10-Q 1 0001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: September 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from: __________ to _________ Commission file number: 1-13754 ALLMERICA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 04-3263626 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 440 Lincoln Street, Worcester, Massachusetts 01653 (Address of principal executive offices) (Zip Code) (508) 855-1000 (Registrant's telephone number, including area code) _________________________________________________________________ (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date: 53,135,446 shares of common stock outstanding, as of November 1, 2000. 36 Total Number of Pages Included in This Document Exhibit Index is on Page 37 Page 1 TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Income 3 Consolidated Balance Sheets 4 Consolidated Statements of Shareholders' Equity 5 Consolidated Statements of Comprehensive Income 6 Consolidated Statements of Cash Flows 7 Notes to Interim Consolidated Financial Statements 8-14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-34 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 35 SIGNATURES 36 Page 2 PART I - FINANCIAL INFORMATION ITEM I - FINANCIAL STATEMENTS ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions, except per share data) 2000 1999 2000 1999 REVENUES Premiums $527.4 $499.9 $1,545.0 $1,452.9 Universal life and investment product policy fees 110.9 91.4 316.1 262.9 Net investment income 152.3 157.3 441.2 469.8 Net realized investment (losses) gains (30.7) (19.8) (97.9) 106.5 Other income 34.1 32.9 107.6 90.6 -------------- ------------------ Total revenues 794.0 761.7 2,312.0 2,382.7 BENEFITS, LOSSES AND EXPENSES Policy benefits, claims, losses and loss adjustment expenses 479.7 451.8 1,395.3 1,335.2 Policy acquisition expenses 107.8 111.9 339.9 316.5 Other operating expenses 126.9 120.5 375.2 358.2 Restructuring costs 0.0 0.0 20.3 0.0 -------------- ------------------ Total benefits, losses and expenses 714.4 684.2 2,130.7 2,009.9 -------------- ------------------ Income from continuing operations before federal income taxes 79.6 77.5 181.3 372.8 -------------- ------------------ Federal income tax expense: Current 6.7 9.5 1.5 82.7 Deferred 6.4 4.9 27.5 1.4 -------------- ------------------ Total federal income tax expense 13.1 14.4 29.0 84.1 -------------- ------------------ Income from continuing operations before minority interest 66.5 63.1 152.3 288.7 Minority interest: Distributions on mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company (4.0) (4.0) (12.0) (12.0) --------------- ------------------- Income from continuing operations 62.5 59.1 140.3 276.7 Loss from operations of discontinued business (less applicable income tax benefit of $8.4 for the quarter ended September 30, 1999 and $10.1 for the nine months ended September 30, 1999) 0.0 (15.5) 0.0 (18.8) Loss on disposal of group life and health business, including provision of $73.0 for operating losses during phase-out period for the quarter and nine months ended September 30, 1999 (less applicable income tax benefit of $16.4) 0.0 (30.5) 0.0 (30.5) --------------- ------------------- Net income $ 62.5 $ 13.1 $ 140.3 $ 227.4 =============== =================== PER SHARE DATA Basic Income from continuing operations $ 1.18 $ 1.09 $ 2.62 $ 5.00 Loss from operations of discontinued business (less applicable income tax benefit of $0.15 for the quarter ended September 30, 1999 and $0.18 for the nine months ended September 30, 1999) 0.00 (0.29) 0.00 (0.34) Loss on disposal of group life and health business, including provision of $1.35 and $1.32 for operating losses during phase-out period for the quarter and nine months ended September 30, 1999, (less applicable income tax benefit of $0.30 for the quarter and nine months ended September 30, 1999) 0.00 (0.56) 0.00 (0.55) --------------- ------------------ Net income $ 1.18 $ 0.24 $ 2.62 $ 4.11 =============== ================== Weighted average shares outstanding 53.1 54.1 53.5 55.3 =============== ================== Diluted Income from continuing operations $ 1.16 $ 1.08 $ 2.59 $ 4.96 Loss from operations of discontinued business (less applicable income tax benefit of $0.15 for the quarter ended September 30, 1999 and $0.18 for the nine months ended September 30, 1999) 0.00 (0.28) 0.00 (0.34) Loss on disposal of group life and health business, including provision of $1.33 and $1.31 for operating losses during phase-out period for the quarter and nine months ended September 30, 1999, (less applicable income tax benefit of $0.30 and $0.29 for the quarter and nine months ended September 30, 1999) 0.00 (0.56) 0.00 (0.55) --------------- ------------------ Net income $ 1.16 $ 0.24 $ 2.59 $ 4.07 =============== ================== Weighted average shares outstanding 53.9 54.7 54.1 55.8 =============== ================== Dividends declared to shareholders $ 0.25 $ 0.25 $ 0.25 $ 0.25 =============== ==================
The accompanying notes are an integral part of these consolidated financial statements. Page 3 ALLMERICA FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS
