 $ 602.9 $ 583.5 Average interest rate 5.84% 5.17% 5.51% 5.45% 5.65% 5.65% 5.59% Individual fixed annuity contracts $ 96.3 $106.9 $115.7 $124.3 $ 134.0 $ 515.3 $1,092.5 $1,057.1 Average interest rate 5.37% 5.18% 5.09% 5.01% 4.84% 3.86% 4.99% Trust instruments supported by funding obligations $ -- $ 50.6 $ -- $ -- $ -- $ -- $ 50.6 $ 49.6 Average interest rate -- 4.33% -- -- -- -- 4.33% Long-term debt $ -- $ -- $ -- $ -- $ -- $ 199.5 $ 199.5 $ 187.4 Average interest rate -- -- -- -- -- 7.63% 7.63% Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company $ -- $ -- $ -- $ -- $ -- $ 300.0 $ 300.0 $ 292.5 Average interest rate -- -- -- -- -- 8.21% 8.21%
38 The following tables for the years ended December 31, 2000 and 1999 provide information about the Company's derivative financial instruments used for purposes other than trading that are sensitive to changes in interest rates. The tables present notional amounts and, as applicable, weighted-average interest rates by contractual maturity date. Notional amounts are used to calculate the contractual payments to be exchanged under the contracts. Weighted-average variable rates are indicated by the applicable floating rate index.
FAIR FOR THE YEAR ENDED VALUE DECEMBER 31, 2000 2001 2002 2003 2004 2005 THEREAFTER TOTAL 12/31/00 - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN MILLIONS) Rate Sensitive Derivative Financial Instruments: Pay fixed/ receive 3 month LIBOR swaps $ 43.1 $ 233.5 $ 191.0 $ 197.3 $ 225.0 $ -- $ 889.9 $(12.7) Average pay rate 5.63% 6.93% 5.85% 5.59% 7.21% -- 6.41% Average receive rate 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR -- 3 Mo. LIBOR Pay fixed/ receive 1 month LIBOR swaps $ -- $ -- $ 150.0 $ -- $ 150.0 $ -- $ 300.0 $(4.5) Average pay rate -- -- 5.71% -- 6.89% -- 6.30% Average receive rate -- -- 1 Mo. LIBOR -- 1 Mo. LIBOR -- 1 Mo. LIBOR Pay fixed/ receive Fed Funds rate swaps $ -- $ -- $ 50.0 $ 110.0 $ 50.0 $ -- $ 210.0 $(2.9) Average pay rate -- -- 5.91% 5.57% 7.18% -- 6.03% Average receive rate -- -- FED FUNDS FED FUNDS FED FUNDS -- FED FUNDS Futures Contracts (long) $ 83.7 $ -- $ -- $ -- $ -- $ -- $ 83.7 $85.0 Number of Contracts (5 Year T Notes) 689,000 -- -- -- -- -- 689,000 Weighted average opening price 101.988 -- -- -- -- -- 101.988
39
FAIR FOR THE YEAR ENDED VALUE DECEMBER 31, 1999 2000 2001 2002 2003 2004 THEREAFTER TOTAL 12/31/99 - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN MILLIONS) Rate Sensitive Derivative Financial Instruments: Pay fixed/ receive 3 month LIBOR swaps $ 44.0 $ 43.1 $ 83.5 $ 191.0 $ 197.3 $ 23.6 $ 582.5 $18.1 Average pay rate 6.16% 5.63% 6.33% 5.85% 5.59% 7.34% 5.90% Average receive rate 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR Pay fixed/ receive 1 month LIBOR swaps $ -- $ -- $ -- $ 195.0 $ -- $ -- $ 195.0 $ 8.2 Average pay rate -- -- -- 5.58% -- -- 5.58% Average receive rate -- -- -- 1 Mo. LIBOR -- -- 1 Mo. LIBOR Pay fixed/ receive Fed Funds rate swaps $ -- $ -- $ -- $ 100.0 $ 122.0 $ -- $ 222.0 $ 7.0 Average pay rate -- -- -- 5.89% 5.63% -- 5.75% Average receive rate -- -- -- FED FUNDS FED FUNDS -- FED FUNDS Pay Fed Funds/ receive 1 month LIBOR swaps $ -- $ -- $ -- $ 50.0 $ -- $ -- $ 50.0 $(0.1) Average pay rate -- -- -- FED FUNDS -- -- FED FUNDS Average receive rate -- -- -- 1 Mo. LIBOR -- -- 1 Mo. LIBOR Futures Contracts (long) $ 33.2 $ -- $ -- $ -- $ -- $ -- $ 33.2 $32.7 Number of Contracts (5 Year T Notes) 334,000 -- -- -- -- -- 334,000 Weighted average opening price 99.258 -- -- -- -- -- 99.258
Foreign Currency Sensitivity A portion of the Company's investments consists of securities denominated in foreign currencies. A portion of the Company's liabilities consists of trust obligations backed by funding agreements denominated in foreign currencies. The Company's operating results are exposed to changes in exchange rates between the U.S. dollar and the Swiss Franc, Japanese Yen, British Pound and Euro. From time to time, the Company may also have exposure to other foreign currencies. To mitigate the short-term effect of changes in currency exchange rates, the Company regularly hedges by entering into foreign exchange swap contracts and compound foreign currency/interest rate swap contracts to hedge its net foreign currency exposure. The following tables for the years ended December 31, 2000 and 1999 provide information about the Company's derivative financial instruments and other financial instruments, used for purposes other than trading, by functional currency and presents fair value information in U.S. dollar equivalents. The tables summarize information on instruments that are sensitive to foreign currency exchange rates, including securities denominated in foreign currencies, compound foreign currency/interest rate swap contracts, and foreign currency forward exchange agreements. For compound foreign currency/interest rate swap contracts and foreign currency denominated securities with contractual maturities, the tables present principal cash flows, related weighted-average interest rates by contractual maturities, and applicable current forward foreign currency exchange rates. For foreign currency forward exchange agreements, the tables present the notional amounts and weighted-average exchange rates by expected (contractual) maturity dates. These notional amounts are used to calculate the contractual payments to be exchanged under the contracts. 40
FAIR VALUE FOR THE YEAR ENDED DECEMBER 31, 2000 2001 2002 2003 2004 2005 THEREAFTER TOTAL 12/31/00 - ------------------------------------------------------------------------------------------------------------------------------ (CURRENCIES IN MILLIONS) Fixed Interest Securities Denominated in Foreign Currencies: Fixed interest rate securities denominated in British Pounds -- -- -- -- -- 9.5 9.5 $ 18.9 Current forward foreign exchange rate -- -- -- -- -- 1.4930 1.4930 Currency Swap Agreements Related to Fixed Interest Securities: Pay British Pounds Notional amount in foreign currency -- -- -- -- -- 9.5 9.5 $ (1.3) Average contract rate -- -- -- -- -- 1.980 1.980 Current forward foreign exchange rate -- -- -- -- -- 1.4930 1.4930 Liabilities Denominated in Foreign Currencies: Trust instruments supported by funding obligations denominated in Euros 150.0 -- -- -- 262.3 -- 412.3 $401.2 Current forward foreign exchange rate 0.9427 -- -- -- 0.9427 -- 0.9427 Trust instruments supported by funding obligations denominated in Japanese Yens -- -- 5,000.0 -- 6,000.0 1,500.0 12,500.0 $109.7 Current forward foreign exchange rate -- -- 0.0087 -- 0.0087 0.0087 0.0087 Trust instruments supported by funding obligations denominated in Swiss Francs -- -- -- -- 70.0 -- 70.0 $ 44.1 Current forward foreign exchange rate -- -- -- -- 0.6207 -- 0.6207 Trust instruments supported by funding obligations denominated in British Pounds -- -- 30.0 -- -- -- 30.0 $ 44.9 Current forward foreign exchange rate -- -- 1.4930 -- -- -- 1.4930 Currency Swap Agreements Related to Trust Obligations: Pay Euros Notional amount in foreign currency 150.0 -- -- -- 262.3 -- 412.3 $(23.1) Average contract rate 0.960 -- -- -- 0.951 -- 0.954 Current forward foreign exchange rate 0.9427 -- -- -- 0.9427 -- 0.9427 Pay Japanese Yens Notional amount in foreign currency -- -- 5,000.0 -- 6,000.0 1,500.0 12,500.0 $(10.9) Average contract rate -- -- 0.009 -- 0.009 0.010 0.009 Current forward foreign exchange rate -- -- 0.0087 -- 0.0087 0.0087 0.0087 Pay Swiss Francs Notional amount in foreign currency -- -- -- -- 70.0 -- 70.0 $ 0.3 Average contract rate -- -- -- -- 0.596 -- 0.596 Current forward foreign exchange rate -- -- -- -- 0.6207 -- 0.6207 Pay British Pounds Notional amount in foreign currency -- -- 30.0 -- -- -- 30.0 $ (1.5) Average contract rate -- -- 1.500 -- -- -- 1.500 Current forward foreign exchange rate -- -- 1.4930 -- -- -- 1.4930
41
FAIR VALUE FOR THE YEAR ENDED DECEMBER 31, 1999 2000 2001 2002 2003 2004 THEREAFTER TOTAL 12/31/99 - ------------------------------------------------------------------------------------------------------------------------------ (CURRENCIES IN MILLIONS) Fixed Interest Securities Denominated in Foreign Currencies: Fixed interest rate securities denominated in Swiss Francs 10.0 -- -- -- -- -- 10.0 $ 6.8 Current forward foreign exchange rate 0.6281 -- -- -- -- -- 0.6281 Fixed interest rate securities denominated in Japanese Yens 620.0 -- -- -- -- -- 620.0 $ 6.1 Current forward foreign exchange rate 0.0098 -- -- -- -- -- 0.0098 Fixed interest rate securities denominated in British Pounds -- -- -- -- -- 9.5 9.5 $ 20.6 Current forward foreign exchange rate -- -- -- -- -- 1.6153 1.6153 Currency Swap Agreements Related to Fixed Interest Securities: Pay Swiss Francs Notional amount in foreign currency 10.0 -- -- -- -- -- 10.0 $ 0.2 Average contract rate 0.665 -- -- -- -- -- 0.665 Current forward foreign exchange rate 0.6281 -- -- -- -- -- 0.6281 Pay Japanese Yens Notional amount in foreign currency 620.0 -- -- -- -- -- 620.0 $ (1.2) Average contract rate 0.008 -- -- -- -- -- 0.008 Current forward foreign exchange rate 0.0098 -- -- -- -- -- 0.0098 Pay British Pounds Notional amount in foreign currency -- -- -- -- -- 9.5 9.5 $ (1.8) Average contract rate -- -- -- -- -- 1.980 1.980 Current forward foreign exchange rate -- -- -- -- -- 1.6153 1.6153 Fixed Interest Liabilities Denominated in Foreign Currencies: Trust instruments supported by funding obligations denominated in Euros -- 50.0 -- -- -- -- 50.0 $ 49.6 Current forward foreign exchange rate -- 1.0062 -- -- -- -- 1.0062 Currency Swap Agreements Related to Fixed Interest Trust Obligations: Pay Euros Notional amount in foreign currency -- 50.0 -- -- -- -- 50.0 $ (2.7) Average contract rate -- 1.006 -- -- -- -- 1.006 Current forward foreign exchange rate -- 1.0062 -- -- -- -- 1.0062
42 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. The provision for federal income taxes before minority interest and discontinued operations was $2.7 million during 2000 compared to $106.9 million during 1999. These provisions resulted in consolidated effective federal tax rates of 1.3% and 22.8%, respectively. The effective tax rates for FAFLIC and AFLIAC and their non-insurance affiliates were 9.6% and 26.1% during 2000 and 1999, respectively. The decrease in the rate for FAFLIC and AFLIAC and their non-insurance affiliates primarily reflects the recognition, in the fourth quarter of 2000, of a $20.2 million tax benefit from a change in the estimate of the ultimate realizability of the dividends received deduction associated with their variable products. This amount includes $13.3 million related to deductions taken in prior years. The effective tax rates for Allmerica P&C and its subsidiaries were (12.8%) and 20.6% during 2000 and 1999, respectively. The decrease in the rate for Allmerica P&C and its subsidiaries is primarily the result of realized capital losses in 2000. The provision for federal income taxes before minority interest and discontinued operations was $106.9 million during 1999 compared to $56.1 million during 1998. These provisions resulted in consolidated effective federal tax rates of 22.8% and 18.7%, respectively. The effective tax rates for FAFLIC and AFLIAC and their non-insurance affiliates were 26.1% and 28.6% during 1999 and 1998, respectively. The decrease in the rate for FAFLIC and AFLIAC and their non-insurance affiliates primarily reflects changes in reserves for prior years tax liabilities. The effective tax rates for Allmerica P&C and its subsidiaries were 20.6% and 10.7% during 1999 and 1998, respectively. The increase in the rate for Allmerica P&C and its subsidiaries is primarily the result of a larger proportion of pre-tax income from realized capital gains in 1999, as well as improved underwriting results. 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 2000, AFC received $108.0 million of dividends from its property and casualty businesses. These funds were principally used to repurchase $104.1 million of AFC capital stock. Additional dividends from the Company's insurance subsidiaries prior to April 2001 would be considered "extraordinary" and would require prior approval from the respective state regulators. 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 capital stock and pay $39.9 million of interest expense on the Senior Debentures and Capital Securities. During the third quarter of 1999, the Company used the remaining funds from the aforementioned dividends, as well as proceeds from sales of AFC holding company investments, to fund a $125.0 million capital contribution from AFC to FAFLIC. As of July 1, 1999, FAFLIC's ownership of Allmerica P&C, as well as several non-insurance subsidiaries, were transferred from FAFLIC to AFC. Under an agreement with the Commonwealth of Massachusetts Insurance Commissioner ("the Commissioner"), AFC contributed the aforementioned $125.0 million and agreed to maintain FAFLIC's statutory surplus at specified levels during the following six years. Future capital contributions from AFC to FAFLIC may be required. In addition, any dividend from FAFLIC to AFC during 2001 would require the prior approval of the Commissioner. 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. 43 Net cash provided by operating activities was $159.0 million, $15.2 million and $37.9 million in 2000, 1999 and 1998, respectively. The increase in 2000 is primarily the result of approximately $86.6 million of decreased federal income tax payments, an increase in premium collections in the Risk Management segment and to the timing of settlements with reinsurance companies. The decrease in 1999 resulted primarily from the timing of premium collections in the Risk Management segment and to the timing of settlements with reinsurance companies. These decreases in cash were partially offset by cash receipts from the Company's separate accounts, as well as the absence of the 1998 payment of $30.3 million related to the Company's exit of its reinsurance pool business. Net cash used in investing activities was $885.2 million and $617.1 million in 2000 and 1998, respectively, while net cash provided by investing activities was $794.9 million in 1999. The $1.7 billion increase in cash used is primarily due to a $1.3 billion year over year increase in purchases of fixed maturities resulting primarily from a net increase in funding agreement deposits. In addition, the absence in 2000 of $310.0 million of equity securities sales that occurred in January 1999 contributed to the decline in cash from investing activities. The $1.4 billion increase from 1998 to 1999 primarily results from a $1.1 billion year over year decrease in net purchases of fixed maturities due to the net decline in funding agreement deposits. Net cash provided by financing activities was $542.5 million and $898.7 million in 2000 and 1998, respectively, as compared to cash used in financing activities of $905.0 million in 1999. The increase in cash in 2000 is primarily due to an increase in net funding agreement deposits, including trust instruments supported by funding obligations, of $1.1 billion, the absence of a $180.0 million repayment of short-term debt which occurred during the first quarter of 1999, and a $146.1 million year over year reduction in cash used for the Company's share repurchase program. The decrease in cash in 1999 compared to 1998 is primarily due to a decline in net funding agreement deposits, including trust instruments supported by funding obligations, of $1.3 billion, the use of cash to pay $180.0 million in short-term debt used to finance the aforementioned acquisition of the minority interest of Citizens Corporation, and $167.5 million year over year reduction in cash used to fund common stock repurchases. In the opinion of management, AFC has sufficient funds at the holding company or available through dividends from FAFLIC and Hanover, or through available credit facilities to meet its obligations to pay interest on the Senior Debentures, Capital Securities and dividends, when and if declared by the Board of Directors, on the common stock. On July 25, 2000, 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, 2000 to shareholders of record at the close of business on November 1, 2000. Whether the Company will pay dividends in the future depends upon the costs of administration as compared to the benefits conferred, and upon the earnings and financial condition of AFC. Based on current trends, the Company expects to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements. The Company maintains a high degree of liquidity within the investment portfolio in fixed maturity investments, common stock and short-term investments. AFC has $150.0 million available under a committed syndicated credit agreement which expires on May 28, 2001. 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 December 31, 2000, no amounts were outstanding under this agreement. The Company had $56.6 million of commercial paper borrowings outstanding at December 31, 2000. These borrowings are used in connection with the Company's premium financing business, which is included in the Risk Management segment. CONTINGENCIES - -------------------------------------------------------------------------------- The Company's insurance subsidiaries are routinely engaged in various legal proceedings arising in the normal course of business, including claims for punitive damages. Additional information on other litigation and claims may be found in Note 21 "Commitments and Contingencies - Litigation" to the consolidated financial statements. In the opinion of management, none of such contingencies are expected to have a material effect on the Company's consolidated financial position, although it is possible that the results of operations in a particular quarter or annual period could be materially affected by an unfavorable outcome. RECENT DEVELOPMENTS - -------------------------------------------------------------------------------- The Company recognized a net benefit from its employee pension plans of $12.5 million in 2000. In 1999 and 1998, the Company recognized net expenses of $0.9 million and $3.7 million, respectively, related to these plans. The benefit or expense related to the pension plans results from several factors, including changes in the market value of plan assets, interest rates and employee compensation levels. The net benefit in 2000 primarily reflects increases in the market value of plan assets in prior years. In 2001, management does not expect a similar benefit from its pension plans, primarily due to a decline in the market value of plan assets in 2000. In January 2001, AFC agreed to sell its defined contribution business to Minnesota Life Insurance Company. This business is comprised of approximately 600 employer-sponsored pension plans for which FAFLIC provides a variety of general and separate account options as well as administration. The transaction, which is subject to regulatory approval, is scheduled to close July 1, 2001 and is not expected to have a material effect on the Company's results of operations or its financial position. 44 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 all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on the type of hedge transaction. For fair value hedge transactions in which the Company is hedging changes in an asset's, liability's or firm commitment's fair value, changes in the fair value of the derivative instruments will generally be offset in the income statement by changes in the hedged item's fair value. For cash flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. To the extent any hedges are determined to be ineffective, all or a portion of the change in value of the derivative will be recognized currently in earnings. This statement is effective for fiscal years beginning after June 15, 2000. The adoption of Statement No. 133 did not have a material effect on the Company's results of operations or its financial position. 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 2001 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes", "anticipates", "expects" and similar expressions are intended to identify forward looking statements. See "Important Factors Regarding Forward-Looking Statements" filed as Exhibit 99-2 to the Company's Annual Report on Form 10-K for the period ended December 31, 2000. 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, or as the result of consolidation within the financial services industry and the entry of additional financial institutions into the insurance industry; (iv) adverse state and federal legislation or regulation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, and tax treatment of insurance and annuity products, as well as continued compliance with state and federal regulations; (v) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) difficulties in recruiting new or retaining existing career agents, wholesalers and partnership relations to support the sale of variable products; (viii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (ix) loss or retirement of key executives; (x) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (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, and A.M. Best; (xiv) lower appreciation on or decline in value of the Company's managed investments or the investment markets in general, resulting in reduced variable products sales, assets and related fees and increased surrenders; (xv) possible claims relating to sales practices for insurance products; (xvi) failure of a reinsurer of the Company's policies to pay its liabilities under reinsurance contracts; (xvii) earlier than expected withdrawals from the Company's general account annuities, GICs (including funding agreements), and other insurance products; (xviii) changes in the mix of assets comprising the Company's investment portfolio and the fluctuation of the market value of such assets; (xix) losses resulting from the Company's participation in certain reinsurance pools; (xx) adverse results of regulatory audits related to the Company's prior years' federal income tax filings; (xxi) losses due to foreign currency fluctuations, and (xxii) the inability to realize expense savings and enhanced revenues from restructuring initiatives. 