-----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, Ql4i4IuKy7dhQc/ci8e8KwLhI3W0rhzOMC/HJWtOuIimrzo3zUgRy/JUymXbIurG XXaIRMY0XOT+8KXgZKF1/A== 0000927016-02-001824.txt : 20020415 0000927016-02-001824.hdr.sgml : 20020415 ACCESSION NUMBER: 0000927016-02-001824 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 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: 1934 Act SEC FILE NUMBER: 001-13754 FILM NUMBER: 02596913 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 d10k.txt FORM 10-K FOR 12/31/2001 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, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from: to Commission file number: 1-13754 ALLMERICA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 04-3263626 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 440 Lincoln Street, Worcester, Massachusetts 01653 (Address of principal executive offices) (Zip Code) 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, 2002 the aggregate market value of the voting and non-voting stock held by nonaffiliates of the registrant was $2,281,932,311. The number of shares outstanding of the registrant's common stock, $.01 par value, was 53,375,394 shares outstanding as of March 21, 2002. DOCUMENTS INCORPORATED BY REFERENCE Portions of Allmerica Financial Corporation's Annual Report to Shareholders for 2001 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 14, 2002 are incorporated by reference in Part III. Total number of pages, including cover page: 45 Exhibit Index is on pages 29-32 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"); Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); The Hanover Insurance Company ("Hanover"); Citizens Insurance Company of America ("Citizens"); and certain other insurance and non-insurance subsidiaries. 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 (mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company) 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 18-31 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 2001 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, 2001, the Risk Management segment accounted for $2,454.8 million, or 71.4%, of consolidated segment revenues and $93.5 million, or 48.3%, of consolidated segment income before federal income taxes and minority interest. The Company underwrites personal and commercial property and casualty insurance primarily through an independent agent network concentrated in the Northeast, Midwest and Southeast United States. 2 The Company strives to maintain a focus on the core disciplines of underwriting, pricing, claims adjusting and investing. The Company's overall strategy is to improve profitability through disciplined underwriting, effective claim handling, marketing, agency management, operating efficiencies and measured growth. The Company, in 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 23rd largest property and casualty insurance group in the United States based on 2000 direct 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, acts of terrorism, 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 Howell, Michigan, Worcester, Massachusetts and Atlanta, Georgia. Administrative functions are centralized in its headquarters in Worcester, Massachusetts. 3 During the fourth quarter of 2001, the Company completed an extensive review of its agency relationships which resulted in the termination of 377 agencies and the withdrawal of commercial lines' underwriting authority from an additional 314 agencies. These actions affected approximately 27% of the approximately 2,500 active agencies representing the Company in 2001. These agencies have consistently produced unsatisfactory loss ratios. In addition, the Company terminated virtually all of its specialty commercial programs, which accounted for $54.4 million of net premiums written in 2001, and discontinued a number of special marketing arrangements. The total earned premium associated with the exited business was $252.9 million in 2001 and is estimated to be approximately $170 million and $65 million in 2002 and 2003, respectively. The Company is contractually or under statutory regulations obligated to renew policies with certain agents that will be in runoff in 2002 and 2003. The Company believes that these actions will ultimately result in improved underwriting results. In connection with these actions, the Company performed an actuarial review of outstanding reserves with segregated loss history on the exited business. Based on this review, losses and expenses totaling $68.3 million were recorded in 2001. Actual future losses from the exited business may vary from the Company's estimate. During 1999, AFC introduced a businessowner policy ("BOP") product called Dimension 2000+SM. The Company has expanded the distribution of this product to additional agents since its inception. 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 through agents utilizing an internet based point-of-sale system which provides full quote-to-issue capabilities. This point-of-sale system was expanded to commercial automobile policies in 2001. These investments in technology have improved the service provided to agents and the timing of policy issuance. 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. 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 two target areas: standard, or traditional markets, and sponsored program 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, 2001 provided for more than $1,550 million of Risk Management's written premium. This channel predominantly markets property and casualty insurance products through approximately 2,000 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 and appropriate relationship actions are made based on this performance. 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 the Company as their principal supplier of insurance products. The Risk Management segment sponsors an 4 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 2001. Sponsored Markets This distribution channel offers primarily 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 the personal segments that are tailored for members of associations, financial institutions and employers. 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. As of December 31, 2001, written premium in the Sponsored Markets distribution channel was more than $650 million. 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 $20.1 million, $26.1 million and $24.2 million in 2001, 2000 and 1999, respectively, relating primarily to coverages for personal and commercial automobile, personal and commercial property, and workers' compensation. The decrease in the underwriting loss in 2001 is primarily related to Hanover's participation in the Massachusetts Commonwealth Automobile Reinsurers ("CAR") pool which is consistent with a decrease in the participation ratio. The increase in the underwriting loss in 2000 compared to 1999 is the primarily the result of an increase in Hanover's participation in the CAR pool 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. 5 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 $34.2 million and $38.0 million in 2001, $37.3 million and $44.5 million in 2000, and $42.8 million and $42.6 million in 1999. At December 31, 2001, CAR represented 10% or more of the Company's reinsurance business. 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. Effective July 1, 2002 this threshold will increase to $300,000 and will continue to increase in amounts, which have not yet been determined, over the next ten years until it reaches $500,000. 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 $7.2 million and $44.5 million in 2001, $3.7 million and $31.1 million in 2000, and $3.7 million and $75.3 million in 1999. At December 31, 2001, the MCCA represented 10% or more of the Company's reinsurance business. At December 31, 2001 and 2000, the Company, in the Risk Management segment, had reinsurance recoverables on paid and unpaid losses from CAR of $40.4 million and $56.4 million, respectively, and from MCCA of $320.2 million and $298.4 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 in excess of retentions 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 20 on page 78 of the Notes to Consolidated Financial Statements of the 2001 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference. 6 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. Voluntary Pools The Company has terminated its participation in virtually all of its voluntary pool business, however the Company continues to be subject to claims related to years in which it was a participant. The Company was a participant in a voluntary excess and casualty reinsurance pool (Excess and Casualty Reinsurance Association "ECRA") from 1950 to 1982. In 1982 the pool was dissolved and since that time the business has been in runoff. The Company's participation in this pool has resulted in an average loss of $2.5 million annually over the past ten years. During 2001, the pool commissioned an independent actuarial review of the current reserve position, which noted a range of reserve deficiency primarily as a result of adverse development of asbestos claims. As a result of this study, the Company recorded an additional $33.0 million of losses in 2001. Management believes that this item is not indicative of overall operating trends of this pool or other voluntary pools in which the Company participates. Because of the inherent uncertainty regarding the types of claims in this pool, there can be no assurance that these additional reserves will be sufficient. Loss and LAE reserves for the Company's voluntary pools were $73.1 million, including $45.3 million related to ECRA, as of December 31, 2001. Other Involuntary Pools 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, 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 Louisiana. 7 Competition The property and casualty industry is 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, 2001, approximately 36% and 16% 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, 2000, 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 9.4% of the total market. In Michigan, AFC's principal personal lines competition is from Auto Club of Michigan, State Farm Group and Allstate. In Michigan, AFC's commercial lines competition is principally from national agency companies, and regional and local companies. According to A.M. Best, as of December 31, 2000, AFC is the largest commercial lines writer in Michigan with approximately 9% of the market. The insurance industry, including the Company, initiated commercial lines rate increases in 2000 and continued to increase rates in 2001, as compared to rate decreases in prior years primarily due 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. Although the environment in Massachusetts' personal automobile market has continued to be competitive, the Company's personal automobile direct written premiums increased by 5.1% in 2001. Approximately 23% 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. There was no material rate change in 2002. The Massachusetts Division of Insurance allows companies to offer discounts for sponsoring organizations and safe drivers. In 2001, the Company modified some of the discounts it previously offered. In 2002, the discount for safe drivers remains consistent with those offered in 2001 at 2%. In addition, the Company's Sponsored Markets unit currently offers more than 125 group programs throughout the state, including a large group plan with approximately 425,000 eligible members. 8 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 (the sum of the ratio of incurred claims and claim expense to premiums earned and the ratio of underwriting expenses incurred to premiums written) 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 minimize 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 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 30% of the total number of paid claims reported in the Midwest 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, terrorism, fires and explosions, and the incidence and severity of catastrophes are inherently unpredictable. The Company manages its catastrophe risks through underwriting procedures, including the use of specific exclusions for floods, terrorism and other factors, and through reinsurance programs. The Company is currently using terrorism exclusion forms from the Insurance Service Office for its commercial property and general liability exposures in states that have approved the use of the forms unconditionally. Some states have limitations related to the use of exclusions that 9 require the Company to demonstrate a lack of reinsurance coverage for the terrorism peril. There are also five states, as of March 21, 2002, that have not approved the use of any terrorism exclusions. 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 25, 26 and 27 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the 2001 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") to reserves determined in accordance with generally accepted accounting principles ("GAAP") at December 31, as follows:
2001 2000 1999 ---- ---- ---- (In millions) Statutory reserve for losses and LAE $2,057.5 $1,906.5 $1,926.6 GAAP adjustments: Reinsurance recoverable on unpaid losses 864.6 816.9 694.2 Other(*) (0.6) (4.3) (2.1) ------------------------------------ GAAP reserve for losses and LAE $2,921.5 $2,719.1 $2,618.7 ====================================
(*) Primarily represents purchase accounting adjustments. 10 Analysis of Losses and Loss Adjustment Expenses Reserve Development The following table sets forth the development of net GAAP reserves for unpaid losses and LAE from 1991 through 2001 for the Company.
Year ended December 31, -------------------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- ---- (In millions) Net reserve for losses and LAE(1) ......... $2,056.9 $1,902.2 $1,924.5 $2,005.5 $2,038.7 $2,117.2 Cumulative amount paid as of(2): One year later ............................ -- 780.3 703.8 638.0 643.0 732.1 Two years later ........................... -- -- 1,063.8 996.0 967.4 1,054.3 Three years later ......................... -- -- -- 1,203.0 1,180.7 1,235.0 Four years later .......................... -- -- -- -- 1,301.5 1,365.9 Five years later .......................... -- -- -- -- -- 1,439.8 Six years later ........................... -- -- -- -- -- -- Seven years later ......................... -- -- -- -- -- -- Eight years later ......................... -- -- -- -- -- -- Nine years later .......................... -- -- -- -- -- -- Ten years later ........................... -- -- -- -- -- -- Net reserve re-estimated as of(3): End of year ............................... 2,056.9 1,902.2 1,924.5 2,005.5 2,038.7 2,117.2 One year later ............................ -- 2,010.8 1,837.1 1,822.1 1,911.5 1,989.3 Two years later ........................... -- -- 1,863.3 1,781.4 1,796.8 1,902.8 Three years later ......................... -- -- -- 1,818.6 1,734.9 1,832.5 Four years later .......................... -- -- -- -- 1,762.9 1,783.7 Five years later .......................... -- -- -- -- -- 1,810.9 Six years later ........................... -- -- -- -- -- -- Seven years later ......................... -- -- -- -- -- -- Eight years later ......................... -- -- -- -- -- -- Nine years later .......................... -- -- -- -- -- -- Ten years later ........................... -- -- -- -- -- -- -------------------------------------------------------------------------- (Deficiency) Redundancy, net(4,5) ......... $ -- $ (108.6) $ 61.2 $ 186.9 $ 275.8 $ 306.3 -------------------------------------------------------------------------- Year ended December 31, ------------------------------------------------------------ 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (In millions) Net reserve for losses and LAE(1) ......... $2,132.5 $2,109.3 $2,019.6 $1,936.9 $1,772.4 Cumulative amount paid as of(2): One year later ............................ 627.6 614.3 566.9 564.3 569.0 Two years later ........................... 1,008.3 940.7 884.4 862.7 888.0 Three years later ......................... 1,217.8 1,172.8 1,078.1 1,068.4 1,077.1 Four years later .......................... 1,325.9 1,300.4 1,210.9 1,184.1 1,207.1 Five years later .......................... 1,408.8 1,369.9 1,289.5 1,267.5 1,279.4 Six years later ........................... 1,459.8 1,427.6 1,353.3 1,323.1 1,337.2 Seven years later ......................... -- 1,466.1 1,377.2 1,355.8 1,377.3 Eight years later ......................... -- -- 1,408.3 1,387.7 1,404.1 Nine years later .......................... -- -- -- 1,413.3 1,431.6 Ten years later ........................... -- -- -- -- 1,453.9 Net reserve re-estimated as of(3): End of year ............................... 2,132.5 2,109.3 2,019.6 1,936.9 1,772.4 One year later ............................ 1,991.1 1,971.7 1,891.5 1,868.1 1,755.0 Two years later ........................... 1,874.3 1,859.4 1,767.4 1,762.8 1,717.7 Three years later ......................... 1,826.8 1,780.3 1,691.5 1,703.3 1,670.8 Four years later .......................... 1,780.7 1,766.2 1,676.3 1,658.9 1,654.1 Five years later .......................... 1,740.1 1,735.6 1,653.7 1,637.3 1,634.6 Six years later ........................... 1,771.3 1,699.2 1,630.3 1,650.5 1,630.6 Seven years later ......................... -- 1,733.1 1,603.9 1,627.2 1,644.2 Eight years later ......................... -- -- 1,637.2 1,607.4 1,626.1 Nine years later .......................... -- -- -- 1,637.6 1,611.8 Ten years later ........................... -- -- -- -- 1,642.2 ------------------------------------------------------------ (Deficiency) Redundancy, net(4,5) ......... $ 361.2 $ 376.2 $ 382.4 $ 299.3 $ 130.2 ------------------------------------------------------------
(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, 2001 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 2001 for the Company: 11
Year ended December 31, ----------------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- -------- (In millions) Reserve for losses and LAE: Gross liability ................... $2,921.5 $2,719.1 $2,618.7 $2,597.2 $2,615.4 $2,744.1 Reinsurance recoverable ........... 864.6 816.9 694.2 591.7 576.7 626.9 -------- -------- -------- -------- -------- -------- Net liability ................... $2,056.9 $1,902.2 $1,924.5 $2,005.5 $2,038.7 $2,117.2 ======== ======== ======== ======== ======== ======== One year later: Gross re-estimated liability ...... $2,882.0 $2,553.4 $2,432.9 $2,472.6 $2,541.9 Re-estimated recoverable .......... 871.2 716.3 610.8 561.1 552.6 -------- -------- -------- -------- -------- Net re-estimated liability ...... $2,010.8 $1,837.1 $1,822.1 $1,911.5 $1,989.3 ======== ======== ======== ======== ======== Two years later: Gross re-estimated liability ...... $2,640.8 $2,379.6 $2,379.3 $2,424.5 Re-estimated recoverable .......... 777.5 598.2 582.5 521.7 -------- -------- -------- -------- Net re-estimated liability ...... $1,863.3 $1,781.4 $1,796.8 $1,902.8 ======== ======== ======== ======== Three years later: Gross re-estimated liability ...... $2,439.7 $2,305.2 $2,395.3 Re-estimated recoverable .......... 621.1 570.2 562.8 -------- -------- -------- Net re-estimated liability ...... $1,818.6 $1,734.9 $1,832.5 ======== ======== ======== Four years later: Gross re-estimated liability ...... $2,351.0 $2,336.3 Re-estimated recoverable .......... 588.1 552.6 -------- -------- Net re-estimated liability ...... $1,762.9 $1,783.7 ======== ======== Five years later: Gross re-estimated liability ...... $2,380.8 Re-estimated recoverable .......... 569.9 -------- Net re-estimated liability ...... $1,810.9 ======== Six years later: Gross re-estimated liability ...... Re-estimated recoverable .......... Net re-estimated liability ...... Seven years later: Gross re-estimated liability ...... Re-estimated recoverable .......... Net re-estimated liability ...... Eight years later: Gross re-estimated liability ...... Re-estimated recoverable .......... Net re-estimated liability ...... Nine years later: Gross re-estimated liability ...... Re-estimated recoverable .......... Net re-estimated liability ...... Year ended December 31, ------------------------------------------- 1995 1994 1993 1992 -------- -------- -------- -------- (In millions) Reserve for losses and LAE: Gross liability .................. $2,896.0 $2,821.7 $2,717.3 $2,598.9 Reinsurance recoverable .......... 763.5 712.4 697.7 662.0 -------- -------- -------- -------- Net liability .................. $2,132.5 $2,109.3 $2,019.6 $1,936.9 ======== ======== ======== ======== One year later: Gross re-estimated liability ..... $2,587.8 $2,593.5 $2,500.5 $2,460.5 Re-estimated recoverable ......... 596.7 621.8 609.0 592.4 -------- -------- -------- -------- Net re-estimated liability ..... $1,991.1 $1,971.7 $1,891.5 $1,868.1 ======== ======== ======== ======== Two years later: Gross re-estimated liability ..... $2,427.7 $2,339.2 $2,333.3 $2,341.9 Re-estimated recoverable ......... 553.4 479.8 565.9 579.1 -------- -------- -------- -------- Net re-estimated liability ..... $1,874.3 $1,859.4 $1,767.4 $1,762.8 ======== ======== ======== ======== Three years later: Gross re-estimated liability ..... $2,358.6 $2,227.0 $2,145.5 $2,257.3 Re-estimated recoverable ......... 531.8 446.7 454.0 554.1 -------- -------- -------- -------- Net re-estimated liability ..... $1,826.8 $1,780.3 $1,691.5 $1,703.2 ======== ======== ======== ======== Four years later: Gross re-estimated liability ..... $2,359.5 $2,220.9 $2,102.0 $2,168.2 Re-estimated recoverable ......... 578.8 454.7 425.7 509.3 -------- -------- -------- -------- Net re-estimated liability ..... $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 ..... $2,351.2 $2,158.9 $2,096.6 $2,022.6 Re-estimated recoverable ......... 579.9 459.7 466.3 372.1 -------- -------- -------- -------- Net re-estimated liability ..... $1,771.3 $1,699.2 $1,630.3 $1,650.5 ======== ======== ======== ======== Seven years later: Gross re-estimated liability ..... $2,210.5 $2,050.3 $2,050.1 Re-estimated recoverable ......... 477.4 446.4 422.9 -------- -------- -------- Net re-estimated liability ..... $1,733.1 $1,603.9 $1,627.2 ======== ======== ======== Eight years later: Gross re-estimated liability ..... $2,099.9 $2,013.6 Re-estimated recoverable ......... 462.7 406.2 -------- -------- Net re-estimated liability ..... $1,637.2 $1,607.4 ======== ======== Nine years later: Gross re-estimated liability ..... $2,062.2 Re-estimated recoverable ......... 424.6 -------- Net re-estimated liability ..... $1,637.6 ========
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 12 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 2001 catastrophe reinsurance program, AFC retained $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, 2002, the Company modified its catastrophe reinsurance program. Under this new program, AFC retains $45.0 million of loss per hurricane occurrence and $30.0 million of loss per occurrence for all other exposures, 15% of all aggregate loss amounts in excess of $45.0 million, or $30.0 million for non-hurricane losses, up to $230.0 million and all amounts in excess of $230.0 million. Additionally, this 2002 program excludes catastrophes related to terrorist activities. Under the Company's 2001 property catastrophe aggregate treaty, the treaty provided for annual aggregate coverage totaling 90% of catastrophe losses in excess of $65.0 million up to $115.0 million. The Company's retention was calculated cumulatively, in the aggregate, on a quarterly basis with the aggregate losses comprised of all catastrophe losses that exceeded $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 was $25.0 million. Effective January 1, 2002, the Company modified its property catastrophe aggregate treaty. Under this new treaty, catastrophe losses will be calculated cumulatively, in the aggregate, at the end of each quarter during the term of the contract and will be subject to a retention limit based on property lines' net earned premium. This limit will equal 13.26% of the net earned premium at March 31, 2002, subject to a minimum net earned premium of $158.0 million and a maximum of $165.0 million, 13.21% of the net earned premium at June 30, 2002, subject to a minimum net earned premium of $318.0 million and a maximum of $328.0 million, 11.6% of the net earned premium at September 30, 2002, subject to a minimum net earned premium of $483.0 million and a maximum of $498.0 million, and 10.7% of the net earned premium at December 31, 2002 subject to a minimum net earned premium of $654.0 million and a maximum of $680.0 million. The 2002 property catastrophe aggregate treaty excludes terrorist related activities. Personal lines' losses due to fire or collapse as a result of an act of terrorism are not excluded from coverage under this treaty, except for those losses that result from biological, chemical or nuclear terrorism. Effective July 1, 2001, 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 monoline inland marine and commercial auto physical damage. All other property business is 100% covered by reinsurers for each loss in excess of $2.0 million per occurrence up to $18.0 million. Amounts in excess of $19.5 million for monoline inland marine and commercial auto physical damage are 100% retained by the Company while amounts in excess of $18.0 million in all other property lines are retained by the Company. Under the 2001 casualty reinsurance program, the reinsurers were 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 covered 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, were retained 100% by the Company, while amounts in excess of $30.5 million, in the general liability line, were retained 100% by the Company. Effective January 1, 2002, under the Company's casualty reinsurance program, the reinsurers are responsible for 45% 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. Amounts in excess of $30.5 million are retained 100% by the Company. In addition, the 2002 program excludes terrorism claims for coverage in excess of $3.0 million. The Company entered into a whole account aggregate excess of loss reinsurance agreement, which provides coverage for accident year 1999 for the Company's property and casualty business. The program covered losses 13 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 $0.2 million, $9.8 million and $15.9 million for the years ended December 31, 2001, 2000, and 1999 respectively, based on estimates of losses and allocated LAE for accident year 1999. The 2001 impact from this treaty includes a $1.1 million net benefit related to the aforementioned exit of selected property and casualty agencies, policies, groups and programs. 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 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 2001 Annual Report to Shareholders, which is incorporated herein by reference. Reference is also made to "Reinsurance Facilities and Pools" on page 6 of this Form 10-K. 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 annuities and life insurance to upper income individuals and small businesses throughout the United States. These products are marketed through the Company's career agency force of 705 agents as of December 31, 2001, 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, 2001, the Allmerica Financial Services segment accounted for $826.5 million, or 24.1%, of consolidated segment revenues and $143.0 million, or 73.9%, 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 and variable 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 14 insurance, (ii) continue to expand existing and develop additional distribution channels, (iii) continue to 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 utilized its technological resources to support its marketing and client service initiatives in this segment. The Company has invested in administration systems and valuation systems to better support its variable product lines. The Company continues to upgrade those systems to provide improved service to its policyholders. According to 2001 A.M Best's Policy Reports, the Company was among the twenty largest writers of individual variable annuity contracts in the United States in 2000, based on statutory premiums and deposits. Sales of variable products represented approximately 98.1%, 98.2% and 97.9% of this segment's statutory premiums and deposits in 2001, 2000 and 1999, respectively. Statutory premiums and deposits, a common industry benchmark for sales achievement, totaled $3,385.6 million, $3,877.0 million and $3,535.9 million in 2001, 2000 and 1999, respectively. 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. Products The following table reflects premiums and deposits on a statutory accounting principles ("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, 2001, 2000 and 1999. 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.
2001 2000 1999 -------- -------- -------- (In millions) Statutory Premiums and Deposits Variable universal life .................. $ 204.1 $ 209.1 $ 187.0 Group variable universal life ............ 64.8 47.7 94.9 Separate account annuities ............... 1,923.1 2,555.1 1,922.2 General account annuities (1) ............ 926.8 524.7 830.2 Retirement investment account annuities .. 6.0 9.3 16.4 Group annuities .......................... 197.7 463.1 409.3 Universal life ........................... 15.4 17.2 23.0 Traditional life ......................... 47.4 50.6 52.6 Individual health ........................ 0.3 0.2 0.3 -------- -------- -------- Total statutory premiums and deposits $3,385.6 $3,877.0 $3,535.9 ======== ======== ========
(1) The general account includes approximately $73.0 million, $145.7 million, and $590.5 million in 2001, 2000, and 1999 respectively, 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. In addition, deposits into the general account in 2001 also reflect approximately $300.0 million related to a promotional annuity program which offered enhanced crediting rates of 7% for new general account deposits, for up to one year. 15 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 450 in 2001, 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 retirement plans of corporate employers. The Company also offers participant recordkeeping and administrative services to defined benefit retirement plans. Currently, the Company provides administration and recordkeeping for approximately 117 qualified pension and profit sharing plans which have assets totaling $0.5 billion. 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. On July 1, 2001, the Company sold its defined contribution business, in which it had provided consulting services to defined contribution benefit retirement plans, to Minnesota Life Insurance Company, as a result ofthe Company's conclusion that this business lacked scale to compete effectively in the 401(k) market. 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. 16 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 Scudder Investments ("Scudder"), Pioneer Investment Management, Inc ("Pioneer"), and Delaware Management Company ("Delaware"). In the fourth quarter of 2001, the Company terminated its distribution relationship with Delaware, which had represented approximately 3% of all individual annuity deposits in 2001 and approximately 7% of average assets at December 31, 2001. The Company's national career agency sales force consists of 705 agents, housed in 19 branches located in or adjacent to most of the major metropolitan centers in the United States. These branches are supported and managed through 7 regional marketing centers. Virtually all of the 705 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 face-to-face presentations to address different investment objectives of clients. During 2001, total statutory premiums and deposits from sales of variable annuities through the agency sales force totaled $679.9 million, compared to $885.7 million and $930.1 million in 2000 and 1999, respectively. Total statutory premiums from sales of variable life insurance through the agency sales force totaled $73.9 million in 2001, compared to $66.3 million and $97.6 million in 2000 and 1999, 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. As part of this strategy, the Company increased its Select wholesaling force from approximately 20 wholesalers to 55 wholesalers in 2001. Through its various distribution channels, the Company has obtained access to over 616 distribution firms employing over 90,000 sales personnel. In addition, establishment of these channels has enabled the Company to offer a broader range of investment options through alliances with Scudder and Pioneer mutual funds as well as other financial institutions. During 2001, total statutory premiums and deposits from sales of variable annuities through additional distribution channels totaled $2,170.0 million, compared to $2,194.1 million and $1,822.3 million in 2000 and 1999, respectively. In addition, total statutory premiums from sales of variable life insurance through additional distribution channels totaled $67.9 million in 2001, compared to $62.1 million and $55.4 million in 2000 and 1999, respectively. 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 a system utilizing advanced demographic screening and telemarketing techniques. The Company also regularly delivers seminars focused on retirement planning to these prospective clients. During 2001, the Company delivered 578 seminars nationally with a total of 9,750 attendees. While developed for and primarily utilized by the agency channel, these programs are being extended to the Company's other distribution channels. 17 Underwriting Life insuranece 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. Underwrting 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, included in the Consolidated Balance Sheets in the 2001 Annual Report to Shareholders, the applicable portions of which are incorporated herein by reference, to meet obligations on various policies and contracts. Reserves for 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. 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 18.3% of this segment's statutory individual life insurance premiums in 2001. In order to manage the mortality risk of its individual universal life and variable universal life businesses, the Company has established a reinsurance program, which provides for annual coverage utilizing both automatic and facultative reinsurance. Under the automatic reinsurance agreements, the Company's retention limits range from 15-20% of the mortality risk and are subject to a $2.0 million limit per life. For life policies that do not qualify for automatic reinsurance, 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. In addition, the Company maintains coinsurance agreements to reinsure substantially all of its individual disability income business and yearly renewable term business. 18 The Company seeks to enter into reinsurance treaties with highly rated reinsurers. The Company's policy is to utilize reinsurers which have received an A.M. Best rating of "A- (Excellent)" or better (Best's Insurance Reports, 2000 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 0.6%. There have been several claims for which the Company's share was approximately $158,550 since the Company entered the pool on January 1, 1989. The Company anticipates that its share in the pool, due to the events of September 11, 2001, will increase to $1,078,583 in 2002. Approximately 122 companies currently participate in this pool. 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, 2001, there were approximately 2,400 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, are issued in conjunction with the Company's 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, 2001, this segment accounted for approximately $155.2 million, or 4.5%, of consolidated segment revenues, and $20.7 million, or 10.7%, of consolidated segment income before federal income taxes and minority interest. 19 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. 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, and put features. 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 2-10 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 2001 were invested in these longer-term funding agreements. During 2001, funding agreement deposits were approximately $1.2 billion, as compared to $1.1 billion and $1.0 billion in 2000 and 1999, respectively. Long term funding agreements, including Euro-GICs, accounted for 100% of these deposits in 2001, compared to 71% in 2000 and 27% 1999. Short term funding agreements accounted for 28% of the deposits in 2000 and 73% in 1999. The decreasing volume of short term funding agreement deposits reflects an overall decline in this market. In addition, the Company's market share has decreased due to its decision to limit its short term funding agreement portfolio and from withdrawals which resulted from uncertainties related to rating agency actions. The Company expects to continue its sales of long term funding agreements in 2002. Reference is made to "Recent Developments" on page 43 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the 2001 Annual Report to Shareholders, which is incorporated herein by reference. 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, 2001, Allmerica Asset Management had assets under management of approximately $18.8 billion, of which approximately $6.2 billion represented assets managed for third party clients (i.e. entities unaffiliated with the Company). One institutional money market fund represents approximately 80% of assets managed for third party clients. Assets under management for third party clients grew by approximately $4.0 billion during 2001. 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. 20 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 offer funding agreements. 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 competitive with comparably rated instruments. 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 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. Reference is made to "Products and Services - Stable Value Products" on page 20 of this Form 10-K. 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 continues to establish and maintain relationships with investment banking firms who manage the distribution of this product. Investment Portfolio General At December 31, 2001, the Company held $10.7 billion of investment assets. 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 in which the Company engages, and the level of surplus (net worth) required to support these businesses. 21 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. During 2001, the Company shifted approximately 3% of its portfolio holdings from below investment grade securities to higher quality fixed maturity securities as a result of the continued deterioration of the high-yield market. 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. 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. 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. Reference is made to "Shareholder Information - Industry Ratings" on page 81 of the 2001 Annual Report to Shareholders, which is incorporated herein by reference. Rating agency actions are included in "Recent Developments" on page 43 in Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2001 Annual Report to Shareholders, which is incorporated herein by reference. Employees The Company has approximately 5,600 employees located throughout the country as of December 31, 2001. Management believes relations with employees and agents are good. 22 ITEM 2 PROPERTIES The Company's headquarters are located at 440 Lincoln Street, Worcester, Massachusetts, and consist primarily of approximately 761,110 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 118,554 rentable square feet. Citizens also owns a three-building complex located at 808 North Highlander Way, Howell, Michigan, with approximately 155,730 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 20 on page 78 of the Notes to Consolidated Financial Statements of the 2001 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. 23 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, 2002, the Company had 41,023 shareholders of record and 53,375,394 million shares outstanding. On the same date, the trading price of the Company's common stock was $44.02 per share. Common Stock Prices and Dividends High Low Dividends ---- --- --------- 2001 First Quarter.................. $67.25 $47.63 -- Second Quarter................. $57.50 $48.01 -- Third Quarter.................. $56.35 $40.62 -- Fourth Quarter................. $46.10 $38.17 $0.25 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 -- 2001 Dividend Schedule Allmerica Financial Corporation declared an annual cash dividend of $0.25 per share on October 23, 2001, which was paid on November 20, 2001. The record date for such dividend was November 5, 2001. 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 41-43 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 2001 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 17 of the 2001 Annual Report to Shareholders, which is incorporated herein by reference. 24 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 18-44 of the 2001 Annual Report to Shareholders, which is incorporated herein by reference. ITEM 7A QUANTATATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Reference is made to "Market Risk and Risk Management Policies" on pages 33-39 of Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2001 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 47-51 and the accompanying Notes to Consolidated Financial Statements on pages 52-79 of the 2001 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 22 of Notes to Consolidated Financial Statements--page 79), which is incorporated herein by reference. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 25 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 14, 2002, 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, 58 Director, Chief Executive Officer and President of the Company since February 1995 See biography under "Directors of the Registrant" above. Bruce C. Anderson, 57 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, 53 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, 47 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. Mark Hug, 44 Vice President of the Company since October 2001 Mr. Hug has been Vice President of AFC since October 2001. He has been President and Chief Executive Officer of AFLIAC since December 2001 and Vice President of FAFLIC since April 2000. Prior to joining AFC, Mr. Hug was Senior Vice President, Product and Marketing of Equitable Life Insurance Company from April 1997 to April 2000. Previously, Mr. Hug was Vice President, Sales of Aetna Insurance Company from April 1992 to April 1997. 26 John P. Kavanaugh, 47 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. Edward J. Parry, III, 42 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, 63 Senior Vice President of the Company since December 2001 Mr. Reilly has been Senior Vice President of AFC and FAFLIC since December 2001, and was Vice President of AFC and FAFLIC from February 1997 and November 1990, respectively, to December 2001. He was also President and Chief Executive Officer of AFLIAC from August 1995 to December 2001 and Vice President of AFLIAC since November 1990. 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., 51 Vice President of the Company since May 1998 Mr. Restrepo has been Vice President of AFC and FAFLIC since May 1998. He has been President and Chief Executive Officer of the Hanover Insurance Company since December 2001. He was President and Chief Executive Officer of Allmerica Property and Casaulty Companies, Inc. 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. Gregory D. Tranter, 45 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 14, 2002, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. 27 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 14, 2002, 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 14, 2002, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934. 28 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 47 through 79 of the 2001 Annual Report to Shareholders have been incorporated herein by reference in their entirety.