(Unaudited) September 30, December 31, (In millions, except per share data) 2000 1999 ASSETS Investments: Fixed maturities-at fair value (amortized cost of $7,726.8 and $7,095.0) $ 7,644.4 $ 6,933.8 Equity securities-at fair value (cost of $56.5 and $49.5) 82.2 83.2 Mortgage loans 489.9 521.2 Policy loans 185.3 170.5 Other long-term investments 195.2 180.0 --------- --------- Total investments 8,597.0 7,888.7 --------- --------- Cash and cash equivalents 305.5 442.2 Accrued investment income 134.4 134.7 Premiums, accounts and notes receivable, net 634.5 583.5 Reinsurance receivable on paid and unpaid losses, benefits and unearned premiums 1,306.6 1,279.9 Deferred policy acquisition costs 1,556.2 1,386.8 Deferred federal income taxes 90.8 141.7 Other assets 573.7 510.2 Closed Block assets 776.0 772.3 Separate account assets 18,660.1 17,629.6 --------- --------- Total assets $32,634.8 $30,769.6 ========= ========= LIABILITIES Policy liabilities and accruals: Future policy benefits $ 2,894.6 $ 2,825.0 Outstanding claims, losses and loss adjustment expenses 2,827.4 2,838.6 Unearned premiums 1,001.6 890.2 Contractholder deposit funds and other policy liabilities 2,066.2 2,041.0 --------- --------- Total policy liabilities and accruals 8,789.8 8,594.8 --------- --------- Expenses and taxes payable 795.0 795.5 Reinsurance premiums payable 91.2 73.0 Trust instruments supported by funding obligations 546.8 50.6 Short-term debt 53.9 45.0 Long-term debt 199.5 199.5 Closed Block liabilities 842.1 842.1 Separate account liabilities 18,659.2 17,628.9 --------- --------- Total liabilities 29,977.5 28,229.4 --------- --------- Minority interest: Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 300.0 ---------- ---------- Commitments and contingencies (Note 10) SHAREHOLDERS' EQUITY Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued 0.0 0.0 Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million shares issued 0.6 0.6 Additional paid-in capital 1,764.1 1,770.5 Accumulated other comprehensive income (36.3) (75.3) Retained earnings 1,009.1 882.2 Treasury stock at cost (7.1 million and 6.2 million shares) (380.2) (337.8) ---------- ---------- Total shareholders' equity 2,357.3 2,240.2 ---------- ---------- Total liabilities and shareholders' equity $32,634.8 $30,769.6 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. Page 4 ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited) Nine Months Ended September 30, (In millions) 2000 1999 PREFERRED STOCK Balance at beginning and end of period $ 0.0 $ 0.0 --------- --------- COMMON STOCK Balance at beginning and end of period 0.6 0.6 --------- --------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of period 1,770.5 1,768.8 Issuance of common stock 0.6 1.3 Unearned compensation related to restricted stock (7.0) 2.8 --------- --------- Balance at end of period 1,764.1 1,772.9 --------- --------- ACCUMULATED OTHER COMPREHENSIVE INCOME NET UNREALIZED APPRECIATION (DEPRECIATION) ON INVESTMENTS Balance at beginning of period (75.3) 180.5 Net appreciation (depreciation) on available-for-sale securities 59.9 (368.4) (Provision) benefit for deferred federal income taxes (20.9) 139.3 --------- --------- Other comprehensive gain (loss) 39.0 (229.1) --------- --------- Balance at end of period (36.3) (48.6) --------- --------- RETAINED EARNINGS Balance at beginning of period 882.2 599.9 Net income 140.3 227.4 Dividends to shareholders (13.4) (13.5) --------- --------- Balance at end of period 1,009.1 813.8 --------- --------- TREASURY STOCK Balance at beginning of period (337.8) (91.2) Shares purchased at cost (61.3) (250.2) Shares reissued at cost 18.9 2.4 --------- --------- Balance at end of period (380.2) (339.0) --------- --------- Total shareholders' equity $2,357.3 $2,199.7 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. Page 5 ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Net income $ 62.5 $ 13.1 $140.3 $227.4 Other comprehensive income: Net appreciation (depreciation) on available-for-sale securities 42.3 (94.4) 59.9 (368.4) (Provision) benefit for deferred federal income taxes (14.9) 43.5 (20.9) 139.3 ------- ------ ------- ------- Other comprehensive income (loss) 27.4 (50.9) 39.0 (229.1) ------- ------ ------- ------- Comprehensive income (loss) $ 89.9 $(37.8) $179.3 $ (1.7) ======= ====== ======= =======
The accompanying notes are an integral part of these consolidated financial statements. Page 6 ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Nine Months Ended September 30, (In millions) 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 140.3 $ 227.4 Adjustments to reconcile net income to net cash provided by operating activities: Net realized investment losses (gains) 102.6 (106.3) Net amortization and depreciation 18.4 25.8 Loss on disposal of group life and health business 0.0 30.5 Deferred federal income taxes 29.8 1.4 Change in deferred acquisition costs (179.2) (140.0) Change in premiums and notes receivable, net of reinsurance payable (32.5) (92.1) Change in accrued investment income (0.2) 14.0 Change in policy liabilities and accruals, net 150.4 157.8 Change in reinsurance receivable (26.5) (69.0) Change in expenses and taxes payable 2.8 (50.5) Separate account activity, net (0.2) 5.4 Other, net (8.2) 10.9 --------- --------- Net cash provided by operating activities 197.5 15.3 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from disposals and maturities of available-for-sale fixed maturities 2,321.2 2,281.1 Proceeds from disposals of equity securities 11.8 376.9 Proceeds from disposals of other investments 31.5 27.3 Proceeds from mortgages matured or collected 83.0 86.5 Purchase of available-for-sale fixed maturities (3,056.7) (2,065.9) Purchase of equity securities (16.1) (71.5) Purchase of other investments (118.2) (113.8) Purchase of company owned life insurance (64.9) 0.0 Capital expenditures (8.4) (24.0) Other, net (0.1) 0.0 --------- --------- Net cash (used in) provided by investing activities (816.9) 496.6 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Deposits and interest credited to contractholder deposit funds 588.1 1,368.0 Withdrawals from contractholder deposit funds (561.1) (1,014.8) Change in trust instruments supported by funding obligations 496.2 0.0 Change in short-term debt 8.9 (177.5) Proceeds from issuance of common stock 0.6 1.3 Treasury stock purchased at cost (58.9) (250.2) Treasury stock reissued at cost 18.9 2.4 