45 - -------------------------------------------------------------------------------- REPORT OF INDEPENDENT ACCOUNTANTS - -------------------------------------------------------------------------------- [PRICEWATERHOUSECOOPERS LOGO] To the Board of Directors and Shareholders of Allmerica Financial Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows present fairly, in all material respects, the financial position of Allmerica Financial Corporation and its subsidiaries (the "Company") at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts February 1, 2001 46 - -------------------------------------------------------------------------------- MANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING - -------------------------------------------------------------------------------- The management of Allmerica Financial Corporation has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and include amounts based on management's informed estimates and judgments. We believe that these statements present fairly the Company's financial position and results of operations and that the other information contained in the annual report is accurate and consistent with the financial statements. Allmerica Financial Corporation's Board of Directors annually appoints independent accountants to perform an audit of its consolidated financial statements. The financial statements have been audited by PricewaterhouseCoopers LLP, independent accountants, in accordance with generally accepted auditing standards. Their audit included consideration of the Company's system of internal control in order to determine the audit procedures required to express their opinion on the consolidated financial statements. Management of Allmerica Financial Corporation has established and maintains a system of internal control that provides reasonable assurance that assets are safeguarded and that transactions are properly authorized and recorded. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management continually monitors the system of internal control for compliance. Allmerica Financial Corporation and its subsidiaries maintain a strong internal audit program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. Management recognizes the inherent limitations in all internal control systems and believes that our system of internal control provides an appropriate balance between the costs and benefits desired. Management believes that the Company's system of internal control provides reasonable assurance that errors or irregularities that would be material to the financial statements are prevented or detected in the normal course of business. The Audit Committee of the Board of Directors, composed solely of outside directors, oversees management's discharge of its financial reporting responsibilities. The committee meets periodically with management, our internal auditors and our independent accountants, PricewaterhouseCoopers LLP. Both our internal auditors and PricewaterhouseCoopers LLP have direct access to the Audit Committee. Management recognizes its responsibility for fostering a strong ethical climate. This responsibility is reflected in the Company's policies which address, among other things, potential conflicts of interest; compliance with all domestic and foreign laws including those relating to financial disclosure and the confidentiality of proprietary information. Allmerica Financial Corporation maintains a systematic program to assess compliance with these policies. /s/ John F. O'Brien John F. O'Brien President and Chief Executive Officer /s/ Edward J. Parry, III Edward J. Parry, III Vice President, Chief Financial Officer and Principal Accounting Officer 47 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) Revenues Premiums $2,068.9 $1,950.5 $1,970.6 Universal life and investment product policy fees 421.1 359.3 296.6 Net investment income 591.9 615.7 604.4 Net realized investment (losses) gains (135.3) 91.0 59.2 Other income 141.3 128.7 103.2 - ------------------------------------------------------------------------------------------------------------------------- Total revenues 3,087.9 3,145.2 3,034.0 - ------------------------------------------------------------------------------------------------------------------------- Benefits, Losses and Expenses Policy benefits, claims, losses and loss adjustment expenses 1,889.3 1,770.7 1,804.0 Policy acquisition expenses 454.5 429.9 449.6 Sales practice litigation -- -- 31.0 Restructuring costs 20.7 (1.9) 9.0 Other operating expenses 504.8 478.5 440.3 - ------------------------------------------------------------------------------------------------------------------------- Total benefits, losses and expenses 2,869.3 2,677.2 2,733.9 - ------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before federal income taxes 218.6 468.0 300.1 - ------------------------------------------------------------------------------------------------------------------------- Federal income tax expense (benefit): Current 1.2 88.1 72.5 Deferred 1.5 18.8 (16.4) - ------------------------------------------------------------------------------------------------------------------------- Total federal income tax expense 2.7 106.9 56.1 - ------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before minority interest 215.9 361.1 244.0 Minority interest: Distributions on mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company (16.0) (16.0) (16.0) Equity in earnings -- -- (13.3) - ------------------------------------------------------------------------------------------------------------------------- Total minority interest (16.0) (16.0) (29.3) - ------------------------------------------------------------------------------------------------------------------------- Income from continuing operations 199.9 345.1 214.7 - ------------------------------------------------------------------------------------------------------------------------- Loss from operations of discontinued business (less applicable income tax benefit of $10.1 and $7.0 for the years ended December 31, 1999 and 1998, respectively) -- (18.8) (13.5) Loss on disposal of group life and health business, including provision of $72.2 for operating losses during phase-out period for the year ended December 31, 1999 (less applicable income tax benefit of $16.4) -- (30.5) -- - ------------------------------------------------------------------------------------------------------------------------- Net income $ 199.9 $ 295.8 $ 201.2 ========================================================================================================================= Earnings per common share: Basic: Income from continuing operations $ 3.75 $ 6.27 $ 3.59 Loss from operations of discontinued business (less applicable income tax benefit of $0.19 and $0.12 for the years ended December 31, 1999 and 1998, respectively) -- (0.34) (0.23) Loss on disposal of group life and health business, including provision of $1.31 for operating losses during phase-out period for the year ended December 31, 1999 (less applicable income tax benefit of $0.30) -- (0.55) -- - ------------------------------------------------------------------------------------------------------------------------- Net income per share $ 3.75 $ 5.38 $ 3.36 Weighted average shares outstanding 53.3 55.0 59.9 - ------------------------------------------------------------------------------------------------------------------------- Diluted: Income from continuing operations $ 3.70 $ 6.21 $ 3.56 Loss from operations of discontinued business (less applicable income tax benefit of $0.19 and $0.12 for the years ended December 31, 1999 and 1998, respectively) -- (0.33) (0.23) Loss on disposal of group life and health business, including provision of $1.30 for operating losses during phase-out period for the year ended December 31, 1999 (less applicable income tax benefit of $0.29) -- (0.55) -- - ------------------------------------------------------------------------------------------------------------------------- Net income per share $ 3.70 $ 5.33 $ 3.33 Weighted average shares outstanding 54.0 55.5 60.3 =========================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 48 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------
DECEMBER 31 2000 1999 - ----------------------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA) Assets Investments: Fixed maturities-at fair value (amortized cost of $7,753.3 and $7,095.0) $ 7,720.5 $ 6,933.8 Equity securities-at fair value (cost of $60.0 and $49.5) 85.5 83.2 Mortgage loans 472.7 521.2 Policy loans 189.6 170.5 Other long-term investments 193.2 180.0 - ----------------------------------------------------------------------------------------------------------- Total investments 8,661.5 7,888.7 - ----------------------------------------------------------------------------------------------------------- Cash and cash equivalents 279.2 442.2 Accrued investment income 140.8 134.7 Premiums, accounts and notes receivable, net 617.2 583.5 Reinsurance receivable on paid and unpaid losses, benefits and unearned premiums 1,423.3 1,279.9 Deferred policy acquisition costs 1,597.2 1,386.8 Deferred federal income taxes 102.3 141.7 Other assets 561.1 510.2 Closed Block assets 768.0 772.3 Separate account assets 17,437.4 17,629.6 - ----------------------------------------------------------------------------------------------------------- Total assets $31,588.0 $30,769.6 =========================================================================================================== Liabilities Policy liabilities and accruals: Future policy benefits $ 2,907.2 $ 2,825.0 Outstanding claims, losses and loss adjustment expenses 2,875.2 2,838.6 Unearned premiums 981.6 890.2 Contractholder deposit funds and other policy liabilities 2,080.1 2,041.0 - ----------------------------------------------------------------------------------------------------------- Total policy liabilities and accruals 8,844.1 8,594.8 - ----------------------------------------------------------------------------------------------------------- Expenses and taxes payable 767.8 795.5 Reinsurance premiums payable 122.3 73.0 Trust instruments supported by funding obligations 621.5 50.6 Short-term debt 56.6 45.0 Long-term debt 199.5 199.5 Closed Block liabilities 829.7 842.1 Separate account liabilities 17,437.4 17,628.9 - ----------------------------------------------------------------------------------------------------------- Total liabilities 28,878.9 28,229.4 - ----------------------------------------------------------------------------------------------------------- Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 300.0 - ----------------------------------------------------------------------------------------------------------- Commitments and contingencies (Notes 16 and 21) Shareholders' Equity Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued -- -- Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million shares issued 0.6 0.6 Additional paid-in capital 1,765.3 1,770.5 Accumulated other comprehensive loss (5.2) (75.3) Retained earnings 1,068.7 882.2 Treasury stock at cost (7.7 and 6.2 million shares) (420.3) (337.8) - ----------------------------------------------------------------------------------------------------------- Total shareholders' equity 2,409.1 2,240.2 - ----------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $31,588.0 $30,769.6 ===========================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 49 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------------------------------- (IN MILLIONS) Preferred Stock $ -- $ -- $ -- - ------------------------------------------------------------------------------------------------------- Common Stock Balance at beginning and end of year 0.6 0.6 0.6 - ------------------------------------------------------------------------------------------------------- Additional Paid-In Capital Balance at beginning of year 1,770.5 1,768.8 1,755.0 Issuance of common stock 0.6 1.1 11.4 Unearned compensation related to restricted stock and other (5.8) 0.6 2.4 - ------------------------------------------------------------------------------------------------------- Balance at end of year 1,765.3 1,770.5 1,768.8 - ------------------------------------------------------------------------------------------------------- Accumulated Other Comprehensive (Loss) Income Net Unrealized (Depreciation) Appreciation on Investments: Balance at beginning of year (75.3) 180.5 217.9 Appreciation (depreciation) during the period: Net appreciation (depreciation) on available-for-sale securities 107.9 (393.8) (82.7) (Provision) benefit for deferred federal income taxes (37.8) 138.0 28.8 Minority interest -- -- 16.5 - ------------------------------------------------------------------------------------------------------- 70.1 (255.8) (37.4) - ------------------------------------------------------------------------------------------------------- Balance at end of year (5.2) (75.3) 180.5 - ------------------------------------------------------------------------------------------------------- Retained Earnings Balance at beginning of year 882.2 599.9 407.8 Net income 199.9 295.8 201.2 Dividends to shareholders (13.4) (13.5) (9.1) - ------------------------------------------------------------------------------------------------------- Balance at end of year 1,068.7 882.2 599.9 - ------------------------------------------------------------------------------------------------------- Treasury Stock Balance at beginning of year (337.8) (91.2) -- Shares purchased at cost (105.0) (252.8) (91.2) Shares reissued at cost 22.5 6.2 -- - ------------------------------------------------------------------------------------------------------- Balance at end of year (420.3) (337.8) (91.2) - ------------------------------------------------------------------------------------------------------- Total shareholders' equity $2,409.1 $2,240.2 $2,458.6 =======================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 50 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------------------------- (IN MILLIONS) Net income $ 199.9 $ 295.8 $ 201.2 - -------------------------------------------------------------------------------------------------- Other comprehensive income (loss): Net appreciation (depreciation) on available for sale securities 107.9 (393.8) (82.7) (Provision) benefit for deferred federal income taxes (37.8) 138.0 28.8 Minority interest -- -- 16.5 - -------------------------------------------------------------------------------------------------- Other comprehensive income (loss) 70.1 (255.8) (37.4) - -------------------------------------------------------------------------------------------------- Comprehensive income $ 270.0 $ 40.0 $ 163.8 ==================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 51 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------- FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------- (IN MILLIONS) Cash Flows From Operating Activities Net Income $ 199.9 $ 295.8 $ 201.2 Adjustments to reconcile net income to net cash provided by operating activities: Minority interest -- -- 13.3 Net realized investment losses (gains) 140.7 (90.4) (61.0) Net amortization and depreciation 22.8 34.2 21.9 Deferred federal income taxes 1.5 18.8 (16.4) Loss on disposal of group life and health business -- 30.5 -- Loss from exiting reinsurance pools -- -- 25.3 Sales practice litigation expense -- -- 31.0 Payment related to exiting reinsurance pools -- -- (30.3) Change in deferred acquisition costs (227.6) (183.8) (185.8) Change in premiums and notes receivable, net of reinsurance payable 15.8 (50.2) 56.7 Change in accrued investment income (6.7) 7.7 -- Change in policy liabilities and accruals, net 172.4 28.7 168.1 Change in reinsurance receivable (143.1) (143.8) (115.4) Change in expenses and taxes payable (21.6) 29.6 9.1 Separate account activity, net 0.7 5.3 (48.5) Other, net 4.2 32.8 (31.3) - ------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 159.0 15.2 37.9 Cash Flows From Investing Activities Proceeds from disposals and maturities of available-for-sale fixed maturities 3,024.8 2,996.5 1,970.6 Proceeds from disposals of equity securities 15.1 424.3 285.3 Proceeds from disposals of other investments 48.5 31.4 120.8 Proceeds from mortgages matured or collected 116.2 128.2 171.2 Purchase of available-for-sale fixed maturities (3,844.3) (2,527.3) (2,566.2) Purchase of equity securities (19.8) (78.9) (119.9) Purchase of other investments (147.2) (140.7) (274.4) Capital expenditures (13.7) (30.1) (22.3) Purchase of company owned life insurance (64.9) -- -- Purchase of minority interest in Citizens Corporation -- -- (195.9) Purchase of Financial Profiles, Inc. -- -- (13.0) Other investing activities, net 0.1 (8.5) 26.7 - ------------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (885.2) 794.9 (617.1) Cash Flows From Financing Activities Deposits and interest credited to contractholder deposit funds 990.3 1,514.6 1,419.2 Withdrawals from contractholder deposit funds (936.7) (2,037.5) (625.0) Change in trust instruments supported by funding obligations 570.9 50.6 -- Change in short-term debt 11.6 (176.3) 188.3 Change in long-term debt -- -- (2.6) Dividends paid to shareholders (13.4) (13.5) (9.9) Net proceeds from issuance of common stock 0.6 1.1 11.4 Treasury stock purchased at cost (104.1) (250.2) (82.7) Treasury stock reissued at cost 23.3 6.2 -- - ------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 542.5 (905.0) 898.7 - ------------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents (183.7) (94.9) 319.5 Net change in cash held in the Closed Block 20.7 (13.2) 15.7 Cash and cash equivalents, beginning of year 442.2 550.3 215.1 - ------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 279.2 $ 442.2 $ 550.3 ========================================================================================================================= Supplemental Cash Flow Information Interest payments $ 21.6 $ 19.9 $ 21.6 Income tax net (refunds) payments $ (8.8) $ 77.8 $ 133.5 - ------------------------------------------------------------------------------------------------------------------------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. - -------------------------------------------------------------------------------------------------------------------------
52 - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- One - -------------------------------------------------------------------------------- Summary of Significant Accounting Policies A. Basis of Presentation and Principles of Consolidation The consolidated financial statements of Allmerica Financial Corporation ("AFC" or the "Company") include the accounts of First Allmerica Financial Life Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); non-insurance subsidiaries (principally brokerage and investment advisory services); Allmerica Asset Management, Inc. ("AAM", a wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance subsidiary of AAM through December 31, 2000); The Hanover Insurance Company ("Hanover", a wholly-owned subsidiary of Allmerica P&C through December 31, 2000); Citizens Corporation (a wholly-owned subsidiary of Hanover through December 31, 2000); and Citizens Insurance Company of America ("Citizens", a wholly-owned subsidiary of Citizens Corporation through December 31, 2000). On December 31, 2000, the Company dissolved Allmerica P&C and Citizens Corporation and transferred subsidiaries of Allmerica P&C to AAM and transferred subsidiaries of Citizens Corporation to Hanover. The Closed Block (See Note 1B) 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. On or about December 3, 1998, the Company acquired all of the outstanding common stock of Citizens Corporation (formerly an 82.5% owned non-insurance subsidiary of Hanover) in exchange for cash of $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 financial statements reflect minority interest in Citizens Corporation, and its wholly-owned subsidiary, Citizens, of approximately 16.8%. Minority interest also includes distributions on mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company. The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. B. Closed Block FAFLIC established and began operating a closed block (the "Closed Block") for the benefit of the participating policies included therein, consisting of certain individual life insurance participating policies, individual deferred annuity contracts and supplementary contracts not involving life contingencies which were in force as of FAFLIC's demutualization on October 16, 1995; such policies constitute the "Closed Block Business". The purpose of the Closed Block is to protect the policy dividend expectations of such FAFLIC dividend paying policies and contracts. Unless the Commonwealth of Massachusetts Insurance Commissioner consents to an earlier termination, the Closed Block will continue to be in effect until the date none of the Closed Block policies are in force. FAFLIC allocated to the Closed Block assets in an amount that is expected to produce cash flows which, together with future revenues from the Closed Block Business, are reasonably sufficient to support the Closed Block Business, including provision for payment of policy benefits, certain future expenses and taxes and for continuation of policyholder dividend scales payable in 1994 so long as the experience underlying such dividend scales continues. The Company expects that the factors underlying such experience will fluctuate in the future and policyholder dividend scales for Closed Block Business will be set accordingly. Although the assets and income allocated to the Closed Block inure solely to the benefit of the holders of policies included in the Closed Block, the excess of Closed Block liabilities over Closed Block assets as measured on a GAAP basis represent the expected future post-tax income from the Closed Block which may be recognized in income over the period the policies and contracts in the Closed Block remain in force. If the actual income from the Closed Block in any given period equals or exceeds the expected income for such period as determined at the inception of the Closed Block, the expected income would be recognized in income for that period. Further, cumulative actual Closed Block income in excess of the expected income would not inure to the shareholders and would be recorded as an additional liability for policyholder dividend