Annual Report Page(s) ------- Report of Independent Accountants........................................................... 45 Consolidated Statements of Income for the years ended December 31, 2001, 2000 and 1999...... 47 Consolidated Balance Sheets as of December 31, 2001 and 2000................................ 48 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2001, 2000 and 1999............................................................................ 49 Consolidated Statements of Comprehensive Income for the years ended December 31, 2001, 2000 and 1999............................................................................ 50 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999............................................................................ 51 Notes to Consolidated Financial Statements.................................................. 52-79
(a)(2) Financial Statement Schedules
Page No. in Schedule this Report ----------- Report of Independent Accountants on Financial Statement Schedules.................... 35 I Summary of Investments--Other than Investments in Related Parties..................... 36 II Condensed Financial Information of Registrant......................................... 37-39 III Supplementary Insurance Information................................................... 40-42 IV Reinsurance........................................................................... 43 V Valuation and Qualifying Accounts..................................................... 44 VI Supplemental Information concerning Property/Casualty Insurance Operations............ 45
(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.+++ 29 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.+++ 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 S-8 (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 Amended 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. ++++ 10.27 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. ++++ 30 10.29 Credit Agreement dated as of June 17, 1998 between the Registrant and the Chase Manhattan Bank. +++++ 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. 10.38 Amendment to the Credit Agreement dated as of May 25, 2001 between the Registrant and the Chase Manhattan Bank incorporated by reference to Exhibit 10.38 to the Allmerica Financial Corporation June 30, 2001 report on Form 10-Q and incorporated herein by reference. 10.39 Stock Pledge and Loan Agreement dated as of February 5, 2001 between AMGRO, Inc., a subsidiary of the Registrant, and Robert P. Restrepo, Jr. incorporated by reference to Exhibit 10.39 to the Allmerica Financial Corporation June 30, 2001 report on Form 10-Q and incorporated herein by reference. 10.40 Severance Agreement, dated November 19, 2001, between First Allmerica Life Insurance Company and Eric A. Simonson. 13 The following sections of the Annual Report to Shareholders for 2001 ("2001 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 18 through 44 of the 2001 Annual Report. . Consolidated Financial Statements and Notes thereto at pages 47 through 79 of the 2001 Annual Report. . Report of Independent Accountants at page 45 of the 2001 Annual Report. . The information appearing under the caption "Five Year Summary of Selected Financial Highlights" at page 17 of the 2001 Annual Report. . The information appearing under the caption "Shareholder Information" at page 81 of the 2001 Annual Report. 21 Subsidiaries of AFC. 23 Consent of Independent Accountants. 24 Power of Attorney. 99.1 Internal Revenue Service Ruling dated April 15, 1995.+ 99.2 Important Factors Regarding Forward Looking Statements. 31 + 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 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 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 On February 15, 2002, Allmerica Financial Corporation adjusted its previously disclosed Shareholders' Equity balance and book value per share as of December 31, 2001 due to final valuation work associated with Statement of Financial Accounting Standards No. 87 "Employers' Accounting for Pensions." 32 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 25, 2002 By: /s/ JOHN F. O'BRIEN -------------------------------------------- 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 25, 2002 By: /s/ JOHN F. O'BRIEN -------------------------------------------- John F. O'Brien, Chairman of the Board, Chief Executive Officer and President Date: March 25, 2002 By: /s/ EDWARD J. PARRY, III -------------------------------------------- Edward J. Parry III, Vice President, Chief Financial Officer and Principal Accounting Officer Date: March 25, 2002 By: * -------------------------------------------- Michael P. Angelini, Director Date: March 25, 2002 By: -------------------------------------------- E. Gordon Gee, Director Date: March 25, 2002 By: * -------------------------------------------- Samuel J. Gerson, Director Date: March 25, 2002 By: * -------------------------------------------- Gail L. Harrison, Director Date: March 25, 2002 By: * -------------------------------------------- Robert P. Henderson, Director 33 Date: March 25, 2002 By: * -------------------------------------------- M Howard Jacobson, Director Date: March 25, 2002 By: * -------------------------------------------- Wendell J. Knox, Director Date: March 25, 2002 By: * -------------------------------------------- Robert J. Murray, Director Date: March 25, 2002 By: * -------------------------------------------- Terrence Murray, Director Date: March 25, 2002 By: * -------------------------------------------- John R. Towers, Director Date: March 25, 2002 By: * -------------------------------------------- Herbert M. Varnum, Director *By: /s/ EDWARD J. PARRY -------------------------------------------- Edward J. Parry, Attorney-in-fact 34 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 15, 2002, which contains an explanatory paragraph with respect to the change in the Company's method of accounting for derivative instruments, appearing in the 2001 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 15, 2002 35 Schedule I ALLMERICA FINANCIAL CORPORATION Summary of Investments--Other than Investments in Related Parties December 31, 2001
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 ......................................... $ 186.8 $ 190.0 $ 190.0 States, municipalities and political subdivisions .......... 1,830.5 1,829.8 1,829.8 Foreign governments ........................................ 34.3 36.5 36.5 Public utilities ........................................... 908.5 914.5 914.5 All other corporate bonds .................................. 6,154.0 6,250.4 6,250.4 Redeemable preferred stocks ..................................... 179.9 180.5 180.5 --------- ---------- ---------- Total fixed maturities ..................................... 9,294.0 9,401.7 9,401.7 --------- ---------- ---------- Equity securities: Common stocks: Banks, trust and insurance companies ....................... 43.7 39.1 39.1 Industrial, miscellaneous and all other .................... 1.1 6.0 6.0 Nonredeemable preferred stocks .................................. 16.4 17.0 17.0 --------- ---------- ---------- Total equity securities .................................... 61.2 62.1 62.1 --------- ---------- ---------- Mortgage loans on real estate ........................................ 321.6 XXXXXX 321.6 Policy loans ......................................................... 379.6 XXXXXX 379.6 Other long-term investments .......................................... 180.9 XXXXXX 161.2 --------- ---------- ---------- Total investments .......................................... $10,237.3 XXXXXX $ 10,326.2 ========= ========== ==========
(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. 36 Schedule II ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Statements of Income for the Years Ended December 31,
2001 2000 1999 ------ ------ ------ Revenues Net investment income ............................................. $ 1.1 $ 3.6 $ 5.3 Net realized investment (losses) gains ............................ (6.1) 2.6 (0.4) ------ ------ ------ Total revenues ............................................... (5.0) 6.2 4.9 ------ ------ ------ Expenses Interest expense .................................................. 40.6 40.6 40.6 Operating expenses ................................................ 4.9 2.7 2.3 ------ ------ ------ Total expenses ............................................... 45.5 43.3 42.9 ------ ------ ------ Net loss before federal income taxes and equity in net income of Unconsolidated subsidiaries ......................................... (50.5) (37.1) (38.0) Income tax benefit: Federal ........................................................... 15.3 13.2 14.2 State ............................................................. 1.2 -- 0.3 Equity in net income of unconsolidated subsidiaries .................... 30.9 223.8 319.3 ------ ------ ------ Net (loss) income ...................................................... $ (3.1) $199.9 $295.8 ====== ====== ======
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 37 Schedule II (continued) ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Balance Sheets
December 31, -------------------------- 2001 2000 -------- -------- (In millions, except share and per share data) Assets Fixed maturities - at fair value (amortized cost of $11.3 in 2001) .................. $ 11.1 $ -- Cash and cash equivalents ........................................................... 16.9 26.6 Investment in unconsolidated subsidiaries ........................................... 2,954.0 2,922.6 Net receivable from subsidiaries .................................................... 62.2 65.3 Other assets ........................................................................ 2.3 8.7 -------- -------- Total assets ................................................................... $3,046.5 $3,023.2 ======== ======== Liabilities Expenses and taxes payable .......................................................... $ 49.6 $ 35.6 Interest and dividends payable ...................................................... 13.9 13.6 Short-term debt ..................................................................... 83.1 56.1 Long-term debt ...................................................................... 508.8 508.8 -------- -------- Total liabilities .............................................................. 655.4 614.1 -------- -------- 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, 2001 and December 31, 2000 ............ 0.6 0.6 Additional paid-in capital .......................................................... 1,758.4 1,765.3 Accumulated other comprehensive loss ................................................ (13.7) (5.2) Retained earnings ................................................................... 1,052.3 1,068.7 Treasury stock at cost (7.5 and 7.7 million shares) ................................. (406.5) (420.3) -------- -------- Total shareholders' equity ..................................................... 2,391.1 2,409.1 -------- -------- Total liabilities and shareholders' equity ..................................... $3,046.5 $3,023.2 ======== ========
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 38 Schedule II (continued) ALLMERICA FINANCIAL CORPORATION Condensed Financial Information of Registrant Parent Company Only Statement of Cash Flows for the Years Ended December 31,
2001 2000 1999 ------ ------ ------ (In millions) Cash flows from operating activities Net (loss) income ...................................................................... $ (3.1) $199.9 $295.8 Adjustments to reconcile net income to net cash used in operating activities: Equity in net income of unconsolidated subsidiaries .................................. (30.9) (223.8) (319.3) Dividend received from unconsolidated subsidiaries ................................... 41.1 109.8 39.5 Net realized investment (gains) losses ............................................... 6.1 (2.6) 0.4 Change in expenses and taxes payable ................................................. 14.0 22.5 (2.8) Change in interest and dividends payable ............................................. 0.3 0.3 0.3 Change in receivable from subsidiaries ............................................... 3.1 (18.1) 3.3 Other, net ........................................................................... 5.9 (1.5) 1.7 ------ ------ ------ Net cash provided by operating activities ................................................. 36.5 86.5 18.9 ------ ------ ------ Cash flows from investing activities Capital contributed to unconsolidated subsidiaries ..................................... (53.9) (16.9) (54.1) Proceeds from disposals and maturities of available-for-sale fixed maturities .......... -- 33.5 84.6 Purchase of available-for-sale fixed maturities ........................................ (11.3) -- (41.4) Proceeds from sale of common stock of subsidiary ....................................... -- -- 247.6 ------ ------ ------ Net cash (used in) provided by investing activities ....................................... (65.2) 16.6 236.7 ------ ------ ------ Cash flow from financing activities Net proceeds from issuance of commercial paper ......................................... 27.0 11.5 3.5 Net proceeds from issuance of common stock ............................................. -- 0.6 1.1 Treasury stock purchased at cost ....................................................... -- (104.1) (250.2) Treasury stock reissued at cost ........................................................ 5.3 23.3 6.2 Dividends paid to shareholders ......................................................... (13.3) (13.4) (13.5) ------ ------ ------ Net cash provided by (used in) financing activities ....................................... 19.0 (82.1) (252.9) ------ ------ ------ Net change in cash and cash equivalents ................................................... (9.7) 21.0 2.7 Cash and cash equivalents at beginning of the period ...................................... 26.6 5.6 2.9 ------ ------ ------ Cash and cash equivalents at end of the period ............................................ $ 16.9 $ 26.6 $ 5.6 ====== ====== ======
The condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto. 39 Schedule III ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 2001
Future policy benefits, Other Deferred losses, policy policy claims and claims and acquisition loss Unearned benefits Premium costs expenses premiums payable revenue ----- -------- -------- ------- ------- (In millions) Risk Management ............. $ 199.0 $3,126.3 $1,049.9 $ 24.9 $2,205.7 Asset Accumulation Allmerica Financial Services 1,585.2 4,003.1 2.6 567.1 49.0 Allmerica Asset Management . -- -- -- 1,171.9 -- Corporate ................... -- -- -- -- -- Eliminations ................ -- -- -- -- -- -------- -------- -------- -------- -------- Total ................. $1,784.2 $7,129.4 $1,052.5 $1,763.9 $2,254.7 ======== ======== ======== ======== ======== Amortization Benefits, of claims, deferred Net losses and policy Other investment settlement acquisition operating Premiums income expenses costs expenses written ------ -------- ----- -------- ------- (In millions) Risk Management ............. $ 216.0 $1,753.1 $ 401.7 $ 309.7 $2,285.0 Asset Accumulation Allmerica Financial Services 288.9 344.6 77.4 252.0 -- Allmerica Asset Management . 144.5 69.5 0.1 100.1 -- Corporate ................... 6.7 -- -- 70.5 -- Eliminations ................ (0.9) -- -- (7.5) -- -------- -------- -------- -------- -------- Total ................. $ 655.2 $2,167.2 $ 479.2 $ 724.8 $2,285.0 ======== ======== ======== ======== ========
40 Schedule III (continued) ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 2000
Future policy benefits, Other Deferred losses, policy policy claims and claims and acquisition loss Unearned benefits Premium costs expenses premiums payable revenue ----- -------- -------- ------- ------- (In millions) Risk Management ............. $ 187.2 $3,017.5 $ 978.8 $ 25.1 $2,066.7 Asset Accumulation Allmerica Financial Services 1,420.8 3,480.8 2.8 531.5 52.1 Allmerica Asset Management . 0.2 -- -- 1,636.5 -- Corporate ................... -- -- -- -- -- Eliminations ................ -- -- -- -- -- -------- -------- -------- -------- -------- Total ................. $1,608.2 $6,498.3 $ 981.6 $2,193.1 $2,118.8 ======== ======== ======== ======== ======== Amortization Benefits, of claims, deferred Net losses and policy Other investment settlement acquisition operating Premiums income expenses costs expenses written ------ -------- ----- -------- ------- (In millions) Risk Management ............. $ 218.4 $1,563.0 $ 373.2 $ 184.9 $2,153.4 Asset Accumulation Allmerica Financial Services 283.6 315.1 83.2 242.5 -- Allmerica Asset Management . 138.1 103.7 0.2 23.0 -- Corporate ................... 6.3 -- -- 82.3 -- Eliminations ................ (0.9) -- -- (7.0) -- -------- -------- -------- -------- -------- Total ................. $ 645.5 $1,981.8 $ 456.6 $ 525.7 $2,153.4 ======== ======== ======== ======== ========
41 Schedule III (continued) ALLMERICA FINANCIAL CORPORATION Supplementary Insurance Information December 31, 1999
Future policy benefits, Other Deferred losses, policy policy claims and claims and acquisition loss Unearned benefits Premium costs expenses premiums payable revenue ----- -------- -------- ------- ------- (In millions) Risk Management ............. $ 173.3 $3,003.8 $ 887.2 $ 24.8 $1,948.2 Asset Accumulation Allmerica Financial Services 1,226.2 3,390.8 3.0 804.4 54.4 Allmerica Asset Management . 0.4 -- -- 1,316.0 -- Corporate ................... -- -- -- -- -- Eliminations ................ -- -- -- -- -- -------- -------- -------- -------- -------- Total ................. $1,399.9 $6,394.6 $ 890.2 $2,145.2 $2,002.6 ======== ======== ======== ======== ======== Amortization Benefits, of claims, deferred Net losses and policy Other investment settlement acquisition operating Premiums income expenses costs expenses written ------ -------- ----- -------- ------- (In millions) Risk Management ............. $ 221.4 $1,420.3 $ 370.6 $ 197.0 $1,977.0 Asset Accumulation Allmerica Financial Services 304.9 323.0 61.6 211.8 -- Allmerica Asset Management . 138.2 118.3 0.2 8.5 -- Corporate ................... 6.0 -- -- 65.3 -- Eliminations ................ (1.0) -- -- (5.9) -- -------- -------- -------- -------- -------- Total ................. $ 669.5 $1,861.6 $ 432.4 $ 476.7 $1,977.0 ======== ======== ======== ======== ========
42 Schedule IV ALLMERICA FINANCIAL CORPORATION Reinsurance December 31,
Assumed Percentage Ceded to from of amount Gross other other Net assumed amount companies companies amount to net ------ --------- --------- ------ ------ (In millions) 2001 Life insurance in force ............................ $30,550.4 $21,108.8 $454.1 $ 9,895.7 4.59% ========= ========= ====== ========= ==== Premiums: Life insurance .............................. $ 58.3 $ 10.3 $ 0.7 $ 48.7 1.44% Accident and health insurance ............... 30.8 27.9 -- 2.9 -- Property and casualty insurance ............. 2,438.6 293.7 53.5 2,198.4 2.43% --------- --------- ------ --------- ---- Total premiums ..................................... $ 2,527.7 $ 331.9 $ 54.2 $ 2,250.0 2.41% ========= ========= ====== ========= ==== 2000 Life insurance in force ............................ $33,752.4 $19,375.5 $488.3 $14,865.2 3.28% ========= ========= ====== ========= ==== Premiums: Life insurance .............................. $ 62.6 $ 11.4 $ 0.7 $ 51.9 1.35% Accident and health insurance ............... 31.7 29.6 -- 2.1 -- Property and casualty insurance ............. 2,297.8 299.8 66.8 2,064.8 3.24% --------- --------- ------ --------- Total premiums ..................................... $ 2,392.1 $ 340.8 $ 67.5 $ 2,118.8 3.19% ========= ========= ====== ========= ==== 1999 Life insurance in force ............................ $43,492.4 $21,281.5 $374.2 $22,585.1 1.66% ========= ========= ====== ========= ==== Premiums: Life insurance .............................. $ 72.7 $ 19.2 $ 0.7 $ 54.2 1.29% Accident and health insurance ............... 33.5 31.4 -- 2.1 -- Property and casualty insurance ............. 2,135.0 261.7 73.0 1,946.3 3.75% --------- --------- ------ --------- Total premiums ..................................... $ 2,241.2 $ 312.3 $ 73.7 $ 2,002.6 3.68% ========= ========= ====== ========= ====
43 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) 2001 Mortgage loans .................................... $ 4.4 $ 0.6 $ -- $ 1.2 $ 3.8 Allowance for doubtful accounts ................... 6.9 18.8 -- 15.4 10.3 ------- ------- -------- ------- ------- $ 11.3 $ 19.4 $ -- $ 16.6 $ 14.1 ======= ======= ======== ======= ======= 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 ======= ======= ======== ======= =======
44 Schedule VI ALLMERICA FINANCIAL CORPORATION Supplemental Information Concerning Property and Casualty Insurance Operations For the Years Ended December 31,
Discount, if Reserves for any, Deferred losses and deducted policy loss from Net Net acquisition adjustment previous Unearned premiums investment Affiliation with Registrant costs expenses(2) column(1) premiums(2) earned income --------------------------- ----- ----------- --------- ----------- ------ ------ (In millions) Consolidated Property and Casualty Subsidiaries 2001....................... $ 195.8 $2,921.5 $ -- $1,047.7 $2,198.4 $ 215.4 ======= ======== ========= ======== ======== ======== 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 ======= ======== ========= ======== ======== ======== Amortization Losses and loss of deferred Paid losses adjustment expenses policy and loss Net ------------------- acquisition adjustment premiums Current Year Prior Years expenses expenses written ------------ ----------- -------- -------- ------- 2001....................... $1,720.4 $ 107.4 $ 401.7 $1,673.1 $2,277.7 ======== ========= ======== ======== ======== 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 ======== ========= ======== ======== ========
(1) The Company does not employ any discounting techniques. (2) Reserves for losses and loss adjustment expenses are shown gross of $864.6 million, $816.9 million and $694.2 million of reinsurance recoverable on unpaid losses in 2001, 2000 and 1999, respectively. Unearned premiums are shown gross of prepaid premiums of $55.6 million, $63.2 million and $57.4 million in 2001, 2000 and 1999, respectively. 45 EX-10.20 3 dex1020.txt EMPLOYMENT CONTINUITY PLAN EXHIBIT 10.20 THE ALLMERICA FINANCIAL CORPORATION EMPLOYMENT CONTINUITY PLAN THE ALLMERICA FINANCIAL CORPORATION EMPLOYMENT CONTINUITY PLAN ARTICLE 1 Purpose 1.1 The purpose of the Plan is (a) to keep top management employees focused on the interests of the Company's shareholders and to secure their continued services in addition to their undivided dedication and objectivity in the event of any threat or occurrence of, or negotiation or other action that could lead to the possibility of, a Change in Control; and (b) to ensure that Participants do not (i) solicit or assist in the solicitation of employees of the Company or any affiliate for a specified period, or (ii) disclose any confidential or proprietary information of the Company or any affiliate prior to or after a Change in Control. ARTICLE 2 Definitions The following capitalized terms used in the Plan have the respective meanings set forth in this Article: 2.1 Actuarial Equivalent: The actuarial equivalent determined in accordance with the methodology specified in the Retirement Plan(s). 2.2 Anticipatory Change in Control: (i) Any "person" including a "group" (as such terms are used in Sections 13(d) and 14(d)(2) of the 1934 Act, but excluding the Company, its affiliates, any employee benefit plan of the Company or any affiliate, and an underwriter temporarily holding securities pursuant to an offering of such securities) commences a tender offer for securities, which if consummated, would result in such person owning 20% or more of the combined voting power of the Company's then outstanding securities, (ii) the Company enters into an agreement the consummation of which would constitute a Change in Control, (iii) proxies for the election of directors of the Company are solicited by anyone other than the Company, (iv) any "person" including a "group" (as such terms are used in Sections 13(d) and 14(d)(2) of the 1934 Act, but excluding the Company, its affiliates, any employee benefit plan of the Company or any affiliate, and an underwriter temporarily holding securities pursuant to an offering of such securities) is required to file a statement under Rule 13d-1(b)(2) of the 1934 Act, or (v) 1 any other event occurs which is deemed to be an Anticipatory Change in Control by the Board or the Committee. 2.3 Board: The Board of Directors of Allmerica Financial Corporation or any successor entity thereto. 2.4 Cause: (i) The continued willful failure of a Participant to perform substantially his or her duties with the Company or any affiliate (other than any such failure resulting from the Participant's incapacity due to disability within the meaning of the Company's short term disability plan as in effect at the time such determination is made) after ten (10) days prior written notice from the Board; (ii) the Participant's conviction of, or plea of guilty or nolo contendere to, a felony; (iii) the willful engaging by the Participant in illegal conduct or gross misconduct which is demonstrably and materially injurious to the Company or any affiliate; or (iv) the breach by the Participant of any nondisclosure or nonsolicitation agreement with the Company or any affiliate, including but not limited to the agreements provided under sections 5.2 and 6.5 hereof. 2.5 Cash Balance Plan: The Allmerica Financial Corporation Cash Balance Retirement Plan, as from time to time amended. 2.6 Change in Control: (i) The members of the Board at the beginning of any consecutive twenty-four (24) calendar month period (the "Incumbent Directors") cease at any time during such period for any reason other than due to death, Disability or Retirement (in the event of a member's death, Disability or Retirement, such member shall be deemed to continue as an Incumbent Director until such member's seat on the Board is filled) to constitute at least a majority of the members of the Board, provided that any director whose election or nomination for election by the Company's stockholders was approved by a vote of at least a majority of such Incumbent Directors shall be treated as an Incumbent Director; (ii) any "person" including a "group" (as such terms are used in Sections 13(d) and 14(d)(2) of the 1934 Act, but excluding the Company, its affiliates, any employee benefit plan of the Company or any affiliate, and an underwriter temporarily holding securities pursuant to an offering of such securities) is or becomes the "beneficial owner" (as defined in Rule 13(d)(3) under the 1934 Act), directly or indirectly, of securities of the Company representing 35% or more of the combined voting power of the Company's then outstanding securities; (iii) the consummation of a merger, consolidation, share exchange or similar form of corporate transaction involving the Company or any affiliate that requires the approval of the Company's stockholders (excluding a corporate transaction involving solely the Company and its affiliates) (a "Business Combination"), unless the stockholders immediately prior to such Business Combination own more than 50% of the total voting power of the successor corporation resulting from such Business Combination or a majority of the board of directors of the successor corporation were Incumbent Directors immediately prior to such Business Combination; (iv) the stockholders of the Company approve a sale of all or substantially all of the Company's assets and such sale is consummated; or (v) the stockholders of the Company approve a plan of complete liquidation or dissolution of the Company. 2.7 Code: The Internal Revenue Code of 1986, as amended from time to time. 2 2.8 Committee: The Compensation Committee of the Board or such other committee or persons designated by the Board. 2.9 Company: Allmerica Financial Corporation or any successor entity thereto, including without limitation, the transferee of all or substantially all of the stock or assets of the Company. 2.10 Coverage Period: The three-year period commencing on the date of termination of employment with the Company and its affiliates for Category 1 Participants; the two-year period commencing on the date of termination of employment with the Company and its affiliates for Category 2 Participants; and the one-year period commencing on the date of termination of employment with the Company and its affiliates for Category 3 Participants. 2.11 Disability: With respect to members of the Board, the inability to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which can be expected to result in death or which can be expected to last for a continuous period of not less than twelve (12) months. 2.12 Early Retirement Age: Early retirement age as defined in the Retirement Plan(s). 2.13 Effective Date: The date on which the Plan becomes effective as set forth in section 3.1 hereof. 2.14 Excess Plan: Any nonqualified plan which provides supplementary retirement benefits for participants in the Cash Balance Plan with compensation in excess of the section 401(a)(17) and section 415 limits of the Code, as from time to time amended. 2.15 [Reserved.] 2.16 Good Reason: Upon or subsequent to a Change in Control, without the Participant's express written consent, (i) any change in the duties or responsibilities of the Participant that are inconsistent in any material and adverse respect with the Participant's duties or responsibilities immediately prior to the Change in Control; provided, that no change in the Participant's responsibilities that occurs as a result of the Company no longer being a public company or becoming a subsidiary after the Change in Control shall constitute Good Reason hereunder, (ii) a reduction in the Participant's rate of annual base salary as in effect immediately prior to such Change in Control, or a failure to provide an annual target bonus opportunity (including any adverse change in the formula for such annual bonus target but excluding the conversion of any cash bonus arrangement into an equity incentive arrangement of commensurate value) substantially similar to that which was in effect immediately prior to such Change in Control; (iii) a failure to provide benefits which are substantially similar in the aggregate to the benefits under any employee benefit plan, compensation plan, welfare benefit plan or material fringe benefit plan in which the Participant is participating immediately prior to the Change in Control (excluding any across-the-board reduction in benefits effected with respect to all executive employees of 3 the Company after the Change in Control); (iv) any requirement that the Participant relocate to an office more than 35 miles from the facility where the Participant is located immediately prior to the Change in Control; or (v) the failure of the Company to cause any successor entity to the Company to assume all obligations under the Plan as set forth in section 8.3 hereof. 2.17 Multiplier: Three (3) for Category 1 Participants; two (2) for Category 2 Participants; and one (1) for Category 3 Participants. 2.18 [Reserved] 2.19 1934 Act: The Securities Exchange Act of 1934, as amended from time to time. 2.20 Normal Retirement Age: Normal retirement age as defined in the Retirement Plan(s). 2.21 Participant: Any individual specified on Appendix A attached hereto in accordance with Article 4 hereof, and who has entered into a non-solicitation agreement in form and substance satisfactory to the Company. 2.22 Plan: The Allmerica Financial Corporation Employment Continuity Plan, as from time to time amended. 2.23 Protection Period: The period beginning with a Change in Control and ending on the second anniversary thereof. 2.24 Retirement: With respect to employees, separation from service with the Company and its affiliates in accordance with a retirement plan maintained by the Company (as in existence immediately prior to the Change in Control) or in accordance with any retirement arrangement established with respect to the Participant with the Participant's consent; with respect to members of the Board, retirement pursuant to a retirement policy then in effect for members of the Board. 2.25 Retirement Plan(s): To the extent a Participant is eligible for retirement benefits thereunder, the Cash Balance Plan and the Excess Plan as applicable. 2.26 Stock Incentive Plans: Allmerica Financial Corporation Long-Term Stock Incentive Plan and any successor(s) to such plans or other stock option or stock incentive plans approved by the Board. 2.27 Transition Group: Participants who have attained an age as of December 31, 1994, which when added with two (2) times their credited service as of December 31, 1994 under the Cash Balance Plan, equals or exceeds eighty-five (85). ARTICLE 3 Plan Term 4 3.1 Effective Date: The Plan shall be effective as of December 17, 1996. 3.2 Expiration: Except as provided in sections 3.3, 3.4 and 3.5 hereof, the Plan shall terminate on the December 31st of the calendar year in which the notice requirement of section 3.6 hereof has been satisfied. 3.3 Initial Term: In no event shall the Plan terminate prior to December 31, 1998. 3.4 Anticipatory Change in Control: In the event the Plan would otherwise terminate pursuant to section 3.2 hereof during any one-year period commencing upon an Anticipatory Change in Control, the Plan shall terminate on the first anniversary of such Anticipatory Change in Control; provided, however, in the event of a Change in Control during the one-year period commencing upon such Anticipatory Change in Control, the Plan shall terminate on the last day of the Protection Period. 3.5 Change in Control: In the event the Plan would otherwise terminate pursuant to section 3.2 hereof during the Protection Period commencing upon a Change in Control, the Plan shall terminate on the last day of the Protection Period. 3.6 Notice: The notice requirement of this section shall be satisfied on the September 30th coincident with or next following the date on which all Participants have received written notice from the Committee of its desire to terminate the Plan. ARTICLE 4 Eligibility 4.1 General: Any individual specified on Appendix A attached hereto shall be a Participant eligible to receive benefits and payments hereunder. Participants shall be designated as "Category 1" or "Category 2" or "Category 3" on Appendix A and shall receive benefits and payments hereunder in accordance with such designation. 4.2 Addition or Move: The Committee in its sole discretion may add the names of additional employees of the Company or any affiliate to Appendix A or move the name of a Participant from Category 3 or Category 2 to Category 1 or from Category 3 to Category 2 (any such move is referred to herein as an "Upward Redesignation") at any time, or subject to the provisions of section 4.3 hereof, move the name of a Participant from Category 1 to Category 2 or Category 3 or from Category 2 to Category 3 (a "Downward Redesignation"). Each such employee shall be eligible to receive benefits and payments hereunder in accordance with the employee's designation on Appendix A. 4.3 Removal or Downward Redesignation: Except as provided in sections 4.4, 4.5 and 4.6 hereof, the Committee in its sole discretion may remove the name of any individual specified on Appendix A or cause a Downward Redesignation effective on the December 31st of the calendar in which the notice requirement of section 4.7 hereof has been satisfied. However, a Participant who voluntarily terminates his/her employment with the Company and/or one of its affiliates shall be removed from Appendix A as of the date 5 that his/her employment is terminated and in the case of a Participant involuntarily terminated by the Company and/or its affiliates prior to the occurrence of an Anticipatory Change of Control, removal of such Participant's name from Appendix A shall occur upon the expiration of thirty (30) days after notice has been received by the Participant's from the Committee. An individual removed from Appendix A shall cease to be eligible to receive benefits and payments hereunder and all rights thereto shall be without further force or effect upon removal from Appendix A. An individual whose Downward Redesignation is effective shall be eligible to receive benefits and payments hereunder in accordance with such individual's revised designation on Appendix A. Notwithstanding any provision in the Plan to the contrary, the Committee may remove the name of any individual specified on Appendix A or cause a Downward Redesignation at any time with such individual's written consent. 4.4 Initial Term: In no event shall the name of any Participant be removed from Appendix A prior to December 31, 1998. 4.5 Anticipatory Change in Control: In the event of an Anticipatory Change in Control, any name which would otherwise be removed from Appendix A or the subject of a Downward Redesignation pursuant to section 4.3 hereof during the one-year period commencing upon such Anticipatory Change in Control shall be removed or redesignated on the first anniversary of such Anticipatory Change in Control; provided, however, in the event of a Change in Control during the one-year period commencing upon such Anticipatory Change in Control, such name shall be removed from Appendix A or such redesignation shall be effective on the first day following the end of the Protection Period. Notwithstanding the foregoing, a Participant may be removed from Appendix A after an Anticipatory Change in Control if such removal is due to a termination for Cause or the Participant voluntarily terminates his employment. 4.6 Change in Control: In the event of a Change in Control, any name which would otherwise be removed from Appendix A or be the subject of a Downward Redesignation shall be so removed or redesignated, as the case may be, on the first day following the end of the Protection Period. 4.7 Notice: The notice requirement of this section shall be satisfied on the September 30th coincident with or next following the date on which the Participant has received written notice from the Committee of its desire to remove such individual's name from the list of Participants on Appendix A or to cause a Downward Redesignation as the case may be. Notwithstanding the foregoing, in the event a Participant is involuntarily terminated by the Company and/or one of its affiliates prior to the occurrence of an Anticipated Change of Control, the notice requirement of this section shall be satisfied upon the expiration of thirty (30) days after the Participant has received written notice from the Committee of its desire to remove such individual's name from the list of Participants on Appendix A, and no notice is required if a Participant voluntarily terminates his employment with the Company and/or one of its affiliates. ARTICLE 5 6 Change in Control Payments 5.1 General: In the event of a Change in Control, the Company shall pay to each Participant within ten (10) days following such Change in Control, a lump-sum cash amount equal to the sum of (a) the fair market value (determined in accordance with the applicable Stock Incentive Plans as of the date of the Change in Control) of shares of common stock awarded to the Participant under the Stock Incentive Plans which are not vested immediately after the Change in Control; and (b) the excess of (i) the fair market value (determined in accordance with the applicable Stock Incentive Plans as of the date of the Change in Control) of the shares of common stock designated to a stock option (or stock appreciation right) granted to the Participant under the Stock Incentive Plans and with respect to which, such stock option (or stock appreciation right) is not exercisable immediately after the Change in Control, over (ii) the exercise price (or base price) for such shares. 5.2 Release: Notwithstanding the foregoing, no amount shall be payable under section 5.1 hereof unless the Participant executes a Waiver and Release in form and substance approved by the Company, which shall be substantially in the form provided in Appendix B attached hereto or as otherwise amended by the Company in accordance with section 8.5 hereof, and such agreement becomes effective waiving and extinguishing any further rights or benefits under the Stock Incentive Plans with respect to shares of common stock, stock options or stock appreciation rights "cashed out" pursuant to Section 5.1 above. ARTICLE 6 Protected Termination Benefits and Payments 6.1 General: Except as provided in section 6.2(b) hereof, in the event of a Change in Control, the Company shall pay the benefits and payments specified in sections 6.3 and 6.4 hereof if, (a) the Company or any affiliate terminates a Participant's employment with the Company and its affiliates without Cause during the Protection Period, (b) the Participant terminates employment with the Company and its affiliates with Good Reason during the Protection Period, or (c) the Participant terminates employment with the Company and its affiliates for any reason at any time during the thirteenth calendar month commencing after the Change in Control. 7 6.2 Retirement, Death or Disability: (a) For purposes of section 6.1(b) hereof, any termination of employment by reason of Retirement without Good Reason shall be deemed to be a termination of employment by the Participant without Good Reason. (b) Notwithstanding the foregoing, no benefits or payments shall be payable to a Participant under this Article in the event the Participant's employment is terminated by reason of death or such Participant becomes eligible for disability benefits under the Company's long-term disability plan. 6.3 Lump-Sum Benefits: In the event of a termination of employment specified in section 6.1 hereof, the Company shall pay to each Participant within thirty (30) days following such termination, a lump-sum cash amount equal to the sum of (a) the Multiplier times the sum of (i) the greater of (A) the Participant's annual base salary in effect on the date of termination of employment or (B) the Participant's annual base salary in effect immediately prior to the date of the Change in Control; and (ii) the target bonus for the Participant under the Short Term Incentive Plan as in effect immediately prior to the Change in Control (if the Short Term Incentive Plan does not have a target bonus for the year in which the Change of Control occurred, the most recent target bonus shall be used); (b) an amount equal to the target bonus potential under the Short Term Incentive Plan for the plan year in which the Participant's employment is terminated, times a fraction (not more than one (1), the numerator of which shall be the number of days the Participant is employed by the Company or any affiliate during the plan year in which the Participant's employment is terminated and the denominator of which shall be 365; (c) if not paid prior to the termination of employment, the Participant's Short Term Incentive Award for the year prior to the year in which the Participant's employment is terminated; and (d) the Multiplier times the amount which would be credited to the Participant's account balance(s) under the Retirement Plan(s) in the plan year in which the Participant's employment is terminated, assuming the Participant's account balance(s) is credited in such year with seven (7) percent of compensation as defined in the Retirement Plan(s) at the greater of (A) the annualized rate of compensation in effect on the date of termination of employment or (B) the compensation for the plan year immediately preceding the year in which the Change in Control occurred; and 8 (e) with respect to any member of the Transition Group, the excess of (i) the Actuarial Equivalent of the final average pay benefit under the Retirement Plan(s) at Normal Retirement Age assuming such member were credited with a number of additional years of service equal to the Multiplier applicable to such Participant over (ii) the Actuarial Equivalent of the actual final average pay benefit under the Retirement Plan(s) at Normal Retirement Age. 6.4 Other Benefits: In the event of a termination of employment specified in section 6.1 hereof, the Company shall (a) continue for the Coverage Period to cover the Participant under those employee benefit plans (including but not limited to life and disability insurance coverage but excluding health plan coverage which is otherwise provided for in sections 6.4(d) and 6.4(e) hereof) which were applicable to the Participant immediately prior to the Change in Control at the same benefit levels then in effect (or shall provide their equivalent); (b) provide outplacement services to the Participant at a cost of no more than 17% of the greater of the Participant's annual base salary in effect on the date of termination of employment or the Participant's annual base salary in effect immediately prior to the date of the Change in Control, or at the Participant's election, in lieu of such outplacement services, pay to the Participant within thirty (30) days following such termination, a lump-sum cash amount equal to $20,000; (c) with respect to any member of the Transition Group who does not satisfy the age and service requirements for early retirement benefits without actuarial reduction under the Retirement Plan(s) upon termination of employment but would satisfy such requirements if such member were, on the date of such termination, as many years older as the number equal to the Multiplier applicable to such Participant and such member were credited with the same number of years of service, provide supplemental payments hereunder at the same time and in the same manner as the payments payable under the Retirement Plan(s) to the Participant so that the Participant receives in the aggregate the benefit (calculated using the Participant's actual age and years of service) that would be payable if the Participant were entitled to an early retirement benefit without actuarial reduction under such Retirement Plan(s); (d) with respect to any Participant who is entitled to post-retirement medical benefits under the post-retirement medical plan or arrangement in effect immediately prior to the Change in Control or who would be entitled to such benefits if such Participant were older or had more years of service than such Participant actually 9 has on the date of the Participant's termination of employment by a number of years equal to the Multiplier and such Participant were credited with a number of additional years of service and age, in each case equal to the Multiplier, (i) during the Coverage Period, provide coverage for the Participant and the applicable dependents under the group health plan maintained by the Company or any affiliate at substantially the same level of coverage in effect immediately prior to the Change in Control or coverage in effect at the date of termination provided such coverage provides a substantially equivalent level of coverage as the coverage in effect immediately prior to the Change in Control, and (ii) upon expiration of such Coverage Period, provide the Participant and applicable dependents with coverage under the post-retirement medical plan or arrangement at a level substantially similar to the level in effect immediately prior to termination of employment, subject to retiree contributions at a rate no greater than that in effect immediately prior to termination of employment or (as the same may be adjusted from time to time) for all similarly situated retirees with comparable age, health background and coverage (or shall provide their equivalent); (e) with respect to any Participant who is not eligible for the benefits specified in section 6.4(d) hereof during the Coverage Period, provide coverage for the Participant and the applicable dependents under the group health plan maintained by the Company or any affiliate at substantially the same level of coverage in effect immediately prior to the Change in Control or coverage in effect at the date of termination provided such coverage provides a substantially equivalent level of coverage as the coverage in effect immediately prior to the Change in Control, except that, for Participants in Category 3 as of February 10, 2002, the coverage provided by this subsection shall be for a period of eighteen months instead of the one year Coverage Period; (f) discontinue one or more of the benefits provided under Sections 6.4(a) and 6.4(e) if a Participant obtains employment with another company pursuant to which substantially equivalent benefits are available, and (g) upon expiration of the group dental or health coverage set forth in Sections 6.4(a) and 6.4(e), if a Participant is not eligible for substantially equivalent coverage as a Participant or dependent under a plan maintained by another employer, then the Participant shall be entitled to receive COBRA Continuation Coverage at their own expense. 6.5 Release: Notwithstanding the foregoing, no amounts shall be payable under sections 6.3 and 6.4 hereof unless the Participant executes a Waiver and General Release, in form and substance approved by the Company, which shall be substantially in the form provided in Appendix C attached hereto or as otherwise amended by the Company in 10 accordance with section 8.5 hereof, and such agreement becomes effective. 6.6 Interim Period: (a) In the event the Company or any affiliate terminates a Participant's employment with the Company and its affiliates without Cause during the period between the commencement of an Anticipatory Change in Control and a Change in Control (the "Interim Period"), and a Change of Control occurs within the one-year period after the date of the Anticipatory Change of Control, such Participant shall become entitled to the benefits he or she otherwise would have received if such termination had occurred on the date of the Change in Control and he or she was terminated on such date without Cause; provided however, (i) any benefits payable shall be reduced by any severance or similar payments or benefits otherwise paid or payable by the Company or its affiliates in connection with such termination; (ii) such Participant shall be subject to the same obligations and responsibilities as any other Participant receiving similar benefits hereunder (including, without limitation, the requirement to provide waivers and releases under Sections 5.2 and 6.5); and (iii) no benefits shall be payable as a result of the application of this Section 6.6 if the removal of such Participant's name from Appendix A has become effective, if a Change in Control does not occur or if the Participant agrees in writing to waive the right to such payments or benefits. (b) If during the Interim Period, (i) any change is made to a Participant's duties or responsibilities, or any reduction is made to the Participant's salary or annual target opportunity, or any reduction is made with respect to other benefit, compensation, welfare benefit or other material fringe benefit plan (excluding with respect to any such plan any across-the-board reductions in benefits effected with respect to all executive employees of the Company), or (ii) the Participant is required to relocate to an office more than 35 miles from the facility where the Participant is located immediately prior thereto, then for purposes of determining whether Good Reason exists, or determining benefits payable pursuant to this Plan, such Participant's duties and responsibilities, salary and annual target opportunity, or other benefit compensation, welfare benefit or other material fringe benefit plan, or location, as applicable, shall be applied as of the date of the Anticipatory Change in Control. ARTICLE 7 11 Taxation of Benefits and Payments 7.1 Withholding Taxes: The Company may withhold from the Participant's benefits and payments payable hereunder the amount which it determines is necessary to satisfy its obligation to withhold federal, state and local income taxes or other taxes or amounts required to be withheld. 7.2 Gross-Up Payment: In the event it shall be determined that any benefit or payment payable hereunder to a Participant would be subject to the excise tax imposed by section 4999 of the Code, the Company shall pay to the Participant (or to the Internal Revenue Service on behalf of the Participant) in any taxable year for which the excise tax is payable an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Participant of all taxes (including but not limited to federal, state and local income taxes, excise taxes, and FICA taxes including hospital insurance taxes) imposed on the Gross-Up Payment, the Participant retains (or has had paid to the Internal Revenue Service on his or her behalf) an amount of the Gross-Up Payment equal to the sum of (a) the excise tax imposed by section 4999 of the Code, and (b) the product of (i) any deductions disallowed because of the inclusion of the Gross-Up Payment in the Participant's adjusted gross income, times (ii) the highest applicable marginal rate of federal income taxation for the calendar year in which the Gross-Up Payment is to be made. For purposes of determining the amount of the Gross-Up Payment, the Participant shall be deemed to (a) pay federal, state and local income taxes (for the residence where the Participant most recently filed a return for such taxes) at the highest marginal rate of taxation for the calendar year in which the Gross-Up Payment is to be made and (b) have otherwise allowable deductions for federal income tax purposes at least equal to the Gross-Up Payment. 7.3 [Reserved] 7.4 Determination of Excise Tax: All determinations of gross-up payments that are required to be made under section 7.2 hereof shall be made by PricewaterhouseCoopers LLP or such other public accounting firm as may be retained by the Company prior to the Change of Control. The determination by such accounting firm shall be final and conclusive, absent manifest error. 