Other, net (1.1) (1.1) --------- --------- Net cash provided by (used in) financing activities 491.6 (71.9) --------- --------- Net change in cash and cash equivalents (127.8) 440.0 Net change in cash held in the Closed Block (8.9) 9.0 Cash and cash equivalents, beginning of period 442.2 550.3 --------- --------- Cash and cash equivalents, end of period $ 305.5 $ 999.3 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. Page 7 ALLMERICA FINANCIAL CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation and Principles of Consolidation The accompanying unaudited consolidated financial statements of Allmerica Financial Corporation ("AFC" or the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the requirements of Form 10-Q. The interim consolidated financial statements of AFC include the accounts of First Allmerica Financial Life Insurance Company ("FAFLIC"); its wholly- owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); non-insurance subsidiaries (principally brokerage and investment advisory services); Allmerica Asset Management, Inc. ("AAM", a wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned non- insurance subsidiary of AAM); The Hanover Insurance Company ("Hanover", a wholly-owned subsidiary of Allmerica P&C); Citizens Corporation (a wholly- owned non-insurance subsidiary of Hanover); and Citizens Insurance Company of America ("Citizens", a wholly-owned subsidiary of Citizens Corporation). The Closed Block assets and liabilities and its results of operations are presented in the consolidated financial statements as single line items. Unless specifically stated, all disclosures contained herein supporting the consolidated financial statements exclude the Closed Block related amounts. All significant intercompany accounts and transactions have been eliminated. The accompanying interim consolidated financial statements reflect, in the opinion of the Company's management, all adjustments necessary for a fair presentation of the financial position and results of operations. The results of operations for the nine months ended September 30, 2000, are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company's 1999 Annual Report to Shareholders, as filed on Form 10-K with the Securities and Exchange Commission. 2. New Accounting Pronouncements 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 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 Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"), which establishes accounting and reporting standards for derivative instruments. Statement No. 133 requires that 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 commitments'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 ineffecive, all or a portion of the change in value of the derivative will be recognized currently in earnings. This statement is effective for fiscal years beginning after June 15, 2000. The Company has not yet determined the impact that the adoption of Statement No. 133 will have on the Company's results of operations or its financial position. Page 8 3. Discontinued Operations During the second quarter of 1999, the Company approved a plan to exit its group life and health insurance business, consisting of its Employee Benefit Services ("EBS") business, its Affinity Group Underwriters ("AGU") business and its accident and health assumed reinsurance pool business ("reinsurance pool business"). During the third quarter of 1998, the Company ceased writing new 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 $47.4 million, partially offset by net proceeds from the sale of the EBS business of approximately $16.9 million. Subsequent to a measurement date of June 30, 1999, approximately $27.5 million of the aforementioned $47.4 million loss has been generated from the operations of the discontinued business. In March of 2000, the Company transferred its EBS business to Great-West Life and Annuity Insurance Company of Denver and received consideration of approximately $22 million, based on renewal rights for existing policies. Additional consideration may be received in 2001, based on premium in force as of March 2001. However, the Company retained policy liabilities estimated at $173.5 million at September 30, 2000 related to this business. As permitted by APB Opinion No. 30, the Consolidated Balance Sheets have not been segregated between continuing and discontinued operations. At September 30, 2000, the discontinued segment had assets of approximately $505.1 million consisting primarily of invested assets, premiums and fees receivable, and reinsurance recoverables, and liabilities of approximately $419.8 million consisting primarily of policy liabilities. Revenues for the discontinued operations were $39.0 million and $91.9 million for the quarters ended September 30, 2000 and 1999, respectively, and $174.7 million and $279.0 million for the nine months ended September 30, 2000 and 1999, respectively. 4. Significant Transactions As of September 30, 2000, the Company has repurchased approximately $391.8 million, or approximately 7.3 million shares, of its common stock under programs authorized by the Board of Directors (the "Board"). The Company repurchased approximately 1.2 million shares at cost of approximately $58.9 million in 2000 while share repurchases were approximately 4.5 million at a cost of approximately $250.2 million in 1999. As of September 30, 2000, the Board had authorized total stock repurchases of $500.0 million, leaving approximately $108.2 million available to the Company for future repurchases. During the second quarter of 2000, the Company adopted a formal company-wide restructuring plan. This plan is the result of a corporate initiative that began in the fall of 1999, intended to reduce expenses and enhance revenues. As a result of the