obligations. This accrual for future dividends effectively limits the actual Closed Block income recognized in income to the Closed Block income expected to emerge from operation of the Closed Block as determined at inception. If, over the period the policies and contracts in the Closed Block remain in force, the actual income from the Closed Block is less than the expected income from the Closed Block, only 53 such actual income (which could reflect a loss) would be recognized in income. If the actual income from the Closed Block in any given period is less than the expected income for that period and changes in dividend scales are inadequate to offset the negative performance in relation to the expected performance, the income inuring to shareholders of the Company will be reduced. If a policyholder dividend liability had been previously established in the Closed Block because the actual income to the relevant date had exceeded the expected income to such date, such liability would be reduced by this reduction in income (but not below zero) in any periods in which the actual income for that period is less than the expected income for such period. C. Valuation of Investments In accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", ("Statement No. 115"), the Company is required to classify its investments into one of three categories: held-to-maturity, available-for-sale or trading. The Company determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities and marketable equity securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Mortgage loans on real estate are stated at unpaid principal balances, net of unamortized discounts and reserves. Reserves on mortgage loans are based on losses expected by the Company to be realized on transfers of mortgage loans to real estate (upon foreclosure), on the disposition or settlement of mortgage loans and on mortgage loans which the Company believes may not be collectible in full. In establishing reserves, the Company considers, among other things, the estimated fair value of the underlying collateral. Fixed maturities and mortgage loans that are delinquent are placed on non-accrual status, and thereafter interest income is recognized only when cash payments are received. Policy loans are carried principally at unpaid principal balances. As of December 31, 2000, there were no real estate properties in the Company's investment portfolio. Real estate held at December 31, 1999 was carried at the estimated fair value less costs of disposal. Depreciation was not recorded on these assets while they were held for disposal. Realized investment gains and losses, other than those related to separate accounts for which the Company does not bear the investment risk, are reported as a component of revenues based upon specific identification of the investment assets sold. When an other than temporary impairment of the value of a specific investment or a group of investments is determined, a realized investment loss is recorded. Changes in the valuation allowance for mortgage loans are included in realized investment gains or losses. D. Financial Instruments In the normal course of business, the Company enters into transactions involving various types of financial instruments, including debt, investments such as fixed maturities, mortgage loans and equity securities, investment and loan commitments, swap contracts and interest rate futures contracts. These instruments involve credit risk and also may be subject to risk of loss due to interest rate fluctuation. The Company evaluates and monitors each financial instrument individually and, when appropriate, obtains collateral or other security to minimize losses. Derivative financial instruments are accounted for under three different methods: fair value accounting, deferral accounting and accrual accounting. Interest rate swap contracts used to hedge interest rate risk are accounted for using a combination of the fair value method and accrual method, with changes in fair value reported in unrealized gains and losses in equity consistent with the underlying hedged security, and the net payment or receipt on the swaps reported in net investment income. Foreign currency swap contracts used to hedge the foreign currency exchange risk associated with investment securities are accounted for using a combination of the fair value method and accrual method, with changes in fair value reported in unrealized gains and losses in equity consistent with the underlying hedged security, and the net payment or receipt on the swaps reported in net investment income. Foreign currency swap contracts used to hedge foreign currency exchange risk associated with trust obligations backed by funding agreements are accounted for using the fair value method, with changes in fair value reported in other operating income consistent with the underlying hedged trust obligation. Futures contracts used to hedge interest rate risk are accounted for using the deferral method, with gains and losses deferred in unrealized gains and losses in equity and recognized in earnings in conjunction with the earnings recognition of the underlying hedged item. Default swap contracts entered into for investment purposes are accounted for using the fair value method, with changes in fair value, if any, reported in realized investment gains and losses in earnings. Premium paid to the Company on default swap contracts is reported in net investment income in earnings. Other swap contracts entered into for investment purposes are accounted for using the fair value method, with changes in fair value reported in realized investment gains and losses in earnings. Any ineffective swaps or futures hedges are recognized currently in realized investment gains and losses in earnings. 54 E. Cash and Cash Equivalents Cash and cash equivalents includes cash on hand, amounts due from banks and highly liquid debt instruments purchased with an original maturity of three months or less. F. Deferred Policy Acquisition Costs Acquisition costs consist of commissions, underwriting costs and other costs, which vary with, and are primarily related to, the production of revenues. Property and casualty insurance business acquisition costs are deferred and amortized over the terms of the insurance policies. Acquisition costs related to universal life products, variable annuities and contractholder deposit funds are deferred and amortized in proportion to total estimated gross profits from investment yields, mortality, surrender charges and expense margins over the expected life of the contracts. This amortization is reviewed periodically and adjusted retrospectively when the Company revises its estimate of current or future gross profits to be realized from this group of products, including realized and unrealized gains and losses from investments. Acquisition costs related to fixed annuities and other life insurance products are deferred and amortized, generally in proportion to the ratio of annual revenue to the estimated total revenues over the contract periods based upon the same assumptions used in estimating the liability for future policy benefits. Deferred acquisition costs for each life product and property and casualty line of business are reviewed to determine if they are recoverable from future income, including investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. Although realization of deferred policy acquisition costs is not assured, the Company believes it is more likely than not that all of these costs will be realized. The amount of deferred policy acquisition costs considered realizable, however, could be reduced in the near term if the estimates of gross profits or total revenues discussed above are reduced. The amount of amortization of deferred policy acquisition costs could be revised in the near term if any of the estimates discussed above are revised. G. Property and Equipment Property, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line or accelerated method over the estimated useful lives of the related assets which generally range from 3 to 30 years. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the term of the leases or the estimated useful life of the improvements. H. Separate Accounts Separate account assets and liabilities represent segregated funds administered and invested by the Company for the benefit of certain pension, variable annuity and variable life insurance contractholders. Assets consist principally of bonds, common stocks, mutual funds, and short-term obligations at market value. The investment income and gains and losses of these accounts generally accrue to the contractholders and, therefore, are not included in the Company's net income. Appreciation and depreciation of the Company's interest in the separate accounts, including undistributed net investment income, is reflected in shareholders' equity or net investment income. I. Policy Liabilities and Accruals Future policy benefits are liabilities for life, health and annuity products. Such liabilities are established in amounts adequate to meet the estimated future obligations of policies in force. The liabilities associated with traditional life insurance products are computed using the net level premium method for individual life and annuity policies, and are based upon estimates as to future investment yield, mortality and withdrawals that include provisions for adverse deviation. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2 1/2% to 6.0% for life insurance and 2 1/2% to 9 1/2% for annuities. Estimated liabilities are established for group life and health policies that contain experience rating provisions. Mortality, morbidity and withdrawal assumptions for all policies are based on the Company's own experience and industry standards. Liabilities for universal life, variable universal life and variable annuities include deposits received from customers and investment earnings on their fund balances, less administrative charges. Universal life fund balances are also assessed mortality and surrender charges. Liabilities for variable annuities include a reserve for benefit claims in excess of a guaranteed minimum fund value. Liabilities for outstanding claims, losses and loss adjustment expenses ("LAE") are estimates of payments to be made on property and casualty and health insurance for reported losses and LAE and estimates of losses and LAE incurred but not reported. These liabilities are determined using case basis evaluations and statistical analyses and represent estimates of the ultimate cost of all losses incurred but not paid. These estimates are continually reviewed and adjusted as necessary; such adjustments are reflected in current operations. Estimated amounts of salvage and subrogation on unpaid property and casualty losses are deducted from the liability for unpaid claims. Premiums for property and casualty insurance are reported as earned on a pro-rata basis over the contract period. The unexpired portion of these premiums is recorded as unearned premiums. 55 Contractholder deposit funds and other policy liabilities include investment-related products such as guaranteed investment contracts, deposit administration funds and immediate participation guarantee funds and consist of deposits received from customers and investment earnings on their fund balances. All policy liabilities and accruals are based on the various estimates discussed above. Although the adequacy of these amounts cannot be assured, the Company believes that it is more likely than not that policy liabilities and accruals will be sufficient to meet future obligations of policies in force. The amount of liabilities and accruals, however, could be revised in the near term if the estimates discussed above are revised. J. Premium and Fee Revenue and Related Expenses Premiums for individual life insurance and individual and group annuity products, excluding universal life and investment-related products, are considered revenue when due. Property and casualty insurance premiums are recognized as revenue over the related contract periods. Benefits, losses and related expenses are matched with premiums, resulting in their recognition over the lives of the contracts. This matching is accomplished through the provision for future benefits, estimated and unpaid losses and amortization of deferred policy acquisition costs. Revenues for investment-related products consist of net investment income and contract charges assessed against the fund values. Related benefit expenses include annuity benefit claims in excess of a guaranteed minimum fund value, and net investment income credited to the fund values after deduction for investment and risk charges. Revenues for universal life products consist of net investment income, with mortality, administration and surrender charges assessed against the fund values. Related benefit expenses include universal life benefit claims in excess of fund values and net investment income credited to universal life fund values. Certain policy charges that represent compensation for services to be provided in future periods are deferred and amortized over the period benefited using the same assumptions used to amortize capitalized acquisition costs. K. Federal 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. Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("Statement No. 109").These differences result primarily from loss and LAE reserves, policy reserves, policy acquisition expenses and unrealized appreciation or depreciation on investments. L. New Accounting Pronouncements In December 2000, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 00-3, "Accounting by Insurance Enterprises for Demutualization and Formations of Mutual Insurance Holding Companies and For Certain Long-Duration Participating Contracts" ("SoP No. 00- 3"). SoP No. 00-3 requires that closed block assets, liabilities, revenues and expenses be displayed together with all other assets, liabilities, revenues and expenses of the insurance enterprise based on the nature of the particular item, with appropriate disclosures relating to the closed block. In addition, the SoP provides guidance on the accounting for participating contracts issued before and after the date of demutualization, recording of closed block earnings and related policyholder dividend liabilities, and the accounting treatment for expenses and equity balances at the date of demutualization. This statement is effective for fiscal years beginning after December 15, 2000. The adoption of SoP No. 00-3 did not have a material impact on the Company's financial position or results of operations. In March 2000, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN 44" or "the Interpretation"). FIN 44 clarifies the application of APB Opinion No. 25 regarding the definition of employee, the criteria for determining a noncompensatory plan, the accounting for changes to the terms of a previously fixed stock option or award, the accounting for an exchange of stock compensation awards in a business combination, and other stock compensation related issues. FIN 44 became effective July 1, 2000 with respect to new awards, modifications to outstanding awards, and changes in grantee status that occur on or after that date. In addition, the Interpretation covers certain events occurring between December 16, 1998 and the July effective date, as well as certain other events occurring between January 13, 2000 and the July effective date. To the extent that applicable events occurred in those periods, the effects of applying the Interpretation are recognized on a prospective basis beginning July 1, 2000. The adoption of FIN 44 did not have a material impact on the Company's financial position or results of operations. 56 In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"), which establishes accounting and reporting standards for derivative instruments. Statement No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on the type of hedge transaction. For fair value hedge transactions in which the Company is hedging changes in an asset's, liability's or firm commitment's fair value, changes in the fair value of the derivative instruments will generally be offset in the income statement by changes in the hedged item's fair value. For cash flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. To the extent any hedges are determined to be ineffective, all or a portion of the change in value of the derivative will be recognized currently in earnings. This statement is effective for fiscal years beginning after June 15, 2000. The adoption of Statement No. 133 did not have a material impact on the Company's results of operation or financial position. 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 became effective for fiscal years beginning after December 15, 1998. The adoption of SoP No. 97-3 did not have a material effect on the results of operations or financial position of the Company. M. Earnings Per Share Earnings per share ("EPS") for the years ended December 31, 2000, 1999, and 1998 are based on a weighted average of the number of shares outstanding during each year. The Company's EPS is based on net income for both basic and diluted earnings per share. The weighted average shares outstanding which were utilized in the calculation of basic earnings per share differ from the weighted average shares outstanding used in the calculation of diluted earnings per share due to the effect of dilutive employee stock options and nonvested stock grants. Options to purchase shares of common stock whose exercise prices are greater than the average market price of the common shares are not included in the computation of diluted earnings per share because the effect would be antidilutive. N. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. Two - -------------------------------------------------------------------------------- Discontinued Operations During the second quarter of 1999, the Company approved a plan to exit its group life and health insurance business, consisting of its Employee Benefit Services ("EBS") business, its Affinity Group Underwriters ("AGU") business and its accident and health assumed reinsurance pool business ("reinsurance pool business"). During the third quarter of 1998, the Company ceased writing new premiums in the reinsurance pool business, subject to certain contractual obligations. Prior to 1999, these businesses comprised substantially all of the former Corporate Risk Management Services segment. Accordingly, the operating results of the discontinued segment, including its reinsurance pool business, have been reported in the Consolidated Statements of Income as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB Opinion No. 30"). In the third quarter of 1999, the operating results from the discontinued segment were adjusted to reflect the recording of additional reserves related to accident claims from prior years. The Company also recorded a $30.5 million loss, net of taxes, on the disposal of this segment, consisting of after tax losses from the run-off of the group life and health business of approximately $46.9 million, partially offset by net proceeds from the sale of 57 the EBS business of approximately $16.4 million. Subsequent to a measurement date of June 30, 1999, approximately $18.6 million of the aforementioned $46.9 million loss has been generated from the operations of the discontinued business. In March of 2000, the Company transferred its EBS business to Great-West Life and Annuity Insurance Company of Denver and received consideration of approximately $22 million, based on renewal rights for existing policies. Additional consideration may be received in 2001, based on premium in force as of March 2001. However, the Company retained policy liabilities estimated at $153.0 million at December 31, 2000 related to this business. As permitted by APB Opinion No. 30, the Consolidated Balance Sheets have not been segregated between continuing and discontinued operations. At December 31, 2000 and 1999, the discontinued segment had assets of approximately $497.9 million and $536.2 million, respectively, consisting primarily of invested assets, premiums and fees receivable, and reinsurance recoverables, and liabilities of approximately $460.0 million and $485.9 million, respectively, consisting primarily of policy liabilities. Revenues for the discontinued operations were $207.7 million, $367.0 million and $398.5 million for the years ended December 31, 2000, 1999 and 1998, respectively. Three - -------------------------------------------------------------------------------- Significant Transactions As of December 31, 2000, the Company has repurchased approximately $436.3 million, or approximately 7.9 million shares, of its common stock under programs authorized by the Board of Directors (the "Board"). The Company repurchased approximately 1.9 million shares at a cost of approximately $103.4 million in 2000 while share repurchases were approximately 4.5 million at a cost of approximately $250.2 million in 1999. As of December 31, 2000, the Board had authorized total stock repurchases of $500.0 million, leaving approximately $63.7 million available to the Company for future repurchases. During the second quarter of 2000, the Company adopted a formal company-wide restructuring plan. This plan is the result of a corporate initiative that began in the fall of 1999, intended to reduce expenses and enhance revenues. This plan consists of various initiatives including a series of internal reorganizations, consolidations in home office operations, consolidations in field offices, changes in distribution channels and product changes. As a result of the Company's restructuring plan, it recognized a pre-tax charge of $21.4 million during 2000 as reflected in restructuring costs in the Consolidated Statements of Income. Approximately $5.7 million of this charge relates to severance and other employee related costs resulting from the elimination of approximately 360 positions, of which 213 employees have been terminated as of December 31, 2000. All levels of employees, from staff to senior management, were affected by the restructuring. In addition, approximately $15.7 million of this charge relates to other restructuring costs, consisting of onetime project costs, lease cancellations and the present value of idle leased space. As of December 31, 2000, the Company has made payments of approximately $16.4 million related to this restructuring plan, of which approximately $3.9 million relates to severance and other employee related costs. Effective January 1, 1999, the Company entered into a whole account aggregate excess of loss reinsurance agreement, which provides coverage for the 1999 accident year for the Company's property and casualty business. The program covered 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 coverage limit for losses and allocated LAE is $150.0 million. 