7.5 Claim by Internal Revenue Service: As soon as practicable, a Participant shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would result in the imposition of the excise tax under section 4999 of the Code. If the Company notifies the Participant in writing that it desires to contest such claim, the Participant shall cooperate in all reasonable ways with the Company in such contest and the Company shall be entitled to participate in all proceedings relating to such claim; 12 provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Participant harmless, on an after-tax basis, for any excise tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing, the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Participant to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Participant agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Participant to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Participant on an interest-free basis, and shall indemnify and hold the Participant harmless, on an after-tax basis, from any excise tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided, further, that if the Participant is required to extend the statute of limitations to enable the Company to contest such claim, the Participant may limit this extension solely to such contested amount. The Company's control of the contest shall be limited to issues with respect to the imposition of the excise tax under section 4999 of the Code and the Participant shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. ARTICLE 8 Miscellaneous 8.1 No Mitigation: No benefit or payment payable hereunder shall be subject to offset including, but not limited to, amounts in respect of any claims which the Company may have against the Participant, provided, however, the amount payable hereunder to any Participant shall be reduced by any amounts payable to such Participant from the Company or any affiliate pursuant to any other severance plan or policy (including any employment agreement). 8.2 Legal Fees: The Company shall reimburse all costs and expenses, including attorneys' fees, of the Participant in connection with any legal proceedings relating to the Plan, any plan listed on Appendix D, or any successor plans; provided, however, the Company shall not reimburse such costs and expenses for the Participant if (a) prior to the initiation of any proceedings by the Participant, such Participant fails to specify in writing all claims relating to the Plan, any plan listed on Appendix D, or any successor plans and to provide the Committee with thirty (30) days to address such claims, or (b) the judge or other individual presiding over the proceedings affirmatively finds that (i) the Participant initiated such proceedings in bad faith, or (ii) the Participant violated the terms of the Waiver and Release required under section 5.2 hereof or the Waiver and General Release required under section 6.5 hereof. 13 8.3 Successors: If the Company shall be merged into or consolidated with another entity, the provisions of this Plan shall be binding upon and inure to the benefit of the entity surviving such merger or resulting from such consolidation. The Company shall require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of the Company to expressly assume and agree to perform the duties set forth hereunder in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place (including but not limited to section 8.7 hereof). 8.4 Indemnification. In addition to such other rights of indemnification as they may have as members of the Board or the Committee, the members of the Board and the Committee shall be indemnified by the Company against all costs and expenses reasonably incurred by them in connection with any action, suit or proceeding to which they or any of them may be party by reason of any action taken or failure to act under or in connection with the Plan and against all amounts paid by them in settlement thereof (provided such settlement is approved by independent legal counsel selected by the Company) or paid by them in satisfaction of a judgment in any such action, suit or proceeding, except a judgment based upon a finding that such member was not acting in good faith on the reasonable belief that he or she was acting in the best interests of the Company; provided that upon the institution of any such action, suit or proceeding, a Committee or Board member shall, in writing, give the Company notice thereof and an opportunity, at its own expense, to handle and defend the same before such Committee or Board member undertakes to handle and defend it on such member's own behalf. 14 8.5 Amendments: The Board or the Committee may at any time, or from time to time, amend the Plan in whole or in part or amend it in such respects as the Board or the Committee may deem appropriate; provided, however, that no amendment to the Plan (including the waiver and release agreements provided in sections 5.2 and 6.5 hereof) shall, without the affected Participant's written consent, impose any obligations on the Participant or impair any rights or obligations hereunder except as provided in section 4.3 hereof. 8.6 Plan Expenses: Any expenses of administering the Plan shall be borne by the Company. 8.7 Survival: Notwithstanding any provision in the Plan to the contrary, the obligations hereunder to the Participants which arise due to an Anticipatory Change in Control or a Change in Control shall survive any termination of the Plan and shall be binding upon the Company. 8.8 Notice: All notices and other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given when actually delivered, or five (5) days after deposit in the United States mail, certified and return receipt requested, for delivery to (a) the Committee at Allmerica Financial, 440 Lincoln Street, Worcester, MA 01653; or (b) the Participant at the last known address specified in the Company's records. 8.9 Governing Law: The validity, construction and effect to the Plan and any actions taken under or relating to the Plan shall be determined in accordance with the laws of the State of Delaware. 15 APPENDIX A APPENDIX B Waiver and Release In exchange for the benefits and payments offered to me by Allmerica Financial Corporation as set forth in section 5.1 of The Allmerica Financial Corporation Employment Continuity Plan (the "Plan"), I hereby release Allmerica Financial Corporation and all of its past and/or present divisions, affiliates, subsidiaries, officers, directors, stockholders, trustees, employees, agents, representatives, administrators, attorneys, insurers, fiduciaries, successors and assigns, in their individual and/or representative capacities (the "Company") from any and all causes of action, suits, agreements, promises, damages, disputes, controversies, contentions, differences, judgments, claims and demands of any kind whatsoever which I or my heirs, executors, administrators, successors and assigns ever had, now have or may have against the Company, whether known or unknown to me, under the Allmerica Financial Corporation Long-Term Stock Incentive Plan and any successor(s) to such plans, but only with respect to shares of common stock, stock options or stock appreciation rights "cashed out" pursuant to Section 5.1 of the Plan ("Stock Rights"). I represent that I have not filed, and will not hereafter file, any claim against the Company relating to such Stock Rights. I understand and agree that if (i) I commence, continue, join in , or in any other manner attempt to assert any claim released herein against the Company, or otherwise violate the terms of this Waiver and Release; (ii) without prior written consent from the Company, I disclose to any other person or entity any non-public information concerning the Company's financial data, strategic business plans, product development (or other proprietary product data), customer lists, marketing plans and other proprietary information, except for specific items which have become publicly available information other than through a breach by me of my fiduciary duties to the Company or which cannot reasonably be expected to adversely affect the business of the Company, unless required to do so by a court of competent jurisdiction or other governmental authority with purported or apparent jurisdiction; (iii) upon termination of employment, I employ, solicit for employment, or recommend for employment any officer of the Company during the [for Category 1 and Category 2 Participants, the "two year period" and for Category 3 Participants the "one year period"] period commencing on the date of termination of employment; or (iv) I violate the terms of any non-competition or non-solicitation agreement between myself and the Company, the Company shall have the right to the return of the benefits and payments paid to me by the Company under section 5.1 of the Plan (together with interest thereon at the rate of six (6) percent per annum from the date of receipt by me to the date of payment by me). Notwithstanding the foregoing, in no event shall this Waiver and Release be construed to waive or release any rights I may have to be indemnified under the Company's Charter, By-Laws, other agreements or documents or statutory provisions providing such indemnification. I understand and agree that I shall notify the Company in writing, as soon as practicable, of any claim by the Internal Revenue Service that, if successful, would result in the imposition of the excise tax under section 4999 of the Code. I further understand and agree that if the Company notifies me in writing that it desires to contest such claim, I shall cooperate in all reasonable ways with the Company in accordance with the provisions of section 7.5 of the Plan. IN WITNESS WHEREOF, the Company has caused this Waiver and Release to be executed by a duly authorized officer of the Company and I have executed this Waiver and Release as of the date set forth below. _____________________________ Name of Participant _____________________________ Signature _____________________________ Date Allmerica Financial Corporation By :_________________________ _____________________________ Title _____________________________ Date APPENDIX C Waiver and General Release In exchange for the benefits and payments offered to me by Allmerica Financial Corporation as set forth in The Allmerica Financial Corporation Employment Continuity Plan (the "Plan"), I hereby release Allmerica Financial Corporation and all of its past and/or present divisions, affiliates, subsidiaries, officers, directors, stockholders, trustees, employees, agents, representatives, administrators, attorneys, insurers, fiduciaries, successors and assigns, in their individual and/or representative capacities (the "Company") from any and all causes of action, suits, agreements, promises, damages, disputes, controversies, contentions, differences, judgments, claims and demands of any kind whatsoever which I or my heirs, executors, administrators, successors and assigns ever had, now have or may have against the Company, whether known or unknown to me, by reason of my employment and/or cessation of employment with the Company or otherwise involving facts relating to such employment which occurred on or prior to the date that I have signed this Release, including without limitation all claims under Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act of 1967, the Reconstruction Era Civil Rights Act, the Civil Rights Act of 1991, the Fair Labor Standards Act, the Employee Retirement Income Security Act, the Americans with Disabilities Act, the Family and Medical Leave Act of 1993, and any and all other federal, state and local laws, statutes, rules and regulations pertaining to employment, as well as any and all claims under state contract or tort law. I represent that I have not filed, and will not hereafter file, any claim against the Company relating to my employment and/or cessation of employment with the Company, or otherwise specified above involving facts which occurred on or prior to the date that I have signed this Waiver and General Release. I understand and agree that if (i) I commence, continue, join in, or in any other manner attempt to assert any claim released herein against the Company, or otherwise violate the terms of this Waiver and General Release, (ii) without prior written consent from the Company, I disclose to any other person or entity any non-public information concerning the Company's financial data, strategic business plans, product development (or other proprietary product data), customer lists, marketing plans and other proprietary information, except for specific items which have become publicly available information other than through a breach by me of my fiduciary duties to the Company or which cannot reasonably be expected to adversely affect the business of the Company, unless required to do so by a court of competent jurisdiction or other governmental authority with purported or apparent jurisdiction; (iii) I employ, solicit for employment, or recommend for employment any officer of the Company during the [for Category 1 and Category 2 Participants, the "two year period" and for Category 3 Participants the "one year period"] commencing on the date of termination of employment; or (iv) I violate the terms of any noncompetition and nonsolicitation agreement between myself and the Company, the Company shall have the right to the return of the benefits and payments paid to me by the Company under the Plan (together with interest thereon at the rate of six (6) percent per annum from the date of receipt by me to the date of payment by me). Notwithstanding the foregoing, in no event shall this Waiver and Release be construed to waive or release any rights I may have to be indemnified under the Company's Charter, By-Laws, other agreements or documents or statutory provisions providing such indemnification. I also agree to respond to questions and/or inquiries and provide other information concerning matters that were within the ambit of my responsibilities during my employment with the Company. It is anticipated that most matters will be addressed through phone calls and/or e-mails. I understand and agree that I shall notify the Company in writing, as soon as practicable, of any claim by the Internal Revenue Service that, if successful, would result in the imposition of the excise tax under section 4999 of the Code. I further understand and agree that if the Company notifies me in writing that it desires to contest such claim, I shall cooperate in all reasonable ways with the Company in accordance with the provisions of section 7.5 of the Plan. I have read this Waiver and General Release carefully, have been given at least 21 days to consider all of its terms, have been advised to consult with an attorney and any other advisors of my choice, and fully understand that by signing below I am, to the extent provided herein, giving up any right which I may have to sue or bring any other claims against the Company. I have not been forced or pressured in any manner whatsoever to sign this Waiver and General Release, and I agree to all of its terms voluntarily. I understand that I have seven days from the date I have signed this Waiver and General Release below to revoke this Waiver and General Release, that this Waiver and General Release will not become effective until the 8th day following the date that I have signed this Waiver and General Release, and that the Company will have no obligation to pay me the benefits and payments under the Plan as agreed unless this Waiver and General Release becomes effective. I further understand that this Waiver and General Release is the complete and exclusive statement of its terms and any waiver prior to the date of my signature below with respect to the Plan shall be without further force or effect on the effective date of this Waiver and General Release. IN WITNESS WHEREOF, the Company has caused this Waiver and General Release to be executed by a duly authorized officer of the Company and I have executed this Waiver and General Release as of the date set forth below. ______________________________ Name of Participant ______________________________ ___________ Signature Date Allmerica Financial Corporation By :_________________________ _____________________________ Title _____________________________ Date APPENDIX D First Allmerica Financial Life Insurance Company Non-Qualified Executive Deferred Compensation Plan First Allmerica Financial Life Insurance Company Non-Qualified Executive Retirement Plan First Allmerica Financial Life Insurance Company Excess Benefit Retirement Plan First Allmerica Financial Life Insurance Company Deferred Compensation Agreements EX-10.23 4 dex1023.txt AMENDED LONG-TERM STOCK INCENTIVE PLAN Exhibt 10.23 ALLMERICA FINANCIAL CORPORATION AMENDED LONG-TERM STOCK INCENTIVE PLAN Section 1. Purpose. The Allmerica Financial Long-Term Stock Incentive Plan (the "Plan") has been adopted to encourage and create significant ownership of the Company's Common Stock among executive officers, other key employees and certain insurance agents and brokers of the Company and its Subsidiaries and Affiliates. The Plan may be adopted by any Subsidiary of the Company, including, but not limited to, First Allmerica Financial Life Insurance Company, The Hanover Insurance Company and Citizens Insurance Company of America. Any Subsidiary adopting the Plan agrees to adhere to the terms and conditions of the Plan as set forth below. Additional purposes of the Plan include: (a) To provide a meaningful incentive to Participants for making substantial contributions to the Company's long-term business growth; (b) To enhance the Company's and its Subsidiaries' ability to attract and retain executive officers, other key employees and certain insurance agents and brokers who will make such contributions; and (c) To closely align the interests of these executive officers and other key employees with those of Company stockholders by providing opportunities for them to obtain significant longer term rewards through stock ownership. Section 2. Definitions. (a) "Affiliate" means any entity, other than a Subsidiary, that is directly or indirectly controlled by the Company or in which the Company has a significant equity interest as determined by the Committee. (b) "Award" means any Stock Option, Stock Appreciation Right or Stock Award granted under the Plan. (c) "Board" means the Company's Board of Directors. (d) "Cause" shall mean (i) the willful failure by the Participant to perform substantially the Participant's duties as an employee of the Company (other than due to physical or mental illness), (ii) the Participant's engaging in serious misconduct that is injurious to the Company, any Subsidiary or any Affiliate, (iii) the Participant's having been convicted of, or entered a plea of nolo contendere to, a crime that constitutes a felony, (iv) the breach by the Participant of any written or unwritten covenant or agreement not to compete with the Company, any Subsidiary or any Affiliate or (v) the breach by the Participant of his or her duty of loyalty to the Company, any Subsidiary or any Affiliate. (e) "Change in Control" means the occurrence of any of the following events: (i) the members of the Board at the beginning of any consecutive twenty-four calendar month period (the "Incumbent Directors") cease for any reason other than due to death or retirement to constitute at least a majority of the members of the Board, provided that any director whose election or nomination for election by the Company's stockholders was approved by a vote of a least a majority of the members of the Board at the beginning of such twenty-four calendar month period shall be treated as an Incumbent Director; (ii) any "person" including a "group" (as such terms are used in Section 13(d) and 14(d)(2) of the 1934 Act, but excluding the Company, any of its Subsidiaries, any employee benefit plan of the Company or any of its Subsidiaries) is or becomes the "beneficial owner" (as defined in Rule 13(d)(3) under the 1934 Act), directly or indirectly, of securities of the Company representing 35% or more of the combined voting power of the Company's then outstanding securities; or (iii) the stockholders of the Company shall approve a definitive agreement (1) for the merger or other business combination of the Company with or into another corporation, a majority of the directors of which were not directors of the Company immediately prior to the merger or other business combination and in which the stockholders of the Company immediately prior to the effective date of such merger or other business combination own less than 50% of the voting power in such corporation and such merger or other business combination is consummated or (2) for the sale or other disposition of all or substantially all of the assets of the Company. (f) "Change in Control Price" means the highest price per Share offered in conjunction with any transaction resulting in a Change in Control (as determined in good faith by the Committee if any part of the offered price is payable other than in cash) or, in the case of a Change in Control occurring solely by reason of a change in the composition of the Board, the highest Fair Market Value of the Stock on any of the 30 trading days immediately preceding the date on which a Change in Control occurs. (g) "Code" means the Internal Revenue Code of 1986, as amended from time to time. (h) "Committee" means a committee of not less than two non-employee members of the Board, appointed by the Board to administer the Plan. The Committee shall be comprised of members who qualify to administer this Plan as contemplated by Rule 16b-3 under the 1934 Act (or any successor rule thereto). (i) "Common Stock" means the common stock, par value $.01 per share, of the Company. (j) "Company" means Allmerica Financial Corporation, a corporation established under the laws of the State of Delaware. (k) "Disability" shall mean long-term disability as defined under the terms of the Company's or any Subsidiaries' applicable long term disability plans or policies. 2 (l) "Early Retirement" with respect to a Participant shall mean retirement under any qualified pension plan maintained by the Company or any of its Subsidiaries or Affiliates at or after the earliest age at which a Participant may retire and receive an immediate, but actuarially reduced, retirement benefit under such plan. If a Participant is not a participant in such a plan, "Early Retirement" shall mean retirement at or after age 55 with at least 15 years of service with the Company or a Subsidiary. (m) "Fair Market Value" means, with respect to Common Stock, the fair market value of a Share as determined by the Committee in good faith in such manner as shall be established by the Committee from time to time; provided that at any time that the Common Stock is traded on an established securities market, Fair Market Value means the last reported sale price at which the Common Stock is traded on such date or, if no Common Stock is traded on such date, the most recent date on which Common Stock was traded, as reflected on such public market. Under no circumstances shall the Fair Market Value be less than the par value of the Common Stock. (n) "Incentive Stock Option" or "ISO" means a Stock Option to purchase Shares awarded to a Participant which is intended to meet the requirements of Section 422 of the Code or any successor provision. (o) "Non-Qualified Stock Option" or "NQSO" means a Stock Option to purchase Shares of Common Stock awarded to a Participant which is not intended to meet the requirements of Section 422 of the Code or any successor provision. (p) "1934 Act" means the Securities Exchange Act of 1934, as amended from time to time. (q) "Normal Retirement" with respect to a Participant shall mean retirement under any qualified pension plan maintained by the Company or any of its Subsidiaries or Affiliates at or after the earliest age at which a Participant may retire and receive a retirement benefit under such plan without an actuarial reduction for early commencement of benefits. If a Participant is not a participant in such a plan, "Normal Retirement" shall mean retirement at or after age 65 with no minimum service requirement. (r) "Participant" means a person selected by the Committee (or its delegate as provided under Section 4) to receive an Award under the Plan. (s) "Reporting Person" means an individual who is subject to Section 16 of the 1934 Act by virtue of his or her relationship with the Company. (t) "Senior Management" means the executive officers (within the meaning of Rule 3b-7 under the 1934 Act) of the Company from time to time, whether such persons are officers of the Company or of a Subsidiary. 3 (u) "Shares" means shares of the Common Stock of the Company. (v) "Stock Appreciation Right" or "SAR" means an Award in the form of a right to receive a payment equal to the excess of Fair Market Value as of the date of exercise over the base value of the SAR. (w) "Stock Award" means an Award to a Participant comprised of Common Stock or valued by reference to Common Stock granted under Section 7 of the Plan. (x) "Stock Option" means an Award in the form of the right to purchase a specified number of Shares at a specified price during a specified period. (y) "Subsidiary" shall mean any entity of which the Company possesses directly or indirectly fifty percent (50%) or more of the total combined voting power of all classes of stock of such entity. Section 3. Effective Date. Subject to the approval of the stockholders of the Company, the Plan shall be effective as of May 22, 1996. Senior Management, however, shall not be eligible to participate until the later of the date the Board adopts the Plan with respect to Senior Management or October 17, 1996. No Awards may be made under the Plan after ten years from the effective date or earlier termination of the Plan by the Board. Section 4. Administration. The Plan shall be administered by the Committee. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the operation of the Plan as it shall from time to time consider advisable. The Committee shall also have full discretion to interpret the provisions of the Plan. Any decision or action taken or to be taken by the Committee, arising out of or in connection with the construction, administration, interpretation and effect of the Plan and of its rules and regulations, shall, to the maximum extent permitted by applicable law, be within its absolute discretion (except as otherwise specifically provided herein) and shall be conclusive and binding upon all Participants and any person claiming under or through any Participant. To the extent permitted by applicable law and the provisions of the Plan, the Committee may delegate to one or more employee members of the Board the power to make Awards to Participants who are not Reporting Persons. Section 5. Eligibility. Any executive officer or other key employee (including, without limitation, insurance agents, brokers and independent agents) of the Company, any Subsidiary or any Affiliates shall be eligible to receive an Award under the Plan, provided that such participation would not jeopardize (i) the Plan's compliance with Rule 16b-3 under the 1934 Act or any successor rule, and (ii) the Company's ability to register shares underlying the Plan on Registration Statements on Form S-8 pursuant to the Securities Act of 1933, as amended, or any successor form. Directors who are not employees shall not be eligible to be granted Awards under the Plan. 4 Section 6. Stock Available for Awards. (a) Common Shares Available. The maximum number of Shares available for Awards under the Plan with respect to each fiscal year the Plan is in effect will be 3.25% of the total Shares of outstanding Common Stock of the Company as of the start of each such fiscal year plus any Shares available for Awards under the Plan in prior fiscal years but not used. Shares of Common Stock underlying any Awards which are forfeited, canceled, reacquired by the Company, satisfied without the issuance of Common Stock or otherwise terminated (other than by exercise) shall be added back to the Shares of Common Stock available for issuance under the Plan. Shares available for issuance under the Plan may be drawn from the Company's Treasury Stock account. (b) Share Usage Limits. For the period that the Plan is in effect, the aggregate number of Shares that may be issued on exercise of Stock Options and as Stock Awards shall be as follows: (i) an amount equal to the sum of (a) five percent (5%) of the number of Shares outstanding at the close of business on May 20, 1997, plus (b) an amount, not to exceed 1,172,000 Shares, equal to the number of Shares underlying Awards granted under the Plan and not surrendered as of May 20, 1997; and (ii) thereafter, commencing with the annual meeting of shareholders in 1998, increasing annually the maximum number of Shares that may be issued under the Plan by an amount equal to one and one-quarter percent (1.25%) of the number of Shares outstanding at the close of business on the day of each annual meeting of shareholders up to and including the 1998 annual meeting of shareholders and to increase annually thereafter on the first day of each fiscal year the maximum number of Shares that may be issued by an amount equal to one and one-quarter percent (1.25%) of the number of Shares outstanding as of the start of each fiscal year commencing on January 1, 1999 and continuing on the first day of each fiscal year for the balance of the term of the Plan. Additionally, the aggregate number of Shares that may be covered by Awards for any one Participant over the period that the Plan is in effect shall not exceed 1,730,638 Shares. (c) Adjustments. In the event of any stock dividend, stock split, combination or exchange of Shares, merger, consolidation, spin-off or other distribution (other than normal cash dividends) of Company assets to stockholders, or any other change affecting Shares, such proportionate adjustments, if any, as the Committee in its discretion may deem appropriate to reflect such change shall be made with respect to (i) the aggregate number of Shares that may be issued under the Plan; (ii) the number of Shares covered by each outstanding Award made under the Plan; and (iii) the option, base or purchase price per Share for any outstanding Stock Options, Stock Appreciation Rights and other Awards granted under the Plan, provided that any such actions are consistently and equitably applicable to all affected Participants. In addition, any Shares issued by the Company through the assumption or substitution of outstanding grants or grant commitments from an acquired entity shall not reduce the Shares available for issuance under the Plan. 5 Section 7. Awards. (a) General. The Committee (or its delegate, as permitted under Section 4), shall determine the type or types of Award(s) (as set forth below) to be made to each Participant and shall approve the terms and conditions of all such Awards in accordance with Sections 4 and 8 of the Plan. Awards may be granted singularly, in combination, or in tandem such that the settlement of one Award automatically reduces or cancels the other. Awards may also be made in replacement of, as alternatives to, or as form of payment for grants or rights under any other employee compensation plan or arrangement of the Company, including the plans of any acquired entity. (b) Stock Option. A Stock Option shall confer on a Participant the right to purchase a specified number of Shares from the Company subject to the terms and conditions of the Stock Option grant. Stock Options may be in the form of ISOs or NQSOs. The terms and conditions of ISOs shall be subject to and comply with Section 422 of the Code, or any successor provision, and any regulations thereunder. Anything in the Plan notwithstanding, no term of the Plan relating to ISOs shall be interpreted, amended or altered, nor shall any discretion or authority granted to the Committee under the Plan be so exercised, so as to disqualify the Plan or, without the consent of the optionee, any ISO granted under the Plan, under Section 422 of the Code. The Committee shall establish the option price at the time each Stock Option is awarded, provided that such price shall not be less than 100% of the Fair Market Value of the Common Stock on the date the Stock Option is granted. If a Participant owns or is deemed to own (by reason of the attribution rules applicable under Section 424(d) of the Code) more than 10% of the combined voting power of all classes of stock of the Company or any subsidiary or parent corporation and an ISO is awarded to such Participant, the option price shall not be less than 110% of the Fair Market Value at the time such ISO is awarded. The aggregate Fair Market Value at time of grant of the Shares covered by ISOs exercisable by any one optionee in any calendar year shall not exceed $100,000 (or such other limit as may be required by the Code). The maximum number of Shares that may be issued as ISOs is 2,350,000 Shares. Each Stock Option shall be exercisable at such times and subject to such terms and conditions as the Committee may specify at or after the time of grant; provided, however, that if the Committee does not establish a different exercise schedule at or after the date of grant of a Stock Option, such Stock Option shall become exercisable in five approximately equal annual installments on each of the first, second, third, fourth and fifth anniversaries of the date the Stock Option is granted. A Stock Option shall not be exercisable after the expiration of ten years from the date of grant. The recipient of a Stock Option shall pay the exercise price for the Shares in cash or pursuant to such other arrangements as are satisfactory to the Committee, including, without limitation, using Shares valued at Fair Market Value on the date of exercise. The Committee may also permit Participants to have the option price delivered to the Company by a broker pursuant to an arrangement whereby the Company, upon irrevocable instructions from a Participant, delivers the exercised Shares to the broker. A Stock Option may include forfeitability contingencies based on continued employment with the Company or a Subsidiary. In addition, a violation of a continued employment provision may entitle the Company or a Subsidiary to repurchase the Shares obtained through the Stock Option at the original exercise 6 price, without interest. Unless the Committee shall otherwise permit a Stock Option to remain exercisable for such greater or lesser period (but not beyond its otherwise stated term) as the Committee shall specify at or after the grant of such Stock Option, a Stock Option shall be exercisable following the termination of a Participant's employment with the Company and each Subsidiary and Affiliate only to the extent provided in this paragraph. If a Participant's employment terminates due to the Participant's death, Disability, Normal Retirement or Early Retirement with the consent of the Committee, the Participant (or, in the event of the Participant's death or Disability during employment or during the period during which a Stock Option is exercisable under this sentence, the Participant's beneficiary or legal representative) may exercise any Option held by the Participant at the time of such termination, regardless of whether then exercisable, for up to three years (or such greater or lesser period as the Committee shall determine at or after grant) following the date of such termination, but in no event after the date the Stock Option otherwise expires. If a Participant's employment is terminated for Cause or, if following the Participant's termination of employment, the Committee determines that the Participant's employment could have been terminated for Cause, all Stock Options held by the Participant shall immediately terminate, regardless of whether then exercisable and any Stock Option exercised by the Participant in anticipation of his/her For Cause termination shall be rescinded and the stock returned to the Company and/or its Subsidiary and the exercise price returned to the Participant. Any option exercised 60 days before notice of termination and all options exercised after notice of termination shall be considered to be exercised in anticipation of termination. (c) Stock Appreciation Rights (SARs). An SAR grant shall confer on a Participant the right to receive in Shares, cash or a combination, up to the positive difference, if any, between the Fair Market Value of a designated number of Shares when the SARs are exercised and the base price of the SAR contained in the terms and conditions of the Award. The Committee shall have the authority to grant an SAR in tandem with a Stock Option, in addition to a Stock Option, or freestanding and unrelated to a Stock Option. An SAR granted in tandem or in addition to a Stock Option may be granted either at the same time as the Stock Option or at a later time. An SAR shall not be exercisable after the expiration of ten years from the date of grant. Shares issued in settlement of the exercise of SARs shall be valued at their Fair Market Value on the date of exercise. The Committee shall establish the base price of the SAR at the time the SARs are awarded; provided that the price of an SAR shall not be less than 100% of the Fair Market Value of Common Stock on the date the SAR is granted. The Committee shall determine the time or times at which or the event or events (including, without limitation, a Change in Control) upon which an SAR may be exercised in whole or in part; provided, however, that unless otherwise specified by the Committee at or after grant, an SAR granted in tandem with a Stock Option shall be exercisable at the same time or times as the related Stock Option is exercisable. (d) Stock Awards. A Stock Award shall confer on a Participant the right to acquire a specified number of Shares for a purchase price (which may be zero) or the right to receive a 7 cash equivalent payment or a combination of both subject to the terms and conditions of the Award, which must include forfeitability contingencies based on continued employment with the Company or a Subsidiary or on meeting performance criteria or both. A Stock Award based on continued employment must have a minimum vesting period of three years from the date of the Stock Award and a Stock Award based on performance must have a minimum vesting period of one year from the date of the Stock Award. The minimum vesting provision may not, under any circumstances, be waived. A Stock Award may be in the form of Shares or share units. In no event shall more than 25% of the total amount of Shares available under the Plan be granted as Stock Awards. Such 25% limit shall be subject to the replenishment provision in Section 6(a). If the vesting of a Stock Award is conditioned in whole or in part upon the attainment of specified performance goals or targets (or if the vesting of a Stock Award that will vest upon the passage of time and the Participant's continued employment is accelerated upon the attainment of such goals or targets), such goals and targets shall be determined by the Committee and set forth in the specific Award agreements. Such performance goals or targets may be related to the performance of (i) the Company; (ii) a Subsidiary or an Affiliate, (iii) a division or unit of the Company, any Subsidiary or any Affiliate, (iv) the Participant or (v) any combination of the foregoing, over a performance period or periods established by the Committee. Except to the extent otherwise expressly provided herein, the Committee may, at any time and from time to time, change the performance objectives applicable with respect to any Stock Award to reflect such factors, including, without limitation, changes in a Participant's duties or responsibilities or changes in business objectives (e.g., from corporate to Subsidiary or business unit performance or vice versa), as the Committee shall deem necessary or appropriate. In making any such adjustment, the Committee shall adjust the number of Shares subject to any such Stock Award or take other appropriate actions to prevent any enlargement or diminution of the Participant's rights related to service rendered and performance attained prior to the effective date of such adjustment. Unless the Committee otherwise determines at or after grant, the rights of a Participant with respect to a Stock Award outstanding at the time of the Participant's termination of employment with the Company and each Subsidiary and Affiliate shall be determined pursuant to this paragraph. In the event that a Participant's employment terminates due to the Participant's (i) death, (ii) disability, (iii) retirement; or, (iv) early retirement with the consent of the Committee, a pro-rated portion of any unvested Shares subject to a Stock Award shall become vested based on the number of days the Participant actually worked since the date the Stock Award was granted (or in the case of any award which becomes vested in installments, since the date, if any, on which the last installment of such Stock Award became vested); provided that, in the case of an award with respect to which the restrictions will lapse, if at all, based on the attainment of performance goals or targets, such vesting shall be deferred until the end of the applicable performance period and be based on that number of Shares of such Stock Award, if any, that would have been earned based on the attainment or partial attainment of such performance goals or targets. Any portion of any Stock Award that has not vested at the date of a Participant's termination of employment (or which does not become vested until after such date under the preceding sentence) shall be forfeited as of such termination date (or, if applicable, 8 such deferred vesting date). Section 8. General Provisions Applicable to Awards. (a) Transferability and Exercisability. Unless the Committee shall permit (on such terms and conditions as it shall establish) an Award to be transferred to a member of the Participant's immediate family, a Guardian, or to a trust or similar vehicle for the benefit of such immediate family members ("Permitted Transferees"), any Award under this Plan will be non-transferable and accordingly shall not be assignable, alienable, saleable or otherwise transferable by the Participant other than by will or the laws of descent and distribution; provided, however, that in no event shall the Committee permit any Award to be transferable if the effect thereof would be to cause any other nontransferable Award to fail to qualify for the exemptive relief available under Rule 16b-3 promulgated under the 1934 Act. Notwithstanding the foregoing, a Participant who has retired in accordance with the definitions of Early Retirement or Normal Retirement may assign vested options to Permitted Transferees. During the Participant's lifetime, only the Participant (or the Participant's Permitted Transferees, if any) shall be able to exercise any Stock Option or SAR awarded to the Participant. If so permitted by the Committee, a Participant may designate a beneficiary or beneficiaries to exercise the Participant's rights and receive any distribution under this Plan upon the Participant's death. (b) General Restriction. Each Award shall be subject to the requirement that, if at any time the Committee shall determine, in its sole discretion, that the listing, registration, exemption or qualification of any Award under the Plan upon any securities exchange or under any state or federal law, or the consent or approval of any government regulatory body, is necessary or desirable as a condition of, or in connection with, the granting of such Award or the grant or settlement thereof, such Award may not be exercised or settled in whole or in part unless such listing, registration, qualification, exemption, consent or approval has been effected or obtained free of any conditions not acceptable to the Committee. (c) Tax Withholding. The Company or any Subsidiary which adopts the Plan shall have the right to deduct from any settlement of an Award, including the delivery or vesting of Shares, made under the Plan, a sufficient amount to cover withholding of any federal, state or local taxes required by law or to take such other actions as may be necessary to satisfy any such withholding obligations. The Committee may require or permit Shares to be used to satisfy required tax withholding and such Shares shall be valued at their Fair Market Value on the date the tax withholding is effective. (d) Documentation of Grants. Awards made under the Plan shall be evidenced by written agreements or such other appropriate documentation as the Committee shall prescribe. Any written agreement or other such documentation shall be delivered to the Participant and shall incorporate the terms of the Plan by reference and specify the terms and conditions thereof and any rules applicable thereto. The Committee need not require the execution of any instrument or acknowledgment of notice of an Award under the Plan, in which case acceptance of such Award by the respective Participant will constitute agreement to the terms of the Award 9 and acceptance of the Award in accordance with the terms of this Agreement. (e) Settlement. The Committee shall determine whether Awards are settled in whole or in part in cash, Shares or other Awards. The Committee may require or permit a Participant to defer all or any portion of a payment under the Plan, including the crediting of interest on deferred amounts denominated in cash. (f) Change in Control. Except as provided below, in the event of a Change in Control, each Stock Option (including, for this purpose, any SAR granted in tandem with such Stock Option) and each freestanding SAR (whether or not then exercisable) shall be cancelled in exchange for a payment in cash of an amount equal to the excess of the Change in Control Price (or, in the case of any ISO, the excess of the Fair Market Value on the date of exercise) over the exercise or base price thereof and all Stock Awards shall become nonforfeitable. Notwithstanding the immediately preceding sentence, no cancellation, cash settlement or acceleration of vesting shall occur with respect to any Award or any class of Awards if the Committee reasonably determines in good faith prior to the occurrence of a Change in Control that such Award or Awards shall be honored or assumed, or new rights substituted therefor (such honored, assumed or substituted award hereinafter called an "Alternative Award"), by a Participant's employer (or the parent or a subsidiary of such employer) immediately following the Change in Control, provided that any such Alternative Award must: (i) be based on stock which is traded on an established securities market, or which will be so traded within 60 days of the Change in Control; (ii) provide such Participant (or each Participant in a class of Participants) with rights and entitlements substantially equivalent to or better than the rights, terms and conditions applicable under such Award, including, but not limited to, an identical or better exercise or vesting schedule and identical or better timing and methods of payment; (iii) have substantially equivalent economic value to such Award (determined at the time of the Change in Control); and (iv) have terms and conditions which provide that in the event that the Participant's employment is involuntarily terminated or constructively terminated, any conditions on a Participant's rights under, or any restrictions on transfer or exercisability applicable to, each such Alternative Award shall be waived or shall lapse, as the case may be. For this purpose, a constructive termination shall mean a termination by a Participant following a material reduction in the Participant's compensation, a material reduction in the Participant's responsibilities or the relocation of the Participant's principal place of employment to another location, in each case without the Participant's written consent. 10 Section 9. Miscellaneous. (a) Plan Amendment. The Board or the Committee may amend the Plan as it deems necessary or appropriate to better achieve the purposes of the Plan, except that no amendment without the approval of the Company's stockholders shall be made which would (i) increase the total number of Shares available for issuance under the Plan, (ii) materially increase the benefits accruing to Participants under the Plan, or (iii) materially modify the requirements as to eligibility for participation in the Plan. (b) No Right to Employment. No person shall have any claim or right to be granted an Award, and the grant of an Award shall not be construed as giving a Participant the right to continued employment. The Company expressly reserves the right at any time to dismiss a Participant free from any liability or claim under the Plan, except as expressly provided by an applicable agreement or other documentation of an Award. (c) No Rights as Shareholder. Only upon issuance of Shares to a Participant (and only in respect to such Shares) shall the Participant obtain the rights of a shareholder, subject, however, to any limitations imposed by the terms of the applicable Award. (d) No Fractional Shares. No fractional shares shall be issued under the Plan, however, the Committee may provide for a cash payment as settlement in lieu of any fractional shares. (e) Other Company Benefit and Compensation Programs. Except as expressly determined by the Committee, settlements of Awards received by Participants under this Plan shall not be deemed as part of a Participant's regular, recurring compensation for purposes of calculating payments or benefits from any Company or Subsidiary benefit or severance program (or severance pay law of any country). The above programs notwithstanding, the Company may adopt other compensation plans or arrangements as it deems appropriate or necessary. (f) Unfunded Plan. The Plan shall be unfunded and shall not create (or be construed to create) a trust or a separate fund(s). Likewise, the Plan shall not establish any fiduciary relationship between the Company, any Subsidiary or Affiliate and any Participant or other person. To the extent any person holds any rights by virtue of an Award granted under the Plan, such rights shall be no greater than the rights of an unsecured general creditor of the Company, any Subsidiary or Affiliate. (g) Successors and Assignees. The Plan shall be binding on all successors and assignees of a Participant, including, without limitation, the estate or beneficiaries of such Participant and the executor, administrator or trustee of such estate, or any receiver or trustee in bankruptcy or representative of the Participant's creditors. (h) Governing Law. The validity, construction and effect to the Plan and any actions 11 taken under or relating to the Plan shall be determined in accordance with the laws of the State of Delaware. 12 EX-10.40 5 dex1040.txt LETTERHEAD OF FIRST ALLMERICA FINANCIAL LIFE INS CO Exhibit 10.40 [Letterhead of First Allmerica Financial Life Insurance Company] November 19, 2001 Eric A. Simonsen Dear Eric: You and First Allmerica Financial Life Insurance Company (the "Company") have agreed to terminate your employment relationship pursuant to the terms and conditions set forth below. 1. Resignation. Effective as of October 1, 2001 you will resign as an officer of the Company and as an officer and/or director of any subsidiary or affiliate of the Company. Your resignation will be in accordance with Exhibit A. Your resignation will not adversely affect your employment status as set forth in paragraph 2 below. 