Company's restructuring plan, it recognized a pre-tax charge of $21.0 million during the second quarter of 2000 as reflected in restructuring costs in the Consolidated Statements of Income. Approximately $4.6 million of this charge relates to severance and other employee related costs resulting from the elimination of approximately 360 positions, of which 160 have been eliminated as of September 30, 2000. All levels of employees, from staff to senior management, were affected by the restructuring. In addition, approximately $16.4 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 September 30, 2000, the Company has made payments of approximately $12.5 million related to this restructuring plan, of which approximately $2.0 million relates to severance and other employee related costs. On October 29, 1998, the Company announced that it had adopted a formal restructuring plan for its Risk Management segment. As a result of this restructuring initiative, the Company recognized a pre-tax loss of $9.0 million in 1998. This loss was reduced by $1.9 million and $0.7 million during the fourth quarter of 1999 and the second quarter of 2000, respectively. The $1.9 million reduction resulted from the reinstatement of 66 positions, whereas the $0.7 million reduction resulted from anticipated idle lease space subsequently utilized. Payments of approximately $0.5 million, $4.8 million and $0.1 million have been made by the Company in 2000, 1999 and 1998, respectively. Page 9 5. Federal Income Taxes Federal income tax expense for the nine months ended September 30, 2000 and 1999 has been computed using estimated effective tax rates. These rates are revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates. 6. Other Comprehensive Income The following table provides a reconciliation of gross unrealized gains (losses) to the net balance shown in the Statements of Comprehensive Income:
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30 September 30 (In millions) 2000 1999 2000 1999 Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (net of income taxes (benefit) of $4.4 million and $(48.2) million for the quarters ended September 30, 2000 and 1999 and $(12.5) million and $(109.2) million for the nine months ended September 30, 2000 and 1999) $10.9 $(67.0) $(36.0) $(156.0) Less: reclassification adjustment for (losses) gains included in net income (net of income taxes (benefit) of $(10.5) million and $(4.7) million for the quarters ended September 30, 2000 and 1999 and $(33.4) million and $30.1 million for the nine months ended September 30, 2000 and 1999) (16.5) (16.1) (75.0) 73.1 ------- ------- ------- -------- Other comprehensive income (loss) $ 27.4 $(50.9) $ 39.0 $(229.1) ======= ======= ======= ========
7. Closed Block Included in other income in the Consolidated Statements of Income is a net pre-tax (loss) contribution from the Closed Block of $(1.1) million and $3.7 million for the third quarter and nine months ended September 30, 2000, respectively, compared to $3.3 million and $10.4 million for the third quarter and nine months ended September 30, 1999, respectively. Summarized financial information of the Closed Block is as follows:
(Unaudited) September 30, December 31, (In millions) 2000 1999 ASSETS Fixed maturities-at fair value (amortized cost of $381.9 and $387.4) $ 371.4 $ 372.9 Mortgage loans 148.9 136.3 Policy loans 195.2 201.1 Cash and cash equivalents 31.5 22.6 Accrued investment income 14.5 14.0 Deferred policy acquisition costs 11.4 13.1 Other assets 3.1 12.3 -------- --------- Total assets $ 776.0 $ 772.3 ======== ========= LIABILITIES Policy liabilities and accruals $ 826.5 $ 835.2 Other liabilities 15.6 6.9 -------- --------- Total liabilities $ 842.1 $ 842.1 ======== =========
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(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30 September 30 (In millions) 2000 1999 2000 1999 REVENUES Premiums $ 7.7 $ 8.0 $42.0 $43.6 Net investment income 13.1 13.9 40.1 40.5 Net realized investment losses (1.1) (0.7) (4.7) (0.2) ------ ------ ------ ------ Total revenues 19.7 21.2 77.4 83.9 ------ ------ ------ ------ BENEFITS AND EXPENSES Policy benefits 20.2 17.2 71.9 71.6 Policy acquisition expenses 0.5 0.6 1.5 1.7 Other operating expenses 0.1 0.1 0.3 0.2 ------ ------ ------ ------ Total benefits and expenses 20.8 17.9 73.7 73.5 ------ ------ ------ ------ (Loss) contribution from the Closed Block $(1.1) $ 3.3 $ 3.7 $10.4 ====== ====== ====== ======
Many expenses related to Closed Block operations are charged to operations outside the Closed Block; accordingly, the contribution from the Closed Block does not represent the actual profitability of the Closed Block operations. Operating costs and expenses outside of the Closed Block are, therefore, disproportionate to the business outside the Closed Block. 8. Segment Information The Company offers financial products and services in two major areas: Risk Management and Asset Accumulation. Within these broad areas, the Company conducts business principally in three operating segments. These segments are Risk Management, Allmerica Financial Services and Allmerica Asset Management. The separate financial information of each segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. A summary of the Company's reportable segments is included below. The Risk Management Segment manages its products through three distribution channels identified as Standard Markets, Sponsored Markets, and Specialty Markets. Standard Markets consists of the aggregate operating results for the three channels previously characterized as Hanover North, Hanover South and Citizens Midwest. Maintaining a strong regional focus, Standard Markets sells property and casualty insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. Sponsored