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 50.0-67.5% 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 net benefits of $9.8 million and $15.9 million for the years ended December 31, 2000 and 1999, respectively, based on estimates of losses and allocated loss adjustment expenses for accident year 1999. On October 29, 1998, the Company announced that it had adopted a formal restructuring plan for its Risk Management segment. As a result of this restructuring initiative, the Company recognized a pre-tax loss of $9.0 million in 1998. This loss was reduced by $1.9 million and $0.7 million during 1999 and 2000, respectively. The $1.9 million reduction resulted from the reinstatement of 66 positions, whereas the $0.7 million reduction resulted from anticipated idle lease space subsequently utilized. Payments of approximately $0.7 million, $4.7 million and $0.1 million have been made by the Company in 2000, 1999 and 1998, respectively. 58 Effective July 1, 1998, the Company entered into a reinsurance agreement that cedes current and future underwriting losses, including unfavorable development of prior year reserves, up to a $40.0 million maximum, relating to the Company's reinsurance pool business. These pools consist primarily of the Company's assumed stop loss business, small group managed care pools, long-term disability and long-term care pools, student accident and special risk business. The agreement is consistent with management's decision to exit this line of business. As a result of this transaction, the Company recognized a $25.3 million pre-tax loss in the third quarter of 1998. This loss is reported as part of the discontinued operations of the Company. Four - -------------------------------------------------------------------------------- Investments A. Summary of Investments The Company accounts for its investments, all of which are classified as available-for-sale, in accordance with the provisions of Statement No. 115. The amortized cost and fair value of available-for-sale fixed maturities and equity securities were as follows: DECEMBER 31 2000 - -------------------------------------------------------------------------------- (IN MILLIONS) GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST(1) GAINS LOSSES VALUE U.S. Treasury securities and U.S. government and agency securities $ 83.6 $ 3.9 $ 1.6 $ 85.9 States and political subdivisions 1,966.7 87.9 36.1 2,018.5 Foreign governments 52.1 2.6 0.8 53.9 Corporate fixed maturities 5,071.9 119.4 223.6 4,967.7 Mortgage-backed securities 579.0 18.3 2.8 594.5 - -------------------------------------------------------------------------------- Total fixed maturities $7,753.3 $ 232.1 $ 264.9 $7,720.5 ================================================================================ Equity securities $ 60.0 $ 32.7 $ 7.2 $ 85.5 ================================================================================ DECEMBER 31 1999 - -------------------------------------------------------------------------------- (IN MILLIONS) GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST(1) GAINS LOSSES VALUE U.S. Treasury securities and U.S. government and agency securities $ 185.0 $ 2.6 $ 2.0 $ 185.6 States and political subdivisions 2,189.8 26.3 78.5 2,137.6 Foreign governments 89.0 3.1 0.2 91.9 Corporate fixed maturities 4,211.9 73.8 175.1 4,110.6 Mortgage-backed securities 419.3 1.8 13.0 408.1 - -------------------------------------------------------------------------------- Total fixed maturities $7,095.0 $ 107.6 $ 268.8 $6,933.8 ================================================================================ Equity securities $ 49.5 $ 35.1 $ 1.4 $ 83.2 ================================================================================ (1) Amortized cost for fixed maturities and cost for equity securities In connection with AFLIAC's voluntary withdrawal of its license in New York, AFLIAC agreed with the New York Department of Insurance to maintain, through a custodial account in New York, a security deposit, the market value of which will at all times equal 102% of all outstanding liabilities of AFLIAC for New York policyholders, claimants and creditors. At December 31, 2000, the amortized cost and market value of these assets on deposit in New York were $186.7 million and $189.8 million, respectively. At December 31, 1999, the amortized cost and market value of these assets on deposit were $196.4 million and $193.0 million, respectively. In addition, fixed maturities, excluding those securities on deposit in New York, with an amortized cost of $115.8 million and $112.7 million were on deposit with various state and governmental authorities at December 31, 2000 and 1999, respectively. There were no contractual fixed maturity investment commitments at December 31, 2000. The amortized cost and fair value by maturity periods for fixed maturities are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or the Company may have the right to put or sell the obligations back to the issuers. Mortgage backed securities are included in the category representing their ultimate maturity. DECEMBER 31 2000 - -------------------------------------------------------------------------------- (IN MILLIONS) AMORTIZED FAIR COST VALUE Due in one year or less $ 422.4 $ 417.5 Due after one year through five years 3,055.2 2,998.4 Due after five years through ten years 1,933.3 1,883.1 Due after ten years 2,342.4 2,421.5 - -------------------------------------------------------------------------------- Total $7,753.3 $7,720.5 ================================================================================ 59 Unrealized gains and losses on available-for-sale and other securities, are summarized as follows: FOR THE YEARS ENDED DECEMBER 31 - -------------------------------------------------------------------------------- (IN MILLIONS) EQUITY FIXED SECURITIES 2000 MATURITIES AND OTHER(1) TOTAL Net (depreciation) appreciation, beginning of year $ (97.0) $ 21.7 $ (75.3) - -------------------------------------------------------------------------------- Net appreciation (depreciation) on available-for-sale securities 144.6 (0.6) 144.0 Net depreciation from the effect on deferred policy acquisition costs and on policy liabilities (36.1) -- (36.1) (Provision) benefit for deferred federal income taxes (38.0) 0.2 (37.8) - -------------------------------------------------------------------------------- 70.5 (0.4) 70.1 - -------------------------------------------------------------------------------- Net (depreciation) appreciation, end of year $ (26.5) $ 21.3 $ (5.2) ================================================================================ 1999 Net appreciation, beginning of year $ 81.9 $ 98.6 $ 180.5 - -------------------------------------------------------------------------------- Net depreciation on available-for-sale securities (352.7) (119.6) (472.3) Net appreciation from the effect on deferred policy acquisition costs and on policy liabilities 78.5 -- 78.5 Benefit for deferred federal income taxes 95.3 42.7 138.0 - -------------------------------------------------------------------------------- (178.9) (76.9) (255.8) - -------------------------------------------------------------------------------- Net (depreciation) appreciation, end of year $ (97.0) $ 21.7 $ (75.3) ================================================================================ 1998 Net appreciation, beginning of year $ 133.3 $ 84.6 $ 217.9 - -------------------------------------------------------------------------------- Net depreciation on available-for-sale securities (108.8) (1.5) (110.3) Purchased minority interest related to the acquisition of minority interest in Citizens 10.7 10.7 21.4 Net appreciation from the effect on deferred policy acquisition costs and on policy liabilities 6.2 -- 6.2 Benefit for deferred federal income taxes and minority interest 40.5 4.8 45.3 - -------------------------------------------------------------------------------- (51.4) 14.0 (37.4) - -------------------------------------------------------------------------------- Net appreciation, end of year $ 81.9 $ 98.6 $ 180.5 ================================================================================ (1) Includes net appreciation (depreciation) on other investments of $1.8 million, $(5.1) million, and $0.8 million in 2000, 1999 and 1998, respectively. B. Mortgage Loans and Real Estate AFC's mortgage loans and real estate are diversified by property type and location. Mortgage loans are collateralized by the related properties and generally are no more than 75% of the property's value at the time the original loan is made. At December 31, 2000 there were no real estate properties in the Company's investment portfolio. Previously, real estate investments were obtained primarily through foreclosures. The carrying values of mortgage loans and real estate investments net of applicable reserves were $472.7 million and $533.8 million at December 31, 2000 and 1999, respectively. Reserves for mortgage loans were $4.4 million and $5.8 million at December 31, 2000 and 1999, respectively. There were no non-cash investing activities, including real estate acquired through foreclosure of mortgage loans, in 2000, 1999 and 1998. There were no contractual commitments to extend credit under commercial mortgage loan agreements at December 31, 2000. Mortgage loans and real estate investments comprised the following property types and geographic regions: DECEMBER 31 2000 1999 - ------------------------------------------------------------------------------- (IN MILLIONS) Property type: Office building $269.5 $301.5 Industrial / warehouse 82.2 83.6 Retail 81.9 92.2 Residential 32.5 50.5 Other 11.0 11.8 Valuation allowances (4.4) (5.8) - ------------------------------------------------------------------------------- Total $472.7 $533.8 =============================================================================== Geographic region: Pacific $138.7 $133.6 South Atlantic 128.3 132.2 East North Central 60.4 62.7 New England 53.7 90.8 West South Central 41.4 40.7 Middle Atlantic 35.7 50.3 Other 18.9 29.3 Valuation allowances (4.4) (5.8) - ------------------------------------------------------------------------------- Total $472.7 $533.8 =============================================================================== At December 31, 2000, scheduled mortgage loan maturities were as follows: 2001 - $47.4 million; 2002 - $43.0 million; 2003 - $39.2 million; 2004 - $74.9 million; 2005 - $27.4 million and $240.8 million thereafter. Actual maturities could differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties and loans may be refinanced. During 2000, the Company did not refinance any mortgage loans based on terms which differed from those granted to new borrowers. 60 C. Mortgage Loans Investment Valuation Allowances Mortgage loans investment valuation allowances which have been deducted in arriving at investment carrying values as presented in the Consolidated Balance Sheets and changes thereto are shown below. FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Balance at beginning of year $ 5.8 $11.5 $20.7 Provisions (1.3) (2.4) (6.8) Write-offs 0.1 3.3 2.4 - ------------------------------------------------------------------------------- Balance at end of year $ 4.4 $ 5.8 $11.5 =============================================================================== Provisions on mortgages during 2000, 1999 and 1998 reflect the release of redundant specific reserves. The carrying value of impaired loans was $3.4 million and $18.0 million, with related reserves of $0.4 million and $0.8 million as of December 31, 2000 and 1999, respectively. All impaired loans were reserved for as of December 31, 2000 and 1999. The average carrying value of impaired loans was $12.1 million, $21.0 million and $26.1 million, with related interest income while such loans were impaired, of $1.4 million, $2.1 million and $3.2 million as of December 31, 2000, 1999 and 1998, respectively. D. Futures Contracts AFC purchases long futures contracts and sells short futures contracts on margin to hedge against interest rate fluctuations associated with the sale of Guaranteed Investment Contracts ("GICs") and other funding agreements, as well as the reinvestment of fixed maturities. The Company is exposed to interest rate risk from the time of sale of the GIC until the receipt of the deposit and purchase of the underlying asset to back the liability. Similarly, the Company is exposed to interest rate risk on reinvestments of fixed maturities from the time of maturity until the purchase of new fixed maturities. The Company only trades futures contracts with nationally recognized brokers, which the Company believes have adequate capital to ensure that there is minimal danger of default. The Company does not require collateral or other securities to support financial instruments with credit risk. The notional amount of futures contracts outstanding was $87.5 million and $37.1 million at December 31, 2000 and 1999, respectively. The notional amounts of the contracts represent the extent of the Company's investment but not future cash requirements, as the Company generally settles open positions prior to maturity. The maturity of all futures contracts outstanding are less than one year. The fair value of futures contracts outstanding was $88.7 million and $36.8 million at December 31, 2000 and 1999, respectively. Gains and losses on hedge contracts related to interest rate fluctuations are deferred and recognized in income over the period being hedged corresponding to related guaranteed investment contracts or fixed maturities purchases. If instruments being hedged by futures contracts are disposed, any unamortized gains or losses on such contracts are included in the determination of the gain or loss from the disposition. Deferred hedging losses were $3.6 million and $0.9 million in 2000 and 1999, respectively. Gains and losses on hedge contracts that are deemed ineffective by the Company are realized immediately. There were $0.3 million and $0.1 million of gains realized on ineffective hedges in 2000 and 1998, respectively. There were no gains or losses in 1999. A reconciliation of the notional amount of futures contracts is as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Contracts outstanding, beginning of year $ 37.1 $ 92.7 $ -- New contracts 1,539.1 947.0 1,117.5 Contracts expired (1,488.7) (1,002.6) (1,024.8) - ------------------------------------------------------------------------------- Contracts outstanding, end of year $ 87.5 $ 37.1 $ 92.7 =============================================================================== E. Foreign Currency and Compound Swap Contracts The Company enters into foreign currency swap contracts with swap counterparties to hedge foreign currency exposure on specific fixed maturities. Additionally, the Company enters into compound foreign currency/interest rate swap contracts to hedge foreign currency and interest rate exposure on specific trust obligations backed by funding agreements. Under these swap contracts, the Company agrees to exchange interest and principal related to foreign fixed maturities and trust obligations payable in foreign currencies, at current exchange rates, for the equivalent payment in U.S. dollars translated at a specific currency exchange rate. The primary risk associated with these transactions is the inability of the counterparty to meet its obligation. The Company regularly assesses the financial strength of its counterparties and generally enters into forward or swap agreements with counterparties rated "A" or better by nationally recognized rating agencies. The Company's maximum exposure to counterparty credit risk is the difference in payments exchanged, which at December 31, 2000 and 1999, was a net receivable of $5.7 million and a net payable of $0.2 million, respectively. 61 The fair values of the foreign currency swap contracts and compound foreign currency/interest rate swap contracts outstanding were $(35.9) million and $(4.7) million at December 31, 2000 and 1999, respectively. Changes in the fair value of contracts hedging fixed maturities are reported as an unrealized gain or loss, consistent with the underlying hedged security. Changes in the foreign currency portion of the fair value of contracts hedging trust obligations backed by funding agreements are reported as other operating income, consistent with the underlying hedged liability. Changes in the interest rate portion of the fair value of contracts hedging trust obligations backed by funding agreements are reported as unrealized gains and losses, consistent with the hedged item. The net decrease in other operating income related to the change in the foreign currency portion of the fair value of these contracts was $8.9 million in 2000 and $2.6 million in 1999. The change in unrealized gains and losses related to the change in both the interest rate portion of the fair value of the contracts hedging trust obligations backed by funding agreements, as well as the change in the fair value of the contracts hedging foreign fixed maturities, was $(22.2) million and $(3.4) million in 2000 and 1999, respectively. The Company does not require collateral or other security to support financial instruments with credit risk. The difference between amounts paid and received on foreign currency and compound swap contracts is reflected in the net investment income related to the underlying assets. This amount was $(10.0) million in 2000 and was not material in 1999 and 1998. Any gain or loss on the termination of swap contracts is deferred and recognized with any gain or loss on the hedged transaction. The Company had no deferred gain or loss on foreign currency and compound swap contracts in 2000 or 1999. A reconciliation of the notional amount of foreign currency and compound swap contracts is as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Contracts outstanding, beginning of year $ 71.5 $ 42.6 $ 42.6 New contracts 544.4 52.9 -- Contracts expired (8.3) (24.0) -- - -------------------------------------------------------------------------------- Contracts outstanding, end of year $607.6 $ 71.5 $ 42.6 ================================================================================ Expected maturities of such foreign currency and compound swap contracts outstanding at December 31, 2000 are $143.9 million in 2001, $91.4 million in 2003, $347.7 million in 2005 and $24.6 million thereafter. There are no expected maturities of such foreign currency and compound swap contracts in 2002 and 2004. F. Interest Rate Swap Contracts The Company enters into interest rate swap contracts to hedge exposure to interest rate fluctuations. Specifically, for floating rate funding agreement liabilities that are matched with fixed rate securities, the Company manages the interest rate risk by hedging with interest rate swap contracts. Under these swap contracts, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated on an agreed-upon notional principal amount. As with foreign currency swap contracts, the primary risk associated with these transactions is the inability of the counterparty to meet its obligation. The Company regularly assesses the financial strength of its counterparties and generally enters into forward or swap agreements with counterparties rated "A" or better by nationally recognized rating agencies. Because the underlying principal of swap contracts is not exchanged, the Company's maximum exposure to counterparty credit risk is the difference in payments exchanged, which at December 31, 2000 and 1999 were net payables of $12.0 million and $4.2 million, respectively. The Company does not require collateral or other security to support financial instruments with credit risk. The net amount receivable or payable is recognized over the life of the swap contract as an adjustment to net investment income. The increase (decrease) in net investment income related to interest rate swap contracts was $4.2 million, $(7.2) million and $(2.8) million for the years ended December 31, 2000, 1999 and 1998, respectively. The fair value of interest rate swap contracts outstanding was $(22.8) million and $33.2 million at December 31, 2000 and 1999, respectively. Changes in the fair value of contracts are reported as an unrealized gain or loss, consistent with the underlying hedged security. Any gain or loss on the termination of interest rate swap contracts accounted for as hedges are deferred and recognized with any gain or loss on the hedged transaction. The Company had no deferred gain or loss on interest rate swap contracts in 2000 or 1999. A reconciliation of the notional amount of interest rate swap contracts is as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Contracts outstanding, beginning of year $1,049.5 $1,112.6 $ 244.1 New contracts 630.0 905.4 873.5 Contracts terminated (259.6) (888.5) -- Contracts expired -- (80.0) (5.0) - ------------------------------------------------------------------------------- Contracts outstanding, end of year $1,419.9 $1,049.5 $1,112.6 =============================================================================== Expected maturities of such interest rate swap contracts outstanding at December 31, 2000 are $43.1 million in 2001, $233.5 million in 2002, $391.0 million in 2003, $307.3 million in 2004, $425.0 million in 2005 and $20.0 million thereafter. 