2. Paid/Unpaid Leave. At the close of business on September 28, 2001, you will be placed in paid leave of absence status. This status will continue until October 26, 2001. You are not required to sign this agreement to receive this four week paid leave of absence. If you accept the terms and conditions of this Letter Agreement your paid leave will be extended pursuant to the terms of this Letter Agreement up to April 1, 2002. During your paid leave of absence you will continue to receive your current base compensation of $450,000 per year, payable bi-weekly, and the fringe benefits set forth on Exhibit B. It shall be noted that after September 28, 2001 you will not be eligible for vacation accrual, to participate in the Group Disability Plans or the Group Accidental Death Plan. (This status is hereinafter referred to as "Paid Leave"). Your receipt of the benefits set forth in Exhibit B or your participation in the Plans set forth in Exhibit B shall be in accordance with the Plan provisions that govern such benefits or the provisions as such may exist from time to time. At the close of business on the last day of your Paid Leave, your employment status will be changed from Paid Leave to unpaid leave (as defined below). If you commence new employment (as said term is defined below) during your Paid Leave, your employment status will be changed from Paid Leave to an unpaid leave. During your unpaid leave you will receive no compensation or benefits. (This status is hereinafter referred to as "Unpaid Leave"). Your Unpaid Leave will continue until April 1, 2003 unless terminated earlier by the Company pursuant to the terms of this Letter Agreement for a violation of the provisions of Sections 8, 9, 10 and/or 11. Eric A. Simonsen November 19, 2001 Page 2 In Paid Leave or Unpaid Leave, you will still be a Participant as said term is defined in the Allmerica Financial Corporation Amended Long-Term Stock Incentive Plan (the "Stock Plan"). As a Participant in the Stock Plan your rights and benefits are subject to the terms and conditions of the Stock Plan as they exist or may exist from time to time. A list of the stock options and restricted stock granted to you is set forth in Exhibit C. On your termination date (as defined below), all vested but unexercised options, all unvested options and all shares of Allmerica Financial Corporation which are restricted on your termination date shall lapse and you shall have no further right to such options or shares. If your Paid Leave ends because the date April 1, 2002 is reached or because of new employment or your death, the Company will pay you, or in the event of your death your beneficiary, within thirty (30) days after your Paid Leave ends, Four Hundred Fifty Thousand Dollars ($450,000) LESS the amount you received while you were in Paid Leave. New employment shall mean full-time employment wherein you are eligible for group medical benefits, providing consulting services on a full-time basis or engaging on a full-time basis in a sole proprietorship or partnership. Full-time basis shall mean an average of thirty (30) hours or more a week. In the event there is a material violation of any provision(s) in paragraphs 8 and/or 11 which is not cured as set forth below or any violation of the provisions in paragraph(s) 9 and/or 10 , the Company may, in its sole discretion, terminate your employment status and stop making payment due you under the provisions of this Letter Agreement and may, in the event of a violation of the provisions in paragraph(s) 9 and/or 10, demand the return of payment(s) made to you under the terms of this paragraph prior to your violation of the provisions in paragraphs 9 and/or 10 as follows: a) If you violate the provisions of paragraph 9 on or before April 1, 2005, the Company may demand a return of all payments made to you under the provisions of this Letter Agreement; and/or; b) If you violate the provisions of paragraph 10 on or before your Paid Leave ends, the Company may demand a return of all payments made to you under the provisions of this Letter Agreement. In the event you materially violate the provisions of paragraph(s) 8 and/or 11, the Company shall have no right to demand a return of payments made to you under the provisions of this Letter Agreement prior to the date of your material violation. In the event you materially violate the provisions of paragraph(s) 8 and/or 11, the Company also agrees to give you notice of such violation and allow you thirty (30) days to correct, rectify and/or eliminate any such violation. Eric A. Simonsen November 19, 2001 Page 3 In the event of your death, any monies due to you pursuant to the terms of this paragraph shall be paid to the beneficiary you have designated prior to your death, or if there is no such designation, then to your estate. In the event of your death prior to your Termination Date, all options held by you, regardless of whether then exercisable, shall vest and will be exercisable by your beneficiary or legal representative for up to three years following your death, but in no event beyond the date the options otherwise expire. Notwithstanding the foregoing, you hereby agree that the 4,000 options that would vest on February 21, 2004 and are a portion of the grant you received on February 21, 1999 are hereby rescinded and you agree that you shall have no further right or claim to such options as of the date this agreement becomes effective. The restricted stock you received on February 21, 1999 and March 10, 2000 shall also vest in the event of your death. However, the restricted stock you received on March 16, 2001 shall not vest and you hereby agree that those shares shall be returned to the Company when this agreement becomes effective and you acknowledge and agree that your interest in these shares shall be extinguished as of said date. During your Paid Leave or until April 1, 2002, if later, you agree to be generally available to respond to questions and/or inquiries and provide other information concerning matters that were within the scope of your responsibility and to cooperate to ensure a smooth transition. It is anticipated that most matters can be addressed through phone calls and/or e-mails. Certain matters, however, may require meetings at mutually acceptable times and places. Unless your employment is terminated earlier for a material violation of the provisions in paragraph(s) 8 and/or 11 or any violation of the provisions of paragraph(s) 9 and/or 10, your employment will terminate when your Unpaid Leave ends, namely, April 1, 2003. This will be your Termination Date. 3. Other Entitlements. The Company will also pay you, on or around the date this agreement becomes effective, any unused vacation days which you are entitled to as of September 28, 2001. Signing this agreement is not required for you to receive this payment. The Company's records reflect that you are entitled to eight (8) vacation days as of September 28, 2001. In addition, you are entitled to the benefits set forth in Exhibit D. These benefits are not subject to forfeiture if you materially violate any of the provisions in Section(s) 8 and/or 11 or if you violate any of the provisions in Section(s) 9 and/or 10. The Company also acknowledges that you are entitled to be indemnified pursuant to the terms of Section 8 of the Company's By-Laws as such provision may exist from time to time. Such indemnification shall cover matters arising from your having been an officer of the Company. 4. Outplacement. The Company will provide you, at its cost, with executive outplacement from a mutually acceptable outplacement firm. This outplacement will continue until you commence new employment. If you materially violate the provisions of paragraph(s) 8 and/or Eric A. Simonsen November 19, 2001 Page 4 11 and such violation is not cured as set forth in paragraph 2 above or if you violate the provisions of paragraph(s) 9 and/or 10, you shall no longer be entitled to this benefit as of the date of such violation. Under current Internal Revenue Service guidelines, the value of this benefit is not considered taxable income to you. 5. 2001 Incentive Compensation. You acknowledge and agree that you will not receive a Short-Term Incentive Compensation award for 2001. 6. Release. In consideration of the Company's agreement as set forth herein, you hereby knowingly and voluntarily release Allmerica Financial Corporation ("AFC"), its subsidiaries and affiliates including, but not limited to, the Company, its and their present, current and former officers, directors, employees, agents and their successors and assigns (collectively "Releasees") from any and all liabilities, demands, debts, damages, suits, covenants, agreements, contracts, benefits, promises, claims including, but not limited to, claims for payment(s) under the Company's 2001 Short Term Incentive Compensation Plan, and rights or benefits, if any, after your Termination Date in connection with stock options and restricted stock received from the Stock Plan including, but not limited to, the 18,000 shares of Restricted Stock you received on March 16, 2001 from the Stock Plan and rights or benefits under the AFC Employment Continuity Plan and claims arising under the Title VII of the Civil Rights Act of 1964, as amended, including, but not limited to, any and all claims which you may have for age, race or sex discrimination and rights or claims arising under the Age Discrimination in Employment Act, the Fair Labor Standards Act, the American with Disabilities Act, the Family and Medical Leave Act and claims, if any, for wrongful termination or any claim arising out of or in any way relating to your employment with the Company. However, this Release shall not affect any obligations of the Company made pursuant to the terms of this Letter Agreement. In addition, this Release does not waive any rights or claims that arise after the date this Release is executed or the right to assist the Massachusetts Commission Against Discrimination in its investigation of any claim of discrimination against the Company. THE FOREGOING MEANS THAT BY SIGNING THIS LETTER AGREEMENT YOU WILL HAVE WAIVED ANY RIGHT YOU HAVE TO BRING A LAWSUIT OR MAKE ANY LEGAL CLAIM AGAINST ALLMERICA FINANCIAL CORPORATION, THE COMPANY, OR ANY OF THE RELEASEES UP TO THE DATE OF THE SIGNING OF THIS LETTER AGREEMENT, AND THAT YOU WILL HAVE RELEASED THE RELEASEES OF ANY AND ALL CLAIMS OF ANY NATURE ARISING ON OR BEFORE THE DATE OF THE SIGNING OF THIS LETTER AGREEMENT. HOWEVER, THIS RELEASE DOES NOT WAIVE ANY RIGHTS OR CLAIMS THAT ARISE AFTER THE DATE THIS RELEASE IS EXECUTED. Eric A. Simonsen November 19, 2001 Page 5 6A. Company Statement. Without having made any specific inquiry, the Company does hereby state that as of the date of this Letter Agreement the Company is not aware of any claims it may have against you. 7. Consent to Removal. You hereby agree to consent to be removed as a participant in the Allmerica Financial Corporation Employment Continuity Plan effective as of October 1, 2001. 8. Confidentiality. The terms and conditions of this Letter Agreement shall be held in confidence by the Company and by you, except as may be required by law, by state or federal tax or regulatory agencies, by an order of a court of competent jurisdiction, or as may be necessary by either party in connection with the enforcement of the terms hereof. You agree not to directly or indirectly discuss with or provide information to the news media, legislative or regulatory bodies, the brokerage, financial or insurance communities, current employees or officers of the Company, or in any form of communication reveal, in any way, information which is detrimental to the best interest of Allmerica Financial Corporation, its subsidiaries and its/their directors, officers and employees. The Company agrees not to directly or indirectly discuss with or provide information to the news media, legislative or regulatory bodies, the brokerage, financial or insurance communities, current employees or officers of the Company, or in any form of communication reveal, in any way, information which is detrimental to your best interest. 9. Non-Solicitation. You acknowledge that you are currently subject to the terms and conditions of certain Non-Solicitation Agreements. These Agreements are between you and Allmerica Financial Corporation ("AFC") and are dated December 7, 1996 (the "December Agreement") and April 4, 1997 (the "April Agreement"). You hereby acknowledge and agree that the non-solicitation period on the April Agreement and the December Agreement is a period of two years after the termination of your employment. 10. Non-Compete. You agree, for the period that you are in Paid Leave, that you will not directly or indirectly own, operate, join, control, participate in or be connected as an officer, director, employee, partner, stockholder, consultant or otherwise with any business or entity which competes with the business of the Company (or its successor or assigns) as such business is now constituted. Notwithstanding the foregoing, you may own up to one percent of the outstanding amount of stock of any company and such ownership shall be not be construed as a violation of the terms and conditions of this paragraph. Similarly, you may seek and accept full time employment which, once commenced, will end the Paid Leave period, and such activity shall not be considered as a violation of the terms and conditions of this paragraph. Eric A. Simonsen November 19, 2001 Page 6 You and the Company are of the belief that the period of time and the area herein specified are reasonable in view of the nature of the business in which the Company is engaged and proposes to engage and your knowledge of this business. However, if such period or such area should be adjudged unreasonable at any proceeding, then the period of time shall be reduced by such number of months or such area shall be reduced by elimination of such portion or such area or both as are deemed unreasonable so that this covenant may be enforced in such area and during such period of time as is adjudged to be reasonable. 11. Proprietary Information. You acknowledge that your position with the Company has been one of high trust and confidence and that in the course of your services to the Company you have had access to and contact with Proprietary Information. You agree not to disclose to others, or use for your benefit or the benefit of others, any Proprietary Information. For purposes of this Agreement, Proprietary Information shall mean confidential information concerning the business, prospects, and goodwill of AFC, the Company and/or its subsidiaries including, by way of illustration and not limitation, all non-public information (whether or not patentable and whether or not copyrightable) owned, possessed or used by AFC, the Company and/or its subsidiaries including, without limitation, any vendor information, policyholder information, potential policyholder lists, trade secrets, new product information, technical data, computer programs, software, software documentation, software development, marketing or business plans, unpublished financial information, budgetary/price/cost information or agent, broker, employee or insured lists. 12. Remedies. You acknowledge that any material breach of the provisions of section(s) 8 and/or 11 or any breach of the provisions of section(s) 9 and/or 10 of this Letter Agreement shall result in serious and irreparable injury to the Company and/or its subsidiaries or affiliates for which the Company cannot be adequately compensated by monetary damages alone. You agree, therefore, that in addition to any other remedy which it may have, the Company shall be entitled to specific performance for a material breach of Section(s) 8 and/or 11 or any breach of section(s) 9 and/or 10 of this Letter Agreement by you and to seek both temporary and permanent injunctive relief (to the extent permitted by law) without the necessity of proving actual damages. 13. Advice of Counsel. You acknowledge that you have been advised by the Company to consult with an attorney prior to executing this Letter Agreement and that you have been given at least twenty-one (21) days in which to consider this agreement. You acknowledge that you were given an earlier version of this agreement on September 26, 2001. 14. Revocation Period. Upon your execution of this Letter Agreement, you shall have seven days in which you may revoke this agreement. In addition, this agreement will not become effective or enforceable until this revocation period has elapsed. 15. Withholding. You acknowledge that any payments made pursuant to this agreement will be subject to appropriate federal and state withholding in the year in which paid. Eric A. Simonsen November 19, 2001 Page 7 16. Arbitration. If any dispute shall arise between you and the Company with reference to the interpretation of this agreement or the rights of either party with respect to any transaction under this Letter Agreement, the dispute shall be referred to an arbitrator mutually acceptable to you and the Company. In the event we do not agree on the selection of the arbitrator within thirty (30) days, then the arbitrator shall be selected pursuant to the Commercial Arbitration Rules of the American Arbitration Association. The arbitration shall take place in the Commonwealth of Massachusetts and the arbitration proceedings are to be governed by the rules of the American Arbitration Association and the Massachusetts Arbitration law. The decision of the arbitrator shall be final and binding upon both you and the Company and judgment upon the award rendered by the arbitrator may be entered into any court having jurisdiction thereof. The expense of arbitrator and of the arbitration shall be equally divided between you and the Company. Arbitration is the sole remedy for disputes arising under this Letter Agreement. 17. Successors and Assigns. This Letter Agreement shall be binding upon you, your heirs, executors, administrators and assigns and upon the Company, its successors and assigns. Very truly yours, FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY By: /s/ Bruce C. Anderson ---------------------- Vice President Accepted: 12/05/ 2001 I knowingly understand and voluntarily agree to and accept the terms and conditions set forth herein. /s/ Eric A. Simonsen - -------------------- Eric A. Simonsen Date: 11/26/01 -------- This agreement shall not be effective or enforceable until seven days following its execution and may be revoked by Eric A. Simonsen prior to its effective date. EX-13 6 dex13.txt SECTIONS OF THE ANNUAL REPORT TO SHAREHOLDERS Exhibit 13
Five Year Summary of Selected Financial Highlights ===================================================================================================================== For the Years Ended December 31 2001 2000 1999 1998 1997 (In millions, except per share data) - -------------------------------------------------------------------------------------------------------------------- Statements of Income Revenues Premiums $ 2,254.7 $ 2,118.8 $ 2,002.6 $ 2,026.0 $ 2,038.8 Universal life and investment product policy fees 391.6 421.1 359.3 296.6 237.3 Net investment income 655.2 645.5 669.5 657.7 684.5 Net realized investment (losses) gains (123.9) (140.7) 90.4 59.3 77.3 Other income 134.2 138.0 116.9 94.4 72.5 - -------------------------------------------------------------------------------------------------------------------- Total revenues 3,311.8 3,182.7 3,238.7 3,134.0 3,110.4 - -------------------------------------------------------------------------------------------------------------------- Benefits, Losses and Expenses Policy benefits, claims, losses and loss adjustment expenses 2,167.2 1,981.8 1,861.6 1,900.6 1,864.6 Policy acquisition expenses 479.2 456.6 432.4 452.3 411.5 Loss from selected property and casualty exited agencies, policies, groups and programs 68.3 -- -- -- -- Losses on derivative instruments 35.2 -- -- -- -- Voluntary pool environmental losses 33.0 -- -- -- -- Restructuring costs 2.7 20.7 (1.9) 9.0 -- Sales practice litigation (benefit) expense (7.7) -- -- 31.0 -- Loss from cession of disability income business -- -- -- -- 53.9 Other operating expenses 593.3 505.0 478.6 441.0 440.4 - -------------------------------------------------------------------------------------------------------------------- Total benefits, losses and expenses 3,371.2 2,964.1 2,770.7 2,833.9 2,770.4 - -------------------------------------------------------------------------------------------------------------------- (Loss) income from continuing operations before federal income taxes (59.4) 218.6 468.0 300.1 340.0 Federal income tax (benefit) expense (75.5) 2.7 106.9 56.1 84.7 - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations before minority interest 16.1 215.9 361.1 244.0 255.3 Minority interest (16.0) (16.0) (16.0) (29.3) (62.7) - -------------------------------------------------------------------------------------------------------------------- Income from continuing operations before cumulative effect of change in accounting principle 0.1 199.9 345.1 214.7 192.6 Discontinued operations: (Loss) income from operations of discontinued group life and health business, net of taxes -- -- (18.8) (13.5) 16.6 Loss from disposal of group life and health business, net of taxes -- -- (30.5) -- -- - -------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of change in accounting principle 0.1 199.9 295.8 201.2 209.2 Cumulative effect of change in accounting principle (3.2) -- -- -- -- - -------------------------------------------------------------------------------------------------------------------- Net (loss) income $ (3.1) $ 199.9 $ 295.8 $ 201.2 $ 209.2 ==================================================================================================================== (Loss) earnings per common share (diluted) $ (0.06) $ 3.70 $ 5.33 $ 3.33 $ 3.82 Dividends declared per common share (diluted) $ 0.25 $ 0.25 $ 0.25 $ 0.15 $ 0.20 - -------------------------------------------------------------------------------------------------------------------- Adjusted net income (1) $ 164.5 $ 301.2 $ 280.9 $ 212.5 $ 164.3 ==================================================================================================================== Balance Sheet (at December 31) Total assets $30,336.1 $31,588.0 $30,769.6 $27,653.1 $22,549.0 Long-term debt 199.5 199.5 199.5 199.5 202.1 Total liabilities 27,645.0 28,878.9 28,229.4 24,894.5 19,714.8 Minority interest 300.0 300.0 300.0 300.0 452.9 Shareholders' equity 2,391.1 2,409.1 2,240.2 2,458.6 2,381.3
(1) Represents net income adjusted for certain items which management believes are not indicative of overall operating trends, including net realized investment gains (losses), losses on derivative instruments, net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes, restructuring costs, 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 (loss) income determined in accordance with generally accepted accounting principles. 17 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 First Allmerica Financial Life Insurance Company ("FAFLIC") and Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"), AFC's principal life insurance and annuity companies; The Hanover Insurance Company ("Hanover") and Citizens Insurance Company of America ("Citizens"), AFC's principal property and casualty companies; and certain other insurance and non-insurance subsidiaries. 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 property and casualty insurance products through three distribution channels identified as Standard Markets, Sponsored Markets, and Specialty Markets. Maintaining a strong regional focus, Standard Markets sells personal and commercial insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. Sponsored Markets offers personal line products to members of affinity groups, other organizations and through employers. Specialty Markets offers specialty or program property and casualty business nationwide. In the fourth quarter of 2001, the Company exited selected property and casualty agencies, policies, groups and programs. (See Risk Management - Selected Property & Casualty Exited Agencies, Policies, Groups & Programs.) 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 certain group retirement products. 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"). GICs, also referred to as funding agreements, are investment contracts, which can contain either short-term or long-term maturities and are issued to institutional buyers or to various business or charitable trusts. Also, this segment is 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 (mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company) 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. Results of Operations - -------------------------------------------------------------------------------- Consolidated Overview Consolidated net (loss) 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 (loss) income also includes certain items which management believes are not indicative of overall operating trends, such as net realized investment gains and losses, losses on derivative instruments, 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 (loss) income determined in accordance with generally accepted accounting principles. The Company's consolidated net income decreased $203.0 million, or 101.6%, to a net loss of $3.1 million, compared to net income of $199.9 million in 2000. The reduction in net income primarily resulted from a decrease in adjusted net income of $136.7 million and a loss from selected property and casualty exited agencies, policies, groups, and programs of $44.4 million. In addition, the reduction in net income in 2001 also resulted from derivative and voluntary pool losses of $22.9 million and $21.5 million, respectively. These decreases in 2001 were partially offset by lower restructuring costs. In 2000, the Company's consolidated net income decreased $95.9 million, or 32.4%, to $199.9 million, compared to $295.8 million in 18 1999. The reduction in net income in 2000 resulted primarily from a $150.8 million decline in net realized investment gains and $13.5 million of restructuring charges, partially offset by a lower federal income tax rate. In addition, 1999 results included a $49.3 million after-tax loss resulting from the discontinuation of the Company's group life and health business. The following table reflects adjusted net income and a reconciliation to consolidated net (loss) income. Adjusted net income consists of segment income (loss), federal income taxes on segment income and minority interest on Capital Securities.
For the Years Ended December 31 2001 2000 1999 ============================================================================================= (In millions) - --------------------------------------------------------------------------------------------- Segment income (loss) before federal income taxes and minority interest: Risk Management $ 93.5 $ 190.0 $ 199.6 Asset Accumulation: Allmerica Financial Services 143.0 222.8 205.5 Allmerica Asset Management 20.7 22.5 23.5 - --------------------------------------------------------------------------------------------- 163.7 245.3 229.0 Corporate (63.8) (60.8) (59.3) - --------------------------------------------------------------------------------------------- Segment income before federal income taxes and minority interest 193.4 374.5 369.3 - --------------------------------------------------------------------------------------------- Federal income taxes on segment income (12.9) (57.3) (72.4) Minority interest on Capital Securities (16.0) (16.0) (16.0) - --------------------------------------------------------------------------------------------- Adjusted net income 164.5 301.2 280.9 Adjustments (net of taxes and amortization, as applicable): Net realized investment (losses) gains (78.8) (87.8) 63.0 Losses on derivative instruments (22.9) -- -- Loss from selected property and casualty exited agencies, policies, groups, and programs (44.4) -- -- Voluntary pool environmental losses (21.5) -- -- Sales practice litigation 5.0 -- -- Restructuring costs (1.8) (13.5) 1.2 - --------------------------------------------------------------------------------------------- Income from continuing operations before cumulative effect of change in accounting principle 0.1 199.9 345.1 Discontinued operations (net of taxes): Loss from operations of discontinued group life and health business -- -- (18.8) Loss on disposal of group life and health business -- -- (30.5) - --------------------------------------------------------------------------------------------- Income before cumulative effect of change in accounting principle 0.1 199.9 295.8 Cumulative effect of change in accounting principle (net of taxes) (3.2) -- -- - --------------------------------------------------------------------------------------------- Net (loss) income $ (3.1) $ 199.9 $ 295.8 =============================================================================================
2001 Compared to 2000 The Company's segment income before federal taxes and minority interest decreased $181.1 million, or 48.4%, to $193.4 million during 2001. This decrease is primarily attributable to a decrease in income from the Risk Management and Allmerica Financial Services segments of $96.5 million and $79.8 million, respectively. The decrease in Risk Management's segment income was primarily attributable to decreased favorable loss and loss adjustment expenses ("LAE") reserve development related to prior years of $121.0 million and to an increase of approximately $62 million in current accident year losses and LAE primarily in the personal automobile, commercial multiple peril and homeowners lines. These decreases were partially offset by net premium rate increases of approximately $101 million. Allmerica Financial Services' segment income decreased $79.8 million principally due to lower asset-based fees, primarily resulting from a decrease in the market value of assets under management in the variable product lines, and to lower investment management fees and brokerage income. The decrease in Allmerica Financial Services' segment income is also attributable to higher policy benefits and other operating expenses, partially offset by lower deferred policy acquisition costs. The effective tax rate for segment income was 6.7% for 2001, as compared to 15.3% in 2000. The decrease in the tax rate was primarily due to lower underwriting income resulting in an increase in the proportion of tax-exempt investment income and low income housing credits to pre-tax income. Net realized losses on investments, after taxes and amortization, were $78.8 million during 2001, primarily due to after-tax realized losses from impairments of fixed maturities of $120.4 million. These losses were partially offset by $37.5 million of after-tax net realized gains from the sale of approximately $2.2 billion of fixed income securities. During 2000, net realized losses on investments, after taxes and amortization, were $87.8 million, primarily attributable to after-tax realized losses of $54.7 million resulting from the sale of approximately $2.2 billion of fixed income securities. In addition, the Company recognized $43.0 million in after-tax realized losses, due to impairments of fixed maturities. The Company recognized losses on derivatives, net of taxes, of $22.9 million during the fourth quarter of 2001. These losses primarily represent an accounting charge for hedge ineffectiveness on certain derivatives in accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"). (See "Derivative Instruments".) During the fourth quarter of 2001, the Company recognized an after-tax loss of $44.4 million related to the exit of selected property and casualty agencies, policies, groups, and 19 programs. This loss primarily reflects an increase in loss reserves for both the current and prior accident years. This resulted from a process whereby the Company evaluated its approximately 2,500 agencies in the Risk Management segment and identified 691 agencies that did not meet certain profitability standards or were not strategically aligned with the Company. For these agents, the Company either terminated the relationship or restricted the agent's ability to offer commercial lines policies. Certain groups and specialty programs were also discontinued. (See "Risk Management - Selected Property & Casualty Exited Agencies, Policies, Groups & Programs".) Voluntary pool environmental losses reflect the Company's participation in a reserve deficiency of a voluntary excess and casualty reinsurance pool. From 1950 to 1982, the Company voluntarily participated in this reinsurance pool along with several other property and casualty carriers. The pool was dissolved in 1982 and since that time has been in run-off. During the fourth quarter of 2001, the pool obtained results from an independent actuarial review of its current reserve position, which noted a range of reserve deficiency, primarily as a result of adverse development of asbestos claims. As a result of this study, the Company recognized losses, net of taxes, of $21.5 million, based on the Company's participation in the reserve deficiency. The Company recognized a benefit of $5.0 million, net of taxes, in 2001, as a result of refining cost estimates related to settlement of a class action lawsuit. In the fourth quarter of 2001, the Company recognized an after-tax charge of $1.8 million related to severance and other employee related costs resulting from the reorganization of its technology support group. 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 consisted 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. During 2001, the Company recognized a $3.2 million loss, net of taxes, upon adoption of Statement No. 133. This loss resulted from recognizing derivative instruments held by the Company on January 1, 2001, at their fair values. This adjustment represents net losses that were previously deferred in other comprehensive income on derivative instruments that do not qualify for hedge accounting. The Company recorded an offsetting gain in other comprehensive income of $3.3 million, net of taxes, to recognize these derivative instruments. 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 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' 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 the aforementioned formal company-wide restructuring plan, intended to reduce expenses and enhance revenues. 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 20 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. 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 2001 2000 1999 ========================================================================================== (In millions) - ------------------------------------------------------------------------------------------ Segment revenues Net premiums written $ 2,285.0 $ 2,153.4 $ 1,977.0 ========================================================================================== Net premiums earned $ 2,205.7 $ 2,066.7 $ 1,948.2 Net investment income 216.0 218.4 221.4 Other income 33.1 22.6 19.8 - ------------------------------------------------------------------------------------------ Total segment revenues 2,454.8 2,307.7 2,189.4 Losses and LAE (1) 1,753.1 1,563.0 1,420.3 Policy acquisition expenses 401.7 373.2 370.6 Other operating expenses 206.5 181.5 198.9 - ------------------------------------------------------------------------------------------ Segment income $ 93.5 $ 190.0 $ 199.6 ==========================================================================================
(1) Includes policyholders' dividends of $8.1 million, $13.8 million and $12.3 million in 2001, 2000 and 1999, respectively. 2001 Compared to 2000 Risk Management's segment income decreased $96.5 million, or 50.8%, to $93.5 million for the year ended December 31, 2001, compared to $190.0 million in 2000. The decline in segment income is primarily attributable to increased losses and LAE resulting from a $121.0 million decrease in favorable development on prior years' reserves. The unfavorable trend in reserve development is primarily the result of an increase in personal automobile loss frequency and severity, and the Company having captured, in 1999 and 2000, the accumulated benefits of its claims redesign efforts. In addition, losses and LAE increased in 2001 due to approximately $62 million of increased current accident year claims activity primarily in the personal automobile, commercial multiple peril, and homeowners lines. Other operating expenses increased during 2001 primarily due to increased technology costs and premium charge-offs. Partially offsetting these items are approximately $101 million of net rate increases, primarily in commercial lines. In addition, net catastrophe losses decreased $19.2 million, to $51.0 million for the year ended December 31, 2001. Net catastrophe losses include $10.5 million of incurred losses related to the events of September 11, 2001. A net loss of $0.9 million and a net benefit of $9.8 million are included in segment income in 2001 and 2000, respectively, as a result of a whole account aggregate excess of loss reinsurance agreement ("aggregate excess of loss reinsurance treaty"), which provides coverage for the 1999 accident year. 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 efficiencies gained through consolidation of underwriting processes. 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. 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. 21 The following table summarizes the results of operations for the distribution channels of the Risk Management segment:
For the Year Ended December 31, 2001 ========================================================================================================= (In millions, except ratios) - --------------------------------------------------------------------------------------------------------- Standard Sponsored Specialty Markets Markets Markets Other Total - --------------------------------------------------------------------------------------------------------- Statutory net premiums written $ 1,565.5 $ 661.7 $ 54.4 $ 1.6 $ 2,283.2 ========================================================================================================= Statutory combined ratio (1) 107.3 100.4 141.3 N/M 106.1 ========================================================================================================= Statutory underwriting loss $ (121.0) $ (9.1) $(22.3) $(2.0) $ (154.4) Reconciliation to segment income: Net investment income 216.0 Other income and expenses, net 17.8 Other statutory to GAAP adjustments 14.1 - --------------------------------------------------------------------------------------------------------- Segment income $ 93.5 ========================================================================================================= For the Year Ended December 31, 2000 ========================================================================================================= (In millions, except ratios) - --------------------------------------------------------------------------------------------------------- Standard Sponsored Specialty Markets Markets Markets Other 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 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. N/M - Not meaningful 22 2001 Compared to 2000 Standard Markets Standard Markets' net premiums written increased $59.8 million, or 4.0%, to $1,565.5 million for the year ended December 31, 2001. The increase in net premiums written primarily resulted from increases of $27.8 million, or 8.9%, $23.9 million, or 4.8%, $7.7 million, or 4.7%, and $7.4 million, or 3.3%, in the commercial multiple peril, personal automobile, homeowners and commercial automobile lines, respectively. The increase in the commercial multiple peril line is primarily the result of rate increases of 12.3% and 8.8% in Michigan and New York, respectively. Commercial multiple peril policies in force also increased 2.4% since December 31, 2000. Personal automobile's net premiums written increased primarily due to a 3.1% increase in policies in force and a 2.9% Michigan rate increase since December 31, 2000. Partially offsetting these favorable items in the personal automobile line is a 5.4% Massachusetts net rate reduction in 2001. The increase in homeowners' net premiums written is primarily the result of a 16.8% Michigan rate increase partially offset by a 1.1% decrease in policies in force in 2001. In addition, the commercial automobile line experienced rate increases of 6.4%, 7.6%, and 16.5% in Michigan, Massachusetts, and New York, respectively, since December 31, 2000. Partially offsetting these favorable items is a $21.7 million, or 10.2% decrease in workers' compensation's net premiums written. The decrease in workers' compensation is primarily attributable to the non-renewal of several large, unprofitable commercial accounts in 2001. Net premiums written reflected ceded premiums of $5.1 million and $16.8 million under the aforementioned aggregate excess of loss reinsurance treaty for 2001 and 2000, respectively. Standard Markets' underwriting results declined $62.9 million to an underwriting loss of $121.0 million for the year ended December 31, 2001, compared to an underwriting loss of $58.1 million in 2000. This is primarily attributable to the aforementioned decrease in favorable development on prior years' reserves primarily in the personal automobile, commercial automobile, and commercial multiple peril lines. Increased current accident year claims activity in the personal automobile line and increased current accident year claims severity in the commercial multiple peril line also contributed to the decline. Partially offsetting these items are approximately $73 million of rate increases, primarily in commercial lines. In addition, catastrophe losses decreased $15.2 million to $29.1 million for the year ended December 31, 2001, compared to $44.3 million for the same period in 2000. Net benefits of $2.7 million and $9.7 million are included in underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty in 2001 and 2000, respectively. Sponsored Markets Sponsored Markets' net premiums written increased $58.5 million, or 9.7%, to $661.7 million for the year ended December 31, 2001. The increase in net premiums written is primarily attributable to a $31.4 million, or 6.6%, and a $20.8 million, or 17.1%, increase in the personal automobile and homeowners lines, respectively. The increase in personal automobile's net premiums written is primarily the result of a 5.0% increase in policies in force and the aforementioned Michigan rate increase, partially offset by a 5.4% Massachusetts net rate reduction since December 31, 2000. In addition, homeowners' net premiums written increased primarily due to a 5.7% increase in policies in force and the aforementioned 16.8% Michigan rate increase in 2001. Net premiums written reflected ceded premiums of $2.3 million and $7.8 million under the aforementioned aggregate excess of loss reinsurance treaty for 2001 and 2000, respectively. Underwriting results declined $17.1 million to an underwriting loss of $9.1 million for the year ended December 31, 2001, compared to an underwriting profit of $8.0 million in 2000. The decline in underwriting results is primarily attributable to the aforementioned decrease in favorable development on prior years' reserves primarily in the personal automobile line in 2001. Partially offsetting this item are approximately $28 million of rate increases, primarily in the personal automobile line and improved current accident year claims activity in the personal automobile and homeowners lines. In addition, net catastrophe losses decreased $4.3 million to $21.6 million for the year ended December 31, 2001, compared to $25.9 million in 2000. Net benefits of $1.2 million and $4.1 million are included in underwriting results relating to the aforementioned aggregate excess of loss reinsurance treaty in 2001 and 2000, respectively. Specialty Markets Specialty Markets' net premiums written increased $16.2 million, or 42.4%, to $54.4 million for the year ended December 31, 2001. This increase is primarily attributable to a $7.7 million, or 113.2%, and $5.0 million, or 38.2%, increase in the commercial multiple peril and commercial automobile lines, respectively. The Company terminated virtually all of its specialty commercial programs during the fourth quarter of 2001. This is discussed in further detail under "Selected Property & Casualty Exited Agencies, Policies, Groups & Programs". Underwriting results declined $18.1 million, to a loss of $22.3 million for the year ended December 31, 2001, compared to a loss of $4.2 million in 2000. The decline in underwriting results is primarily attributable to an $11.8 million increase in policy acquisition and other underwriting expenses since December 31, 2000 primarily related to an absence of ceding commission income from business that has not been renewed. In addition, an increase in current accident year claims severity in the commercial automobile line unfavorably impacted results. 23 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 in 2000. The increase in commercial automobile's 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 in 2000. In addition, the commercial multiple peril line experienced a 16.2% rate increase in Michigan and policies in force increased 3.3% in 2000. Workers' compensation's net premiums written increased as a result of 36.8%, 8.0%, and 13.0% rate increases in Maine, Michigan and Indiana, respectively, in 2000. 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' 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 in 2000. 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' 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 in 2000. 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. 24 Investment Results - -------------------------------------------------------------------------------- Net investment income before tax was $216.0 million, $218.4 million and $221.4 million for the years ended December 31, 2001, 2000 and 1999, respectively. The decrease in net investment income in 2001, compared to 2000, primarily reflects the impact of bonds that defaulted and a reduction in average invested assets, partially offset by an increase in average pre-tax yields on debt securities. Average invested assets decreased $23.7 million, or 0.7%, to $3,378.1 million in 2001, compared to $3,401.8 million in 2000. Average pre-tax yields on debt securities increased to 6.9% in 2001, compared to 6.8% in 2000, due to the 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 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 $122.3 million, or 3.5%, to $3,401.8 million in 2000, compared to $3,524.1 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. 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 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 2001 2000 1999 ================================================================================================ (In millions) - ------------------------------------------------------------------------------------------------ Reserve for losses and LAE, beginning of year $ 2,719.1 $ 2,618.7 $ 2,597.3 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 1,708.3 1,634.9 1,601.4 Increase (decrease) in provision for insured events of prior years 33.6 (87.4) (183.4) Losses related to selected property & casualty exited agencies, policies, groups & programs 52.9 -- -- Losses related to voluntary pool environmental claims 33.0 -- -- - ------------------------------------------------------------------------------------------------ Total incurred losses and LAE 1,827.8 1,547.5 1,418.0 - ------------------------------------------------------------------------------------------------ Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 892.8 870.2 861.1 Losses and LAE attributable to insured events of prior years 780.3 703.8 638.0 - ------------------------------------------------------------------------------------------------ Total payments 1,673.1 1,574.0 1,499.1 - ------------------------------------------------------------------------------------------------ Change in reinsurance recoverable on unpaid losses 47.7 126.9 102.5 - ------------------------------------------------------------------------------------------------ Reserve for losses and LAE, end of year $ 2,921.5 $ 2,719.1 $ 2,618.7 ================================================================================================
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were increased by $107.4 million in 2001 and decreased by $87.4 million and $183.4 million in 2000 and 1999, respectively. Included in 2001 were increased reserves of $40.8 million related to the exit of selected property and casualty agencies, policies, groups and programs, and $33.0 million related to voluntary pool environmental claims. During the year ended December 31, 2001, estimated loss reserves for claims occurring in prior years developed unfavorably by $72.8 million and LAE reserves developed favorably by $39.2 million. Favorable development on prior years' loss reserves and LAE reserves was $25.9 million and $61.5 million, respectively, in 2000, and $93.1 million and $90.3 million, respectively, in 1999. The unfavorable loss reserve development in 2001 is primarily the result of an increase in personal automobile loss frequency and severity, increased commercial lines loss severity and additional losses related to fourth quarter 2000 non-catastrophe weather related claims in Michigan. These non-catastrophe claims primarily affected the personal automobile, workers' compensation and commercial multiple peril lines. The favorable loss reserve development in both 2000 and 1999 25 is primarily the result of the Company capturing the accumulated benefits of its claim redesign efforts. Favorable development on prior years' LAE reserves in 2001, 2000 and 1999 is primarily attributable to claims process improvement initiatives taken by the Company over the past four 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 complete. The Company currently expects no significant favorable or adverse LAE reserve development in 2002. Reserves established for current year losses and LAE in 2001 and 2000 consider the factors that resulted in the favorable development of prior years' loss and LAE reserves during 1999 and earlier years. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in years prior to 2000. 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 and reserves, to anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserving position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. Environmental Reserves Although the Company does not specifically underwrite policies that include environmental damage and toxic tort liability, the Company may be required to defend such claims. Loss and LAE reserves for all direct business written by its property and casualty companies related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $26.7 million, $25.4 million and $34.8 million, net of reinsurance of $13.0 million, $15.9 million and $11.2 million in 2001, 2000 and 1999, respectively. 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 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. The Company was a participant in a voluntary excess and casualty reinsurance pool (Excess and Casualty Reinsurance Association, "ECRA") from 1950 to 1982. In 1982 the pool was dissolved and since that time the business has been in runoff. The Company's participation in this pool has resulted in an average loss of $2.5 million annually over the past ten years. During 2001, the pool commissioned an independent actuarial review of the current reserve position, which noted a range of reserve deficiency primarily as a result of adverse development of asbestos claims. As a result of this study, the Company recorded an additional $33.0 million of losses in the fourth quarter of 2001. This reserving action has been presented as a separate line item in the Consolidated Statements of Income and has been excluded from adjusted net income due to management's belief that this item is not indicative of overall operating trends. Loss and LAE reserves for assumed reinsurance and pool business with environmental damage and toxic tort liability, including the aforementioned ECRA reserve adjustment, were $39.3 million, $10.6 million, and $12.5 million in 2001, 2000 and 1999, respectively. These reserves relate to pools in which the Company has terminated its participation, however, the Company continues to be subject to claims related to years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, there can be no assurance that these reserves will be sufficient. Selected Property & Casualty Exited Agencies, Policies, Groups & Programs During the fourth quarter of 2001, the Company completed an extensive review of its agency relationships which resulted in the termination of 377 agencies and the withdrawal of commercial lines' underwriting authority from 314 agencies. These actions affected approximately 27% of the approximately 2,500 active agencies representing the Company in 2001. These agencies have consistently produced unsatisfactory loss ratios. In addition, the Company terminated virtually all of its specialty commercial programs and discontinued a number of special marketing arrangements. The total earned premium associated with the exited business was $252.9 million in 2001 and is estimated to be approximately $170 million and $65 million in 2002 and 2003, respectively. The Company is contractually or 26 under statutory regulations obligated to renew policies with certain agents that will be in runoff in 2002 and 2003. The estimated future premium deficiency on these policies is $7.2 million and this loss was recorded during 2001. In connection with these actions, the Company performed an actuarial review of outstanding reserves with segregated loss history on the exited business. Based on this review, an increase to reserves of $52.9 million was recorded in the fourth quarter of 2001. This increase includes $12.1 million of adverse development in the current year and $40.8 million of adverse development on prior year reserves, which is net of a $5.9 million benefit from the aforementioned aggregate excess of loss reinsurance treaty. Under the aggregate excess of loss reinsurance treaty, the Company recognized a net benefit of $1.1 million, including the aforementioned $5.9 million benefit related to prior year reserves. In addition, as a result of projected future losses on the exited business, the Company recorded an impairment to the deferred acquisition costs asset ("DAC") of $3.4 million. This resulted in an increase in policy acquisition expenses and a decrease in the Company's DAC asset balance as of December 31, 2001. The total charge of $68.3 million has been presented as a separate line item in the Consolidated Statements of Income and has been excluded from adjusted net income due to management's belief that this item is not indicative of overall operating trends. Actual future losses from the exited business may vary from the Company's estimate. 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. Under the Company's catastrophe reinsurance agreements, the Company ceded $20.3 million of losses in 2001 as a result of deterioration in the 2000 accident year and $35.2 million of losses in 2000. The Company entered into a whole account aggregate excess of loss reinsurance agreement, which provides coverage for accident year 1999 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 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 $0.2 million, $9.8 million and $15.9 million for the years ended December 31, 2001, 2000, and 1999 respectively, based on estimates of losses and allocated LAE for accident year 1999. The 2001 impact from this treaty includes a $1.1 million net benefit related to the aforementioned exit of selected property and casualty agencies, policies, groups and programs. 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. Asset Accumulation Allmerica Financial Services - -------------------------------------------------------------------------------- The following table summarizes the results of operations for the Allmerica Financial Services segment.