Markets offers property and casualty products to members of affinity groups and other organizations. This distribution channel also focuses on worksite distribution, which offers discounted property and casualty (automobile and homeowners) insurance through employer sponsored programs. Specialty Markets offers specialty or program property and casualty business nationwide. This channel focuses on niche classes of risks and leverages specific underwriting processes. During the second quarter of 1999, the Company approved a plan to exit its group life and health business, consisting of its EBS business, its AGU business and its reinsurance pool business. Results of operations from this business have been segregated and reported as a component of discontinued operations in the Consolidated Statements of Income. Operating results from this business were previously reported in the Sponsored Markets and Specialty Markets distribution channels. Prior to 1999, results of the group life and health business were included in the Corporate Risk Management Services segment, while all other Risk Management business was reflected in the Property and Casualty segment. Page 11 The Asset Accumulation group includes two segments: Allmerica Financial Services and Allmerica Asset Management. The Allmerica Financial Services segment includes variable annuities, variable universal life and traditional life insurance products, as well as group retirement products, such as defined benefit and 401(k) plans and tax-sheltered annuities. Through its Allmerica Asset Management segment, the Company offers its customers the option of investing in Guaranteed Investment Contracts ("GICs"), such as short term and long term funding agreements. Short term funding agreements are investment contracts issued to institutional buyers, such as money market funds, corporate cash management programs and securities lending collateral programs, which typically have short maturities and periodic interest rate resets based on an index such as LIBOR. Long term funding agreements are investment contracts issued to various businesses or charitable trusts, which are used to support debt issued by the trust to foreign and domestic institutional buyers, such as banks, insurance companies, and pension plans. These funding agreements have long maturities and may be issued with a fixed or variable interest rate based on an index such as LIBOR. This segment is also a Registered Investment Advisor providing investment advisory services, primarily to affiliates and to third parties, such as money market and other fixed income clients. Income in the Allmerica Asset Management segment is generated by interest margins earned on the Company's GICs, as well as investment advisory fees earned on assets under management. In addition to the three operating segments, the Company has a Corporate segment, which consists primarily of cash, investments, corporate debt, Capital Securities and corporate overhead expenses. Corporate overhead expenses reflect costs not attributable to a particular segment, such as those generated by certain officers and directors, technology, finance, human resources and legal. 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, 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, 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, segment income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles. Page 12 Summarized below is financial information with respect to business segments for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Segment revenues: Risk Management $588.4 $558.4 $1,725.3 $1,634.2 ------ ------ -------- -------- Asset Accumulation Allmerica Financial Services 216.2 200.2 656.7 598.8 Allmerica Asset Management 41.0 41.5 105.2 116.3 ------ ------ -------- -------- Subtotal 257.2 241.7 761.9 715.1 ------ ------ -------- -------- Corporate 2.2 1.3 4.9 4.9 Intersegment revenues (1.2) (1.3) (3.8) (4.3) ------ ------ -------- -------- Total segment revenues including Closed Block 846.6 800.1 2,488.3 2,349.9 Adjustments to segment revenues: Adjustment for Closed Block (21.9) (18.6) (78.4) (73.7) Net realized (losses) gains (30.7) (19.8) (97.9) 106.5 ------ ------ -------- -------- Total revenues $794.0 $761.7 $2,312.0 $2,382.7 ====== ====== ======== ======== Segment income (loss) before federal income taxes and minority interest: Risk Management $ 59.4 $ 49.5 $ 156.4 $ 134.6 ------ ------ -------- -------- Asset Accumulation Allmerica Financial Services 56.7 54.7 166.6 151.3 Allmerica Asset Management 5.8 5.7 15.5 18.2 ------ ------ -------- -------- Subtotal 62.5 60.4 182.1 169.5 ------ ------ -------- -------- Corporate (13.7) (13.7) (40.4) (43.2) ------ ------ -------- -------- Segment income before federal income taxes and minority interest 108.2 96.2 298.1 260.9 Adjustments to segment income: Net realized investment (losses) gains, net of amortization (28.6) (18.7) (96.5) 111.9 Restructuring costs 0.0 0.0 (20.3) 0.0 ------ ------ -------- -------- Income from continuing operations before federal income taxes and minority interest $ 79.6 $ 77.5 $ 181.3 $ 372.8 ====== ====== ======== ========
Identifiable Assets Deferred Acquisition Costs (Unaudited) (Unaudited) September 30, December 31, September 30, December 31, (In millions) 2000 1999 2000 1999 Risk Management $ 6,055.5 $ 5,869.0 $ 188.3 $ 173.3 ---------- ---------- ---------- ---------- Asset Accumulation Allmerica Financial Services 24,269.9 23,435.7 1,367.7 1,213.1 Allmerica Asset Management 2,193.7 1,387.6 0.2 0.4 ---------- ---------- ---------- ---------- Subtotal 26,463.6 24,823.3 1,367.9 1,213.5 Corporate 115.7 77.3 0.0 0.0 ---------- ---------- ---------- ---------- Total $ 32,634.8 $ 30,769.6 $ 1,556.2 $ 1,386.8 ========== ========== ========== ==========