62 G. Other Swap Contracts The Company enters into insurance portfolio-linked and credit default swap contracts for investment purposes. Under the insurance portfolio-linked swap contracts, the Company agrees to exchange cash flows according to the performance of a specified underwriter's portfolio of insurance business. As with interest rate swap contracts, the primary risk associated with insurance portfolio-linked swap contracts is the inability of the counterparty to meet its obligation. Under the terms of the credit default swap contracts, the Company assumes the default risk of a specific high credit quality issuer in exchange for a stated annual premium. In the case of default, the Company will pay the counterparty par value for a pre-determined security of the issuer. The primary risk associated with these transactions is the default risk of the underlying companies. The Company regularly assesses the financial strength of its counterparties and the underlying companies in default swap contracts, and generally enters into forward or swap agreements with companies rated "A" or better by nationally recognized rating agencies. Because the underlying principal of swap contracts is not exchanged, the Company's maximum exposure to counterparty credit risk is the difference in payments exchanged, which at December 31, 2000 and 1999, was not material to the Company. The Company does not require collateral or other security to support financial instruments with credit risk. The swap contracts are marked to market with any gain or loss recognized currently. The fair values of swap contracts outstanding were $(0.3) million at December 31, 2000 and 1999. The net amount receivable or payable under insurance portfolio-linked swap contracts is recognized when the contracts are marked to market. The net (decrease) increase in realized investment gains related to these contracts was $(0.7) million, $(0.2) million, and $1.0 million for the years ended December 31, 2000, 1999 and 1998, respectively. The stated annual premium under credit default swap contracts is recognized currently in net investment income. The net increase to investment income related to credit default swap contracts was $0.2 million, $0.4 million, and $0.2 million for the years ended December 31, 2000, 1999, and 1998, respectively. A reconciliation of the notional amount of other swap contracts is as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Contracts outstanding, beginning of year $ 190.0 $ 255.0 $ 15.0 New contracts -- 50.0 266.3 Contracts expired -- (115.0) (26.3) Contracts terminated (150.0) -- -- - ------------------------------------------------------------------------------- Contracts outstanding, end of year $ 40.0 $ 190.0 $ 255.0 =============================================================================== At December 31, 2000, all other swap contracts are expected to mature in 2001. H. Other At December 31, 2000 and 1999, AFC had no concentration of investments in a single investee exceeding 10% of shareholders' equity. Five - -------------------------------------------------------------------------------- Investment Income and Gains and Losses A. Net Investment Income The components of net investment income were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Fixed maturities $529.1 $524.8 $517.9 Mortgage loans 40.8 45.5 57.6 Equity securities 2.0 2.4 7.2 Policy loans 14.3 12.7 11.9 Other long-term investments 7.3 12.9 7.1 Short-term investments 13.8 33.1 17.7 - ------------------------------------------------------------------------------- Gross investment income 607.3 631.4 619.4 Less investment expenses (15.4) (15.7) (15.0) - ------------------------------------------------------------------------------- Net investment income $591.9 $615.7 $604.4 =============================================================================== The Company had fixed maturities with a carrying value of $7.5 million and $1.4 million on non-accrual status at December 31, 2000 and 1999, respectively. There were no mortgage loans on non-accrual status at December 31, 2000 and 1999. The effect of non-accruals, compared with amounts that would have been recognized in accordance with the original terms of the investments, was a reduction in net investment income of $3.6 million and $2.0 million in 2000 and 1999, respectively, and had no impact in 1998. The payment terms of mortgage loans may from time to time be restructured or modified. The investment in restructured mortgage loans, based on amortized cost, amounted to $3.8 million and $18.8 million at December 31, 2000 and 1999, respectively. Interest income on restructured mortgage loans that would have been recorded in accordance with the original terms of such loans amounted to $1.7 million, $2.5 million and $3.3 million and in 2000, 1999 and 1998, respectively. Actual interest income on these loans included in net investment income aggregated $1.4 million, $1.8 million and $3.3 million in 2000, 1999 and 1998, respectively. 63 There were no mortgage loans which were non-income producing for the years ended December 31, 2000 and 1999. There were, however, fixed maturities with a carrying value of $3.8 million and $2.0 million which were non-income producing for the years ended December 31, 2000 and 1999, respectively. Included in other long-term investments is income from limited partnerships of $7.8 million and $7.2 million in 2000 and 1999, respectively, and losses of $6.3 million in 1998. B. Net Realized Investment Gains and Losses Realized gains (losses) on investments were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Fixed maturities $(146.3) $ (62.6) $ (13.3) Mortgage loans 1.3 2.5 8.8 Equity securities 3.8 141.8 63.7 Other long-term investments 5.9 9.3 -- - ------------------------------------------------------------------------------- Net realized investment (losses) gains $(135.3) $ 91.0 $ 59.2 =============================================================================== The proceeds from voluntary sales of available-for-sale securities and the gross realized gains and gross realized losses on those sales were as follows: FOR THE YEARS ENDED DECEMBER 31 - -------------------------------------------------------------------------------- (IN MILLIONS) PROCEEDS FROM GROSS GROSS 2000 VOLUNTARY SALES GAINS LOSSES Fixed maturities $1,912.3 $ 10.9 $ 94.0 Equity securities $ 13.1 $ 4.0 $ 0.2 ================================================================================ 1999 Fixed maturities $1,884.3 $ 20.4 $ 37.5 Equity securities $ 420.1 $ 149.4 $ 7.6 ================================================================================ 1998 Fixed maturities $ 899.5 $ 13.5 $ 11.1 Equity securities $ 258.7 $ 72.8 $ 9.0 ================================================================================ C. Other Comprehensive Income Reconciliation The following table provides a reconciliation of gross unrealized (losses) gains to the net balance shown in the Statements of Comprehensive Income: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Unrealized (losses) gains on securities: Unrealized holding losses arising during period, (net of tax benefit and minority interest of $12.9 million, $108.0 million and $20.7 million in 2000, 1999 and 1998, respectively) $ (24.1) $(200.0) $ (1.1) Less: reclassification adjustment for (losses) gains included in net income (net of taxes (benefit) and minority interest of $(50.7) million, $30.0 million and $24.6 million in 2000, 1999 and 1998, respectively) (94.2) 55.8 36.3 - ------------------------------------------------------------------------------- Other comprehensive income (loss) $ 70.1 $(255.8) $ (37.4) =============================================================================== Six - -------------------------------------------------------------------------------- Fair Value Disclosures of Financial Instruments Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", requires disclosure of fair value information about certain financial instruments (insurance contracts, real estate, goodwill and taxes are excluded) for which it is practicable to estimate such values, whether or not these instruments are included in the balance sheet. The fair values presented for certain financial instruments are estimates which, in many cases, may differ significantly from the amounts which could be realized upon immediate liquidation. In cases where market prices are not available, estimates of fair value are based on discounted cash flow analyses which utilize current interest rates for similar financial instruments which have comparable terms and credit quality. Included in the fair value of fixed maturities are swap contracts used to hedge fixed maturities with a fair value of $(47.1) million and $31.1 million at December 31, 2000 and 1999, respectively. In addition, the Company held futures contracts with a carrying value of $(3.6) million and $(0.9) million at December 31, 2000 and 1999, respectively. The fair value of these contracts was $88.7 million and $36.8 million at December 31, 2000 and 1999, respectively. The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and Cash Equivalents For these short-term investments, the carrying amount approximates fair value. Fixed Maturities Fair values are based on quoted market prices, if available. If a quoted market price is not available, fair values are estimated using independent pricing sources or internally developed pricing models using discounted cash flow analyses. 64 Equity Securities Fair values are based on quoted market prices, if available. If a quoted market price is not available, fair values are estimated using independent pricing sources or internally developed pricing models. Mortgage Loans Fair values are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair value of below investment grade mortgage loans are limited to the lesser of the present value of the cash flows or book value. Policy Loans The carrying amount reported in the Consolidated Balance Sheets approximates fair value since policy loans have no defined maturity dates and are inseparable from the insurance contracts. Company Owned Life Insurance Fair values are based on the current cash surrender value of the policy. This value is dependent on the fair value of the underlying securities which is based on quoted market prices, if available. If a quoted market price is not available, fair values are estimated using independent pricing sources or internally developed pricing models. Investment Contracts (Without Mortality Features) Fair values for the Company's liabilities under guaranteed investment type contracts are estimated using discounted cash flow calculations using current interest rates for similar contracts with maturities consistent with those remaining for the contracts being valued. Liabilities under supplemental contracts without life contingencies are estimated based on current fund balances and other individual contract funds represent the present value of future policy benefits. Other liabilities are based on current surrender values. Trust Instruments Supported by Funding Obligations Fair values are estimated using discounted cash flow calculations using current interest rates for similar contracts with maturities consistent with those remaining for the contracts being valued. Debt The carrying value of short-term debt reported in the Consolidated Balance Sheets approximates fair value. The fair value of long-term debt was estimated using market quotes, when available, and when not available, discounted cash flow analyses. Mandatorily Redeemable Preferred Securities of a Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company Fair values are based on quoted market prices, if available. If a quoted market price is not available, fair values are estimated using independent pricing sources. The estimated fair values of the financial instruments were as follows:
DECEMBER 31 2000 1999 - ------------------------------------------------------------------------------------------------------------- (IN MILLIONS) CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE Financial Assets Cash and cash equivalents $ 279.2 $ 279.2 $ 442.2 $ 442.2 Fixed maturities 7,720.5 7,720.5 6,933.8 6,933.8 Equity securities 85.5 85.5 83.2 83.2 Mortgage loans 472.7 490.1 521.2 521.9 Policy loans 189.6 189.6 170.5 170.5 Company owned life insurance 65.6 65.6 -- -- - ------------------------------------------------------------------------------------------------------------- $8,813.1 $8,830.5 $8,150.9 $8,151.6 ============================================================================================================= Financial Liabilities Guaranteed investment contracts $1,636.5 $1,663.3 $1,316.0 $1,341.4 Supplemental contracts without life contingencies 40.7 40.7 48.8 48.8 Dividend accumulations 88.5 88.5 88.1 88.1 Other individual contract deposit funds 45.0 44.9 48.4 48.2 Other group contract deposit funds 323.1 319.0 602.9 583.5 Individual fixed annuity contracts 1,026.1 991.7 1,092.5 1,057.1 Trust instruments supported by funding obligations 621.5 620.5 50.6 49.6 Short-term debt 56.6 56.6 45.0 45.0 Long-term debt 199.5 194.7 199.5 187.4 Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 280.2 300.0 292.5 - ------------------------------------------------------------------------------------------------------------- $4,337.4 $4,300.1 $3,791.8 $3,741.6 =============================================================================================================
65 Seven - -------------------------------------------------------------------------------- Closed Block Included in other income in the Consolidated Statements of Income in 2000, 1999 and 1998 is a net pre-tax contribution from the Closed Block of $6.3 million, $13.8 million and $10.4 million, respectively. Summarized financial information of the Closed Block as of December 31, 2000 and 1999 and for the periods ended December 31, 2000, 1999 and 1998 is as follows: DECEMBER 31 2000 1999 - -------------------------------------------------------------------------------- (IN MILLIONS) Assets Fixed maturities, at fair value (amortized cost of $400.3 and $387.4, respectively) $397.5 $372.9 Mortgage loans 144.9 136.3 Policy loans 191.7 201.1 Cash and cash equivalents 1.9 22.6 Accrued investment income 14.6 14.0 Deferred policy acquisition costs 11.0 13.1 Other assets 6.4 12.3 - -------------------------------------------------------------------------------- Total assets $768.0 $772.3 ================================================================================ Liabilities Policy liabilities and accruals $828.9 $835.2 Other liabilities 0.8 6.9 - -------------------------------------------------------------------------------- Total liabilities $829.7 $842.1 ================================================================================ FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Revenues Premiums and other income $ 49.9 $ 52.1 $ 55.4 Net investment income 53.6 53.8 53.3 Realized investment (losses) gains (5.4) (0.6) 0.1 - ------------------------------------------------------------------------------- Total revenues 98.1 105.3 108.8 - ------------------------------------------------------------------------------- Benefits and expenses Policy benefits 89.5 88.9 95.0 Policy acquisition expenses 2.1 2.5 2.7 Other operating expenses 0.2 0.1 0.7 - ------------------------------------------------------------------------------- Total benefits and expenses 91.8 91.5 98.4 - ------------------------------------------------------------------------------- Contribution from the Closed Block $ 6.3 $ 13.8 $ 10.4 =============================================================================== Cash flows Cash flows from operating activities: Contribution from the Closed Block $ 6.3 $ 13.8 $ 10.4 Change in: Deferred policy acquisition costs 2.1 2.5 2.6 Policy liabilities and accruals (12.0) (13.1) (13.5) Accrued investment income (0.6) 0.1 -- Other assets 5.9 (8.3) 2.4 Expenses and taxes payable (10.1) (2.9) (2.9) Other, net 5.3 0.8 0.3 - ------------------------------------------------------------------------------- Net cash used in operating activities (3.1) (7.1) (0.7) - ------------------------------------------------------------------------------- Cash flows from investing activities: Sales, maturities and repayments of investments 133.3 139.0 83.6 Purchases of investments (160.3) (128.5) (106.5) Other, net 9.4 9.8 7.9 - ------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (17.6) 20.3 (15.0) - ------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (20.7) 13.2 (15.7) Cash and cash equivalents, beginning of year 22.6 9.4 25.1 - ------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 1.9 $ 22.6 $ 9.4 =============================================================================== There were no valuation allowances on mortgage loans at December 31, 2000, 1999 and 1998, respectively. 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. 66 Eight - -------------------------------------------------------------------------------- Debt Short and long-term debt consisted of the following: DECEMBER 31 2000 1999 - -------------------------------------------------------------------------------- (IN MILLIONS) Short-term Commercial paper $ 56.6 $ 45.0 ================================================================================ Long-term Senior Debentures (unsecured) $199.5 $199.5 ================================================================================ AFC issues commercial paper primarily to manage imbalances between operating cash flows and existing commitments primarily in its premium financing business which is part of the Risk Management segment. Commercial paper borrowing arrangements are supported by a credit agreement. At December 31, 2000, the weighted average interest rate for outstanding commercial paper was approximately 6.72%. At December 31, 2000 the Company had $150.0 million available for borrowing under a committed syndicated credit agreement which expires on May 28, 2001. 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. Senior Debentures of the Company have a $200.0 million face value, pay interest semiannually at a rate of 7 5/8%, and mature on October 16, 2025. The Senior Debentures are subject to certain restrictive covenants, including limitations on issuance of or disposition of stock of restricted subsidiaries and limitations on liens. The Company is in compliance with all covenants. Interest expense was $21.4 million, $22.0 million and $23.4 million in 2000, 1999 and 1998, respectively. Interest expense included $15.3 million related to the Company's Senior Debentures for each year. Interest expense related to borrowings under the credit agreements were approximately $0.1 million, $1.0 million and $0.7 million in 2000, 1999, and 1998, respectively. All interest expense is recorded in other operating expenses. Nine - -------------------------------------------------------------------------------- Federal Income Taxes Provisions for federal income taxes have been calculated in accordance with the provisions of Statement No. 109. A summary of the federal income tax expense (benefit) in the Consolidated Statements of Income is shown below: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Federal income tax expense (benefit) Current $ 1.2 $ 88.1 $ 72.5 Deferred 1.5 18.8 (16.4) - ------------------------------------------------------------------------------- Total $ 2.7 $106.9 $ 56.1 =============================================================================== The federal income taxes attributable to the consolidated results of operations are different from the amounts determined by multiplying income before federal income taxes by the statutory federal income tax rate. The sources of the difference and the tax effects of each were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Expected federal income tax expense $ 76.5 $163.8 $104.9 Tax-exempt interest (33.2) (37.4) (38.9) Dividend received deduction (10.8) (3.8) (5.1) Changes in tax reserve estimates for prior years' dividend received deduction (13.3) -- -- Changes in other tax reserve estimates (7.5) (8.7) 2.3 Tax credits (10.3) (8.5) (8.5) Other, net 1.3 1.5 1.4 - ------------------------------------------------------------------------------- Federal income tax expense $ 2.7 $106.9 $ 56.1 =============================================================================== 67 The deferred income tax (asset) liability represents the tax effects of temporary differences attributable to the Company's consolidated federal tax return group. Its components were as follows: DECEMBER 31 2000 1999 - ------------------------------------------------------------------------------- (IN MILLIONS) Deferred tax (assets) liabilities AMT & low income housing credit carryforwards $ (66.5) $ (28.9) Loss reserve discounting (428.2) (439.9) Deferred acquisition costs 479.9 414.2 Employee benefit plans (51.8) (47.4) Investments, net (18.3) (19.3) Discontinued operations (11.9) (11.7) Bad debt reserve (2.5) (2.1) Litigation reserves (8.0) (6.0) Software capitalization 22.4 9.5 Other, net (17.4) (10.1) - ------------------------------------------------------------------------------- Deferred tax asset, net $(102.3) $(141.7) =============================================================================== Gross deferred income tax assets totaled $676.9 million and $716.6 million at December 31, 2000 and 1999, respectively. Gross deferred income tax liabilities totaled $574.6 million and $574.9 million at December 31, 2000 and 1999, respectively. The Company believes, based on its recent earnings history and its future expectations, that the Company's taxable income in future years will be sufficient to realize all deferred tax assets. In determining the adequacy of future income, the Company considered the future reversal of its existing temporary differences and available tax planning strategies that could be implemented, if necessary. At December 31, 2000, there are available alternative minimum tax credit carryforwards and low income housing credit carryforwards of $49.1 million and $17.4 million, respectively. The alternative minimum tax credit carry-forwards have no expiration date, whereas the low income housing credit carryforwards will expire beginning in 2018. The Company's federal income tax returns are routinely audited by the IRS, and provisions are routinely made in the financial statements in anticipation of the results of these audits. The IRS has examined the FAFLIC/AFLIAC consolidated group's federal income tax returns through 1994. The IRS has also examined the former Allmerica P&C consolidated group's federal income tax returns through 1994. The Company has appealed certain adjustments proposed by the IRS with respect to the federal income tax returns for 1992, 1993 and 1994 for the FAFLIC/AFLIAC consolidated group. Also, certain adjustments proposed by the IRS with respect to FAFLIC/AFLIAC's federal income tax returns for 1982 and 1983 remain unresolved. In the Company's opinion, adequate tax liabilities have been established for all years. However, the amount of these tax liabilities could be revised in the near term if estimates of the Company's ultimate liability are revised. Ten - -------------------------------------------------------------------------------- Pension Plans AFC provides retirement benefits to substantially all of its employees under a defined benefit pension plan. This plan is based on a defined benefit cash balance formula, whereby the Company annually provides an allocation to each eligible employee based on a percentage of that employee's salary, similar to a defined contribution plan arrangement. The 2000, 1999 and 1998 allocations were based on 7.0% of each eligible employee's salary. In addition to the cash balance allocation, certain transition group employees, who have met specified age and service requirements as of December 31, 1994, are eligible for a grandfathered benefit based primarily on the employees' years of service and compensation during their highest five consecutive plan years of employment. The Company's policy for the plans is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Components of net periodic pension cost were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Service cost - benefits earned during the year $ 18.5 $ 19.3 $ 19.0 Interest cost 28.6 26.5 25.5 Expected return on plan assets (43.1) (38.9) (34.9) Recognized net actuarial gain (11.2) (0.4) (0.8) Amortization of transition asset (2.2) (2.3) (2.2) Amortization of prior service cost (3.1) (3.3) (2.9) - ------------------------------------------------------------------------------- Net periodic pension (benefit) cost $(12.5) $ 0.9 $ 3.7 =============================================================================== The following table summarizes the status of the plan. At December 31, 2000, the projected benefit obligations exceeded the plans' assets while at December 31, 1999, the plans' assets exceeded their projected benefit obligations. 