For the Years Ended December 31 2001 2000 1999 ===================================================================================== (In millions) - ------------------------------------------------------------------------------------- Segment revenues Premiums $ 49.0 $ 52.1 $ 54.5 Fees 391.6 421.1 359.3 Net investment income 288.9 283.6 304.8 Other income 97.0 110.4 89.7 - ------------------------------------------------------------------------------------- Total segment revenues 826.5 867.2 808.3 - ------------------------------------------------------------------------------------- Policy benefits, claims and losses 346.8 315.1 323.0 Policy acquisition and other operating expenses 336.7 329.3 279.8 - ------------------------------------------------------------------------------------- Segment income $143.0 $222.8 $205.5 =====================================================================================
27 2001 Compared to 2000 Segment income decreased $79.8 million, or 35.8%, to $143.0 million in 2001. This decrease primarily reflects lower asset-based fees and other income, as well as an increase in policy benefits and other operating expenses, net of lower deferred acquisition costs. The decline in asset-based fees and other income is principally attributable to a decrease in the market value of assets under management in the variable product lines, and to lower brokerage income. Segment revenues decreased $40.7 million, or 4.7%, in 2001, primarily due to lower asset-based fees and other income. Fee income decreased $29.5 million, or 7.0%, to $391.6 million, primarily due to variable annuity fees which decreased $21.3 million, or 9.0%. This was primarily due to a decline in the market value of average variable annuity assets under management. In addition, group annuity and non-variable universal life policy fees decreased $9.3 million and $8.4 million, respectively, during 2001. These declines were primarily due to lower average invested assets resulting from the Company's decision to exit its defined contribution group retirement business and from the continued shift in focus to variable life insurance and annuity products. Additionally, the decline in non-variable universal life fees included approximately $4 million due to changes in certain actuarial assumptions in 2000. These decreases in fees were partially offset by a $9.5 million increase in variable universal life fees principally due to additional deposits. Other income decreased $13.4 million, or 12.1%, to $97.0 million. This decline was primarily due to lower investment management fees of $8.3 million resulting from depreciation and reduced deposits in variable product assets under management as well as to lower brokerage income of $6.1 million resulting from a decrease in mutual fund and general securities transaction volumes. Net investment income increased $5.3 million primarily due to additional income from the investment of higher general account deposits, partially offset by the impact of defaulted bonds, lower average mortgage investments and yields, and to the aforementioned decision to exit the defined contribution group retirement business. Policy benefits, claims and losses increased $31.7 million, or 10.1%, to $346.8 million in 2001, primarily due to increased interest credited of approximately $22 million related to an increase in general account deposits. Additionally, policy benefits include guaranteed minimum death benefits ("GMDB") related to variable annuities. In the event of the death of an annuitant, the GMDB provides beneficiaries with a payment equal to the greater of a prescribed death benefit or the current account value of the annuity. This results in increased annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. The Company has established reserves for GMDB based on its best estimate of the long-term cost of GMDB. During 2001, the GMDB expense increased $10.5 million, primarily due to the recent, sustained decline in the financial markets. If market levels as of December 31, 2001 continue, GMDB expenses in 2002 are expected to increase by $20 million to $25 million over 2001. Approximately one third to one half of this increase will be offset by reduced amortization of deferred policy acquisition costs. Additional declines in the financial markets would further increase these costs. Policy acquisition and other operating expenses increased $7.4 million, or 2.2%, to $336.7 million in 2001. Other operating expenses increased approximately $18.3 million, primarily due to increases in technology and distribution costs, partially offset by lower brokerage commissions and administrative expenses due to the aforementioned decrease in trading volumes for mutual fund and general securities transactions. In addition, other operating expenses in 2000 included a $4.7 million net reduction in premium tax and guaranty fund reserves. Management expects technology and distribution costs to continue to increase in 2002 due to new sales initiatives. Policy acquisition expenses decreased $10.9 million or 12.3%, to $77.8 million. In 2001, policy acquisition expense reflects a refinement in the methodology used by the Company's deferred policy acquisition cost valuation system which decreased amortization expense by approximately $6 million. 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. Excluding the effects of the aforementioned unusual items, policy acquisition costs declined approximately $15.2 million, primarily due to lower variable annuity profits. Since variable products' deferred policy acquisition costs are amortized in proportion to gross profits, the lower annuity gross profits in 2001 resulted in less amortization expense. However, if lower annuity gross profits persist, a partial writeoff of the existing DAC asset may occur. This would increase policy acquisition expenses in the period of the partial writeoff. 2000 Compared to 1999 Segment income increased $17.3 million, or 8.4%, to $222.8 million in 2000. This increase was 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 $58.9 million, or 7.3%, 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 28 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 provided for immediate benefits to annuitants upon depositing funds into an annuity issued by the Company. This product was 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 did 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 were less than average separate account assets during 2000, reflecting the net market depreciation during the year. Investment and other income decreased $0.5 million, or 0.1%, in 2000. This decrease was 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 $7.9 million, or 2.4%, to $315.1 million in 2000. This decrease was 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 provided for a limited time, enhanced crediting rates on general account deposits. Under this program, general account deposits were transferred ratably over a period of time into the Company's separate accounts. Also contributing to this decrease was 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 that 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 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 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 in 2000. 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 2001 2000 1999 ========================================================================================== (In millions) - ------------------------------------------------------------------------------------------ Insurance: Traditional life $ 47.4 $ 50.6 $ 52.6 Universal life 15.4 17.2 23.0 Variable universal life 204.1 209.1 187.0 Individual health 0.3 0.2 0.3 Group variable universal life 64.8 47.7 94.9 - ------------------------------------------------------------------------------------------ Total insurance 332.0 324.8 357.8 - ------------------------------------------------------------------------------------------ Annuities: Separate account annuities 1,923.1 2,555.1 1,922.2 General account annuities 926.8 524.7 830.2 Retirement investment accounts 6.0 9.3 16.4 - ------------------------------------------------------------------------------------------ Total individual annuities 2,855.9 3,089.1 2,768.8 Group annuities 197.7 463.1 409.3 - ------------------------------------------------------------------------------------------ Total annuities 3,053.6 3,552.2 3,178.1 - ------------------------------------------------------------------------------------------ Total premiums and deposits $3,385.6 $ 3,877.0 $ 3,535.9 ==========================================================================================
2001 Compared to 2000 For the year ended December 31, 2001, total premiums and deposits decreased $491.4 million, or 12.7%, to $3,385.6 million. These decreases are primarily due to lower separate account and group annuity deposits, partially offset by higher general account deposits. The Company believes that the lower separate account and group annuity deposits reflect an industry-wide 29 trend resulting from a general decline in the equity markets. In addition, group annuity deposits decreased due to the Company's decision to exit its defined contribution retirement plan business and to cease marketing activities for new defined benefit retirement business. Partially offsetting these decreases were higher annuity deposits into the Company's general account resulting, in part, from the introduction of a promotional annuity program. This program offered an enhanced crediting rate of 7% for new general account deposits, for up to one year. 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 Scudder Investments ("Scudder"), Pioneer Investment Management, Inc. and Delaware Management Company ("Delaware"). Partners, Select, and Agency represented, respectively, approximately 38%, 38%, and 24% of individual annuity deposits in 2001, and Scudder represented 28% of all individual annuity deposits. During 2000, Partners, Select, and Agency represented, respectively, approximately 46%, 25%, and 29% of individual annuity deposits. Deposits in the Partners channel decreased during the year primarily due to the aforementioned overall decline in the equity markets, as well as to decreased sales through the Delaware distribution channel due to its emphasis on sales of proprietary products. Delaware represented approximately 3% of all individual annuity deposits in 2001. In the fourth quarter of 2001, the Company terminated its relationship with Delaware. The increase in deposits within the Select channel resulted primarily from the aforementioned promotional annuity program which offered an enhanced crediting rate of 7% and from the net addition of 22 wholesalers in 2001. 2000 Compared to 1999 For the year ended December 31, 2000, total premiums and deposits increased $341.1 million, or 9.6%, to $3,877.0 million. This increase was 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 resulted 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 did not include the bonus feature. Lower general account annuity deposits resulted from decreased utilization of an annuity program with enhanced crediting rates which required the transfer of deposits ratably over a period of time into the Company's separate accounts. Allmerica Asset Management - -------------------------------------------------------------------------------- The following table summarizes the results of operations for the Allmerica Asset Management segment.
For the Years Ended December 31 2001 2000 1999 =========================================================================================== (In millions) - ------------------------------------------------------------------------------------------- Interest margins on GICs: Net investment income $ 144.3 $ 137.8 $ 137.9 Interest credited 127.5 119.7 118.6 - ------------------------------------------------------------------------------------------- Net interest margin 16.8 18.1 19.3 - ------------------------------------------------------------------------------------------- Fees and other income: External 6.5 6.3 6.2 Internal 5.2 5.1 6.4 Other operating expenses (7.8) (7.0) (8.4) - ------------------------------------------------------------------------------------------- Segment income $ 20.7 $ 22.5 $ 23.5 =========================================================================================== Average GIC deposits outstanding $2,737.9 $1,887.9 $2,068.5 ===========================================================================================
2001 Compared to 2000 Segment income decreased $1.8 million, or 8.0%, to $20.7 million in 2001 primarily due to decreased earnings on GICs and to lower earnings related to external clients. Earnings on GICs decreased $1.3 million primarily due to a shift from short-term funding agreements to lower margin long-term funding agreements in 2001 and to lower investment income due to defaults on certain bonds supporting GIC obligations. These declines were partially offset by increased earnings from higher net GIC deposits during the year. The decrease in earnings related to external clients resulted from a decrease in management fees from a securitized investment portfolio, partially offset by an increase in new external assets under management. In the fourth quarter of 2001, the Company was notified of short-term funding agreement withdrawals of approximately $380 million which resulted from uncertainty regarding the rating agency actions described in "Recent Developments." These withdrawals precipitated losses from related interest rate swap contracts as described in "Derivative Instruments." Management expects income from the GIC product line to be unfavorably affected in future periods due to short-term funding agreement withdrawals and a continued shift to lower margin long-term funding agreements. Further ratings downgrades may negatively affect GIC sales and results of operations. 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 following the insolvency of one specific company, resulting in greater redemptions for the industry overall. 30 Corporate - -------------------------------------------------------------------------------- The following table summarizes the results of operations for the Corporate segment for the periods indicated.
For the Years Ended December 31 2001 2000 1999 ===================================================================================== (In millions) - ------------------------------------------------------------------------------------- Segment revenues Investment and other income $ 6.7 $ 6.3 $ 6.0 Interest expense 15.3 15.3 15.4 Other operating expenses 55.2 51.8 49.9 - ------------------------------------------------------------------------------------- Segment loss $ (63.8) $ (60.8) $ (59.3) =====================================================================================
2001 Compared to 2000 Segment loss increased $3.0 million, or 4.9%, to $63.8 million in 2001, primarily as a result of increased corporate overhead costs, including technology costs and certain corporate overhead expenses previously allocated to other operating segments, partially offset by state tax credits recognized by the holding company. Interest expense for both periods relates principally to the interest paid on the Senior Debentures of the Company. 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. 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. The EBS business provided managed care products and offered group life, medical, dental, and disability insurance to the middle market. In March 2000, the Company transferred its EBS business to Great-West Life and Annuity Insurance Company of Denver. The sales transaction effectively transferred the business upon renewal subjecting the Company to losses on its existing book during the runoff period. AGU operated as a Managing Group Underwriting unit offering members of affinity groups medical, life and disability insurance. The reinsurance pool business consisted 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. 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. The following table summarizes the loss from operations and disposal for the discontinued group life and health insurance business for the year ended December 31, 1999. There were no additional losses recognized in 2001 or 2000 related to the Company's discontinued group life and health insurance business.
For the Year Ended December 31 1999 ============================================================================= (In millions) - ----------------------------------------------------------------------------- Loss from operations of discontinued group life and health business, net of taxes $ (18.8) Loss from disposal of discontinued group life and health business, net of taxes (30.5) - ----------------------------------------------------------------------------- Net loss from discontinued segment $ (49.3) =============================================================================
The $18.8 million loss from operations for the year ended December 31, 1999 primarily resulted from additional reserves provided for accident claims related to prior years. As required by APB Opinion No. 30, the loss from disposal of the discontinued segment includes estimated proceeds from the aforementioned sale of the Company's EBS business, as well as an estimate of future losses expected from the runoff of the discontinued operations after the June 30, 1999 measurement date. Accordingly, the Company recognized a loss from disposal of its group life and health insurance business, net of taxes, of $30.5 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) Federal income tax benefit 16.4 - -------------------------------------------------- $(30.5) ==================================================
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. 31 Investment Portfolio - -------------------------------------------------------------------------------- The Company held general account investment assets diversified across several asset classes, as follows:
December 31 2001 2000 ============================================================================================ (In millions) - -------------------------------------------------------------------------------------------- % of Total % of Total Carrying Carrying Carrying Carrying Value Value Value Value - -------------------------------------------------------------------------------------------- Fixed maturities (1) $ 9,401.7 88.1% $ 8,118.0 83.9% Equity securities (1) 62.1 0.6 85.5 0.9 Mortgages 321.6 3.0 617.6 6.4 Policy loans 379.6 3.5 381.3 3.9 Cash and cash equivalents 350.2 3.3 281.1 2.9 Other long-term investments 161.2 1.5 193.2 2.0 - -------------------------------------------------------------------------------------------- Total $10,676.4 100.0% $ 9,676.7 100.0% ============================================================================================
(1) The Company carries the fixed maturities and equity securities in its investment portfolio at market value. Total investment assets increased $1.0 billion, or 10.3%, to $10.7 billion during 2001. This increase consisted primarily of additional fixed maturities of $1.3 billion partially offset by a decrease of $296.0 million in mortgages. The increase in fixed maturities is primarily due to the investment of funds received from net GIC deposits in the Allmerica Asset Management segment, as well as an increase in general account deposits, including those relating to the aforementioned promotional annuity program, in the Allmerica Financial Services segment. These increases were partially offset by sales of mortgage loans during the year. The proceeds from these sales were reinvested in fixed maturities. 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 90.7% and 88.1% of the Company's total fixed maturity portfolio at December 31, 2001 and 2000, respectively. The average yield on fixed maturities was 7.3% and 7.4% for December 31, 2001 and 2000, 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. Due to the current interest rate environment, management expects its investment yield to be negatively affected by lower prevailing fixed maturity investment rates in 2002. Principally as a result of the Company's exposure to below investment grade securities, the Company recognized $179.0 million and $66.1 million of realized losses on other-than-temporary impairments of fixed maturities for the years ended December 31, 2001 and 2000, respectively. The losses reflect the continued deterioration of the high-yield market. The recognition of these losses followed the review of recent defaults on interest payments, financial information from issuers, estimated future cash flows and other trends in the high-yield market. In addition, the Company had fixed maturity securities with a carrying value of $9.8 million and $7.5 million on non-accrual status at December 31, 2001 and 2000, respectively. No assurance can be given that the fixed maturity impairments will, in-fact, be adequate to cover future losses or that substantial additional impairments will not be required in the future. The effect of holding securities for which income is not accrued, 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 $11.3 million, $3.6 million and $2.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. This includes the impact of securities held as of the aforementioned financial statement dates, as well as securities sold during those periods. Management expects that defaults in the fixed maturities portfolio may continue to negatively impact investment income. Derivative Instruments - -------------------------------------------------------------------------------- The Company enters into interest rate swap contracts with indices that correlate to balance sheet instruments to modify its indicated net interest sensitivity to levels deemed to be appropriate. Specifically, for floating rate funding agreements that are matched with fixed rate securities, the Company manages the risk of cash flow variability by hedging with interest rate swap contracts designed to pay fixed and receive floating interest. With the adoption of Statement No. 133 on January 1, 2001, the swap contracts were considered cash flow hedges of the interest rate risk associated with the floating rate funding agreements, including funding agreements with put features allowing the policyholder to cancel the contract prior to maturity. During the fourth quarter of 2001, the Company reviewed the trend in put activity since inception of the funding agreement business in order to determine the ongoing effectiveness of the hedging relationship. Based upon the historical trend in put activity, as well as management's uncertainty about possible future events, the Company has determined that it is probable that some of the future variable cash flows of the puttable funding agreements will not occur, and therefore the hedges were ineffective. The Company analyzed the future payments under 32 each outstanding funding agreement, and determined the amount of payments that are probable of occurring versus those that are probable of not occurring. The total accumulated market value losses deferred in other comprehensive income related to the payments that are probable of not occurring, which totals $35.8 million, was reclassified to earnings during the fourth quarter of 2001. This loss of $35.8 million includes $13.7 million of losses related to funding agreements that have already been put back to the Company, as well as $22.1 million of losses related to funding agreements that have not been put, but which management believes are probable of being put in the future. If the funding agreements are not put back to the Company but held to maturity, then the market value losses on the associated swap contracts will reverse as gains recognized in earnings over time. The total accumulated market value losses related to the payments that are probable of occurring, which totals $4.3 million, remains deferred in other comprehensive income at December 31, 2001. These market value losses will reverse as unrealized gains in other comprehensive income as the funding agreement payments are made over time. The Company no longer offers floating rate funding agreements that include a put feature. 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 mandatorily 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 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, 2001 and 2000 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, unless otherwise noted below. 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 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. Variable interest rate GIC liabilities are included in the category representing their contractual maturity, regardless of whether the liability includes a put feature. 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. 33
Fair Value For the Year Ended December 31, 2001 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 ============================================================================================================================= (Dollars in millions) - ----------------------------------------------------------------------------------------------------------------------------- Rate Sensitive Assets: Available-for-sale securities $836.5 $636.7 $692.9 $1,424.1 $1,104.5 $4,657.5 $9,352.2 $9,466.2 Average interest rate 6.72% 6.30% 7.20% 7.36% 7.11% 6.80% 6.91% Mortgage loans $ 33.4 $ 29.4 $ 70.5 $ 26.3 $ 30.6 $ 135.6 $ 325.8 $ 335.1 Average interest rate 8.04% 6.34% 7.47% 7.34% 8.27% 7.78% 7.62% Policy loans $ -- $ -- $ -- $ -- $ -- $ 379.6 $ 379.6 $ 379.6 Average interest rate -- -- -- -- -- 7.09% 7.09% Company owned life insurance $ -- $ -- $ -- $ -- $ -- $ 67.3 $ 67.3 $ 67.3 Average interest rate -- -- -- -- -- 2.42% 2.42% Rate Sensitive Liabilities: Fixed interest rate GICs $ 30.5 $ 2.3 $ -- $ -- $ 105.5 $ -- $ 138.3 $ 212.8 Average interest rate 7.53% 7.20% -- -- 6.87% -- 7.02% Variable interest rate GICs $483.6 $100.2 $223.1 $ 70.2 $ 85.3 $ -- $ 962.4 $ 961.3 Average interest rate 2.31% 2.15% 2.50% 2.21% 2.36% -- 2.33% Supplemental contracts without life contingencies $ 26.1 $ 13.2 $ 8.0 $ 5.4 $ 0.2 $ 4.4 $ 57.3 $ 57.3 Average interest rate 2.91% 2.99% 3.10% 3.30% 3.81% 3.78% 3.05% Other individual contract deposit funds $ 13.2 $ 11.8 $ 10.4 $ 9.0 $ 8.0 $ 86.7 $ 139.2 $ 139.2 Average interest rate 4.35% 4.30% 4.26% 4.21% 4.17% 4.14% 4.25% Other group contract deposit funds $ 33.6 $ 30.1 $ 21.8 $ 19.1 $ 15.1 $ 93.7 $ 213.4 $ 212.4 Average interest rate 5.80% 6.00% 5.92% 5.91% 5.88% 5.98% 5.92% Individual fixed annuity contracts $234.2 $186.5 $161.3 $ 145.7 $ 130.9 $ 827.5 $1,686.2 $1,621.3 Average interest rate 4.00% 3.90% 3.75% 3.75% 3.75% 3.75% 3.84% Trust instruments supported by funding obligations $100.2 $126.4 $ 49.3 $ 716.4 $ 228.6 $ 297.7 $1,518.6 $1,534.0 Average interest rate 2.22% 3.03% 2.57% 4.58% 3.50% 6.00% 4.35% Long-term debt $ -- $ -- $ -- $ -- $ -- $ 199.5 $ 199.5 $ 204.4 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 $ 286.0 Average interest rate -- -- -- -- -- 8.21% 8.21%
34
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%
35 The following tables for the years ended December 31, 2001 and 2000 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 Value For the Year Ended December 31, 2001 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 ========================================================================================================================= (Dollars in millions) - ------------------------------------------------------------------------------------------------------------------------- Rate Sensitive Derivative Financial Instruments: Pay fixed/receive 3 month LIBOR swaps $ 233.5 $ 50.0 $ 162.3 $ 225.0 $ -- $-- $ 670.8 $ (30.4) Average pay rate 6.93% 5.41% 5.66% 7.21% -- -- 6.60% Average receive rate 3 Mo. 3 Mo. 3 Mo. 3 Mo. 3 Mo. -- 3 Mo. LIBOR LIBOR LIBOR LIBOR LIBOR LIBOR Pay fixed/receive 1 month LIBOR swaps $ -- $ -- $ -- $ 50.0 $ -- $-- $ 50.0 $ (4.4) Average pay rate -- -- -- 7.37% -- -- 7.37% Average receive rate -- -- -- 1 Mo. -- -- 1 Mo. LIBOR LIBOR Pay fixed/receive Fed Funds rate swaps $ -- $ 50.0 $ 110.0 $ 50.0 $ -- $-- $ 210.0 $ (11.8) 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) $ 3.1 $ -- $ -- $ -- $ -- $-- $ 3.1 $ 3.2 Number of Contracts (S&P Index Futures) 2,750 -- -- -- -- -- 2,750 Weighted average opening price $1,135.4 $ -- $ -- $ -- $ -- $-- $1,135.4
36
Fair Value For the Year Ended 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. 3 Mo. 3 Mo. 3 Mo. 3 Mo. -- 3 Mo. LIBOR LIBOR LIBOR LIBOR LIBOR 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. -- 1 Mo. -- 1 Mo. LIBOR LIBOR 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
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, 2001 and 2000 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. 37
Fair Value For the Year Ended December 31, 2001 2002 2003 2004 2005 2006 Thereafter Total 12/31/01 ================================================================================================================== (Currencies in millions) - ------------------------------------------------------------------------------------------------------------------ Fixed Interest Securities Denominated in Foreign Currencies: Fixed interest rate securities denominated in British Pounds -- -- -- -- 9.5 -- 9.5 $ 18.4 Current forward foreign exchange rate -- -- -- -- 1.4546 -- 1.4546 Currency Swap Agreements Related to Fixed Interest Securities: Pay British Pounds Notional amount in foreign currency -- -- -- -- 9.5 -- 9.5 $ (1.0) Average contract rate -- -- -- -- 1.98 -- 1.98 Current forward foreign exchange rate -- -- -- -- 1.4546 -- 1.4546 Liabilities Denominated in Foreign Currencies: Trust instruments supported by funding obligations denominated in Euros -- 50.0 -- 262.3 -- -- 312.3 $ 286.3 Current forward foreign exchange rate -- 0.8895 -- 0.8895 -- -- 0.8895 Trust instruments supported by funding obligations denominated in Japanese Yen -- 5,000.0 -- 56,000.0 30,000.0 1,500.0 92,500.0 $ 784.9 Current forward foreign exchange rate -- 0.0076 -- 0.0076 0.0076 0.0076 0.0076 Trust instruments supported by funding obligations denominated in Swiss Francs -- -- 40.0 70.0 -- -- 110.0 $ 67.1 Current forward foreign exchange rate -- -- 0.6023 0.6023 -- -- 0.6023 Trust instruments supported by funding obligations denominated in British Pounds -- 30.0 -- -- -- 175.0 205.0 $ 307.0 Current forward foreign exchange rate -- 1.4546 -- -- -- 1.4546 1.4546 Currency Swap Agreements Related to Trust Obligations: Pay Euros Notional amount in foreign currency -- 50.0 -- 262.3 -- -- 312.3 $ (26.1) Average contract rate -- 0.879 -- 0.951 -- -- 0.940 Current forward foreign exchange rate -- 0.8895 -- 0.8895 -- -- 0.8895 Pay Japanese Yen Notional amount in foreign currency -- 5,000.0 -- 56,000.0 30,000.0 1,500.0 92,500.0 $ (21.9) Average contract rate -- 0.009 -- 0.009 0.008 0.010 0.009 Current forward foreign exchange rate -- 0.0076 -- 0.0076 0.0076 0.0076 0.0076 Pay Swiss Francs Notional amount in foreign currency -- -- 40.0 70.0 -- -- 110.0 $ (2.1) Average contract rate -- -- 0.591 0.596 -- -- 0.594 Current forward foreign exchange rate -- -- 0.6023 0.6023 -- -- 0.6023 Pay British Pounds Notional amount in foreign currency -- 30.0 -- -- -- 175.0 205.0 $ (10.8) Average contract rate -- 1.500 -- -- -- 1.442 1.450 Current forward foreign exchange rate -- 1.4546 -- -- -- 1.4546 1.4546
38
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 Yen -- -- 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 Yen 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
39 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, discontinued operations and the effect of a change in accounting principle was a $75.5 million benefit during 2001. This benefit resulted in a consolidated effective federal tax rate of 127.1% of pre-tax losses from continuing operations. During 2000, the provision for federal income taxes before minority interest and discontinued operations was a $2.7 million expense and resulted in a consolidated effective federal tax rate of 1.3%. The change in the rate is primarily due to lower underwriting income in 2001 resulting in an increase in the proportion of tax-exempt investment income, the dividends received deduction associated with the Company's variable products and low income housing credits to pre-tax 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 decrease in the rate 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 the Company's variable products. This amount includes $13.3 million related to deductions taken in prior years. In addition, the rate decreased due to realized investment losses in 2000, as compared to realized investment gains during 1999, resulting in an increase in the proportion of tax-exempt investment income to pre-tax income. Critical Accounting Policies - -------------------------------------------------------------------------------- The discussion and analysis of the Company's financial condition and results of operations are based upon the consolidated financial statements. These statements have been prepared in accordance with generally accepted accounting principles which require management 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. The following critical accounting policies, among others, are those which management believes affect the more significant judgments and estimates used in the preparation of the Company's financial statements. Additional information about the Company's significant accounting policies may be found in Note 1, "Summary of Significant Accounting Policies" to the consolidated financial statements. Property & Casualty Insurance Loss Reserves The amount of loss and loss adjustment expense reserves (the "loss reserves") is determined based on an estimation process that is very complex and uses information obtained from both company specific and industry data, as well as general economic information. The estimation process is highly judgmental, and requires the Company to continuously monitor and evaluate the life cycle of claims on type-of-business and nature-of-claim bases. Using data obtained from this monitoring and assumptions about emerging trends, the Company develops information about the size of ultimate claims based on its historical experience and other available market information. The most significant assumptions, which vary by line of business, used in the estimation process include determining the trend in loss costs, the expected consistency in the frequency and severity of claims incurred but not yet reported to prior year claims, changes in the timing of the reporting of losses from the loss date to the notification date, and expected costs to settle unpaid claims. Because the amount of the loss reserves is sensitive to the Company's assumptions, the Company does not completely rely on only one estimate to determine its loss reserves. Rather, the Company develops several estimates using generally recognized actuarial projection methodologies that result in a range of reasonably possible loss reserve outcomes; the Company's best estimate is within that range. When trends emerge that the Company believes affect the future settlement of claims, the Company would react accordingly by adjusting its reserves. Reserve adjustments are reflected in the Consolidated Statements of Income as adjustments to losses and loss adjustment expenses. Often, these adjustments are recognized in periods subsequent to the period in which the underlying loss event occurred. These types of subsequent adjustments are disclosed and discussed separately as "prior year reserve development". Such development can be either favorable or unfavorable to the financial results of the Company. Property & Casualty Reinsurance Recoverables The Company shares a significant amount of insurance risk of the primary underlying contracts with various insurance entities through the use of reinsurance contracts. As a result, when the Company experiences loss events that are subject to the reinsurance contract, reinsurance recoverables are recorded. The amount of the reinsurance recoverable can vary based on the size of the individual loss or the aggregate amount of all losses in a particular line, book of business or an aggregate amount associated with a particular accident year. The valuation of losses recover- 40 able depends on whether the underlying loss is a reported loss, or an incurred but not reported loss. For reported losses, the Company values reinsurance recoverable at the time the underlying loss is recognized, in accordance with contract terms. For incurred but not reported losses, the Company estimates the amount of reinsurance recoverable based on the terms of the reinsurance contracts and historical reinsurance recovery information and applies that information to the gross loss reserve estimates. The most significant assumption the Company uses is the average size of the individual losses for those claims that have occurred but have not yet been recorded by the Company. The reinsurance recoverable is based on reasonable estimates and is disclosed separately on the financial statements. However, the ultimate amount of the reinsurance recoverable is not known until all losses are settled. Variable Products' Deferred Policy Acquisition Costs Deferred policy acquisition costs consist of commissions, underwriting costs and other costs, which vary with, and are primarily related to, the production of insurance deposits. Acquisition costs related to the Company's variable products (variable universal life and variable annuities) are recorded on the balance sheet and amortized through the income statement in proportion to total estimated gross profits over the expected life of the contracts. The Company's estimated gross profits are based on assumptions including mortality, persistency, asset growth rates and expenses associated with policy maintenance. The principal source of earnings for these policies are from asset based fees, which can vary in relation to changes in the equity markets. At each balance sheet date, the Company evaluates the historical and expected future gross profits. Any adjustment in estimated profit requires that the amortization rate be revised retroactively to the date of policy/annuity issuance. The cumulative difference related to prior periods is recognized as a component of the current periods' amortization, along with amortization associated with the actual gross profits of the period. Lower actual gross profits would typically result in less amortization expense. The converse would also be true. However, if lower gross profits were to continue into the future, a partial write-off of the existing DAC asset may occur. The Company periodically reviews the DAC asset to determine if it is recoverable from future income. If DAC is determined to be unrecoverable, such costs are expensed at the time of determination. The amount of DAC considered realizable would be reduced in the near term if the estimate of ultimate or future gross profits is reduced. The amount of DAC amortization would be revised if any of the estimates discussed above are revised. Other-Than-Temporary Impairments The Company employs a systematic methodology to evaluate declines in market values below cost or amortized cost for its investments. This methodology ensures that available evidence concerning the declines is evaluated in a disciplined manner. In determining whether a decline in market value below amortized cost is other-than-temporary, the Company evaluates the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the issuer's financial performance, including earnings trends, dividend payments, and asset quality; any specific events which may influence the operations of the issuer; general market conditions; and, the financial condition and prospects of the issuer's market and industry. The Company applies judgment in assessing whether the aforementioned factors have caused an investment to decline in value to be other-than-temporary. When an other-than-temporary decline in value is deemed to have occurred, the Company reduces the cost basis of the investment to the new estimated realizable value. This reduction is permanent and is recognized as a realized investment loss. 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 2001, AFC received $100.0 million of dividends from its property and casualty businesses. These funds were used for interest payments of $39.9 million related to the Capital Securities and Senior Debentures, a $30.0 million capital contribution to FAFLIC and to AFLIAC and for dividends to shareholders of $13.3 million. Additional dividends from the Company's property and casualty insurance subsidiaries prior to April 2002 would be considered "extraordinary" and would require prior approval from the respective state regulators. The Company does not expect dividend payments from its life insurance subsidiaries in 2002. Additionally, under an agreement with the Commonwealth of Massachusetts Insurance Commissioner associated with the transfer of FAFLIC's ownership of the Company's property and casualty insurance subsidiaries, as well as several non-insurance subsidiaries, to AFC, the Company agreed to maintain FAFLIC's 41 statutory surplus at specified levels through 2005. Future capital contributions to FAFLIC may be required. 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. Sources of cash for the Company's insurance subsidiaries are from premiums and fees collected, investment income and maturing investments. Primary cash outflows are paid benefits, claims, losses and loss adjustment expenses, policy acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to benefits, claims, losses and loss adjustment expenses can be variable because of uncertainties surrounding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. The Company periodically adjusts its investment policy to respond to changes in short-term and long-term cash requirements. Net cash provided by operating activities was $597.6 million, $169.5 million and $23.0 million in 2001, 2000 and 1999, respectively. The increase in 2001 is primarily the result of higher general account deposits, including funds received from the aforementioned promotional annuity program with enhanced crediting rates of 7%, and to an increase in premiums received from the property and casualty business. These increases in cash were partially offset by increased loss and LAE payments in the property and casualty business. The increase in 2000 resulted primarily from 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. Net cash used in investing activities was $979.8 million and $895.7 million in 2001 and 2000, respectively, while net cash provided by investing activities was $787.1 million in 1999. The $84.1 million increase in cash used in 2001 is primarily the result of higher net purchases of fixed maturities, partially offset by cash provided by sales of mortgage loans, and year over year declines in purchases of mortgages and company owned life insurance. Net purchases of fixed maturities increased principally due to additional deposits into the general account, including those related to the aforementioned promotional annuity program. The $1.7 billion increase in cash used from 1999 to 2000 resulted primarily from a $1.3 billion year over year increase in purchases of fixed maturities due to the 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. Net cash provided by financing activities was $451.3 million and $542.5 million in 2001 and 2000, respectively, as compared to cash used in financing activities of $905.0 million in 1999. The decrease in cash provided in 2001 compared to 2000 is primarily due to lower net funding agreement deposits, including trust instruments supported by funding obligations, in the current year, partially offset by the absence of common stock repurchases in 2001. The increase in cash in 2000 resulted primarily from 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 common stock repurchase program. In the opinion of management, AFC has sufficient funds at the holding company or available through dividends from its insurance subsidiaries, 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. In November 2001, the Company paid an annual dividend of $0.25 per share. 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 $215.0 million available under a committed syndicated credit agreement, which expires on May 24, 2002. 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, 2001, no amounts were outstanding under this agreement. The Company had $83.3 million of commercial paper borrowings outstanding at December 31, 2001. These borrowings are used in connection with the Company's premium financing business, which is included in the Risk Management segment. In 2002, the Company intends to fund this business through sales of receivables of this business. Rating agency downgrades from current levels may adversely affect the Company's cost and availability of any additional debt financing. 42 The Company's financing obligations generally include debt, minority interest on and repayment of the Company's Capital Securities, operating lease payments, debt instruments supported by funding obligations and funding agreements. The following table represents the Company's annual payments related to the principal payments of these financing obligations as of December 31, 2001 and operating lease payments reflect expected cash payments based upon lease terms:
(In millions) - -------------------------------------------------------------------------------------------------- Maturity in Maturity less Maturity Maturity excess of than 1 year 1-3 years 4-5 years 5 years Total - -------------------------------------------------------------------------------------------------- Long-term debt (1) $ -- $ -- $ -- $ 200.0 $ 200.0 Capital Securities (2) -- -- -- 300.0 300.0 Trust instruments supported by funding obligations (3) 100.2 175.7 945.0 297.7 1,518.6 Funding agreements (4) 514.1 325.6 261.0 -- 1,100.7 Operating lease commitments 26.1 33.6 10.1 -- 69.8 - --------------------------------------------------------------------------------------------------
(1) Long-term debt relates to the Company's senior debentures due in 2025, which pay annual interest at a rate of 7 5/8%. (2) Capital Securities of the Company, due in 2027, pay cumulative dividends at an annual rate of 8.207%. (3) Trust instruments supported by funding obligations payments are reflected in the category representing their contractual maturity. (4) Funding agreements are reflected in the category representing their contractual maturity, regardless of whether the liability includes a put feature. Contingencies - -------------------------------------------------------------------------------- The Company's insurance subsidiaries are routinely engaged in various legal proceedings arising in the normal course of business, including claims for extracontractual or punitive damages. Additional information on other litigation and claims may be found in Note 20, "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 net expenses from its employee pension plans of $0.3 million and $0.9 million, in 2001 and 1999, respectively. In 2000, the Company recognized a net benefit of $12.5 million related to these plans. The expense or benefit 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 expense in 2001 and 1999 primarily reflects decreased market values of plan assets as compared to 2000, while the net benefit in 2000 primarily reflects increases in the market value of plan assets. In 2002, management expects an increase of approximately $20 million in employee pension plan costs due to declines in the market value of plan assets and interest rates in 2001. In 2001, Standard and Poor's re-affirmed its "AA-" (Very Strong) claims paying ability ratings for both the life and the property and casualty insurance companies, A.M. Best reaffirmed the "A" (Excellent) financial strength ratings assigned to the life insurance and property and casualty insurance companies, and Fitch rating service, formerly Duff & Phelps, reaffirmed the "AA" (Very High) claims paying ability ratings of the life insurance companies. During March 2002, Moody's Investors Service also re-affirmed the life and property and casualty insurance companies' financial strength ratings of "A1" (Good), with a negative outlook for the insurance companies. Rating downgrades from current levels may adversely affect the Company's product sales, the persistency of investment contracts or funding agreements sold through the Company's Allmerica Asset Management segment and results of operations. In addition, certain rating downgrades from current levels could precipitate the payment of funds held by the Company related to its aggregate excess of loss reinsurance treaty. Additionally, during 2001, A.M. Best re-affirmed the "a-" senior debt rating and the "bbb+" Capital Securities rating and Fitch re-affirmed its "A+" senior debt rating assigned to the Company. Also, in 2001, Standard and Poor's re-affirmed the Company's debt ratings, except for a downgrade of the Company's short-term debt rating from "A1" (Strong) to "A2" (Satisfactory). In addition, in March 2002, Moody's revised downward its senior debt rating from "A2" (Good) to "A3" (Good), the Company's capital securities rating from "A3" (Good) to "Baa1" (Adequate), and the short-term debt rating assigned to the Company from "P-1" (Superior) to "P-2" (Strong). Rating downgrades from current levels may adversely affect the cost and availability of any additional debt financing. 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 2002 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes", "anticipated", "expects" and similar expressions are intended to identify for- 43 ward 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, 2001. 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 has insured in either the current or 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, requirements to write certain classes of business and recent and future changes affecting the 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, broker-dealers 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, administra tive or management information systems expenditures; (ix) loss or retirement of key executives; (x) increases in costs, particulary those occurring after the time our products are priced and including construction, automobile, and medical and rehabilitation costs; (xi) changes in the Company's liquidity due to changes in asset and liability matching; (xii) restrictions on insurance underwriting; (xiii) adverse changes in the ratings obtained from independent rating agencies, such as Fitch, 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 product sales, assets and related variable product, management and brokerage fees, lapses and increased surrenders, as well as increased cost of guaranteed minimum death benefits/decreased account balances supporting our guaranteed benefits products; (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 or adverse effects on the cost and availability of reinsurance resulting from the September 11 terrorist attack; (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) losses due to foreign currency fluctuations; (xxi) defaults in debt securities held by the Company, and (xxii) higher employee benefit costs due to changes in market values of plan assets, interest rates and employee compensation levels. 44 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 at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, 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. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for derivative instruments in 2001. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts February 15, 2002 45 Management's 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 /s/ Edward J. Perry, III John F. O'Brien Edward J. Parry, III President and Chief Vice President, Executive Officer Chief Financial Officer and Principal Accounting Officer 46
Consolidated Statements of Income ===================================================================================================================== For the Years Ended December 31 2001 2000 1999 ===================================================================================================================== (In millions, except per share data) - --------------------------------------------------------------------------------------------------------------------- Revenues Premiums $ 2,254.7 $ 2,118.8 $ 2,002.6 Universal life and investment product policy fees 391.6 421.1 359.3 Net investment income 655.2 645.5 669.5 Net realized investment (losses) gains (123.9) (140.7) 90.4 Other income 134.2 138.0 116.9 - --------------------------------------------------------------------------------------------------------------------- Total revenues 3,311.8 3,182.7 3,238.7 - --------------------------------------------------------------------------------------------------------------------- Benefits, Losses and Expenses Policy benefits, claims, losses and loss adjustment expenses 2,167.2 1,981.8 1,861.6 Policy acquisition expenses 479.2 456.6 432.4 Loss from selected property and casualty exited agencies, policies, groups, and programs 68.3 -- -- Losses on derivative instruments 35.2 -- -- Voluntary pool environmental losses 33.0 -- -- Restructuring costs 2.7 20.7 (1.9) Other operating expenses 585.6 505.0 478.6 - --------------------------------------------------------------------------------------------------------------------- Total benefits, losses and expenses 3,371.2 2,964.1 2,770.7 - --------------------------------------------------------------------------------------------------------------------- (Loss) income from continuing operations before federal income taxes (59.4) 218.6 468.0 - --------------------------------------------------------------------------------------------------------------------- Federal income tax (benefit) expense: Current (12.4) 1.2 88.1 Deferred (63.1) 1.5 18.8 - --------------------------------------------------------------------------------------------------------------------- Total federal income tax (benefit) expense (75.5) 2.7 106.9 - --------------------------------------------------------------------------------------------------------------------- Income from continuing operations before minority interest 16.1 215.9 361.1 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) - --------------------------------------------------------------------------------------------------------------------- Income from continuing operations before cumulative effect of change in accounting principle 0.1 199.9 345.1 - --------------------------------------------------------------------------------------------------------------------- Loss from operations of discontinued business (less applicable income tax benefit of $10.1 for the year ended December 31, 1999) -- -- (18.8) 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) - --------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of change in accounting principle 0.1 199.9 295.8 Cumulative effect of change in accounting principle (3.2) -- -- - --------------------------------------------------------------------------------------------------------------------- Net (loss) income $ (3.1) $ 199.9 $ 295.8 ===================================================================================================================== Earnings per common share: Basic: Income from continuing operations before cumulative effect of $ -- $ 3.75 $ 6.27 change in accounting principle Loss from operations of discontinued business (less applicable income tax benefit of $0.19 for the year ended December 31, 1999) -- -- (0.34) 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) Cumulative effect of change in accounting principle (0.06) -- -- - --------------------------------------------------------------------------------------------------------------------- Net (loss) income per share $ (0.06) $ 3.75 $ 5.38 Weighted average shares outstanding 52.7 53.3 55.0 ===================================================================================================================== Diluted: Income from continuing operations before cumulative effect of $ -- $ 3.70 $ 6.21 change in accounting principle Loss from operations of discontinued business (less applicable income tax benefit $0.19 for the year ended December 31, 1999) -- -- (0.33) 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) Cumulative effect of change in accounting principle (0.06) -- -- - --------------------------------------------------------------------------------------------------------------------- Net (loss) income per share $ (0.06) $ 3.70 $ 5.33 Weighted average shares outstanding 53.1 54.0 55.5 =====================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 47
Consolidated Balance Sheets ============================================================================================================== December 31 2001 2000 ============================================================================================================== (In millions, except per share data) - -------------------------------------------------------------------------------------------------------------- Assets Investments: Fixed maturities-at fair value (amortized cost of $9,294.0 and $8,153.7) $ 9,401.7 $ 8,118.0 Equity securities-at fair value (cost of $61.2 and $60.0) 62.1 85.5 Mortgage loans 321.6 617.6 Policy loans 379.6 381.3 Other long-term investments 161.2 193.2 - -------------------------------------------------------------------------------------------------------------- Total investments 10,326.2 9,395.6 - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 350.2 281.1 Accrued investment income 152.3 155.4 Premiums, accounts and notes receivable, net 628.4 618.1 Reinsurance receivable on paid and unpaid losses, benefits and unearned premiums 1,426.8 1,423.8 Deferred policy acquisition costs 1,784.2 1,608.2 Deferred federal income taxes 168.1 103.8 Other assets 661.5 564.6 Separate account assets 14,838.4 17,437.4 - -------------------------------------------------------------------------------------------------------------- Total assets $ 30,336.1 $ 31,588.0 ============================================================================================================== Liabilities Policy liabilities and accruals: Future policy benefits $ 4,099.6 $ 3,617.4 Outstanding claims, losses and loss adjustment expenses 3,029.8 2,880.9 Unearned premiums 1,052.5 981.6 Contractholder deposit funds and other policy liabilities 1,763.9 2,193.1 - -------------------------------------------------------------------------------------------------------------- Total policy liabilities and accruals 9,945.8 9,673.0 - -------------------------------------------------------------------------------------------------------------- Expenses and taxes payable 934.1 768.6 Reinsurance premiums payable 125.3 122.3 Trust instruments supported by funding obligations 1,518.6 621.5 Short-term debt 83.3 56.6 Long-term debt 199.5 199.5 Separate account liabilities 14,838.4 17,437.4 - -------------------------------------------------------------------------------------------------------------- Total liabilities 27,645.0 28,878.9 - -------------------------------------------------------------------------------------------------------------- Minority interest: Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 300.0 - -------------------------------------------------------------------------------------------------------------- Commitments and contingencies (Notes 16 and 20) 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 1,758.4 1,765.3 Accumulated other comprehensive loss (13.7) (5.2) Retained earnings 1,052.3 1,068.7 Treasury stock at cost (7.5 and 7.7 million shares) (406.5) (420.3) - -------------------------------------------------------------------------------------------------------------- Total shareholders' equity 2,391.1 2,409.1 - -------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 30,336.1 $ 31,588.0 ==============================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 48
Consolidated Statements of Shareholders' Equity ========================================================================================================== For the Years Ended December 31 2001 2000 1999 ========================================================================================================== (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 1,765.3 1,770.5 1,768.8 Unearned compensation related to restricted stock and other (6.9) (5.2) 1.7 - ---------------------------------------------------------------------------------------------------------- Balance at end of year 1,758.4 1,765.3 1,770.5 - ---------------------------------------------------------------------------------------------------------- Accumulated Other Comprehensive Income (Loss) Net Unrealized Appreciation (Depreciation) on Investments: Balance at beginning of year (5.2) (75.3) 180.5 Appreciation (depreciation) during the period: Net appreciation (depreciation) on available-for-sale securities and derivative instruments 51.7 107.9 (393.8) (Provision) benefit for deferred federal income taxes (18.1) (37.8) 138.0 - ---------------------------------------------------------------------------------------------------------- 33.6 70.1 (255.8) - ---------------------------------------------------------------------------------------------------------- Balance at end of year 28.4 (5.2) (75.3) - ---------------------------------------------------------------------------------------------------------- Minimum Pension Liability: Balance at beginning of year -- -- -- Increase (decrease) during the period: Increase in minimum pension liability (64.8) -- -- Benefit for deferred federal income taxes 22.7 -- -- - ---------------------------------------------------------------------------------------------------------- (42.1) -- -- - ---------------------------------------------------------------------------------------------------------- Balance at end of year (42.1) -- -- - ---------------------------------------------------------------------------------------------------------- Total accumulated other comprehensive loss (13.7) (5.2) (75.3) - ---------------------------------------------------------------------------------------------------------- Retained Earnings Balance at beginning of year 1,068.7 882.2 599.9 Net (loss) income (3.1) 199.9 295.8 Dividends to shareholders (13.3) (13.4) (13.5) - ---------------------------------------------------------------------------------------------------------- Balance at end of year 1,052.3 1,068.7 882.2 - ---------------------------------------------------------------------------------------------------------- Treasury Stock Balance at beginning of year (420.3) (337.8) (91.2) Shares purchased at cost -- (105.0) (252.8) Shares reissued at cost 13.8 22.5 6.2 - ---------------------------------------------------------------------------------------------------------- Balance at end of year (406.5) (420.3) (337.8) - ---------------------------------------------------------------------------------------------------------- Total shareholders' equity $ 2,391.1 $ 2,409.1 $2,240.2 ==========================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 49
Consolidated Statements of Comprehensive Income ============================================================================================================= For the Years Ended December 31 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------- (In millions) - ------------------------------------------------------------------------------------------------------------- Net (loss) income $ (3.1) $199.9 $ 295.8 - ------------------------------------------------------------------------------------------------------------- Other comprehensive income (loss): Net unrealized appreciation (depreciation) in investments: Net appreciation (depreciation) on available for sale securities and derivative instruments 51.7 107.9 (393.8) (Provision) benefit for deferred federal income taxes (18.1) (37.8) 138.0 - ------------------------------------------------------------------------------------------------------------- 33.6 70.1 (255.8) - ------------------------------------------------------------------------------------------------------------- Minimum pension liability: Increase in minimum pension liability (64.8) -- -- Benefit for deferred federal income taxes 22.7 -- -- - ------------------------------------------------------------------------------------------------------------- (42.1) -- -- - ------------------------------------------------------------------------------------------------------------- Other comprehensive (loss) income (8.5) 70.1 (255.8) - ------------------------------------------------------------------------------------------------------------ Comprehensive (loss) income $ (11.6) $270.0 $ 40.0 =============================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 50
Consolidated Statements of Cash Flows ==================================================================================================================== For the Years Ended December 31 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------- (In millions) - -------------------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net (loss) income $ (3.1) $ 199.9 $ 295.8 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Net realized investment losses (gains) 123.9 140.7 (90.4) Losses on derivative instruments 35.2 -- -- Net amortization and depreciation 23.0 22.8 34.2 Deferred federal income taxes (63.1) 1.5 18.8 Loss on disposal of group life and health business -- -- 30.5 Change in deferred acquisition costs (183.7) (227.6) (183.8) Change in premiums and notes receivable, net of reinsurance premiums payable 20.5 26.3 (42.4) Change in accrued investment income 3.1 (6.7) 7.7 Change in policy liabilities and accruals, net 688.1 172.4 28.7 Change in reinsurance receivable (3.0) (143.1) (143.8) Change in expenses and taxes payable (76.3) (21.6) 29.6 Separate account activity, net 0.1 0.7 5.3 Other, net 32.9 4.2 32.8 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 597.6 169.5 23.0 - -------------------------------------------------------------------------------------------------------------------- Cash Flows From Investing Activities Proceeds from disposals and maturities of available-for-sale fixed maturities 3,420.1 3,024.8 2,996.5 Proceeds from disposals of equity securities 42.7 15.1 424.3 Proceeds from disposals of other investments 48.3 48.5 31.4 Proceeds from mortgages sold, matured or collected 307.1 116.2 128.2 Proceeds from collections of installment finance and notes receivable 212.1 164.9 149.8 Purchase of available-for-sale fixed maturities (4,698.4) (3,844.3) (2,527.3) Purchase of equity securities (12.9) (19.8) (78.9) Purchase of other investments (28.8) (147.2) (140.7) Disbursements to fund installment finance and notes receivables (239.9) (175.4) (157.6) Capital expenditures (32.1) (13.7) (30.1) Purchase of company owned life insurance -- (64.9) -- Other investing activities, net 2.0 0.1 (8.5) - -------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (979.8) (895.7) 787.1 - -------------------------------------------------------------------------------------------------------------------- Cash Flows From Financing Activities Deposits and interest credited to contractholder deposit funds 156.5 990.3 1,514.6 Withdrawals from contractholder deposit funds (621.0) (936.7) (2,037.5) Deposits and interest credited to trust instruments supported by funding 1,181.8 570.9 50.6 obligations Withdrawals from trust instruments supported by funding obligations (284.7) -- -- Change in short-term debt 26.7 11.6 (176.3) Dividends paid to shareholders (13.3) (13.4) (13.5) Net proceeds from issuance of common stock -- 0.6 1.1 Treasury stock purchased at cost -- (104.1) (250.2) Treasury stock reissued at cost 5.3 23.3 6.2 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 451.3 542.5 (905.0) - -------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents 69.1 (183.7) (94.9) Cash and cash equivalents, beginning of year 281.1 464.8 559.7 - -------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 350.2 $ 281.1 $ 464.8 ==================================================================================================================== Supplemental Cash Flow Information Interest payments $ 19.5 $ 21.6 $ 19.9 Income tax net (refunds) payments $ (14.1) $ (8.8) $ 77.8
The accompanying notes are an integral part of these consolidated financial statements. 51 Notes To Consolidated Financial Statements ================================================================================ 1. == 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"); Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); The Hanover Insurance Company ("Hanover"); Citizens Insurance Company of America ("Citizens"), and other insurance and non-insurance subsidiaries. All significant intercompany accounts and transactions have been eliminated. 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 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. 52 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, 2001, there was one real estate property in the Company's investment portfolio which was acquired upon the foreclosure of a mortgage loan. The asset is being carried at the estimated fair value less cost of disposal. Depreciation is not recorded on this asset while it is held for disposal. As of December 31, 2000, there were no real estate properties in the Company's investment portfolio. 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 reserves 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 are also 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. E. Derivatives and Hedging Activities All derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair value of a recognized asset or liability ("fair value" hedge); (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); (3) a foreign-currency fair value or cash flow hedge ("foreign currency" hedge); or (4) "held for trading". Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). Changes in the fair value of derivatives that are highly effective and that are designated and qualify as foreign currency hedges are recorded in either current period earnings or other comprehensive income, depending on whether the hedge transaction is a fair value hedge or a cash flow hedge. Lastly, changes in the fair value of derivative trading instruments are reported in current period earnings. The Company may hold financial instruments that contain "embedded" derivative instruments. The Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument, or host contract, and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a fair-value, cash-flow, or foreign currency hedge, or as a trading derivative instrument. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value, cash flow, or foreign currency hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below. The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item, including forecasted transactions; (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is no longer designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the balance sheet at its fair value, and the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situa- 53 tions in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings. F. 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. G. 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. H. 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. I. Separate Accounts Separate account assets and liabilities represent segregated funds administered and invested by the Company for the benefit of variable annuity and variable life insurance contractholders and certain pension funds. 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. J. 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% to 9 1/2% for annuities. 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. 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. 54 Trust instruments supported by funding obligations consist of deposits received from customers, investment earnings on their fund balance, and the effect of changes in foreign currencies related to these deposits. 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. K. Mandatorily Redeemable Preferred Securities of a Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company reflects the 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. L. 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. M. 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 policy acquisition expenses, loss and LAE reserves, policy reserves, tax credit carryforwards, net operating loss carryforwards, employee benefit plans and unrealized appreciation or depreciation on investments. N. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"), which requires that goodwill and intangible assets that have indefinite useful lives no longer be amortized over their useful lives, but instead be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. In addition, the statement provides specific guidance for testing the impairment of intangible assets. Additional financial statement disclosures about goodwill and other intangible assets, including changes in the carrying amount of goodwill, carrying amounts by classification of amortized and non-amortized assets, and estimated amortization expenses for the next five years, are also required. This statement is effective for fiscal years beginning after December 15, 2001 for all goodwill and other intangible assets held at the date of adoption. Certain provisions of this statement are also applicable for goodwill and other intangible assets acquired after June 30, 2001, but prior to adoption of this statement. At December 31, 2001 and 2000, the Company's assets reflected goodwill of $139.2 million and $142.3 million, respectively. Amortization expense related to the Company's goodwill was $6.1 million, $5.9 million and $5.5 million during 2001, 2000 and 1999, respectively. Effective January 1, 2002, the Company ceased its amortization of goodwill in accordance with Statement No. 142. Included in goodwill at December 31, 2001 was approximately $123.4 million related to the Company's property and casualty business, for which the Company has reviewed in accordance with Statement No. 142 and determined that it is fully recoverable. The remaining goodwill relates to small, non-insurance subsidiaries. The Company is currently completing its assessment of the impact related to these subsidiaries. 55 In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("Statement No. 141"), which requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. It further specifies the criteria that intangible assets must meet in order to be recognized and reported apart from goodwill. The implementation of Statement No. 141 is not expected to have a material effect on the Company's financial statements. In December 2000, the American Institute of Certified Public Accountants 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 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 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. 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. 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 was effective for fiscal years beginning after June 15, 2000. The Company adopted Statement No. 133 on January 1, 2001. In accordance with the transition provisions of the statement, the Company recorded a $3.2 million charge, net of taxes, in earnings to recognize all derivative instruments at their fair values. This adjustment represents net losses that were previously deferred in other comprehensive income on derivative instruments that do not qualify for hedge accounting. The Company recorded an offsetting gain in other comprehensive income of $3.3 million, net of taxes, to recognize these derivative instruments. O. Earnings Per Share Earnings per share ("EPS") for the years ended December 31, 2001, 2000, and 1999 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. P. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. 56 2. == 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 the EBS business of approximately $16.4 million. Subsequent to a measurement date of June 30, 1999, approximately $11.5 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. As a result of this transaction, the Company has received consideration of approximately $27 million, based on renewal rights for existing policies. The Company retained policy liabilities estimated at $84.6 million at December 31, 2001 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, 2001 and 2000, the discontinued segment had assets of approximately $397.6 million and $497.9 million, respectively, consisting primarily of invested assets and reinsurance recoverables, and liabilities of approximately $369.3 million and $460.0 million, respectively, consisting primarily of policy liabilities. Revenues for the discontinued operations were $34.4 million, $207.7 million and $367.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. 3. == Significant Transactions - -------------------------------------------------------------------------------- As of December 31, 2001, the Company has repurchased approximately $436.3 million, or approximately 8 million shares, of its common stock under programs authorized by the Board of Directors (the "Board"). As of December 31, 2001, the Board had authorized total stock repurchases of $500.0 million, leaving approximately $63.7 million available to the Company for future repurchases. There were no share repurchases in 2001. The Company repurchased approximately 1.9 million and 4.5 million shares at a cost of approximately $103.4 million and $250.2 million in 2000 and 1999, respectively. During the fourth quarter of 2001, the Company completed an extensive review of its agency relationships which resulted in the termination of 377 agencies and the withdrawal of commercial lines' underwriting authority in an additional 314 agencies. These actions affected approximately 27% of the approximately 2,500 active agencies representing the Company in 2001. These agencies have consistently produced unsatisfactory loss ratios. In addition, the Company terminated virtually all of its specialty commercial programs and discontinued a number of special marketing arrangements. The Company is contractually or under statutory regulations obligated to renew policies with certain agents that will be in runoff in 2002 and 2003. The estimated future premium deficiency on these policies is $7.2 million and this loss was recorded during 2001. In connection with these actions, the Company performed an actuarial review of outstanding reserves with segregated loss history on the exited business. Based on this review, an increase to reserves of $52.9 million was recorded in the fourth quarter of 2001. This increase includes $12.1 million of adverse development in the current year and $40.8 million of adverse development on prior years' reserves, which is net of a $5.9 million benefit from the aggregate excess of loss reinsurance treaty. Under the aggregate excess of loss reinsurance treaty the Company recognized a net benefit of $1.1 million, including the aforementioned $5.9 million benefit related to prior year reserves. In addition, as a result of projected future losses on the exited business, the Company recorded an impairment to the deferred acquisition costs asset ("DAC") of $3.4 million. This resulted in an increase in policy acquisition expenses and a decrease in the Company's DAC asset balance as of December 31, 2001. The total charge of $68.3 million has been presented as a separate line item in the Consolidated Statements of Income. Actual future losses from the exited business may vary from the Company's estimate. 57 In the fourth quarter of 2001, the Company recognized a pre-tax charge of $2.7 million related to severance and other employee related costs resulting from the reorganization of its technology support group. Approximately 82 position have been eliminated as a result of this restructuring plan, of which 81 employees have been terminated as of December 31, 2001. The Company made $0.5 million of payments in 2001 related to this restructuring plan. During 2000, the Company adopted a formal company-wide restructuring plan. This plan was the result of a corporate initiative that began in the fall of 1999, intended to reduce expenses and enhance revenues. This plan consisted 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. 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 240 employees have been terminated as of December 31, 2001 and 120 vacant positions have been eliminated. 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 one-time project costs, lease cancellations and the present value of idle leased space. As of December 31, 2001, the Company has made payments of approximately $21.2 million related to this restructuring plan, of which approximately $5.6 million relates to severance and other employee related costs. This plan has been substantially implemented. 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 $0.2 million, $9.8 million and $15.9 million for the years ended December 31, 2001, 2000, and 1999, respectively, based on estimates of losses and allocated loss adjustment expenses for accident year 1999. 4. == Investments - -------------------------------------------------------------------------------- A. Fixed Maturities and Equity Securities The Company accounts for its investments in fixed maturities and equity securities, 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 2001 ============================================================================================== (In millions) - ---------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost (1) Gains Losses Value - ---------------------------------------------------------------------------------------------- U.S. Treasury securities and U.S. government and agency securities $ 174.3 $ 5.2 $ 1.8 $ 177.7 States and political subdivisions 1,830.5 43.1 43.8 1,829.8 Foreign governments 34.3 2.5 0.3 36.5 Corporate fixed maturities 6,251.2 202.5 127.9 6,325.8 Mortgage-backed securities 1,003.7 32.5 4.3 1,031.9 - ---------------------------------------------------------------------------------------------- Total fixed maturities $ 9,294.0 $ 285.8 $ 178.1 $ 9,401.7 ============================================================================================== Equity securities $ 61.2 $ 10.0 $ 9.1 $ 62.1 ==============================================================================================
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 53.4 2.5 0.8 55.1 Corporate fixed maturities 5,415.6 125.6 234.0 5,307.2 Mortgage-backed securities 634.4 19.8 2.9 651.3 - ---------------------------------------------------------------------------------------------- Total fixed maturities $ 8,153.7 $ 239.7 $ 275.4 $ 8,118.0 ============================================================================================== Equity securities $ 60.0 $ 32.7 $ 7.2 $ 85.5 ==============================================================================================
(1) Amortized cost for fixed maturities and cost for equity securities. 58 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 equal 102% of all outstanding liabilities of AFLIAC for New York policyholders, claimants and creditors. At December 31, 2001, the amortized cost and market value of these assets on deposit in New York were $180.0 million and $182.9 million, respectively. At December 31, 2000, the amortized cost and market value of these assets on deposit were $186.7 million and $189.8 million, respectively. In addition, fixed maturities, excluding those securities on deposit in New York, with an amortized cost of $140.5 million and $116.1 million were on deposit with various state and governmental authorities at December 31, 2001 and 2000, respectively. Contractual fixed maturity investment commitments were not material at December 31, 2001. 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 2001 ===================================================================================== (In millions) - ------------------------------------------------------------------------------------- Amortized Fair Cost Value - ------------------------------------------------------------------------------------- Due in one year or less $ 654.5 $ 664.1 Due after one year through five years 3,512.9 3,590.8 Due after five years through ten years 2,355.4 2,355.9 Due after ten years 2,771.2 2,790.9 - ------------------------------------------------------------------------------------- Total $ 9,294.0 $ 9,401.7 =====================================================================================