Page 13 9. Earnings Per Share The following table provides share information used in the calculation of the Company's basic and diluted earnings per share:
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions, except per share data) 2000 1999 2000 1999 Basic shares used in the calculation of earnings per share 53.1 54.1 53.5 55.3 Dilutive effect of securities: Employee stock options 0.5 0.4 0.3 0.3 Non-vested stock grants 0.3 0.2 0.3 0.2 ----- ----- ----- ----- Diluted shares used in the calculation of earnings per share 53.9 54.7 54.1 55.8 ===== ===== ===== ===== Per share effect of dilutive securities on income from continuing operations $0.02 $0.01 $0.03 $0.04 ===== ===== ===== ===== Per share effect of dilutive securities on net income $0.02 $0.00 $0.03 $0.04 ===== ===== ===== =====
10. Commitments and Contingencies Litigation In 1997, a lawsuit on behalf of a putative class was instituted against the Company alleging fraud, unfair or deceptive acts, breach of contract, misrepresentation, and related claims in the sale of life insurance policies. In November 1998, the Company and the plaintiffs entered into a settlement agreement and in May 1999, the Federal District Court in Worcester, Massachusetts approved the settlement agreement and certified the class for this purpose. AFC recognized a $31.0 million pre-tax expense in 1998 related to this litigation. Although the Company believes that this expense reflects appropriate recognition of its obligation under the settlement, this estimate assumes the availability of insurance coverage for certain claims, and the estimate may be revised based on the amount of reimbursement actually tendered by AFC's insurance carriers, and based on changes in the Company's estimate of the ultimate cost of the benefits to be provided to members of the class. The Company has been named a defendant in various other legal proceedings arising in the normal course of business. In the Company's opinion, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised. Page 14 PART I ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the interim consolidated results of operations and financial condition of the Company should be read in conjunction with the interim Consolidated Financial Statements and related footnotes included elsewhere herein and the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the 1999 Annual Report to Shareholders, as filed on Form 10-K with the Securities and Exchange Commission. INTRODUCTION The results of operations for Allmerica Financial Corporation and subsidiaries ("AFC" or "the Company") include the accounts of AFC; First Allmerica Financial Life Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); Allmerica Asset Management, Inc. ("AAM," a wholly-owned non-insurance subsidiary of AFC); Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C," a wholly-owned non-insurance subsidiary of AAM); The Hanover Insurance Company ("Hanover," a wholly-owned subsidiary of Allmerica P&C); Citizens Corporation (a wholly-owned non-insurance subsidiary of Hanover); Citizens Insurance Company of America ("Citizens," a wholly-owned subsidiary of Citizens Corporation) and certain other insurance and non-insurance subsidiaries. Description of Operating Segments The Company offers financial products and services in two major areas: Risk Management and Asset Accumulation. Within these broad areas, the Company conducts business principally in three operating segments. These segments are Risk Management, Allmerica Financial Services, and Allmerica Asset Management. The separate financial information of each segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. A summary of the Company's reportable segments is included below. The Risk Management Segment manages its products through three distribution channels identified as Standard Markets, Sponsored Markets, and Specialty Markets. Standard Markets consists of the aggregate operating results for the three channels previously characterized as Hanover North, Hanover South and Citizens Midwest. Maintaining a strong regional focus, Standard Markets sells property and casualty insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. Sponsored Markets offers property and casualty products to members of affinity groups and other organizations. This distribution channel also focuses on worksite distribution, which offers discounted property and casualty (automobile and homeowners) insurance through employer sponsored programs. Specialty Markets offers specialty or program property and casualty business nationwide. This channel focuses on niche classes of risks and leverages specific underwriting processes. The Asset Accumulation group includes two segments: Allmerica Financial Services and Allmerica Asset Management. The Allmerica Financial Services segment includes variable annuities, variable universal life and traditional life insurance products, as well as group retirement products, such as defined benefit and 401(k) plans and tax-sheltered annuities. Through its Allmerica Asset Management segment, the Company offers its customers the option of investing in Guaranteed Investment Contracts ("GICs"), such as short term and long term funding agreements. Short term funding agreements are investment contracts issued to institutional buyers, such as money market funds, corporate cash management programs and securities lending collateral programs, which typically have short maturities and periodic interest rate resets based on an index such as LIBOR. Long term funding agreements are investment contracts issued to various business or charitable trusts, which are used to support debt issued by the trust to foreign and domestic institutional buyers, such as banks, insurance companies, and pension plans. These funding agreements