68 DECEMBER 31 2000 1999 - ------------------------------------------------------------------------------- (IN MILLIONS) Change in benefit obligations: Projected benefit obligation at beginning of year $ 392.7 $ 414.2 Service cost - benefits earned during the year 18.5 19.3 Interest cost 28.6 26.5 Actuarial losses (gains) 37.7 (44.4) Benefits paid (26.6) (22.9) - ------------------------------------------------------------------------------- Projected benefit obligation at end of year 450.9 392.7 - ------------------------------------------------------------------------------- Change in plan assets: Fair value of plan assets at beginning of year 470.6 441.6 Actual return on plan assets (2.5) 51.9 Benefits paid (26.6) (22.9) - ------------------------------------------------------------------------------- Fair value of plan assets at end of year 441.5 470.6 - ------------------------------------------------------------------------------- Funded status of the plan (9.4) 77.9 Unrecognized transition obligation (19.4) (21.6) Unamortized prior service cost (8.9) (12.0) Unrecognized net actuarial gains (6.4) (101.6) - ------------------------------------------------------------------------------- Net pension liability $ (44.1) $ (57.3) =============================================================================== As a result of the Company's merger with Allmerica P&C, certain pension liabilities were reduced to reflect their fair value as of the merger date. These pension liabilities were reduced by $7.5 million and $8.9 million in 2000 and 1999, respectively, which reflects fair value, net of applicable amortization. Determination of the projected benefit obligations was based on weighted average discount rates of 7.25% and 7.75% in 2000 and 1999, respectively, and the assumed long-term rate of return on plan assets was 9.5% in 2000 and 9.0% in 1999. The actuarial present value of the projected benefit obligations was determined using assumed rates of increase in future compensation levels ranging from 5.0% to 5.5%. Plan assets are invested primarily in various separate accounts and the general account of FAFLIC. Plan assets also include 796,462 shares of AFC common stock at December 31, 2000 and 1999 with a market value of $57.7 million and $44.3 million at December 31, 2000 and 1999, respectively. The Company has a defined contribution 401(k) plan for its employees, whereby the Company matches employee elective 401(k) contributions, up to a maximum percentage determined annually by the Board of Directors. During 2000, 1999 and 1998, the Company matched 50% of employees' contributions up to 6.0% of eligible compensation. The total expense related to this plan was $6.1 million, $5.9 million and $5.6 million in 2000, 1999 and 1998, respectively. In addition to this plan, the Company has a defined contribution plan for substantially all of its agents. The Plan expense in 2000, 1999 and 1998 was $3.2 million, $3.1 million and $3.0 million, respectively. Eleven - -------------------------------------------------------------------------------- Other Postretirement Benefit Plans In addition to the Company's pension plans, the Company currently provides postretirement medical and death benefits to certain full-time employees, agents, retirees and their dependents, under a plan sponsored by FAFLIC. Generally, employees become eligible at age 55 with at least 15 years of service. Spousal coverage is generally provided for up to two years after death of the retiree. Benefits include hospital, major medical and a payment at death equal to retirees' final compensation up to certain limits. Effective January 1, 1996, the Company revised these benefits so as to establish limits on future benefit payments and to restrict eligibility to current employees. The medical plans have varying copayments and deductibles, depending on the plan. These plans are unfunded. The plans' funded status reconciled with amounts recognized in the Company's Consolidated Balance Sheets were as follows: DECEMBER 31 2000 1999 - ------------------------------------------------------------------------------- (IN MILLIONS) Change in benefit obligations: Accumulated postretirement benefit obligation at beginning of year $ 66.8 $ 84.0 Service cost 1.9 2.9 Interest cost 4.9 4.6 Actuarial losses (gains) 5.6 (21.2) Benefits paid (3.7) (3.5) - ------------------------------------------------------------------------------- Accumulated postretirement benefit obligation at end of year 75.5 66.8 - ------------------------------------------------------------------------------- Fair value of plan assets at end of year -- -- =============================================================================== Funded status of the plan (75.5) (66.8) Unamortized prior service cost (7.6) (9.8) Unrecognized net actuarial gains (7.7) (13.8) - ------------------------------------------------------------------------------- Accumulated postretirement benefit costs $(90.8) $(90.4) =============================================================================== The components of net periodic postretirement benefit cost were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Service cost $ 1.9 $ 2.9 $ 3.1 Interest cost 4.9 4.6 5.1 Recognized net actuarial (gain) loss (0.5) 0.1 0.1 Amortization of prior service cost (2.2) (2.3) (2.4) - ------------------------------------------------------------------------------- Net periodic postretirement benefit cost $ 4.1 $ 5.3 $ 5.9 =============================================================================== 69 As a result of the Company's merger with Allmerica P&C, certain postretirement liabilities were reduced to reflect their fair value as of the merger date. These postretirement liabilities were reduced by $3.9 million and $4.6 million in 2000 and 1999, respectively, which reflects fair value, net of applicable amortization. For purposes of measuring the accumulated postretirement benefit obligation at December 31, 2000, health care costs were assumed to increase 8.5% in 2001, declining thereafter until the ultimate rate of 5.5% is reached in 2007 and remains at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 2000 by $4.8 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2000 by $0.5 million. Conversely, decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation at December 31, 2000 by $4.2 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2000 by $0.4 million. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% and 7.75% at December 31, 2000 and 1999, respectively. In addition, the actuarial present value of the accumulated postretirement benefit obligation was determined using an assumed rate of increase in future compensation levels of 5.5% for FAFLIC agents. Twelve - -------------------------------------------------------------------------------- Stock-Based Compensation Plans The Company has elected to apply the provisions of APB No. 25 (Accounting Principles Board Opinion No. 25) in accounting for its stock-based compensation plans, and thus compensation cost is not generally required to be recognized for the Company's stock options in the financial statements. The pro forma effect of recognizing compensation cost based on an instrument's fair value at the date of grant, consistent with Statement No. 123, "Accounting for Stock-Based Compensation", results in net income and earnings per share of $190.8 million and $3.54 per share-diluted ($3.58 per share-basic) in 2000, $286.5 million and $5.17 per share-diluted ($5.21 per share-basic) in 1999, and $194.4 million and $3.23 per share-diluted ($3.25 per share-basic) in 1998. Since options vest over several years and additional awards generally are made each year, the aforementioned pro forma effects are not likely to be representative of the effects on reported net income for future years. In March 2000, the FASB issued FIN 44, which clarifies the application of APB Opinion No. 25 regarding the definition of an employee, the criteria for determining a noncompensatory plan, the accounting for changes to the terms of a previously fixed stock option or award, the accounting for an exchange of stock compensation awards in a business combination, and other stock compensation related issues. Costs associated with the issuance of stock options to certain agents who did not qualify as an employee as defined in FIN 44 were recognized in 2000 and were not material to the results of operations or financial position of the Company. Effective June 17, 1996, the Company adopted a Long-Term Stock Incentive Plan for employees of the Company (the "Employees' Plan"). Key employees of the Company and its subsidiaries are eligible for awards pursuant to the Plan administered by the Compensation Committee of the Board of Directors (the "Committee") of the Company. Under the terms of the Employees' Plan, the maximum number of shares authorized for grants over the life of the Plan is equal to 5,842,601 shares as of December 31, 2000, increasing annually by 1.25% of the Company's outstanding stock. In addition, in February 2000, the Committee increased the maximum number of shares available for award in any given year from 2.25% of the outstanding common stock of the Company at the beginning of the year to 3.25% of the outstanding common stock of the Company at the beginning of the year, plus any awards authorized but unused from prior years. Options may be granted to eligible employees at a price not less than the market price of the Company's common stock on the date of grant. Option shares may be exercised subject to the terms prescribed by the Committee at the time of grant, otherwise options vest at the rate of 20% annually for five consecutive years and must be exercised not later than ten years from the date of grant. Stock grants may be awarded to eligible employees at a price established by the Committee (which may be zero). Under the Employees' Plan, stock grants may vest based upon performance criteria or continued employment. Stock grants which vest based on performance vest over a minimum one year period. Stock grants which vest based on continued employment vest at the end of a minimum of three consecutive years. 70 Information on the Company's stock option plan is summarized below:
2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------- (IN WHOLE SHARES AND DOLLARS) WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE Outstanding at beginning of year 2,793,779 $46.76 1,746,239 $42.39 1,075,044 $33.45 Granted 938,013 45.60 1,286,917 52.39 807,511 54.06 Converted from Citizens acquisition -- -- -- -- 38,976 28.27 Exercised 256,835 38.73 63,150 37.09 61,693 31.34 Forfeited 276,536 48.16 176,227 29.03 113,599 41.85 - ------------------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 3,198,421 $46.94 2,793,779 $46.76 1,746,239 $42.39 =============================================================================================================================== Options exercisable at end of year 816,264 $43.82 546,521 $38.41 240,384 $32.61 ===============================================================================================================================
No options expired during 2000, 1999, or 1998. The fair value of each option is estimated on the date of grant or date of conversion using the Black-Scholes option-pricing model. For options granted through 2000, the exercise price equaled the market price of the stock on the grant date. The weighted average fair value of options granted in 2000, 1999 and 1998 was $17.11 per share, $20.97 per share, and $23.68 per share, respectively. For options converted pursuant to the acquisition of the minority interest in Citizens Corporation, the exercise price was less than the fair value of the stock on the conversion date. The weighted average fair value of these options was $27.87 per share. The following significant assumptions were used to determine fair value for 2000 options granted and converted: WEIGHTED AVERAGE ASSUMPTIONS FOR OPTIONS AWARDED DURING 2000 1999 1998 - -------------------------------------------------------------------------------- Dividend yield 0.5% 0.6% 0.4% Expected volatility 37.60% 40.69% 47.49% Risk-free interest rate 5.03% 5.70% 4.84% Expected lives range (in years) 2.5 to 7 2.5 to 7 2.5 to 7 The following table summarizes information about employee options outstanding and exercisable at December 31, 2000.
OPTIONS OUTSTANDING OPTIONS CURRENTLY EXERCISABLE WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIVES EXERCISE PRICE NUMBER EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------------ $24.50 to $30.66 156,773 5.27 $27.69 107,832 $27.48 $33.375 to $37.125 514,586 6.38 $35.39 278,266 $35.39 $44.5625 to $50.00 840,613 9.08 $44.80 13,200 $49.84 $51.00 to $52.50 1,027,036 8.16 $52.05 193,415 $52.07 $52.625 to $72.50 659,413 7.47 $55.31 223,551 $54.71
71 During 2000, 1999 and 1998, the Company granted shares of nonvested stock to eligible employees, which vest after three years of continuous employment. During 2000 and 1999, the Company also granted shares of nonvested stock to certain agents, which vest 60% after three years, and 20% per year thereafter. The following table summarizes information about employee and agent nonvested stock. STOCK AWARDS 2000 1999 1998 - -------------------------------------------------------------------------------- Common stock granted 190,141 66,710 237,394 Weighted average fair value per share at the date of grant $ 38.01 $ 52.06 $ 37.21 The Company recognizes compensation expense related to nonvested shares over the vesting period on a pro rata basis. As a result, the Company recognized $5.3 million $4.3 million and $3.3 million of compensation cost in 2000, 1999 and 1998 respectively. In October 2000, the Company granted 500,250 stock appreciation rights to certain employees, payable after December 31, 2001. These rights provide for stock or cash awards to participants based upon the appreciation of the Company's stock from October 2, 2000 through December 31, 2001, the vesting period. Appreciation, if any, will be determined based on the difference between AFC's opening stock price on October 2, 2000 of $64.1875 and the average of AFC's stock price for the last fifteen business days in 2001. Compensation cost associated with these rights is recorded over the vesting period and was $0.7 million in 2000. Thirteen - -------------------------------------------------------------------------------- Earnings Per Share The following table provides share information used in the calculation of the Company's basic and diluted earnings per share: DECEMBER 31 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS EXCEPT PER SHARE DATA) Basic shares used in the calculation of earnings per share 53.3 55.0 59.9 Dilutive effect of securities: Employee stock options 0.4 0.3 0.3 Non-vested stock grants 0.3 0.2 0.1 - -------------------------------------------------------------------------------- Diluted shares used in the calculation of earnings per share 54.0 55.5 60.3 ================================================================================ Per share effect of dilutive securities on income from continuing operations $0.05 $0.06 $0.03 ================================================================================ Per share effect of dilutive securities on net income $0.05 $0.05 $0.03 ================================================================================ Options to purchase 729,363 shares and 97,500 shares of common stock were outstanding during 1999 and 1998, respectively, but were not included in the computation of diluted earnings per share because the option's exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. In 2000, all options to purchase shares of common stock were included in the computation of diluted earnings per share. Fourteen - -------------------------------------------------------------------------------- Dividend Restrictions Massachusetts, Delaware, New Hampshire and Michigan have enacted laws governing the payment of dividends to stockholders by insurers. These laws affect the dividend paying ability of FAFLIC, AFLIAC, Hanover and Citizens, respectively. Massachusetts' statute limits the dividends an insurer may pay in any twelve month period, without the prior permission of the Commonwealth of Massachusetts Insurance Commissioner, to the greater of (i) 10% of its statutory policyholder surplus as of the preceding December 31 or (ii) the individual company's statutory net gain from operations for the preceding calendar year (if such insurer is a life company), or its net income for the preceding calendar year (if such insurer is not a life company). In addition, under Massachusetts law, no domestic insurer may pay a dividend or make any distribution to its shareholders from other than unassigned funds unless the Commissioner has approved such dividend or distribution. During 2000 and 1999, no dividends were declared by FAFLIC to AFC. During 1998, FAFLIC paid dividends of $50.0 million to AFC. As of July 1, 1999, FAFLIC's ownership of Allmerica P&C, as well as several non-insurance subsidiaries, was transferred from FAFLIC to AFC. Under an agreement with the Commonwealth of Massachusetts Insurance Commissioner, any dividend from FAFLIC to AFC for 2001 would require the prior approval of the Commissioner and may require AFC to make additional capital contributions to FAFLIC. Pursuant to Delaware's statute, the maximum amount of dividends and other distributions that an insurer may pay in any twelve month period, without the prior approval of the Delaware Commissioner of Insurance, is limited to the greater of (i) 10% of its policyholders' surplus as of the preceding December 31 or (ii) the individual company's statutory net gain from operations for the preceding calendar year (if such insurer is a life company) or its net income (not including realized capital gains) for the preceding calendar year (if such insurer is not a life company). Any dividends to be paid by an insurer, whether or not in excess of the aforementioned threshold, from a source other than statutory earned surplus would also require the prior approval of the Delaware Commissioner of Insurance. No dividends were declared by AFLIAC to FAFLIC during 2000, 1999 72 or 1998. During 2001, AFLIAC could pay dividends of $28.2 million to FAFLIC without prior approval. Pursuant to New Hampshire's statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the New Hampshire Insurance Commissioner, is limited to 10% of such insurer's statutory policyholder surplus as of the preceding December 31. Hanover declared dividends to Allmerica P&C totaling $108.0 million, $350.0 million and $125.0 million during 2000, 1999 and 1998, respectively. Included in these amounts were extraordinary dividends totaling $225.0 million and $125.0 million in 1999 and 1998, respectively, which were approved by the Commissioner. Prior to May 2001, Hanover can pay no dividends to AAM without prior approval of the New Hampshire Insurance Commissioner. The allowable dividend without prior approval will increase to approximately $103.3 million on May 5, 2001. Pursuant to Michigan's statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the Michigan Insurance Commissioner, is limited to the greater of 10% of policyholders' surplus as of December 31 of the immediately preceding year or the statutory net income less realized gains, for the immediately preceding calendar year. Citizens declared dividends to Citizens Corporation totaling $55.0 million in 2000 and $200.0 million in both 1999 and 1998. Included in these amounts were extraordinary dividends totaling $200.0 million and $180.0 million in 1999 and 1998 respectively, which were approved by the Commissioner. Prior to May 2001, Citizens could pay dividends of $65.8 million to Hanover without prior approval of the Michigan Insurance Commissioner. The allowable dividend without prior approval will increase to approximately $86.3 million on May 5, 2001. Fifteen - -------------------------------------------------------------------------------- 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. In accordance with Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information", 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. The Risk Management Segment manages its products through three distribution channels identified as Standard Markets, Sponsored Markets, and Specialty Markets. Standard Markets consists of the aggregate operating results for the three channels previously characterized as Hanover North, Hanover South and Citizens Midwest. Maintaining a strong regional focus, Standard Markets sells property and casualty insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. Sponsored Markets offers property and casualty products to members of affinity groups and other organizations. This distribution channel also focuses on worksite distribution, which offers discounted property and casualty (automobile and homeowners) insurance through employer sponsored programs. Specialty Markets offers specialty or program property and casualty business nationwide. This channel focuses on niche classes of risks and leverages specific underwriting processes. 