B. Mortgage Loans and Real Estate AFC's mortgage loans 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. The carrying values of mortgage loans net of applicable reserves were $321.6 million and $617.6 million at December 31, 2001 and 2000, respectively. Reserves for mortgage loans were $3.8 million and $4.4 million at December 31, 2001 and 2000, respectively. During 2001, the Company received proceeds of $194.3 million as a result of the sale of $182.2 million of its mortgage loan portfolio. At December 31, 2001 there was one real estate property in the Company's investment portfolio. The Company did not hold any real estate investments in 2000. This real estate, at December 31, 2001, which had a carrying value of $1.9 million was acquired through the foreclosure of a mortgage loan and rep- resents the one non-cash investing activity in 2001. There were no non-cash investing activities, including real estate acquired through foreclosure of mortgage loans, in 2000 and 1999. There were no contractual commitments to extend credit under commercial mortgage loan agreements at December 31, 2001. Mortgage loan investments comprised the following property types and geographic regions:
December 31 2001 2000 ======================================================== (In millions) - -------------------------------------------------------- Property type: Office building $ 177.0 $ 318.9 Industrial / warehouse 68.3 130.5 Retail 67.9 106.8 Residential 11.5 54.8 Other 0.7 11.0 Valuation allowances (3.8) (4.4) - -------------------------------------------------------- Total $ 321.6 $ 617.6 ======================================================== Geographic region: South Atlantic $ 91.8 $ 159.7 Pacific 78.2 217.6 New England 50.5 70.4 East North Central 40.0 63.4 West South Central 33.3 47.7 Middle Atlantic 16.8 35.8 Other 14.8 27.4 Valuation allowances (3.8) (4.4) - -------------------------------------------------------- Total $ 321.6 $ 617.6 ========================================================
At December 31, 2001, scheduled mortgage loan maturities were as follows: 2002 - $33.0 million; 2003 - $29.0 million; 2004 - $69.7 million; 2005 - $26.0 million; 2006 - $30.2 million and $133.7 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 2001, the Company did not refinance any mortgage loans based on terms which differed from those granted to new borrowers. Mortgage loans investment valuation allowances of $3.8 million and $4.4 million at December 31, 2001 and 2000, respectively, have been deducted in arriving at investment carrying values as presented in the Consolidated Balance Sheets. There were no impaired loans or related reserves as of December 31, 2001. The carrying value of impaired loans was $3.4 million, with related reserves of $0.4 million as of December 31, 2000. All impaired loans were reserved for as of December 31, 2000. The average carrying value of impaired loans was $2.2 million, $12.1 million and $21.0 million, as of December 31, 2001, 2000 and 1999, respectively. Related interest income while such loans were impaired were $1.4 million and $2.1 million in 2000 and 1999, respectively. There was no interest income received in 2001 related to impaired loans. 59 C. Derivative Instruments The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate or foreign currency volatility. 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, and sectors. The Company uses derivative financial instruments, primarily interest rate swaps and futures contracts, with indices that correlate to balance sheet instruments to modify its indicated net interest sensitivity to levels deemed to be appropriate. Specifically, for floating rate funding agreements that are matched with fixed rate securities, the Company manages the risk of cash flow variability by hedging with interest rate swap contracts designed to pay fixed and receive floating interest. Under interest rate 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. Additionally, the Company uses exchange traded financial futures contracts to hedge against interest rate risk on anticipated sales of guaranteed investment contracts ("GIC") 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 fixed maturity reinvestments 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 risk of default. As a result of the Company's issuance of trust instruments supported by funding obligations denominated in foreign currencies, as well as the Company's investment in securities 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 enters into foreign exchange swap contracts to hedge its net foreign currency exposure. Additionally, the Company enters into compound currency/interest rate swap contracts to hedge foreign currency and interest rate exposure on specific trust instruments supported by funding obligations. Under these swap contracts, the Company agrees to exchange interest and principal related to foreign fixed income securities 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. By using derivative instruments, the Company is exposed to credit risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain (including any accrued receivable) in a derivative. 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. Depending on the nature of the derivative transaction, the Company maintains bilateral Collateral Standardized Arrangements ("CSA") with each counterparty. In general, the CSA sets a minimum threshold of $10 million of exposure that must be collateralized, although thresholds may vary by CSA. At December 31, 2001, collateral of $69.7 million in the form of cash, bonds and US Treasury notes were held by our counterparties related to these agreements. The Company's derivative activities are monitored by management, who review portfolio activities and risk levels. Management also oversees all derivative transactions to ensure that the types of transactions entered into and the results obtained from those transactions are consistent with the Company's risk management strategy and with Company policies and procedures. D. Fair Value Hedges The Company enters into compound foreign currency/interest rate swaps to convert its foreign denominated fixed rate trust instruments supported by funding obligations to U.S. dollar floating rate instruments. For the year ended December 31, 2001, the Company recognized a net gain of $0.3 million, reported in losses on derivative instruments in the Consolidated Statements of Income, which represented the ineffective portion of all fair value hedges. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. 60 E. Cash Flow Hedges The Company enters into various types of 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 risk of cash flow variability 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. The Company also purchases long futures contracts and sells short futures contracts on margin to hedge against interest rate fluctuations associated with the sale of 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 uses U.S. Treasury Note futures to hedge this risk. The Company also enters into foreign currency swap contracts to hedge foreign currency exposure on specific fixed income securities, as well as compound foreign currency/interest rate swap contracts to hedge foreign currency and interest rate exposure on specific trust instruments supported by funding obligations. 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. For the year ended December 31, 2001, the Company recognized a net loss of $35.5 million, reported as losses on derivative instruments in the Consolidated Statements of Income, which represented the total ineffectiveness of all cash flow hedges. This net loss included a total loss of $35.8 million related to ineffective hedges of floating rate funding agreements with put features allowing the policyholder to cancel the contract prior to maturity. During the fourth quarter of 2001, the Company reviewed the trend in put activity since inception of the funding agreement business in order to determine the ongoing effectiveness of the hedging relationship. Based upon the historical trend in put activity, as well as management's uncertainty about possible future events, the Company has determined that it is probable that some of the future variable cash flows of the funding agreements will not occur, and therefore the hedges were ineffective. The Company analyzed the future payments under each outstanding funding agreement, and determined the amount of payments that are probable of occurring versus those that are probable of not occurring. The total accumulated market value losses deferred in other comprehensive income related to the payments that are probable of not occurring, which totals $35.8 million, was reclassified to earnings during the fourth quarter of 2001. This loss includes $13.7 million of losses related to funding agreements that have already been put back to the Company, as well as $22.1 million of losses related to funding agreements that have not been put, but which management believes are probable of being put in the future. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. As of December 31, 2001, $79.5 million of the deferred net losses on derivative instruments accumulated in other comprehensive income could be recognized in earnings during the next twelve months depending on the forward interest rate and currency rate environment. Transactions and events that (1) are expected to occur over the next twelve months and (2) will necessitate reclassifying to earnings these derivatives gains (losses) include (a) the re-pricing of variable rate trust instruments supported by funding obligations, (b) the interest payments (receipts) on foreign denominated trust instruments supported by funding obligations and foreign securities, (c) the anticipated sale of GICs and other funding agreements, (d) the possible put or non-renewal of GICs and other funding agreements, and (e) the anticipated reinvestment of fixed maturities. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments on funding agreements) is 12 months. F. Trading Activities The Company enters into insurance portfolio-linked, credit default, and other swap contracts for investment purposes. These products are not linked to specific assets and liabilities on the balance sheet or to a forecasted transaction, and therefore do not qualify for hedge accounting. 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. 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. Under the other swap contract entered into for investment purposes, the Company agrees to exchange the difference between fixed and floating interest amounts calculated on an agreed upon notional principal amount. As of December 31, 2001, the Company no longer held insurance portfolio-linked or credit default swap contracts. Net realized investment losses related to insurance portfolio-linked contracts was $4.3 million, $0.7 million and $0.2 million for the years ended December 31, 2001, 2000 and 1999, respectively. The fair values of insurance portfolio-linked swap contracts outstanding were immaterial at December 31, 2000. The stated annual premium under credit default swap contracts is recognized currently in net investment income. There 61 was no net increase to investment income related to credit default swap contracts for the year ended December 31, 2001; however, there was a net increase of $0.2 million and $0.4 million for the years ended December 31, 2000 and 1999, respectively. The fair value of the other swap contract held for investment purposes was $(2.1) million and $(1.2) million at December 31, 2001 and 2000, respectively. The net decrease in net investment income related to this contract was $0.7 million and $0.1 million for the years ended December 31, 2001 and 2000, respectively. There was no net investment income related to this contract in 1999. G. Unrealized Gains and Losses Unrealized gains and losses on available-for-sale securities, other securities, and derivative instruments are summarized as follows:
For the Years Ended December 31 ==================================================================================================== (In millions) - ---------------------------------------------------------------------------------------------------- Equity Fixed Securities 2001 Maturities(1) And Other(2) Total - ---------------------------------------------------------------------------------------------------- Net (depreciation) appreciation, beginning of year $ (26.5) $ 21.3 $ (5.2) - ---------------------------------------------------------------------------------------------------- Net appreciation (depreciation) on available-for-sale securities and derivative instruments 96.9 (25.5) 71.4 Net depreciation from the effect on deferred policy acquisition costs and on policy liabilities (19.7) -- (19.7) (Provision) benefit for deferred federal income taxes (27.0) 8.9 (18.1) - ---------------------------------------------------------------------------------------------------- 50.2 (16.6) 33.6 - ---------------------------------------------------------------------------------------------------- Net appreciation, end of year $ 23.7 $ 4.7 $ 28.4 ==================================================================================================== 2000 - ---------------------------------------------------------------------------------------------------- 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) ====================================================================================================
(1) Includes net appreciation on derivative instruments of $1.4 million in 2001. Balances at December 31, 2001 and 2000 include net depreciation from derivative instruments of $45.1 million and $46.5 million, respectively. (2) Includes net appreciation (depreciation) on other investments of $0.5 million, $1.8 million, and $(5.1) million in 2001, 2000 and 1999, respectively. H. Other At December 31, 2001 and 2000, AFC had no concentration of investments in a single investee exceeding 10% of shareholders' equity. 5. == 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 2001 2000 1999 ================================================================================= (In millions) - --------------------------------------------------------------------------------- Fixed maturities $ 614.0 $ 564.6 $ 561.9 Mortgage loans 42.7 52.1 56.1 Equity securities 2.3 2.0 2.4 Policy loans 27.1 26.1 24.5 Derivative instruments (48.0) (5.6) (6.7) Other long-term investments 16.5 7.2 13.4 Short-term investments 17.3 14.5 33.6 - --------------------------------------------------------------------------------- Gross investment income 671.9 660.9 685.2 Less investment expenses (16.7) (15.4) (15.7) - --------------------------------------------------------------------------------- Net investment income $ 655.2 $ 645.5 $ 669.5 =================================================================================
62 The Company had fixed maturities with a carrying value of $9.8 million and $7.5 million on non-accrual status at December 31, 2001 and 2000, respectively. There were no mortgage loans on non-accrual status at December 31, 2001 and 2000. 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 $11.3 million in 2001, and $3.6 million in 2000, and $2.0 million in 1999. The payment terms of mortgage loans may from time to time be restructured or modified. There were no restructured mortgage loans remaining at December 31, 2001. The investment in restructured mortgage loans, based on amortized cost, amounted to $3.8 million at December 31, 2000. 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 and $2.5 million in 2000 and 1999, respectively. Actual interest income on these loans included in net investment income aggregated $1.4 million and $1.8 million in 2000 and 1999, respectively. There were no mortgage loans which were non-income producing at December 31, 2001 and 2000. There were, however, fixed maturities with a carrying value of $2.9 million and $3.8 million at December 31, 2001 and 2000, respectively, which were non-income producing during 2001 and 2000. Included in other long-term investments is income from limited partnerships of $9.4 million, $7.8 million, and $7.2 million in 2001, 2000, and 1999, respectively. B. Net Realized Investment Gains and Losses Realized (losses) gains on investments were as follows:
For the Years Ended December 31 2001 2000 1999 =================================================================================================== (In millions) - --------------------------------------------------------------------------------------------------- Fixed maturities $ (121.1) $ (151.7) $ (63.2) Mortgage loans 10.7 1.3 2.5 Equity securities 28.4 3.8 141.8 Derivative instruments (32.9) 3.1 (0.2) Other long-term investments (9.0) 2.8 9.5 - --------------------------------------------------------------------------------------------------- Net realized investment (losses) gains $ (123.9) $ (140.7) $ 90.4 ===================================================================================================
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 2001 Voluntary Sales Gains Losses - ---------------------------------------------------------------------- Fixed maturities $ 2,165.7 $ 114.3 $ 57.5 Equity securities $ 40.1 $ 30.0 $ -- ====================================================================== 2000 - ---------------------------------------------------------------------- Fixed maturities $ 1,997.0 $ 11.0 $ 99.5 Equity securities $ 13.1 $ 4.0 $ 0.2 ====================================================================== 1999 - ---------------------------------------------------------------------- Fixed maturities $ 1,950.6 $ 21.5 $ 39.3 Equity securities $ 420.1 $149.4 $ 7.6 ======================================================================
The Company recognized losses of $185.3 million, $66.1 million and $46.6 million in 2001, 2000 and 1999, respectively, related to other-than-temporary impairments of fixed maturities and other securities. C. Other Comprehensive Income (Loss) 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 2001 2000 1999 ====================================================================================================== (In millions) - ------------------------------------------------------------------------------------------------------ Unrealized (depreciation) appreciation on available-for sale securities: Unrealized holding losses arising during period, (net of tax benefit of $18.3 million, $12.9 million and $108.0 million in 2001, 2000 and 1999, respectively) $ (34.0) $ (24.1) $ (200.0) Less: reclassification adjustment for (losses) gains included in net income (net of taxes (benefit) of $35.9 million, $(50.7) million and $30.0 million in 2001, 2000 and 1999, respectively) (66.7) (94.2) 55.8 - ------------------------------------------------------------------------------------------------------ Total available-for-sale securities 32.7 70.1 (255.8) - ------------------------------------------------------------------------------------------------------ Unrealized depreciation on derivative instruments: Unrealized holding losses arising during period, (net of tax benefit of $63.4 million in 2001) (117.7) -- -- Less: reclassification adjustment for losses included in net income (net of tax benefit of $63.9 million in 2001) (118.6) -- -- - ------------------------------------------------------------------------------------------------------ Total derivative instruments 0.9 -- -- - ------------------------------------------------------------------------------------------------------ Net unrealized appreciation (depreciation) on investments $ 33.6 $ 70.1 $ (255.8) ======================================================================================================
63 6. == 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. Prior to the implementation of Statement No. 133 on January 1, 2001, the Company included swap contracts used to hedge fixed maturities in the fair value of fixed maturities. The fair value of fixed maturities below included swap contracts with a fair value of $(47.7) million at December 31, 2000. At December 31, 2001, these swap contracts are reflected in other assets and expenses and taxes payable in the Consolidated Balance Sheets at fair value. 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. 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. Derivative Instruments Fair values are estimated using independent pricing sources. 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. 64 The estimated fair values of the financial instruments were as follows:
December 31 2001 2000 ========================================================================================================= (in millions) - --------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Value Value Value Value - --------------------------------------------------------------------------------------------------------- Financial Assets Cash and cash equivalents $ 350.2 $ 350.2 $ 281.1 $ 281.1 Fixed maturities 9,401.7 9,401.7 8,118.0 8,118.0 Equity securities 62.1 62.1 85.5 85.5 Mortgage loans 321.6 335.1 617.6 640.4 Policy loans 379.6 379.6 381.3 381.3 Derivative instruments 73.3 73.3 88.7 88.7 Company owned life insurance 67.3 67.3 65.6 65.6 - --------------------------------------------------------------------------------------------------------- $10,655.8 $10,669.3 $9,637.8 $9,660.6 ========================================================================================================= Financial Liabilities Guaranteed investment contracts $ 1,171.1 $ 1,174.1 $1,636.5 $1,663.3 Derivative instruments 180.3 180.3 11.8 11.8 Supplemental contracts without life contingencies 57.3 57.3 40.7 40.7 Dividend accumulations 88.8 88.8 88.5 88.5 Other individual contract deposit funds 50.4 50.4 45.0 44.9 Other group contract deposit funds 213.4 212.4 323.1 319.0 Individual fixed annuity contracts 1,686.2 1,621.3 1,026.1 991.7 Trust instruments supported by funding obligations 1,518.6 1,534.0 621.5 620.5 Short-term debt 83.3 83.3 56.6 56.6 Long-term debt 199.5 204.4 199.5 194.7 Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 286.0 300.0 280.2 - --------------------------------------------------------------------------------------------------------- $ 5,548.9 $ 5,492.3 $4,349.3 $4,311.9 =========================================================================================================
65 7. == Closed Block - -------------------------------------------------------------------------------- Summarized financial information of the Closed Block as of December 31, 2001 and 2000 and for the periods ended December 31, 2001, 2000 and 1999 is as follows:
December 31 2001 2000 ================================================================================ (In millions) - -------------------------------------------------------------------------------- Assets Fixed maturities, at fair value (amortized cost of $498.1 and $400.3, respectively) $ 504.2 $ 397.5 Mortgage loans 55.7 144.9 Policy loans 182.1 191.7 Cash and cash equivalents 9.2 1.9 Accrued investment income 14.6 14.6 Deferred policy acquisition costs 10.4 11.0 Other assets 6.2 6.4 - -------------------------------------------------------------------------------- Total assets $ 782.4 $ 768.0 ================================================================================ Liabilities Policy liabilities and accruals $ 798.2 $ 808.9 Policyholder dividends 30.7 20.0 Other liabilities 7.0 0.8 - -------------------------------------------------------------------------------- Total liabilities $ 835.9 $ 829.7 ================================================================================ Excess of Closed Block liabilities over assets designated to the Closed Block $ 53.5 $ 61.7 Amounts included in accumulated other comprehensive income: Net unrealized investment losses, net of deferred federal income tax benefit of $8.8 million and $1.3 million, respectively (16.4) (2.5) - -------------------------------------------------------------------------------- Maximum future earnings to be recognized from Closed Block assets and liabilities $ 37.1 $ 59.2 ================================================================================
For the Years Ended December 31 2001 2000 1999 ===================================================================================== (In millions) - ------------------------------------------------------------------------------------- Revenues Premiums and other income $ 47.2 $ 49.9 $ 52.1 Net investment income 54.1 53.6 53.8 Realized investment losses (2.2) (5.4) (0.6) - ------------------------------------------------------------------------------------- Total revenues 99.1 98.1 105.3 - ------------------------------------------------------------------------------------- Benefits and expenses Policy benefits 83.1 89.5 88.9 Policy acquisition expenses 0.6 2.1 2.5 Other operating expenses -- 0.2 0.1 - ------------------------------------------------------------------------------------- Total benefits and expenses 83.7 91.8 91.5 - ------------------------------------------------------------------------------------- Contribution from the Closed Block $ 15.4 $ 6.3 $ 13.8 ===================================================================================== Cash flows Cash flows from operating activities: Contribution from the Closed Block $ 15.4 $ 6.3 $ 13.8 Change in: Deferred policy acquisition costs 0.6 2.1 2.5 Policy liabilities and accruals (12.3) (12.0) (13.1) Other assets 2.1 5.3 (8.2) Expenses and taxes payable (0.2) (10.1) (2.9) Other, net 2.5 5.3 0.8 - ------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 8.1 (3.1) (7.1) - ------------------------------------------------------------------------------------- Cash flows from investing activities: Sales, maturities and repayments of investments 136.8 133.3 139.0 Purchases of investments (147.2) (160.3) (128.5) Other, net 9.6 9.4 9.8 - ------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (0.8) (17.6) 20.3 - ------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 7.3 (20.7) 13.2 Cash and cash equivalents, beginning of year 1.9 22.6 9.4 - ------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 9.2 $ 1.9 $ 22.6 =====================================================================================
There were no reserves on mortgage loans at December 31, 2001 and 2000. 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 8. == Debt - -------------------------------------------------------------------------------- Short and long-term debt consisted of the following:
December 31 2001 2000 ================================================================================ (In millions) - -------------------------------------------------------------------------------- Short-term Commercial paper $ 83.3 $ 56.6 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, 2001, the weighted average interest rate for outstanding commercial paper was approximately 2.82%. At December 31, 2001, the Company had $215.0 million available for borrowing under a committed syndicated credit agreement which expires on May 24, 2002. 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 $19.5 million, $21.4 million and $22.0 million in 2001, 2000 and 1999, 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 and $1.0 million in 2000 and 1999, respectively. In 2001, there was no interest expense related to credit agreements. All interest expense is recorded in other operating expenses. 9. == 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 (benefit) expense in the Consolidated Statements of Income is shown below:
For the Years Ended December 31 2001 2000 1999 ======================================================================================= (In millions) - --------------------------------------------------------------------------------------- Federal income tax (benefit) expense Current $ (12.4) $ 1.2 $ 88.1 Deferred (63.1) 1.5 18.8 - --------------------------------------------------------------------------------------- Total $ (75.5) $ 2.7 $ 106.9 =======================================================================================
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 2001 2000 1999 ======================================================================================== (In millions) - ---------------------------------------------------------------------------------------- Expected federal income tax expense $ (20.8) $ 76.5 $ 163.8 Tax-exempt interest (30.3) (33.2) (37.4) Dividend received deduction (12.6) (10.8) (3.8) Changes in tax reserve estimates for prior years' dividend received deduction -- (13.3) -- Changes in other tax reserve estimates (1.4) (7.5) (8.7) Tax credits (10.8) (10.3) (8.5) Other, net 0.4 1.3 1.5 - ---------------------------------------------------------------------------------------- Federal income tax expense $ (75.5) $ 2.7 $ 106.9 ========================================================================================
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 2001 2000 ============================================================================= (In millions) - ----------------------------------------------------------------------------- Deferred tax (assets) liabilities Tax credit carryforwards $ (105.3) $ (66.5) Insurance reserves (381.6) (428.3) Deferred acquisition costs 518.7 480.1 Employee benefit plans (72.7) (51.8) Investments, net (38.0) (19.2) Discontinued operations (14.2) (11.9) Bad debt reserve (3.0) (2.5) Litigation reserves (3.3) (8.0) Software capitalization 23.7 22.4 Loss carryforwards (94.4) (2.5) Other, net 2.0 (15.6) - ----------------------------------------------------------------------------- Deferred tax asset, net $ (168.1) $(103.8) =============================================================================
Gross deferred income tax assets totaled approximately $1.9 billion and $1.3 billion at December 31, 2001 and 2000, respectively. Gross deferred income tax liabilities totaled approximately $1.7 billion and $1.2 billion at December 31, 2001 and 2000, 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, 2001, there are available alternative minimum tax credit carryforwards and low income housing credit carryforwards of $63.2 million and $38.5 million, respectively. The alternative minimum tax credit carryforwards 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 Property and Casualty Companies, Inc. ("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. 10. == Pension Plans - -------------------------------------------------------------------------------- AFC provides retirement benefits to substantially all of its employees under defined benefit pension plans. These plans are 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 2001 allocation was based on 5.0%, and the 2000 and 1999 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 2001 2000 1999 ===================================================================================== (In millions) - ------------------------------------------------------------------------------------- Service cost - benefits earned during the year $ 14.7 $ 18.5 $ 19.3 Interest cost 30.9 28.6 26.5 Expected return on plan assets (39.6) (43.1) (38.9) Recognized net actuarial gain (0.4) (11.2) (0.4) Amortization of transition asset (2.2) (2.2) (2.3) Amortization of prior service cost (3.1) (3.1) (3.3) - ------------------------------------------------------------------------------------- Net periodic pension cost (benefit) $ 0.3 $(12.5) $ 0.9 =====================================================================================
The following table summarizes the status of the plans. At December 31, 2001 and 2000, the projected benefit obligations exceeded the plans' assets. During the fourth quarter of 2001, the Company recorded a $64.8 million increase in its minimum pension liability related to its qualified pension plan. This is reflected as a adjustment to accumulated other comprehensive income in accordance with Financial Accounting Standards No. 130, "Reporting Comprehensive Income" and primarily reflects the difference between the present value of accumulated benefit obligations and the market value of assets funding the plan. This liability resulted primarily from a decrease in the market value of assets held by the plan due to a general decline in the equity markets. 68
December 31 2001 2000 ================================================================================ (In millions) - -------------------------------------------------------------------------------- Change in benefit obligations: Projected benefit obligation at beginning of year $ 450.9 $ 392.7 Service cost - benefits earned during the year 14.7 18.5 Interest cost 30.9 28.6 Actuarial losses (gains) 12.4 37.7 Benefits paid (25.7) (26.6) - -------------------------------------------------------------------------------- Projected benefit obligation at end of year 483.2 450.9 - -------------------------------------------------------------------------------- Change in plan assets: Fair value of plan assets at beginning of year 441.5 470.6 Actual return on plan assets (51.5) (2.5) Benefits paid (25.7) (26.6) - -------------------------------------------------------------------------------- Fair value of plan assets at end of year 364.3 441.5 - -------------------------------------------------------------------------------- Funded status of the plan (118.9) (9.4) Unrecognized transition obligation (17.2) (19.4) Unamortized prior service cost (1.7) (8.9) Unrecognized net actuarial gains 27.6 (6.4) - -------------------------------------------------------------------------------- Net pension liability $(110.2) $ (44.1) ================================================================================
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 $6.1 million and $7.5 million in 2001 and 2000, respectively, which reflects fair value, net of applicable amortization. Determination of the projected benefit obligations was based on weighted average discount rates of 6.88% and 7.25% in 2001 and 2000, respectively, and the assumed long-term rate of return on plan assets was 9.5% in 2001 and 2000. The actuarial present value of the projected benefit obligations was determined using assumed rates of increase in future compensation levels of 4.0% in 2001 and levels ranging from 5.0% to 5.5% in 2000. 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, 2001 and 2000 with a market value of $35.5 million and $57.7 million at December 31, 2001 and 2000, 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 2001, 2000 and 1999, the Company matched 50% of employees' contributions up to 6.0% of eligible compensation. The total expense related to this plan was $5.7 million, $6.1 million and $5.9 million in 2001, 2000 and 1999, respectively. In addition to this plan, the Company has a defined contribution plan for substantially all of its agents. The Plan expense in 2001, 2000 and 1999 was $3.3 million, $3.2 million and $3.1 million, respectively. 11. == 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 2001 2000 =============================================================================== (In millions) - ------------------------------------------------------------------------------- Change in benefit obligations: Accumulated postretirement benefit obligation at beginning of year $ 75.5 $ 66.8 Service cost 2.3 1.9 Interest cost 4.9 4.9 Actuarial (gains) losses (1.2) 5.6 Benefits paid (4.3) (3.7) - ------------------------------------------------------------------------------- Accumulated postretirement benefit obligation at end of year 77.2 75.5 - ------------------------------------------------------------------------------- Fair value of plan assets at end of year -- -- - ------------------------------------------------------------------------------- Funded status of the plan (77.2) (75.5) Unamortized prior service cost (5.4) (7.6) Unrecognized net actuarial gains (8.4) (7.7) - ------------------------------------------------------------------------------- Accumulated postretirement benefit costs $(91.0) $ (90.8) ===============================================================================
The components of net periodic postretirement benefit cost were as follows:
For the Years Ended December 31 2001 2000 1999 ============================================================================== (In millions) - ------------------------------------------------------------------------------ Service cost $ 2.3 $ 1.9 $ 2.9 Interest cost 4.9 4.9 4.6 Recognized net actuarial (gain) loss (0.4) (0.5) 0.1 Amortization of prior service cost (2.2) (2.2) (2.3) - ------------------------------------------------------------------------------ Net periodic postretirement benefit cost $ 4.6 $ 4.1 $ 5.3 ==============================================================================
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 $3.2 million and $3.9 million in 2001 and 2000, respectively, which reflects fair value, net of applicable amortization. For purposes of measuring the accumulated postretirement benefit obligation at December 31, 2001, health care costs were assumed to increase 10.0% in 2002, declining thereafter until the ultimate rate of 5.0% is reached in 2010 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, 2001 by $4.6 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2001 by $0.6 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, 2001 by $4.0 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2001 by $0.5 million. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 6.88% and 7.25% at December 31, 2001 and 2000, 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 4.0% for FAFLIC agents. 12. == 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. Net loss and loss per share after 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" ("Statement No. 123"), were $13.2 million and $0.25 per share - diluted and basic, in 2001. Net income and earnings per share was $190.8 million and $3.54 per share - diluted ($3.58 per share - basic) in 2000, and $286.5 million and $5.17 per share - diluted ($5.21 per share - basic) in 1999 after the effect of Statement No. 123. 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 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 2001 and 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 6,500,836 shares as of December 31, 2001, increasing annually by 1.25% of the Company's outstanding stock. Additionally, the maximum number of shares available for award in any given year is equal 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 or agents 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:
(In whole shares and dollars) 2001 2000 1999 ================================================================================================================= Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price - ----------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 3,198,421 $ 46.94 2,793,779 $ 46.76 1,746,239 $ 42.39 Granted 1,286,075 56.74 938,013 45.60 1,286,917 52.39 Exercised 135,175 36.80 256,835 38.73 63,150 37.09 Forfeited 470,611 51.39 276,536 48.16 176,227 29.03 - ----------------------------------------------------------------------------------------------------------------- Outstanding at end of year 3,878,710 $ 49.91 3,198,421 $ 46.94 2,793,779 $ 46.76 ================================================================================================================= Options exercisable at end of year 1,306,159 $ 45.12 816,264 $ 43.82 546,521 $ 38.41 =================================================================================================================
No options expired during 2001, 2000, or 1999. 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 2001, the exercise price equaled the market price of the stock on the grant date. The weighted average fair value of all options granted in 2001, 2000 and 1999 was $19.49 per share $17.11 per share, and $20.97 per share, respectively. The following significant assumptions were used to determine fair value for 2001 options granted and converted:
Weighted Average Assumptions for Options Awarded 2001 2000 1999 ==================================================================== Dividend yield 0.4% 0.5% 0.6% Expected volatility 40.16% 37.60% 40.69% Risk-free interest rate 1.74% 5.03% 5.70% 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, 2001.
Options Outstanding Options Currently Exercisable Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Range of Exercise Prices Number Lives Price Number Price - ---------------------------------------------------------------------------------- $24.50 to $30.66 126,372 4.27 $ 27.59 126,372 $ 27.59 $35.375 to $43.10 450,760 5.54 $ 35.60 343,700 $ 35.39 $44.56 to $49.6875 711,766 8.12 $ 44.73 156,847 $ 44.85 $50.38 to $55.00 1,329,637 6.91 $ 52.26 615,740 $ 52.31 $55.00 to $59.8125 1,146,375 9.09 $ 57.05 14,100 $ 58.36 $60.375 to $72.50 113,800 7.20 $ 64.26 51,400 $ 64.38
71 During 2001, 2000 and 1999, the Company granted shares of nonvested stock to eligible employees, which vest after three years of continuous employment. During 2001, 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 or after three years of continuous service. The following table summarizes information about employee and agent nonvested stock.