have long maturities and may be issued with a fixed or variable interest rate based on an index such as LIBOR. This segment is also a Registered Investment Advisor providing investment advisory services, primarily to affiliates and to third parties, such as money market and other fixed income clients. In addition to the three operating segments, the Company has a Corporate segment, which consists primarily of cash, investments, corporate debt, Capital Securities and corporate overhead expenses. Corporate overhead expenses reflect costs not attributable to a particular segment, such as those generated by certain officers and directors, technology, finance, human resources and legal. Page 15 Results of Operations Consolidated Overview Consolidated net income includes the results of each segment of the Company, which management evaluates on a pre-tax and pre-minority interest basis. In addition, net income also includes certain items which management believes are not indicative of overall operating trends, such as net realized investment gains and losses, net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes and certain other items. While these items may be significant components in understanding and assessing the Company's financial performance, management believes that the presentation of "Adjusted Net Income", which excludes these items, enhances understanding of the Company's results of operations by highlighting net income attributable to the normal, recurring operations of the business. However, adjusted net income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles. Net income for the third quarter increased $49.4 million, or 377.1%, to 62.5 million, compared to $13.1 million for the same period in 1999, primarily due to the absence in 2000 of $46.0 million after tax losses resulting from the discontinuation of the Company's group life and health business in 1999. Net income for the first nine months of 2000 decreased $87.1 million, or 38.3%, to $140.3 million, compared to $227.4 million for the first nine months of 1999. The reduction in net income resulted primarily from a $143.9 million decline in net realized investment gains and $13.2 million of restructuring charges in 2000. These items were partially offset by the aforementioned discontinuation of the Company's group life and health business and an increase in adjusted net income. The following table reflects adjusted net income and a reconciliation to consolidated net income. Adjusted net income consists of segment income (loss), federal income taxes on segment income and minority interest on preferred dividends.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Segment income (loss) before federal income taxes and minority interest: Risk Management $ 59.4 $ 49.5 $156.4 $134.6 ------ ------ ------ ------- Asset Accumulation Allmerica Financial Services 56.7 54.7 166.6 151.3 Allmerica Asset Management 5.8 5.7 15.5 18.2 ------ ------ ------ ------- Subtotal 62.5 60.4 182.1 169.5 Corporate (13.7) (13.7) (40.4) (43.2) ------ ------ ------ ------- Segment income before federal income taxes and minority interest 108.2 96.2 298.1 260.9 Federal income taxes on segment income (24.3) (16.4) (65.3) (48.8) Minority interest on preferred dividends (4.0) (4.0) (12.0) (12.0) ------ ------ ------ ------- Adjusted net income 79.9 75.8 220.8 200.1 Adjustments (net of taxes, minority interest and amortization, as applicable): Net realized investment (losses) gains (17.4) (16.7) (67.3) 76.6 Restructuring costs 0.0 0.0 (13.2) 0.0 ------ ------ ------- ------- Income from continuing operations 62.5 59.1 140.3 276.7 Discontinued operations: Loss from operations of discontinued group life and health business (net of applicable taxes) 0.0 (15.5) 0.0 (18.8) Loss on disposal of group life and health business (net of applicable taxes) 0.0 (30.5) 0.0 (30.5) ------ ------- ------ ------- Net income $ 62.5 $ 13.1 $140.3 $227.4 ====== ======= ====== =======
Page 16 Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 The Company's segment income before taxes and minority interest increased $12.0 million, or 12.5%, to $108.2 million in the third quarter of 2000. This increase is attributable to increased income from Risk Management, Allmerica Financial Services and Allmerica Asset Management of $9.9 million, $2.0 million and $0.1 million, respectively. Risk Management's segment income increased primarily due to growth of net premiums earned of approximately $13.0 million, principally attributable to commercial lines rate increases and to improved loss adjustment, policy acquisition and other operating expenses totaling $14.6 million. In addition, decreased catastrophe losses and net activity related to the Company's aggregate excess of loss reinsurance treaty, further discussed in the Risk Management Reinsurance section, favorably impacted segment income by $4.2 million and $2.6 million, respectively. These favorable items were partially offset by a $27.4 million decrease in favorable development on prior years' reserves. The increase in the Allmerica Financial Services segment was principally due to higher asset-based fee income driven by market appreciation and additional deposits in the variable product lines, partially offset by higher policy benefits, and policy acquisition and other operating expenses. The effective tax rate for segment income was 22.5% for the third quarter of 2000 compared to 17.0% for the third quarter of 1999. The increase in the tax rate was driven primarily by an increase in property and casualty underwriting income and by a decrease in tax-exempt investment income. Net realized losses on investments, after taxes, were $17.4 million in the third quarter of 2000, resulting primarily from the recognition of after tax realized losses of $13.9 million related to sales of approximately $600 million of fixed maturities. In addition, the Company recognized $6.3 million in after tax realized losses due to impairments of fixed maturities. During the third quarter of 1999, net realized losses on investments after taxes of $16.7 million resulted primarily from net realized losses of $11.0 million and $5.9 million on sales of fixed maturities and equity securities, respectively. 