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, as well as group retirement products, such as defined benefit and 401(k) plans and tax-sheltered annuities. Allmerica Financial Services also includes brokerage and non-institutional investment advisory services. Through its Allmerica Asset Management segment, the Company offers its customers the option of investing in GICs, such as long-term and short-term funding agreements. Short-term 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. Long-term funding agreements are investment contracts issued to various business or charitable trusts, which are used to support debt issued by the trust to foreign and domestic institutional buyers, such as banks, insurance companies and pension plans. These funding agreements have long maturities and may be issued with a fixed or variable interest rate based on an index such as LIBOR. This segment is also a Registered Investment Advisor providing investment advisory services, primarily to affiliates and to third parties, such as money market and other fixed income clients. 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, technology, finance, human resources and legal. Management evaluates the results of the aforementioned segments based on a pre-tax and pre-minority interest basis. Segment income is determined by adjusting net income for net 73 realized investment gains and losses, net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes and certain other items which management believes are not indicative of overall operating trends. While these items may be significant components in understanding and assessing the Company's financial performance, management believes that the presentation of segment income enhances understanding of the Company's results of operations by highlighting net income attributable to the normal, recurring operations of the business. However, segment income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles. Summarized below is financial information with respect to business segments: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Segment revenues: Risk Management $2,307.7 $2,189.4 $2,222.1 Asset Accumulation Allmerica Financial Services 864.2 806.3 724.0 Allmerica Asset Management 149.2 150.5 121.7 - ------------------------------------------------------------------------------- Subtotal 1,013.4 956.8 845.7 - ------------------------------------------------------------------------------- Corporate 6.3 6.0 12.9 Intersegment revenues (7.0) (5.9) (7.6) - ------------------------------------------------------------------------------- Total segment revenues including Closed Block 3,320.4 3,146.3 3,073.1 - ------------------------------------------------------------------------------- Adjustments to segment revenues: Adjustment for Closed Block (97.2) (92.1) (98.3) Net realized (losses) gains (135.3) 91.0 59.2 - ------------------------------------------------------------------------------- Total revenues $3,087.9 $3,145.2 $3,034.0 =============================================================================== Segment income (loss) before federal income taxes and minority interest: Risk Management $ 190.0 $ 199.6 $ 149.6 Asset Accumulation Allmerica Financial Services 222.8 205.5 169.0 Allmerica Asset Management 22.5 23.5 23.7 - ------------------------------------------------------------------------------- Subtotal 245.3 229.0 192.7 - ------------------------------------------------------------------------------- Corporate (60.8) (59.3) (50.9) - ------------------------------------------------------------------------------- Segment income before federal income taxes and minority interest 374.5 369.3 291.4 - ------------------------------------------------------------------------------- Adjustments to segment income: Net realized investment (losses) gains, net of amortization (135.2) 96.8 49.5 Sales practice litigation expense -- -- (31.0) Restructuring costs (20.7) 1.9 (9.0) Other items -- -- (0.8) - ------------------------------------------------------------------------------- Income from continuing operations before federal income taxes and minority interest $ 218.6 $ 468.0 $ 300.1 =============================================================================== IDENTIFIABLE ASSETS DEFERRED ACQUISITION COSTS DECEMBER 31 2000 1999 2000 1999 - -------------------------------------------------------------------------------- (IN MILLIONS) Risk Management $ 6,186.6 $ 5,869.0 $ 187.2 $ 173.3 Asset Accumulation Allmerica Financial Services 23,082.5 23,435.7 1,409.8 1,213.1 Allmerica Asset Management 2,238.4 1,387.6 0.2 0.4 - -------------------------------------------------------------------------------- Subtotal 25,320.9 24,823.3 1,410.0 1,213.5 Corporate 80.5 77.3 -- -- - -------------------------------------------------------------------------------- Total $31,588.0 $30,769.6 $ 1,597.2 $ 1,386.8 ================================================================================ Sixteen - -------------------------------------------------------------------------------- Lease Commitments Rental expenses for operating leases, including those related to the discontinued operations of the Company, amounted to $32.8 million, $33.2 million and $34.9 million in 2000, 1999 and 1998, respectively. These expenses relate primarily to building leases of the Company. At December 31, 2000, future minimum rental payments under non-cancelable operating leases were approximately $59.9 million, payable as follows: 2001 - $26.2 million; 2002 - $16.0 million; 2003 - $10.1 million; 2004 - $5.9 million; and $1.7 million thereafter. It is expected that, in the normal course of business, leases that expire may be renewed or replaced by leases on other property and equipment; thus, it is anticipated that future minimum lease commitments may not be less than the amounts shown for 2001. Seventeen - -------------------------------------------------------------------------------- Reinsurance In the normal course of business, the Company seeks to reduce the losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Reinsurance transactions are accounted for in accordance with the provisions of Statement No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. 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; consequently, allowances are established for amounts 74 deemed uncollectible. The Company determines the appropriate amount of reinsurance based on evaluation of the risks accepted and analyses prepared by consultants and reinsurers and on market conditions (including the availability and pricing of reinsurance). 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. Effective January 1, 1999, the Company entered into a whole account aggregate excess of loss reinsurance agreement (See Note 3). The Company is subject to concentration of risk with respect to this reinsurance agreement, which represented 10% or more of the Company's reinsurance business at December 31, 2000. Net premiums earned and losses and loss adjustment expenses ceded under this agreement in 2000 for accident year 1999 were $25.0 million and $34.1 million, respectively. Net premiums earned and losses and loss adjustment expenses ceded under this agreement in 1999 were $21.9 million and $35.0 million, respectively. The effect of this agreement on the results of operations in future periods is not currently determinable, as it will be based on future losses and allocated LAE for accident year 1999. In addition, the Company 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 Massachusetts Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers' Compensation Residual Market Pool ("MWCRP") and the Michigan Catastrophic Claims Association ("MCCA"). At December 31, 2000, CAR also represented 10% or more of the Company's reinsurance business. As a servicing carrier in Massachusetts, the Company cedes a significant portion of its private passenger and commercial automobile premiums to CAR. Net premiums earned and losses and loss adjustment expenses ceded to CAR in 2000, 1999 and 1998 were $37.3 million and $44.5 million, $42.8 million and $42.6 million, and $34.3 million and $38.1 million, respectively. Additionally, the Company ceded to MCCA premiums earned and losses and loss adjustment expenses in 2000, 1999 and 1998 of $3.7 million and $31.1 million, $3.7 million and $75.3 million, and $3.7 million and $18.0 million, respectively. On June 2, 1998, the Company recorded a $124.2 million one-time reduction of its direct and ceded written premiums as a result of a return of excess surplus from MCCA. This transaction had no impact on the total net premiums recorded by the Company in 1998. Because the MCCA is supported by assessments permitted by statute, and all amounts billed by the Company to CAR, MWCRP and MCCA have been paid when due, the Company believes that it has no significant exposure to uncollectible reinsurance balances. The effects of reinsurance were as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Life and accident and health insurance premiums: Direct $ 43.7 $ 53.5 $ 51.4 Assumed 0.7 0.7 0.7 Ceded (40.3) (50.0) (47.8) - ------------------------------------------------------------------------------- Net premiums $ 4.1 $ 4.2 $ 4.3 =============================================================================== Property and casualty premiums written: Direct $2,391.7 $2,179.0 $1,970.4 Assumed 63.5 67.3 58.8 Ceded (303.6) (270.9) (74.1) - ------------------------------------------------------------------------------- Net premiums $2,151.6 $1,975.4 $1,955.1 =============================================================================== Property and casualty premiums earned: Direct $2,297.8 $2,135.0 $1,967.9 Assumed 66.8 73.0 64.5 Ceded (299.8) (261.7) (66.1) - ------------------------------------------------------------------------------- Net premiums $2,064.8 $1,946.3 $1,966.3 =============================================================================== Life and accident and health insurance and other individual policy benefits, claims, losses and loss adjustment expenses: Direct $ 363.1 $ 391.9 $ 359.5 Assumed 0.3 0.1 0.3 Ceded (35.4) (39.2) (49.5) - ------------------------------------------------------------------------------- Net policy benefits, claims, losses and loss adjustment expenses $ 328.0 $ 352.8 $ 310.3 =============================================================================== Property and casualty benefits, claims, losses and loss adjustment expenses: Direct $1,819.5 $1,603.8 $1,589.2 Assumed 68.1 61.7 62.7 Ceded (326.3) (247.6) (158.2) - ------------------------------------------------------------------------------- Net policy benefits, claims, losses and loss adjustment expenses $1,561.3 $1,417.9 $1,493.7 =============================================================================== 75 Eighteen - -------------------------------------------------------------------------------- Deferred Policy Acquisition Costs The following reflects the changes to the deferred policy acquisition asset: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Balance at beginning of year $1,386.8 $1,161.2 $ 965.5 Acquisition expenses deferred 684.1 616.2 638.0 Amortized to expense during the year (454.5) (429.9) (449.6) Adjustment to equity during the year (19.2) 39.3 7.3 - ------------------------------------------------------------------------------- Balance at end of year $1,597.2 $1,386.8 $1,161.2 =============================================================================== Nineteen - -------------------------------------------------------------------------------- Liabilities for Outstanding Claims, Losses and Loss Adjustment Expenses The Company regularly updates its estimates of liabilities for outstanding claims, losses and loss adjustment expenses as new information becomes available and further events occur which may impact the resolution of unsettled claims for its property and casualty and its accident and health lines of business. Changes in prior estimates are recorded in results of operations in the year such changes are determined to be needed. The liability for future policy benefits and outstanding claims, losses and loss adjustment expenses related to the Company's accident and health business was $520.7 million and $601.3 million at December 31, 2000 and 1999, respectively. Accident and health claim liabilities were re-estimated for all prior years and were decreased by $18.6 million in 2000 and increased by $51.2 million in 1999. The decrease in 2000 primarily resulted from the Company's entrance into a reinsurance agreement which provided for the cession of the Company's long-term group disability reserves, partially offset by reserve strengthening in the reinsurance pool business. The 1999 increase resulted from the Company's reserve strengthening primarily in the EBS and reinsurance pool business. The table below provides a reconciliation of the beginning and ending property and casualty reserve for unpaid losses and LAE as follows: FOR THE YEARS ENDED DECEMBER 31 2000 1999 1998 - ------------------------------------------------------------------------------- (IN MILLIONS) Reserve for losses and LAE, beginning of year $2,618.7 $2,597.3 $2,615.4 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 1,634.9 1,601.4 1,609.0 Decrease in provision for insured events of prior years (87.4) (183.4) (127.2) - ------------------------------------------------------------------------------- Total incurred losses and LAE 1,547.5 1,418.0 1,481.8 - ------------------------------------------------------------------------------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 870.2 861.1 871.9 Losses and LAE attributable to insured events of prior years 703.8 638.0 643.0 - ------------------------------------------------------------------------------- Total payments 1,574.0 1,499.1 1,514.9 - ------------------------------------------------------------------------------- Change in reinsurance recoverable on unpaid losses 126.9 102.5 15.0 - ------------------------------------------------------------------------------- Reserve for losses and LAE, end of year $2,719.1 $2,618.7 $2,597.3 =============================================================================== As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $87.4 million, $183.4 million and $127.2 million in 2000, 1999 and 1998, respectively, reflecting favorable development on reserves for both losses and loss adjustment expenses. Favorable development on prior years' loss reserves was $25.9 million, $93.1 million, and $58.9 million for the years ended December 31, 2000, 1999, and 1998, respectively. The decrease of $67.2 million in 2000 is primarily due to increased medical costs and severity in the workers' compensation line, in addition to less favorable development in the commercial multiple peril and to a lesser degree, personal automobile lines. The increase of $34.2 million in 1999 is primarily due to improved personal automobile results in the Northeast and to payments received from reinsurers related to prior years' losses in the commercial multiple peril line. Favorable development on prior years' loss adjustment expense reserves was $61.5 million, $90.3 million, and $68.3 million for the years ended December 31, 2000, 1999, and 1998, respectively. The favorable development in these periods is primarily attributable to claims process improvement initiatives taken by the Company over the past three years. Since 1997, the Company has lowered claim settlement costs through increased utilization of in-house attorneys and consolidation of claim offices. These measures are substantially complete. 76 Reserves established for current year losses and LAE consider the factors that resulted in the recent favorable development of prior years' loss and LAE reserves. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in prior years and the Company expects continued reductions in the amount of favorable development in future years. Due to the nature of the business written by the Risk Management segment, the exposure to environmental liabilities is relatively small and therefore its reserves are relatively small compared to other types of liabilities. Loss and LAE reserves related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $36.0 million, $47.3 million and $49.9 million, net of reinsurance of $15.9 million, $11.2 million and $14.2 million in 2000, 1999 and 1998, respectively. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company may be required to defend such claims. The Company estimated its ultimate liability for these claims based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not significant, their existence gives rise to uncertainty and are discussed because of the possibility, however remote, that they may become significant. The Company believes that, notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate. In addition, the Company is not aware of any litigation or pending claims that are expected to result in additional material liabilities in excess of recorded reserves. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. Twenty - -------------------------------------------------------------------------------- Minority Interest The Company's interest in Citizens Corporation prior to the acquisition of minority interest completed on or about December 3, 1998, whereby Citizens Corporation became a wholly-owned subsidiary, was 83.2%. Minority interest at December 31, 2000 and 1999 also reflects the Company's issuance through a subsidiary business trust, of $300.0 million of Series B Capital Securities, which are registered under the Securities Act of 1933, and related Junior Subordinated Deferrable Interest Debentures due 2027. These capital securities pay cumulative dividends at a rate of 8.207% semiannually. Through certain guarantees, these subordinated debentures and the terms of related agreements, AFC has irrevocably and unconditionally guaranteed the obligations of the subsidiary business trust under these capital securities. Twenty-One - -------------------------------------------------------------------------------- Contingencies Regulatory and Industry Developments Unfavorable economic conditions may contribute to an increase in the number of insurance companies that are under regulatory supervision. This may result in an increase in mandatory assessments by state guaranty funds, or voluntary payments by solvent insurance companies to cover losses to policyholders of insolvent or rehabilitated companies. Mandatory assessments, which are subject to statutory limits, can be partially recovered through a reduction in future premium taxes in some states. The Company is not able to reasonably estimate the potential impact of any such future assessments or voluntary payments. Litigation In 1997, a lawsuit on behalf of a putative class was instituted against the Company alleging fraud, unfair or deceptive acts, breach of contract, misrepresentation, and related claims in the sale of life insurance policies. In November 1998, the Company and the plaintiffs entered into a settlement agreement, and in May 1999, the Federal District Court in Worcester, Massachusetts approved the settlement agreement and certified the class for this purpose. AFC recognized a $31.0 million pre-tax expense in 1998 related to this litigation. Although the Company believes that this expense reflects appropriate recognition of its obligation under the settlement, this estimate assumes the availability of insurance coverage for certain claims, and the estimate may be revised based on the amount of reimbursement actually tendered by AFC's insurance carriers, and based on changes in the Company's estimate of the ultimate cost of the benefits to be provided to members of the class. The Company has been named a defendant in various other legal proceedings arising in the normal course of business. In the Company's opinion, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised. Residual Markets The Company is required to participate in residual markets in various states. The results of the residual markets are not subject to the predictability associated with the Company's own managed business, and are significant to the workers' compensation line of business and both the private passenger and commercial automobile lines of business. 