Stock Awards 2001 2000 1999 ================================================================================ Common stock granted 269,690 190,141 66,710 Weighted average fair value per share at the date of grant $ 52.08 $ 38.01 $52.06
The Company recognizes compensation expense related to non-vested shares over the vesting period on a pro rata basis. As a result, the Company recognized $7.2 million $5.3 million and $4.3 million of compensation cost in 2001, 2000 and 1999 respectively. In October 2000, the Company granted 500,250 stock appreciation rights to certain employees, payable after December 31, 2001. These rights provided for stock or cash awards to participants based upon the appreciation, if any, of the Company's stock from October 2, 2000 through December 31, 2001, the vesting period. Compensation costs associated with these rights was recorded over the vesting period and was $(0.7) million and $0.7 million in 2001 and 2000, respectively. 13. == 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, 2001 2000 1999 ================================================================================ (In millions, except per share data) - -------------------------------------------------------------------------------- Basic shares used in the calculation of earnings per share 52.7 53.3 55.0 Dilutive effect of securities: Employee stock options 0.2 0.4 0.3 Non-vested stock grants 0.2 0.3 0.2 - -------------------------------------------------------------------------------- Diluted shares used in the calculation of earnings per share 53.1 54.0 55.5 ================================================================================ Per share effect of dilutive securities on income from continuing operations before cumulative effect of change in accounting principle $ -- $0.05 $0.06 ================================================================================ Per share effect of dilutive securities on net (loss) income $ -- $0.05 $0.05 ================================================================================
Options to purchase 3.4 million shares and 0.7 million shares of common stock were outstanding during 2001 and 1999, 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. 14. == 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. 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 through 2001 would have required the prior approval of the Commissioner. In addition, the agreement requires that FAFLIC maintain certain surplus levels through 2005. Accordingly, no dividends were declared by FAFLIC to AFC during 2001, 2000, or 1999. FAFLIC cannot pay dividends to AFC without prior approval from the Commissioner during 2002. 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 72 approval of the Delaware Commissioner of Insurance. No dividends were declared by AFLIAC to FAFLIC during 2001, 2000, or 1999. During 2002, AFLIAC cannot pay dividends 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 Asset Management, Inc. ("AAM") totaling $100.0 million in 2001 and dividends to Allmerica P&C totaling $108.0 million and $350.0 million during 2000 and 1999, respectively. The 1999 dividend included an extraordinary dividend totaling $225.0 million, which was approved by the Commissioner. Prior to April 2002, Hanover can declare no dividends to AAM without prior approval of the New Hampshire Insurance Commissioner. The allowable dividend without prior approval will increase to $92.2 million on April 8, 2002. 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 Hanover totaling $50.0 million in 2001 and dividends to Citizens Corporation totaling $55.0 million and $200.0 million in 2000 and 1999, respectively. The 1999 dividend included an extraordinary dividend totaling $200.0 million, which was approved by the Commissioner. Prior to April 2002, Citizens can declare no dividends to Hanover without prior approval of the Michigan Insurance Commissioner. The allowable dividend without prior approval will increase to approximately $48.3 million on April 8, 2002. 15. == 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 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, other organizations and through employers. Specialty Markets offers specialty or program property and casualty business nationwide. In the fourth quarter of 2001, the Company exited selected property and casualty agencies, policies, groups, and programs. (See Note 3 - Significant Transactions.) 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. 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. GICs, also referred to as funding agreements, are investment contracts which can contain either short-term or long-term maturities and are issued to institutional buyers or to various business or charitable trusts. Also, this segment is 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 realized investment gains and losses, losses on derivative instruments, 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 (loss) income determined in accordance with generally accepted accounting principles. 73 Summarized below is financial information with respect to business segments:
For the Years Ended December 31 2001 2000 1999 ====================================================================================== (In millions) - -------------------------------------------------------------------------------------- Segment revenues: Risk Management $2,454.8 $2,307.7 $2,189.4 Asset Accumulation Allmerica Financial Services 826.5 867.2 808.3 Allmerica Asset Management 155.2 149.2 150.5 - -------------------------------------------------------------------------------------- Subtotal 981.7 1,016.4 958.8 - -------------------------------------------------------------------------------------- Corporate 6.7 6.3 6.0 Intersegment revenues (7.5) (7.0) (5.9) - -------------------------------------------------------------------------------------- Total segment revenues 3,435.7 3,323.4 3,148.3 - -------------------------------------------------------------------------------------- Adjustments to segment revenues: Net realized (losses) gains (123.9) (140.7) 90.4 - -------------------------------------------------------------------------------------- Total revenues $3,311.8 $3,182.7 $3,238.7 ====================================================================================== Segment income (loss) before federal income taxes and minority interest: Risk Management $ 93.5 $ 190.0 $ 199.6 Asset Accumulation Allmerica Financial Services 143.0 222.8 205.5 Allmerica Asset Management 20.7 22.5 23.5 - -------------------------------------------------------------------------------------- Subtotal 163.7 245.3 229.0 - -------------------------------------------------------------------------------------- Corporate (63.8) (60.8) (59.3) - -------------------------------------------------------------------------------------- Segment income before income taxes and minority interest 193.4 374.5 369.3 - -------------------------------------------------------------------------------------- Adjustments to segment income: Net realized investment (losses) gains, net of amortization (121.3) (135.2) 96.8 Losses from selected property and casualty exited agencies, policies, groups, and programs (68.3) -- -- Losses on derivative instruments (35.2) -- -- Voluntary pool environmental losses (33.0) -- -- Restructuring costs (2.7) (20.7) 1.9 Sales practice litigation 7.7 -- -- - -------------------------------------------------------------------------------------- (Loss) income from continuing operations before federal income taxes and minority interest $ (59.4) $ 218.6 $ 468.0 ======================================================================================
December 31 2001 2000 2001 2000 ============================================================================================ (In millions) - -------------------------------------------------------------------------------------------- Identifiable Assets Deferred Acquisition Costs - -------------------------------------------------------------------------------------------- Risk Management $ 6,239.8 $ 6,186.6 $ 199.0 $ 187.2 Asset Accumulation Allmerica Financial Services 21,113.0 23,082.5 1,585.2 1,420.8 Allmerica Asset Management 2,829.3 2,238.4 -- 0.2 - -------------------------------------------------------------------------------------------- Subtotal 23,942.3 25,320.9 1,585.2 1,421.0 Corporate 154.0 80.5 -- -- - -------------------------------------------------------------------------------------------- Total $30,336.1 $31,588.0 $1,784.2 $1,608.2 ============================================================================================
16. == Lease Commitments - -------------------------------------------------------------------------------- Rental expenses for operating leases, including those related to the discontinued operations of the Company, amounted to $32.7 million, $32.8 million and $33.2 million in 2001, 2000 and 1999, respectively. These expenses relate primarily to building leases of the Company. At December 31, 2001, future minimum rental payments under non-cancelable operating leases were approximately $69.8 million, payable as follows: 2002 - $26.1 million; 2003 - $19.7 million; 2004 - $13.9 million; 2005 - $6.9 million; and $3.2 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 2002. 17. == 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." 74 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 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 - Significant Transactions). The Company is subject to concentration of risk with respect to this reinsurance agreement. Net premiums earned under this agreement during 2001, 2000 and 1999 for accident year 1999 were $12.1 million, $25.0 million and $21.9 million, respectively, while net losses and LAE ceded during 2001, 2000 and 1999 were $15.8 million, $34.1 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, 2001, CAR 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 2001, 2000 and 1999 were $34.2 million and $38.0 million, $37.3 million and $44.5 million, and $42.8 million and $42.6 million, respectively. Additionally, the Company ceded to MCCA premiums earned and losses and loss adjustment expenses in 2001, 2000 and 1999 of $7.2 million and $44.5 million, $3.7 million and $31.1 million, and $3.7 million and $75.3 million, respectively. 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 2001 2000 1999 ========================================================================================== (In millions) - ------------------------------------------------------------------------------------------ Life and accident and health insurance premiums: Direct $ 89.1 $ 94.3 $ 106.2 Assumed 0.7 0.7 0.7 Ceded (38.2) (41.0) (50.6) - ------------------------------------------------------------------------------------------ Net premiums $ 51.6 $ 54.0 $ 56.3 ========================================================================================== Property and casualty premiums written: Direct $ 2,510.6 $ 2,391.7 $ 2,179.0 Assumed 52.7 63.5 67.3 Ceded (285.6) (303.6) (270.9) - ------------------------------------------------------------------------------------------ Net premiums $ 2,277.7 $ 2,151.6 $ 1,975.4 ========================================================================================== Property and casualty premiums earned: Direct $ 2,438.6 $ 2,297.8 $ 2,135.0 Assumed 53.5 66.8 73.0 Ceded (293.7) (299.8) (261.7) - ------------------------------------------------------------------------------------------ Net premiums $ 2,198.4 $ 2,064.8 $ 1,946.3 ========================================================================================== Life and accident and health insurance and other individual policy benefits, claims, losses and loss adjustment expenses: Direct $ 463.0 $ 455.3 $ 479.4 Assumed 0.3 0.3 0.1 Ceded (46.1) (35.1) (35.8) - ------------------------------------------------------------------------------------------ Net policy benefits, claims, losses and loss adjustment expenses $ 417.2 $ 420.5 $ 443.7 ========================================================================================== Property and casualty benefits, claims, losses and loss adjustment expenses: Direct $ 2,026.4 $ 1,819.5 $ 1,603.8 Assumed 91.4 68.1 61.7 Ceded (281.9) (326.3) (247.6) - ------------------------------------------------------------------------------------------ Net policy benefits, claims, losses and loss adjustment expenses $ 1,835.9 $ 1,561.3 $ 1,417.9 ==========================================================================================
75 18. == Deferred Policy Acquisition Costs - -------------------------------------------------------------------------------- The following reflects the changes to the deferred policy acquisition asset:
For the Years Ended December 31 2001 2000 1999 ==================================================================================== (In millions) - ------------------------------------------------------------------------------------ Balance at beginning of year $ 1,608.2 $ 1,399.9 $ 1,179.3 Acquisition expenses deferred 688.8 684.1 613.7 Amortized to expense during the year (479.2) (456.6) (432.4) Adjustment for commission buyout program (31.6) -- -- Adjustment to equity during the year (2.0) (19.2) 39.3 - ------------------------------------------------------------------------------------ Balance at end of year $ 1,784.2 $ 1,608.2 $ 1,399.9 ====================================================================================
During the first quarter of 2001, the Company implemented an in-force trail commission program on certain annuity business previously written by qualifying agents. This program provided for the election of a trail commission on in-force business in exchange for the buyout of deferred commissions. 19. == 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, net of reinsurance, related to the Company's accident and health business, consisting of the Company's exited individual health business and its discontinued group accident and health business, was $120.5 million, $184.7 million and $265.5 million at December 31, 2001, 2000 and 1999, respectively. Reinsurance recoverables related to this business were $343.0 million, $335.9 million and $335.7 million in 2001, 2000 and 1999, respectively. The decreases in 2001 and 2000 were primarily attributable to the continued run-off of the group accident and health business. Also, the decrease in 2000 was impacted by 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 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 2001 2000 1999 ==================================================================================== (In millions) - ------------------------------------------------------------------------------------ Reserve for losses and LAE, beginning of year $ 2,719.1 $ 2,618.7 $ 2,597.3 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 1,708.3 1,634.9 1,601.4 Increase (decrease) in provision for insured events of prior years 33.6 (87.4) (183.4) Losses related to selected property & casualty exited agencies, policies, groups & programs 52.9 -- -- Losses related to voluntary pool environmental claims 33.0 -- -- - ------------------------------------------------------------------------------------ Total incurred losses and LAE 1,827.8 1,547.5 1,418.0 - ------------------------------------------------------------------------------------ Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 892.8 870.2 861.1 Losses and LAE attributable to insured events of prior years 780.3 703.8 638.0 - ------------------------------------------------------------------------------------ Total payments 1,673.1 1,574.0 1,499.1 - ------------------------------------------------------------------------------------ Change in reinsurance recoverable on unpaid losses 47.7 126.9 102.5 - ------------------------------------------------------------------------------------ Reserve for losses and LAE, end of year $ 2,921.5 $ 2,719.1 $ 2,618.7 ====================================================================================
76 As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were increased by $107.4 million in 2001 and decreased by $87.4 million and $183.4 million in 2000 and 1999, respectively. Included in 2001 were increased reserves of $40.8 million related to the exit of selected property and casualty agencies, policies, groups and programs, and $33.0 million related to voluntary pool environmental claims. During the year ended December 31, 2001, estimated loss reserves for claims occurring in prior years developed unfavorably by $72.8 million and LAE reserves developed favorably by $39.2 million. Favorable development on prior years' loss reserves and LAE reserves was $25.9 million and $61.5 million, respectively, in 2000, and $93.1 million and $90.3 million, respectively, in 1999. The unfavorable loss reserve development in 2001 is primarily the result of an increase in personal automobile loss frequency and severity, increased commercial lines loss severity and additional losses related to fourth quarter 2000 non-catastrophe weather related claims in Michigan. These non-catastrophe claims primarily affected the personal automobile, workers' compensation and commercial multiple peril lines. The favorable loss reserve development in both 2000 and 1999 is primarily the result of the Company capturing the accumulated benefits of its claim redesign efforts. Favorable development on prior years' LAE reserves in 2001, 2000 and 1999 is primarily attributable to claims process improvement initiatives taken by the Company over the past four 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 complete. Reserves established for current year losses and LAE in 2001 and 2000 consider the factors that resulted in the favorable development of prior years' loss and LAE reserves during 1999 and earlier years. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in years prior to 2000. During the fourth quarter of 2001, the Company recorded an increase in carried reserves of $52.9 million, net of reinsurance, related to its exit of selected property and casualty agencies, policies, groups and programs. This increase in reserves reflects the results of an actuarial review of outstanding reserves related to this business. (See Note 3 - Significant Transactions.) Although the Company does not specifically underwrite policies that include environmental damage and toxic tort liability, the Company may be required to defend such claims. Loss and LAE reserves for all direct business written by its property and casualty companies related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $26.7 million, $25.4 million and $34.8 million, net of reinsurance of $13.0 million, $15.9 million and $11.2 million in 2001, 2000 and 1999, respectively. 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 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. The Company was a participant in a voluntary excess and casualty reinsurance pool (Excess and Casualty Reinsurance Association, "ECRA") from 1950 to 1982. In 1982 the pool was dissolved and since that time the business has been in runoff. The Company's participation in this pool has resulted in an average loss of $2.5 million annually over the past ten years. During 2001, the pool commissioned an independent actuarial review of the current reserve position, which noted a range of reserve deficiency primarily as a result of adverse development of asbestos claims. As a result of this study, the Company recorded an additional $33.0 million of losses in the fourth quarter of 2001. This reserving action has been presented as a separate line item in the Consolidated Statements of Income. Loss and LAE reserves for assumed reinsurance and pool business with environmental damage and toxic tort liability, including the aforementioned ECRA reserve adjustment were $39.3 million, $10.6 million, and $12.5 million in 2001, 2000 and 1999, respectively. These reserves relate to pools in which the Company has terminated its participation, however, the Company continues to be subject to claims related to years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, there can be no assurance that these reserves will be sufficient. 77 20. == 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. In 2001, the Company recognized a pre-tax benefit of $7.7 million resulting from the refinement of cost estimates. Although the Company believes that it has appropriately recognized its obligation under the settlement, this 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. 21. == 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, statutory accounting priciples require asset valuation and interest maintenance reserves, postretirement benefit costs are based on different assumptions and reflect a different method of adoption, life insurance reserves are based on different assumptions and the recognition of deferred tax assets is based on different recoverability assumptions. Effective January 1, 2001, the Company's insurance subsidiaries adopted the National Association of Insurance Commissioner's uniform statutory accounting principles, or Codification, in accordance with requirements prescribed by state authorities. A cumulative effect of the change in accounting principle resulted from the adoption of Codification and was reflected as an adjustment to surplus in 2001. This adjustment represents the difference between total capital and surplus as of 78 January 1, 2001 and the amount total capital and surplus would have been had the accounting principles been applied retroactively for all prior periods. As of January 1, 2001, the property and casualty and life and health insurance subsidiaries recorded cumulative effect adjustments of $82.4 million and $45.0 million, respectively. The adjustment reflected by the property and casualty insurance subsidiaries consisted of an increase in surplus of $141.9 million related to the establishment of deferred tax assets and reductions in surplus of $59.5 million related to changes in valuations of other invested assets and non-admitted assets. The adjustment reflected by the life and health insurance subsidiaries included an increase in surplus of $49.7 related to the establishment of deferred tax assets and the change in valuation of pension liabilities. Reductions in surplus reflected by the life and health insurance subsidiaries totaled $4.7 million and resulted from the change in valuations of post-employment benefits and non-admitted assets. Statutory net (loss) income and surplus are as follows:
2001 2000 1999 ================================================================================ In millions - -------------------------------------------------------------------------------- Statutory Net (Loss) Income - Combined Property and Casualty Companies $ (7.9) $ 111.8 $ 511.6 Life and Health Companies (44.9) (43.6) 239.0 - -------------------------------------------------------------------------------- Statutory Shareholders' Surplus - Combined Property and Casualty Companies $926.1 $1,036.2 $1,089.1 Life and Health Companies 377.9 528.5 590.1 - --------------------------------------------------------------------------------
22. == Quarterly Results of Operations (Unaudited) - -------------------------------------------------------------------------------- The quarterly results of operations for 2001 and 2000 are summarized below:
For the Three Months Ended ================================================================================================== (In millions, except per share data) - -------------------------------------------------------------------------------------------------- 2001 March 31 June 30 Sept. 30 Dec. 31 - -------------------------------------------------------------------------------------------------- Total revenues $ 845.9 $ 795.2 $ 853.0 $ 817.7 Net income $ 23.2 $ 13.2 $ 31.2 $ (70.7) Net income per share: Basic $ 0.44 $ 0.25 $ 0.59 $ (1.34) Diluted $ 0.44 $ 0.25 $ 0.59 $ (1.33) Dividends declared per share $ -- $ -- $ -- $ 0.25 - -------------------------------------------------------------------------------------------------- 2000 - -------------------------------------------------------------------------------------------------- Total revenues $ 768.9 $ 804.0 $ 815.8 $ 794.0 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 $ -- - --------------------------------------------------------------------------------------------------
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 2001, the Company recognized after-tax charges of $44.4 million and $21.5 million related to the exit of selected property and casualty agencies, policies, groups and programs, and to voluntary pool environmental losses, respectively. (See Note 19 - Liabilities for Outstanding Claims, Losses and Loss Adjustment Expenses.) In addition, the Company recognized losses on derivative instruments of $24.4 million, net of taxes, in the fourth quarter of 2001, primarily as a result of hedge ineffectiveness. (See Note 4 - Investments, Cash Flow Hedges.) 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. 79
Board of Directors Operating Committee ==================================================================================================== Michael P. Angelini /(I)/ Bruce C. Anderson Chairman and Partner, Bowditch & Dewey, LLP Vice President, Corporate Services E. Gordon Gee /(D)/ Mark R. Colborn Chancellor, Vanderbilt University Vice President, Operations Services Samuel J. Gerson /(D)/ J. Kendall Huber Chairman, GenuOne, Inc. Vice President and General Counsel Mark A. Hug Gail L. Harrison /(A)/ President and Chief Executive Officer, Principal, Powell Tate Allmerica Financial Life Insurance and Annuity Company Robert P. Henderson /(C) (I)/ General Partner, John P. Kavanaugh Greylock Management Corporation Vice President and Chief Investment Officer M Howard Jacobson /(C) (I)/ John F. O'Brien Senior Advisor and Consultant, President and Chief Executive Officer Bankers Trust Private Bank Edward J. Parry, III Wendell J. Knox /(A)/ Vice President and Chief Financial Officer President and Chief Executive Officer, Abt Associates Richard M. Reilly Senior Vice President Robert J. Murray /(A)/ Chairman, President and Chief Executive Officer, Robert P. Restrepo, Jr. New England Business Service, Inc. President and Chief Executive Officer, Allmerica Property and Casualty Companies Terrence Murray /(D)/ Chairman, FleetBoston Financial Corporation Gregory D. Tranter Vice President and Chief Information Officer 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 80 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 14, 2002, 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, 2002, the Company had 41,114 shareholders of record. On the same date, the trading price of the Company's common stock closed at $43.48 per share. Common Stock Prices and Dividends 2001 High Low Dividends - ---------------------------------------------------------- First Quarter $ 67.25 $ 47.63 - - ---------------------------------------------------------- Second Quarter $ 57.50 $ 48.01 - - ---------------------------------------------------------- Third Quarter $ 56.35 $ 40.62 - - ---------------------------------------------------------- Fourth Quarter $ 46.10 $ 38.17 $ 0.25 - ---------------------------------------------------------- 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 - - ---------------------------------------------------------- Dividends Allmerica Financial Corporation currently pays an annual cash dividend of $0.25 per share. IMSA [GRAPHIC] 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, LP 525 Washington Boulevard Jersey City, NJ 07310 (800) 317-4454 Independent Accountants PricewaterhouseCoopers LLP 160 Federal Street Boston, MA 02110 Printed partially on recycled paper. Design: The Graphic Expression, Inc., New York City www.tgenyc.com Industry Ratings
A.M. Standard Financial Strength Ratings Best & Poor's Moody's Fitch - -------------------------------------------------------------------------------------- First Allmerica Financial Life Insurance Company A AA- A1 AA - -------------------------------------------------------------------------------------- Allmerica Financial Life Insurance and Annuity Company A AA- A1 AA - -------------------------------------------------------------------------------------- The Hanover Insurance Company A AA- A1 - - -------------------------------------------------------------------------------------- Citizens Insurance Company of America A - - - - -------------------------------------------------------------------------------------- A.M. Standard Debt Ratings Best & Poor's Moody's Fitch - -------------------------------------------------------------------------------------- Allmerica Financial Corporation Senior Debt a- A- A3 A+ - -------------------------------------------------------------------------------------- Allmerica Financial Corporation Capital Securities bbb+ BBB Baa1 A - -------------------------------------------------------------------------------------- Allmerica Financial Corporation Short Term Debt AMB-1 A2 P2 F1 - -------------------------------------------------------------------------------------- First Allmerica Financial Life Insurance Company Short Term Debt - A1+ - - - -------------------------------------------------------------------------------------- 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) 853-3051 Electronic Delivery of Customer Information Allmerica Financial customers with variable annuity and variable life products may elect to receive prospectuses, supplements, annual and semi-annual reports electronically through www.e-z-delivery.com. 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 81 EX-21 7 dex21.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 Investment Insurance Agency, Inc. of Georgia (Georgia) 8. Allmerica Investment 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 8 dex23.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 15, 2002 relating to the financial statements, which appears in the Allmerica Financial Corporation 2001 Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 15, 2002 relating to the financial statement schedules, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Boston, Massachusetts March 29, 2002 EX-99.2 9 dex992.txt IMPORTANT FACTORS REGARDING FORWARD LOOKING STATEM EXHIBIT 99.2 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. Risks Relating to Our Risk Management Business Our results may fluctuate as a result of cyclical changes in the property and casualty insurance industry. We generate a significant portion of our total revenues through our property and casualty insurance subsidiaries. The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties. Our profitability could be affected significantly by: . increases in costs occurring after the time our insurance products are priced; . competitive and regulatory pressures which may affect the prices of our products and the nature of the risks covered; . volatile and unpredictable developments, including severe weather catastrophes; . legal, regulatory and socio-economic developments, such as new theories of insurer liability and related claims, increases in the size of jury awards, and increases in construction, automobile repair and medical and rehabilitation costs; . fluctuations in interest rates, inflationary pressures, default rates and other factors that affect investment returns; and . other general economic conditions and trends that may affect the adequacy of reserves. The demand for property and casualty insurance can also vary significantly based on general economic conditions, rising as the overall level of economic activity increases and falling as such activity decreases. The fluctuations in demand and competition could produce underwriting results that would have a negative impact on our results of operations and financial condition. Actual losses from claims against our property and casualty insurance subsidiaries may exceed their reserves for claims. Our property and casualty insurance subsidiaries maintain reserves to cover their estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability. Rather, reserves represent estimates, involving actuarial projections at a given time, of what they expect the ultimate settlement and administration of claims will cost based on facts and circumstances then known to them, predictions of future events, estimates of future trends in claims frequency and severity and judicial theories of liability, costs of repair and replacement, legislative activity and other factors. The inherent uncertainties of estimating reserves are greater for certain types of property and casualty insurance lines. These include 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. We regularly review our reserving techniques, reinsurance and the overall adequacy of our reserves based upon: . our review of historical data, legislative enactments, judicial decisions, legal developments in imposition of damages, changes in political attitudes and trends in general economic conditions; . our review of per claim information; . historical loss experience of our property and casualty insurance subsidiaries and the industry as a whole; and . the relative short-term nature of most of our property and casualty insurance policies. Because setting reserves is inherently uncertain, we cannot provide assurance that the existing reserves or future reserves established by our property and casualty insurance subsidiaries will prove adequate in light of subsequent events. Our results of operations and financial condition could therefore be materially affected by adverse loss development for events that we insure. Due to our geographical concentration in our Risk Management business, changes in the economic, regulatory and other conditions in the regions where we operate could have a significant negative impact on our business as a whole. We generate a significant portion of our property and casualty insurance net premiums written and earnings in Michigan, Massachusetts and other states in the Northeast, including Connecticut, Maine, New York, New Jersey, New Hampshire, Rhode Island and Vermont. In the year ended December 31, 2001, approximately 36% and 16% of our net written premium in our Risk Management business was generated in the states of Michigan and Massachusetts, respectively. The revenues and profitability of our property and casualty insurance subsidiaries are therefore subject to prevailing economic, regulatory, demographic and other conditions, including adverse weather, in Michigan and the Northeast. Because of our strong regional focus, our business as a whole could be significantly affected by changes in the economic, regulatory and other conditions in the regions where we transact business. Catastrophe losses could materially reduce our profitability or cash flow. Our property and casualty insurance subsidiaries are subject to claims arising out of catastrophes that may have a significant impact on their results of operations and financial condition. We may experience catastrophe losses which could have a material adverse impact on our business. Catastrophes can be caused by various events including hurricanes, earthquakes, tornadoes, wind, hail, fires, severe winter weather, sabotage, terrorist actions and explosion. The frequency and severity of catastrophes are inherently unpredictable. The extent of gross 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. The extent of net losses depends on the amount and collectibility of reinsurance. 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 our catastrophe-related claims. Our catastrophe losses have historically been principally weather related, particularly snow and ice damage from winter storms. -2- We purchase catastrophe reinsurance as protection against catastrophe losses. Based upon our review of our reinsurers' financial statements and reputations in the reinsurance marketplace, we believe that the financial condition of our reinsurers is sound. However, reinsurance is subject to credit risks, including those resulting from over-concentration within the industry. The availability, scope of coverage and cost of reinsurance could be adversely affected by the losses incurred from the September 11, 2001 terrorist attacks and the perceived risks associated with possible future terrorist activities. We cannot currently estimate the impact of these events on us. We also cannot provide assurance that our current reinsurance will be adequate to protect us against future catastrophe losses or that reinsurance will continue to be available to us at commercially reasonable rates or with coverage provisions reflective of the risks underwritten in our primary policies. We may incur financial losses resulting from our participation in shared market mechanisms and mandatory and voluntary pooling arrangements. As a condition to conducting business in several states, our property and casualty insurance subsidiaries are required to participate in mandatory property and casualty shared market mechanisms or pooling arrangements. These arrangements are designed to provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage voluntarily provided by private insurers. We cannot predict whether our participation in these shared market mechanisms or pooling arrangements will provide underwriting profits or losses to us. In 2001, 2000, and 1999, we incurred an underwriting loss from participation in these mechanisms and pooling arrangements of $20.1 million, $26.1 million, and $24.2 million, respectively. We may face similar losses in the future. In addition, we may be adversely affected by liabilities resulting from our previous participation in certain voluntary assumed reinsurance pools, including accident and health reinsurance pools. We discontinued our participation in such pools in 1998, but remain subject to claims from periods in which we participated as well as for certain continuing obligations in a limited number of accident and health pools that we were prohibited from exiting in full. Although the accident and health assumed reinsurance business has suffered substantial losses during the past several years, we believe that our reserves appropriately reflect both current claims and unreported losses. However, due to the inherent volatility in this business, possible issues related to the enforceability of reinsurance treaties in the industry and to its recent history of increased losses, we cannot provide assurance that our current reserves are adequate or that we will not incur losses in the future. Although we have discontinued participation in these reinsurance pools as described above, we may become subject to claims related to prior years or from pools we could not exit in full. Our operating results and financial position may be harmed from liabilities resulting from any such claims. Our profitability could be adversely affected by periodic changes to our relationships with our agencies. Our Risk Management segment reviews our agencies from time to time to identify those that do not meet our profitability standards or are not strategically aligned with our business. Following these periodic reviews, we may restrict such agencies' access to certain types of policies or terminate our relationship with them, subject to applicable contractual and regulatory requirements to renew certain policies for a limited time. For example, we recently identified approximately 700 agencies with whom we plan to either limit or terminate our relationship. Although we currently anticipate a decline of approximately $170 million in our annual written premium in 2002 as a result of these actions, we expect our overall profitability to improve over time as a result of expected lower losses incurred. However, we cannot be sure that we will achieve the desired results from these measures, and our failure to do so could negatively affect our operating results and financial position. -3- Risks Relating to Our Asset Accumulation Business Interest rate fluctuations could negatively affect our profitability. Some of our products, including guaranteed investment contracts, funding agreements, the general account options in our variable products, traditional whole and universal life insurance and fixed annuities expose us to the risk that changes in interest rates will reduce our "spread", or the difference between the amounts that we are required to pay under the contracts and the rate of return we are able to earn on our general account investments intended to support our obligations under the contracts. Declines in our spread from these products or other spread businesses we conduct could have a material adverse effect on our business or results of operations. In periods of increasing interest rates, we may not be able to replace the assets in our general account investment portfolios with higher yielding assets needed to fund the higher crediting rates necessary to keep our interest sensitive products competitive. We therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In periods of declining interest rates, we may have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments then available. Moreover, borrowers may prepay fixed-income securities, commercial mortgages and mortgage-backed securities in our general account in order to borrow at lower market rates, which increases this risk. Because we are entitled to reset the interest rates on our general account supported life insurance and annuity products and guaranteed investment contracts only at limited, pre-established intervals, and since many of our policies have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative. A decline in market interest rates available on investments could also reduce our return from investments of capital that do not support particular policy obligations, which could have a material adverse effect on our results of operations. Increases in interest rates may cause increased surrenders and withdrawal of insurance products. In periods of increasing interest rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as policyholders seek to buy products with perceived higher returns. This process may lead to a flow of cash out of our businesses. These outflows may require investment assets to be sold at a time when prices for those assets are lower because of the increase in market interest rates, which may result in realized investment losses. The value of fixed income investments, in particular, tends to fluctuate in an inverse relationship to interest rates. A sudden demand among consumers to change product types or withdraw funds could lead us to sell assets at a loss to meet the demand for funds. In addition, unanticipated withdrawals and terminations also may require us to accelerate the amortization of deferred policy acquisition costs. This would increase our current expenses. A continued decline or increase in volatility in the securities markets may negatively affect our business. Our investment-based and asset management products and services expose us to the risk that sales will continue to decline and lapses in variable life and annuity products and withdrawal of assets from other investment products will increase if, as a result of a continued market downturn, increased market volatility or other market conditions, customers become dissatisfied with their investments. A declining market also leads to lower account balances as a result of decreases in market value of assets under management. In many cases, our fees in these businesses are based on a percentage of the assets we manage and, if account values decline, our fee revenue declines. A declining market also results in a decline in the volume of transactions that we execute for our customers in our brokerage business, and therefore a decline in our commission and fee revenue. In addition, the lower account balances that result from a declining securities market particularly affect our variable annuity products that offer guaranteed minimum death benefits, or GMDB. Under certain market conditions, including those we currently face, the assets in an annuitant's account may be insufficient to satisfy our -4- GMDB obligations at the time of an annuitant's death. In this case, we must satisfy the difference from other cash sources. In the event that a significant number of deaths of such annuitants occur at a time that account balances are decreased as a result of a market downturn, our liquidity, level of statutory capital and earnings would be significantly and adversely affected. During 2001, the GMDB expense increased $10.5 million, primarily due to the recent, sustained decline in the financial markets. If market levels as of December 31, 2001 continue, GMDB expenses in 2002 are expected to increase by $20 million to $25 million over 2001. Approximately one third to one half of this increase will be offset by reduced amortization of deferred policy acquisition costs. Additional declines in the financial markets could further increase this expense. Actual losses from claims against our life insurance subsidiaries may exceed their reserves for claims. For our life insurance and annuity products, we calculate reserves based on assumptions and estimates such as estimated premiums we will receive over the assumed life of policy, the timing of the event covered by the insurance policy, the expected life of the insured or annuitant, the anticipated market performance of underlying investments, the amount of benefits or claims to be paid and the investment returns on the assets we purchase with the premiums we receive. We establish reserves based on assumptions and estimates of mortality and morbidity rates, policy and claim termination rates, benefit amounts, investment returns and other factors. Because setting reserves is inherently uncertain, we cannot provide assurance that our existing reserves or future reserves to support our obligations under our life and insurance annuity products will prove adequate in light of subsequent events. Our results of operations and financial condition could therefore be materially affected by adverse loss development for events that we insure. We rely heavily on key relationships to market our variable products, and we could lose sales if we are unable to maintain these relationships. The future sale of our variable products will depend on our ability to recruit new or retain existing career agents, wholesalers, broker-dealers, partnership and other distribution relationships. For example, our relationship with Scudder is important for marketing our annuity products. For the year ended December 31, 2001, Scudder generated approximately 28% of our annuity product sales, based on statutory premiums and deposits. Competition for such relationships is intense. Our success in marketing our variable products is highly dependent on these relationships and deterioration in them could adversely affect future sales and surrender activities. We could be adversely affected by litigation regarding insurers' sales practices. A number of civil jury verdicts have been returned against life and health insurers in the jurisdictions in which we do business. These cases involved 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 judgments against the insurer, including material amounts of punitive damages. In some states, juries are given substantial discretion in awarding punitive damages in these circumstances. We, from time to time, are subject to litigation of this type. Risks Relating to Our Business Generally Other market fluctuations and general economic, market and political conditions may also negatively affect our business and profitability. At December 31, 2001, we held approximately $10.7 billion of investment assets in categories such as fixed maturities, equity securities, mortgage loans and other long-term investments. Our investment returns, and thus our profitability, may be adversely affected from time to time by conditions affecting our specific investments and, more generally, by bond, stock, real estate and other market fluctuations and general economic, market and political conditions. Our ability to make a profit on insurance products, fixed annuities and guaranteed investment -5- products depends in part on the returns on investments supporting our obligations under these products and the value of specific investments may fluctuate substantially depending on the foregoing conditions. We use a variety of strategies to hedge our exposure to interest rate and other market risk. However, hedging strategies are not always available and carry certain credit risks, and our hedging could be ineffective. The current uncertainties in the U.S. and international economic and investment climates have adversely affected our businesses and profitability in 2001, and can be expected to continue to do so, unless conditions improve. General uncertainties in our business illustrate this risk. The incomes from 2001 of our Risk Management and Allmerica Financial Services segments decreased by 50.8% and 35.8%, respectively, compared to the same period in 2000. Market conditions also affect the value of assets under our employee pension plans. The expense or benefit related to our employee pension plans results from several factors, including changes in the market value of plan assets, interest rates and employee compensation levels. For 2001, we recognized net expenses of $0.3 million related to our employee pension plans. In 2002, we expect a significant increase in such costs due to a decline in the market value of plan assets and interest rates in 2001. Such increased costs could negatively affect our results of operations. In addition, debt securities comprise a material portion of our investment portfolio. The issuers of those securities, as well as borrowers under the loans we make, customers, trading counterparties, counterparties under swaps and other derivative contracts and reinsurers, may be affected by the declining market. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure or other reasons. The current uncertain trend in the U.S. and other economies has resulted in rising investment impairments. Our ability to fulfill our debt and other obligations could be adversely affected by the default of third parties on their obligations owed to us. We are a holding company and rely on our insurance company subsidiaries for cash flow; we may not be able to receive dividends from our subsidiaries in needed amounts. We are a holding company for a diversified group of insurance and financial services companies and our principal assets are the shares of capital stock of our subsidiaries. Our ability to make required debt service payments as well as our ability to pay operating expenses and pay dividends to shareholders, depends upon the receipt of sufficient funds from our subsidiaries. The payment of dividends by our insurance company subsidiaries is subject to regulatory restrictions and will depend on the surplus and future earnings of these subsidiaries, as well as the regulatory restrictions. For example, during 2001, we received $100.0 million of dividends from our property and casualty businesses. Additional dividends from our insurance subsidiaries prior to April 2002 would be considered "extraordinary" and would require approval from state regulators. In addition, we have agreed with the Commonwealth of Massachusetts Insurance Commissioner not to receive any dividends from FAFLIC in 2001 without the Commissioner's prior approval. The ability of FAFLIC to make dividends may also be affected by our commitment with the Commonwealth of Massachusetts Insurance Commissioner to maintain a minimum risk-based capital ratio for FAFLIC of 225% until December 31, 2004. In the event that FAFLIC's risk-based capital falls below 225%, the Commissioner has the authority to require FAFLIC to increase the ratio to at least 225% pursuant to a reasonable plan approved by the Commissioner. This ratio is higher than that which we would otherwise be required to maintain under state law and could impede our ability to receive dividends from FAFLIC. We have not received, and cannot depend on receiving, dividends from our life insurance subsidiaries. Because of the regulatory limitations on the payment of dividends from our insurance company subsidiaries, we may not always be able to receive dividends from these subsidiaries at times and in amounts necessary to meet our debt and other obligations. The inability of our subsidiaries to pay dividends to us in an amount sufficient to meet our debt service and funding obligations would have a material adverse effect on us. -6- These regulatory dividend restrictions also impede our ability to transfer cash and other capital resources among our subsidiaries. Our dependence on our insurance subsidiaries for cash flow exposes us to the risk of changes in their 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 investment losses. In addition, a shortage of available cash could limit our life and annuity companies' ability to generate product sales (deposits), as most life and annuity sales require immediate cash payments to agents, brokers or other producers upon the sale of the product. Reductions in cash flow from our subsidiaries would have a material adverse effect on our business and results of operations. Fluctuations in currency exchange rates may adversely affect our financial condition. We have investments in securities denominated in foreign currencies. As of December 31, 2001, our investments in foreign currency denominated securities amounted to approximately $22.1 million, based on the exchange ratio prevailing on that date between the U.S. dollar and the relevant foreign currency. We also hold trust obligations backed by funding obligations denominated in foreign currencies. As a result, we are exposed to changes in exchange rates between the U.S. dollar and various foreign currencies, including the Swiss Franc, Japanese Yen, British Pound and the Euro. To the extent these exchange rates fluctuate in the future, our financial condition could be adversely affected. We enter into foreign exchange swap contracts and compound foreign currency or interest rate swap contracts from time to time to mitigate risks from foreign currency fluctuations. However, we cannot provide assurance that these measures will be adequate, or that these risks will not adversely affect our business. Furthermore, swap contracts and similar transactions also expose us to credit risk with the counter-party to the transaction. Our businesses are heavily regulated and changes in regulation may reduce our profitability. Our insurance businesses are subject to supervision and regulation by the state insurance authority in each state in which we transact business. This system of supervision and regulation relates to numerous aspects of an insurance company's business and financial condition, including limitations on the authorization of lines of business, underwriting limitations, the ability to terminate agents, supervisory and liability responsibilities for agents and registered representatives, the setting of premium rates, the requirement to write certain classes of business which we might otherwise avoid or charge different 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. Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors. State regulatory oversight and various proposals at the federal level may in the future adversely affect our 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. Products that are also "securities", such as variable life insurance and variable annuities, are also subject to federal and state securities laws and such products and their distribution are regulated and supervised by the Securities and Exchange Commission, the National Association of Securities Dealers, or NASD, and state securities commissions. Our business could be negatively impacted by adverse state and federal legislation or regulation, including those resulting in: . decreases in rates; . limitations on premium levels; -7- . increases in minimum capital and reserve requirements; . benefit mandates; . limitations on the ability to manage care and utilization; . requirements to write certain classes of business; . tax treatment of insurance and annuity products; and . restrictions on underwriting. We are rated by several rating agencies, and a decline in our ratings could adversely affect our operations. Ratings have become increasingly important in establishing the competitive position of insurance companies. Our ratings are important in marketing the products of our insurance companies to our agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Our insurance company subsidiaries are rated by A.M. Best and Moody's, and certain of our insurance company subsidiaries are rated for their claims-paying ability by Standard & Poor's and Fitch. These ratings reflect a rating agency's opinion of our insurance subsidiaries' financial strength, operating performance, strategic position and ability to meet their obligations to policyholders. These ratings are not evaluations directed to investors, and are not recommendations to buy, sell or hold our securities. Our ratings are subject to periodic review by the rating agencies and we cannot guarantee the continued retention of our ratings. Negative changes in our level of statutory surplus could adversely affect our rates and profitability. 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. Regulators may require that additional capital be contributed to increase the level of statutory surplus. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by private rating agencies. The National Association of Insurance Commissioners, or 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 various risk elements in an insurer's business and investments to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. We believe that any failure to maintain appropriate levels of statutory surplus would have an adverse impact on our rates and profitability. We are subject to mandatory assessments by state guaranty funds; an increase in these assessments could adversely affect our results of operations and financial condition. All fifty states of the United States have insurance guaranty fund laws requiring life and property and casualty insurance companies doing business within the state to participate in guaranty associations. These associations are organized to pay contractual obligations under insurance policies issued by impaired or insolvent insurance companies. The 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 -8- a reduction in future premium taxes in many states. During 2001, we had a total assessment of approximately $5.3 million levied against us. These assessments may increase in the future depending upon the rate of insolvencies of insurance companies. An increase in assessments could adversely affect our results of operations and financial condition. Intense competition could negatively affect our ability to maintain or increase our profitability. We compete with a large number of other companies in each of our three principal segments: risk management, financial services and asset management. We compete, and will continue to compete, with national and regional insurers, mutual companies, specialty insurance companies, underwriting agencies and financial services institutions. In recent years, there has been substantial consolidation and convergence among companies in the financial services industry, particularly as the laws separating banking, insurance and securities have been relaxed, resulting in increased competition from large, well-capitalized financial services firms. Many of our competitors have greater financial, technical and operating resources than we do. In addition, competition in the property and casualty insurance markets has intensified over the past several years. This competition may have an adverse impact on our revenues and profitability. A number of new, proposed or potential legislative or industry developments could further increase competition in our industry. These developments include: . the enactment of the Gramm-Leach-Bliley Act of 1999, which could result in increased competition from new entrants to our markets; . the implementation of commercial lines deregulation in several states; . programs in which state-sponsored entities provide property insurance in catastrophe prone areas or other alternative markets types of coverage; and . changing practices caused by the Internet, which have led to greater competition in the insurance business in general. In addition, we could face heightened competition resulting from the entry of new competitors and the introduction of new products by new and existing competitors. Increased competition could make it difficult for us to obtain new customers, retain existing customers or maintain policies in force by existing customers. It could also result in increasing our service, administrative, policy acquisition or general expense due to the need for additional advertising and marketing of our products. In addition, our administrative or management information systems expenditures could also increase substantially as we try to maintain our competitive position. We cannot provide assurance that we will be able to maintain our current competitive position in the markets in which we operate, or that we will be able to expand our operations into new markets. If we fail to do so, our business could be materially adversely affected. If we are unable to attract and retain qualified personnel, we may not be able to compete effectively and our operations could be impacted significantly. Our future success will be affected by our continued ability to attract and retain qualified executives. Our success depends in large part on our President and Chief Executive Officer, John F. O'Brien, the loss of whom could adversely affect our business. We do not currently have an employment agreement with Mr. O'Brien or any of our key executives. We cannot be sure that our reinsurers will pay in a timely fashion, if at all. We purchase reinsurance by transferring part of the risk that we have assumed (known as ceding) to a reinsurance company in exchange for part of the premium we receive in connection with the risk. As of December -9- 31, 2001, our reinsurance receivable amounted to approximately $1.4 billion. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us (the reinsured) of our liability to our policyholders or, in cases where we are a reinsurer, to our reinsureds. Accordingly, we bear credit risk with respect to our reinsurers. We cannot be sure that our reinsurers will pay the reinsurance recoverables owed to us currently or in the future or that they will pay such recoverables on a timely basis. Additionally, as discussed above, the availability, scope of coverage, cost, and creditworthiness of reinsurance, could be adversely affected as a result of the September 11, 2001 terrorist attacks and the perceived risks associated with future terrorist activities. We cannot currently estimate the impact of these events on us. Changes in federal income tax law could make some of our products less attractive to customers and increase our tax costs. In June 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 was enacted. The 2001 Act contains provisions that will, over time, significantly lower individual tax rates. This will have the effect of reducing the benefits of deferral on the build-up value of annuities and life insurance products. The 2001 Act also includes provisions that will eliminate, over time, the estate, gift and generation-skipping taxes and partially eliminate the step-up in basis rule applicable to property held in a decedent's estate. Some of these changes might hinder our life and annuity product sales and result in increased surrender of insurance products. We cannot predict the overall effect on the sales of our products of the tax law changes included in the 2001 Act. Congress has, from time to time, also considered other tax legislation that could make our products less attractive to consumers, including legislation that would reduce or eliminate the benefit of the current federal income tax rule under which tax on the build-up value of annuities and life insurance products can generally be deferred until payments are made to our policyholder or other beneficiary and excluded when paid as a death benefit under a life insurance contract. Congress, as well as foreign, state and local governments, also consider from time to time legislation that could increase our tax costs. If such legislation is adopted, our consolidated net income could decline. We cannot predict whether such legislation will be enacted, what the specific terms of any such legislation will be or how, if at all, it might affect sales of our products. -10- -----END PRIVACY-ENHANCED MESSAGE-----