77 Twenty-Two - -------------------------------------------------------------------------------- Statutory Financial Information The Company's insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Statutory surplus differs from shareholders' equity reported in accordance with generally accepted accounting principles primarily because policy acquisition costs are expensed when incurred, investment reserves are based on different assumptions, postretirement benefit costs are based on different assumptions and reflect a different method of adoption, life insurance reserves are based on different assumptions and income tax expense reflects only taxes paid or currently payable. As of December 31, 2000, 49 out of 50 states have adopted the National Association of Insurance Commissioners proposed Codification, which provides for uniform statutory accounting principles. These principles are effective January 1, 2001. The Company is currently assessing the impact that the adoption of Codification will have on its insurance subsidiaries. Statutory net income and surplus are as follows: 2000 1999 1998 - -------------------------------------------------------------------------------- (IN MILLIONS) Statutory Net Income (Loss)-Combined Property and Casualty Companies $ 111.8 $ 511.6 $ 180.7 Life and Health Companies (43.6) 239.0 86.4 - -------------------------------------------------------------------------------- Statutory Shareholders' Surplus-Combined Property and Casualty Companies $1,036.2 $1,089.1 $1,269.3 Life and Health Companies 528.5 590.1 1,164.1 ================================================================================ As of July 1, 1999, FAFLIC transferred its remaining ownership in Allmerica P&C to AFC. At December 31, 1998, the life and health companies' statutory surplus reflected interest in Allmerica P&C of approximately 70.0%. Twenty-Three - -------------------------------------------------------------------------------- Quarterly Results of Operations (Unaudited) The quarterly results of operations for 2000 and 1999 are summarized below: FOR THE THREE MONTHS ENDED - -------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT PER SHARE DATA)) 2000 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 Total revenues $732.2 $785.8 $794.0 $775.9 Net income $ 30.2 $ 47.6 $ 62.5 $ 59.6 Net income per share: Basic $ 0.56 $ 0.89 $ 1.18 $ 1.13 Diluted $ 0.56 $ 0.88 $ 1.16 $ 1.11 Dividends declared per share $ -- $ -- $ 0.25 $ -- ================================================================================ 1999 Total revenues $856.2 $764.8 $761.7 $762.5 Net income $154.1 $ 60.2 $ 13.1 $ 68.4 Net income per share: Basic $ 2.69 $ 1.10 $ 0.24 $ 1.26 Diluted $ 2.67 $ 1.09 $ 0.24 $ 1.25 Dividends declared per share $ -- $ -- $ 0.25 $ -- ================================================================================ Note: Due to the use of weighted average shares outstanding when calculating earnings per common share, the sum of the quarterly per common share data may not equal the per common share data for the year. During the fourth quarter of 2000, the Company recorded an after-tax benefit of approximately $7 million primarily related to a change in premium tax rate estimates. In addition, the Company also recorded a $20.2 million tax benefit from a change in the estimate of the ultimate realizability of the dividends received deduction associated with the Company's variable products. 78 - -------------------------------------------------------------------------------- BOARD OF DIRECTORS - -------------------------------------------------------------------------------- MICHAEL P. ANGELINI (I) Chairman and Partner, Bowditch & Dewey, LLP E. GORDON GEE (D) Chancellor, Vanderbilt University SAMUEL J. GERSON (D) Chairman, GenuOne, Inc. GAIL L. HARRISON (A) Principal, Powell Tate ROBERT P. HENDERSON (C) (I) General Partner, Greylock Management Corporation M HOWARD JACOBSON (C) (I) Senior Advisor and Consultant, Bankers Trust Private Bank WENDELL J. KNOX (A) President and Chief Executive Officer, Abt Associates ROBERT J. MURRAY (A) Chairman, President and Chief Executive Officer, New England Business Service, Inc. TERRENCE MURRAY (D) Chairman and Chief Executive Officer, FleetBoston Financial Corporation JOHN F. O'BRIEN President and Chief Executive Officer, Allmerica Financial Corporation JOHN R. TOWERS (A) Vice Chairman and Chief Administrative Officer, State Street Corporation HERBERT M. VARNUM (C) Former Chairman and Chief Executive Officer, Quabaug Corporation (A) AUDIT COMMITTEE (C) COMPENSATION COMMITTEE (D) DIRECTORS COMMITTEE (I) INVESTMENT COMMITTEE - -------------------------------------------------------------------------------- OPERATING COMMITTEE - -------------------------------------------------------------------------------- BRUCE C. ANDERSON Vice President, Corporate Services MARK R. COLBORN Vice President, Operations Services J. KENDALL HUBER Vice President and General Counsel JOHN P. KAVANAUGH Vice President and Chief Investment Officer JOHN F. O'BRIEN President and Chief Executive Officer EDWARD J. PARRY, III Vice President and Chief Financial Officer RICHARD M. REILLY President and Chief Executive Officer, Allmerica Financial Life Insurance and Annuity Company ROBERT P. RESTREPO, JR. President and Chief Executive Officer, Allmerica Property and Casualty Companies ERIC A. SIMONSEN President, Allmerica Financial Partners GREGORY D. TRANTER Vice President and Chief Information Officer 79 - -------------------------------------------------------------------------------- SHAREHOLDER INFORMATION - -------------------------------------------------------------------------------- ANNUAL MEETING OF SHAREHOLDERS The management and Board of Directors of Allmerica Financial Corporation invite you to attend the Company's Annual Meeting of Shareholders. The meeting will be held on May 15, 2001, at 9:00 a.m. at Allmerica Financial, 440 Lincoln Street, Worcester, Massachusetts. COMMON STOCK AND SHAREHOLDER OWNERSHIP PROFILE The common stock of Allmerica Financial Corporation is traded on the New York Stock Exchange under the symbol "AFC." As of the end of business on February 28, 2001, the Company had 42,293 shareholders of record. On the same date, the trading price of the Company's common stock closed at $53.15 per share. COMMON STOCK PRICES AND DIVIDENDS 2000 HIGH LOW DIVIDENDS ================================================================================ First Quarter $53.50 $35.31 -- - -------------------------------------------------------------------------------- Second Quarter $60.13 $46.31 -- - -------------------------------------------------------------------------------- Third Quarter $65.44 $54.00 $ 0.25 - -------------------------------------------------------------------------------- Fourth Quarter $72.50 $58.13 -- - -------------------------------------------------------------------------------- 1999 HIGH LOW DIVIDENDS ================================================================================ First Quarter $57.88 $50.19 -- - -------------------------------------------------------------------------------- Second Quarter $62.25 $54.50 -- - -------------------------------------------------------------------------------- Third Quarter $64.44 $47.56 $ 0.25 - -------------------------------------------------------------------------------- Fourth Quarter $59.69 $46.50 -- - -------------------------------------------------------------------------------- DIVIDENDS Allmerica Financial Corporation currently pays an annual cash dividend of $0.25 per share. IMSA [LOGO] Allmerica Financial is proud to be a charter member of the Insurance Marketplace Standards Association. The Association promotes high standards of conduct in the sale and servicing of individual life insurance and annuity products. Our membership demonstrates Allmerica's commitment to the high ethical standards and practices set forth in IMSA's Principles of Ethical Conduct and accompanying Code of Life Insurance Ethical Market Conduct. Membership in the association requires the successful completion of rigorous internal and independent, third party assessments, designed to determine whether Allmerica's policies and procedures satisfy IMSA's principles and codes. REGISTRAR AND STOCK TRANSFER AGENT Equiserve First Chicago Trust Division 525 Washington Boulevard Jersey City, NJ 07303-2512 (800) 317-4454 INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP 160 Federal Street Boston, MA 02110 INDUSTRY RATINGS A.M. STANDARD CLAIMS PAYING ABILITY BEST & POOR'S MOODY'S ================================================================================ First Allmerica Financial Life Insurance Company A AA- A1 - -------------------------------------------------------------------------------- Allmerica Financial Life Insurance and Annuity Company A AA- A1 - -------------------------------------------------------------------------------- The Hanover Insurance Company A AA- A1 - -------------------------------------------------------------------------------- Citizens Insurance Company of America A - - - -------------------------------------------------------------------------------- STANDARD DEBT RATINGS & POOR'S MOODY'S ================================================================================ Allmerica Financial Corporation Senior Debt A- A2 - -------------------------------------------------------------------------------- Allmerica Financial Corporation Capital Securities BBB a2 - -------------------------------------------------------------------------------- Allmerica Financial Corporation Short Term Debt A1 P1 - -------------------------------------------------------------------------------- First Allmerica Financial Life Insurance Company Short Term Debt A1+ P1 - -------------------------------------------------------------------------------- First Allmerica Financial Life Insurance Company Short Term Insurance Financial Strength Rating A1+ P1 - -------------------------------------------------------------------------------- TOLL-FREE INVESTOR INFORMATION LINE Call our toll-free investor information line, (800) 407-5222, to receive additional printed information, including Form 10-Ks or quarterly reports on Form 10-Q filed with the Securities and Exchange Commission, fax-on-demand services, access to shareholder services, prerecorded messages and other services. Alternatively, investors may address questions to: Henry P. St. Cyr, CFA, Vice President, Investor Relations Allmerica Financial Corporation 440 Lincoln Street, Worcester, MA 01653 tel: (508) 855-2959 fax: (508) 853-4481 William J. Steglitz, CPA, Manager, Investor Relations tel: (508) 855-3883 fax: (508) 856-9526 CORPORATE OFFICES AND PRINCIPAL SUBSIDIARIES Allmerica Financial Corporation 440 Lincoln Street Worcester, MA 01653 The Hanover Insurance Company 100 North Parkway Worcester, MA 01605 Citizens Insurance Company of America 645 West Grand River Howell, MI 48843 WEB SITE Please visit our Internet site at http://www.allmerica.com Printed partially on recycled paper. Design: The Graphic Expression, Inc., New York 80 EX-21 3 0003.txt SUBSIDIARIES OF AFC Exhibit 21 - Direct and Indirect Subsidiaries of the Registrant I. Allmerica Financial Corporation (Delaware) A. Allmerica Asset Management, Inc. (Massachusetts) a. Allmerica Financial Insurance Brokers, Inc. (Massachusetts) b. Citizens Insurance Company of Illinois (Illinois) c. The Hanover Insurance Company (New Hampshire) 1. Allmerica Financial Benefit Insurance Company (Michigan) 2. Allmerica Plus Insurance Agency, Inc. (Massachusetts) 3. The Hanover American Insurance Company (New Hampshire) 4. Hanover Texas Insurance Management Company, Inc. (Texas) 5. Citizens Insurance Company of Ohio (Ohio) 6. Citizens Insurance Company of America (Michigan) a. Citizens Management Inc. (Michigan) 7. Citizens Insurance Company of the Midwest (Indiana) 8. AMGRO, Inc. (Massachusetts) a. Lloyds Credit Corporation (Massachusetts) 9. Massachusetts Bay Insurance Company (New Hampshire) 10. Allmerica Financial Alliance Insurance Company (New Hampshire) d. Sterling Risk Management Services, Inc. (Delaware) e. Allmerica Benefits, Inc. (Florida) f. Allmerica Asset Management, Limited (Bermuda) B. Financial Profiles, Inc. (California) C. Allmerica, Inc. (Massachusetts) D. Allmerica Funding Corp. (Massachusetts) E. First Allmerica Financial Life Insurance Company (Massachusetts) a. Allmerica Trust Company, N.A. (Federally Chartered) (99.2% owned) b. Advantage Insurance Network, Inc. (Delaware) c. Allmerica Financial Life Insurance and Annuity Company (Delaware) 1. Allmerica Investments, Inc. (Massachusetts) 2. Allmerica Investment Management Company, Inc. (Massachusetts) 3. Allmerica Financial Investment Management Services, Inc. (Massachusetts) 4. Allmerica Financial Services Insurance Agency, Inc. (Massachusetts) 5. Allmerica Investments Insurance Agency, Inc. of Alabama (Alabama) 6. Allmerica Investments Insurance Agency of Florida, Inc. (Florida) 7. Allmerica Investments Insurance Agency, Inc. of Georgia (Georgia) 8. Allmerica Investments Insurance Agency, Inc. of Kentucky (Kentucky) 9. Allmerica Investments Insurance Agency, Inc. of Mississippi (Mississippi) F. AFC Capital Trust I (Delaware) G. VeraVest, Inc. (Massachusetts) H. First Sterling Limited (Bermuda) a. First Sterling Reinsurance Company Limited (Bermuda) EX-23 4 0004.txt CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-72491, No. 333-576, No. 333-578, No. 333-580, No. 333-582, No. 333-24929 and No. 333-31397) of our report dated February 1, 2001 relating to the financial statements, which appears in the Allmerica Financial Corporation 2000 Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K for the year ended December 31, 2000. We also consent to the incorporation by reference of our report dated February 1, 2001 relating to the financial statement schedules, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Boston, Massachusetts March 30, 2001 EX-24 5 0005.txt POWER OF ATTORNEY EXHIBIT 24 POWER OF ATTORNEY We, the undersigned, hereby severally constitute and appoint John F. O'Brien, J. Kendall Huber and Edward J. Parry III, and each of them singly, our true and lawful attorneys, with full power in each of them, sign for and in each of our names and in any and all capacities, Form 10-K of Allmerica Financial Corporation (the "Company") and any other filings made on behalf of said Company pursuant to the requirements of the Securities Exchange Act of 1934, and to file the same with all exhibits and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys and each of them, acting alone, full power and authority to do and perform each and every act and thing requisite or necessary to be done, hereby ratifying and confirming all that said attorneys or any of them may lawfully do or cause to be done by virtue hereof. Witness our hands and common seal on the date set forth below. Signature Title Date --------- ----- ---- /s/ John F. O'Brien Director, President and CEO 2/19/01 - ---------------------------- John F. O'Brien /s/ Edward J. Parry III Vice President and CFO 2/19/01 - ---------------------------- Edward J. Parry III /s/ Michael P. Angelini Director 2/19/01 - ---------------------------- Michael P. Angelini /s/ E. Gordon Gee Director 2/19/01 - ---------------------------- E. Gordon Gee /s/ Samuel J. Gerson Director 2/19/01 - ---------------------------- Samuel J. Gerson /s/ Gail L. Harrison Director 2/19/01 - ---------------------------- Gail L. Harrison /s/ Robert P. Henderson Director 2/19/01 - ---------------------------- Robert P. Henderson /s/ M. Howard Jacobson Director 2/19/01 - ---------------------------- M. Howard Jacobson /s/ Wendell J. Knox Director 2/19/01 - ---------------------------- Wendell J. Knox /s/ Robert J. Murray Director 2/19/01 - ---------------------------- Robert J. Murray /s/ Terrence Murray Director 2/20/01 - ---------------------------- Terrence Murray /s/ John R. Towers Director 2/19/01 - ---------------------------- John R. Towers /s/ Herbert M. Varnum Director 2/19/01 - ---------------------------- Herbert M. Varnum EX-27 6 0006.txt FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE. EX-27 7 0007.txt
7 This Schedule contains summary financial information extracted from the Consolidated Financial Statements of Allmerica Financial Corporation as of December 31, 2000 and for the period then ended, and is qualified in its entirety by reference to such financial statements. 1,000,000 12-MOS DEC-31-2000 DEC-31-2000 7721 0 0 86 473 0 8662 279 1423 1597 31588 2907 982 2875 2080 256 300 0 1 2408 31588 2069 592 (135) 141 1889 455 526 219 3 200 0 0 0 200 3.75 3.70 2619 1635 (87) 870 704 2719 0
EX-99.2 8 0008.txt IMPORTANT FACTORS REGARDING FORWARD LOOKING STATE 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, Maine, Massachusetts, New York, New Jersey, New Hampshire, Rhode Island and Vermont). 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 and regulatory developments affecting insurer liability, extracontractual liabilities and the size of jury awards, medical and other costs, 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, reinsurance is subject to credit risks (including over-concentration within the industry), and 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. 1 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. These estimates are regularly reviewed and revised. 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' general account 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, 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. Sensitivity to Equity Markets Relative to Life Insurance Subsidiaries The Company's life insurance subsidiaries are exposed to risk of reduced variable product assets, fewer deposits and lower related fee income, and increased surrenders that may result from equity market declines. In addition, a decrease in variable product assets may result in the expectation of reduced future profit margins, which could require the Company to accelerate the amortization of deferred policy acquisition costs. Liquidity AFC is dependent on its insurance subsidiaries for cash flows. As such, the Company is exposed to risk of decreased cash flows due to changes in its subsidiaries ability to generate sufficient cash inflows from new or existing customers or from increased cash outflows. Cash outflows may result from claims activity, surrenders, lapses or changes in asset values due to fluctuations in the investment markets. In addition, a shortage of available cash could limit the Company's ability to generate product sales (deposits), as most life and annuity sales require immediate cash payments to agents, brokers or other producers. 2 Losses Due to Foreign Currency Fluctuations A portion of the Company's investments consists of securities denominated in foreign currencies. The Company also holds trust obligations backed by funding agreements denominated in foreign currencies. The Company's operating results are exposed to changes in exchange rates between the U.S. dollar and various foreign currencies. Management attempts to mitigate any negative impact from foreign currency fluctuations by entering into foreign exchange swap contracts and compound foreign currency/interest rate swap contracts. Uncertainty Regarding Accident and Health Assumed Reinsurance Pool Business The Company believes that notwithstanding the losses incurred by the accident and health assumed reinsurance business during the past several years, the Company's 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, there can be no assurance that the Company's current reserves are adequate or that the Company will not have losses in the future. Although AFC has discontinued participation in these reinsurance pools, the Company may become subject to claims related to prior years. AFC's operating results and financial position may be harmed from liabilities resulting from any such claims. 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 uses a system for assessing the adequacy of statutory capital for life and health insurers and property and casualty insurers. The system, known as risk-based capital, is in addition to the states' fixed dollar minimum capital and other requirements. The 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 3 various risk elements in an insurer's business to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. Management believes that its 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. State Guaranty Funds, Shared Markets Mechanisms and Pooling Arrangements All fifty states of the United States 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 three principal segments: Risk Management, 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. 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 since prior regulatory prohibitions on the ability of such institutions to directly or indirectly engage in the insurance business have been 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 or any of its key executives. Retention of Variable Products Relationships The future sale of variable products will be affected by the Company's ability to recruit new or retain existing career agents, wholesalers, broker- dealers, partnership and other distribution relations. 4 Competition for such relationships is intense. The success of the variable products line is highly dependent on these relationships and deterioration in them could adversely affect future sales and surrender activities. Sales of annuity products are particularly dependent on the relationship with Zurich- Kemper. 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, only when the insurance or annuity benefits are actually paid or to be paid. 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, from time to time considered by Congress, the Treasury Department or other federal agencies. 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. Several legislative proposals are currently under consideration by Congress that could modify or repeal the existing estate tax laws. If these or similar proposals were enacted, the market demand for some of the Company's life products could be adversely affected. The Company cannot predict the impact of such changes in tax law. 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 or disclosures, 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 for which the Company has not established appropriate reserves. Sales of variable life insurance and annuity products are subject to regulation by the Securities and Exchange Commission ("SEC"), NASD Regulation, Inc. ("NASDR") and various other federal, state and self-regulatory agencies. Recently, the SEC, NASDR and various other agencies have increased scrutiny of sales practices relating to the sales of variable life insurance and annuity products, particularly bonus annuity products, including in the areas of suitability and replacements. Such increased scrutiny and accompanying adverse publicity could negatively impact sales activities. 5 -----END PRIVACY-ENHANCED MESSAGE-----