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 business and its accident and health assumed 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 Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". In the third quarter of 1999, the operating results from the discontinued segment were adjusted to reflect the recording of additional reserves related to accident claims from prior years. On October 6, 1999, the Company entered into an agreement with Great-West Life and Annuity Insurance Company of Denver, which provided for the sale of the Company's EBS business effective March 1, 2000. The Company has recorded a $30.5 million loss, net of taxes, on the disposal of its group life and health business. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 The Company's segment income before taxes and minority interest increased $37.2 million, or 14.3%, to $298.1 million in the first nine months of 2000. This increase is attributable to increased income of $21.8 million from the Risk Management segment, $12.6 million from the Asset Accumulation group and a decreased loss of $2.8 million in the Corporate segment. The increase in the Risk Management segment is primarily attributable to growth of net premiums earned of approximately $44.0 million principally due to commercial lines rate increases and to a $24.1 million decrease in catastrophe losses. In addition, policy acquisition and other operating expenses decreased $14.4 million, excluding the effects of the aforementioned aggregate excess of loss treaty. Partially offsetting these favorable items is a $54.1 million decrease in favorable development on prior years' reserves. The increase in the Allmerica Financial Services segment of $15.3 million is primarily attributable to higher asset-based fee income driven by market appreciation and additional deposits in the variable product lines, partially offset by higher policy acquisition and other operating expenses. The operating loss in the Corporate segment decreased primarily due to lower corporate overhead costs. These items were partially offset by a decrease in the Allmerica Asset Management segment of $2.7 million principally due to decreased earnings on GICs. This decline resulted from short-term funding agreement withdrawals in the fourth quarter of 1999 and a shift to lower margin long- term funding agreements in 2000. The effective tax rate for segment income was 21.9% for the first nine months of 2000 compared to 18.7% for the first nine months of 1999. The increase in the tax rate was driven primarily by an increase in property and casualty underwriting income and by a decrease in tax-exempt investment income. Page 17 Net realized losses on investments after taxes were $67.3 million in the firstnine months of 2000, primarily attributable to after tax realized losses of $57.6 million resulting from the sale of approximately $1.7 billion fixed income securities. In addition, the Company recognized $21.0 million in after tax realized losses due to impairments of fixed maturities During the first nine months of 1999, net realized gains on investments after taxes of $76.6 million resulted primarily from net realized gains on equity securities and partnership investments of $93.2 million and $4.0 million, respectively, partially offset by $22.2 million of after-tax realized losses from impairments recognized on fixed maturities. During the second quarter of 2000, the Company recognized a one-time after-tax restructuring charge of $13.2 million. This charge is the result of a formal company-wide restructuring plan, intended to reduce expenses and enhance revenues. 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:
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Segment revenues Net premiums earned $527.2 $499.6 $1,543.8 $1,451.8 Net investment income 55.2 54.3 164.8 167.8 Other income 6.0 4.5 16.7 14.6 ------ ------ -------- -------- Total segment revenues 588.4 558.4 1,725.3 1,634.2 Losses and operating expenses Policy benefits, claims, losses and loss adjustment expenses 390.9 364.2 1,150.2 1,069.7 Policy acquisition expenses 93.4 94.6 279.4 276.2 Other operating expenses 44.7 50.1 139.3 153.7 ------ ------ -------- -------- Total losses and operating expenses 529.0 508.9 1,568.9 1,499.6 ------ ------ -------- -------- Segment income $ 59.4 $ 49.5 $ 156.4 $ 134.6 ====== ====== ======== ======== Includes policyholders' dividends of $4.9 million and $2.0 million for the quarters ended September 30, 2000 and 1999, respectively, and $11.3 million and $8.1 million for the nine months ended September 30, 2000 and 1999, respectively.
Page 18 Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Premium Risk Management's net premiums earned increased $27.6 million, or 5.5%, to $527.2 million during the quarter ended September 30, 2000. This is primarily attributable to increases of $9.8 million, or 4.3%, $7.5 million, or 14.9%, $6.5 million, or 10.4%, and $5.8 million, or 11.9%, in the personal automobile, commercial automobile, homeowners, and workers' compensation lines, respectively. The increase in personal automobile net premiums earned is primarily the result of a 4.9% increase in policies in force and a 1.0% Massachusetts rate increase since September 30, 1999. The increase in the commercial automobile line is the result of an overall rate increase of 7.5% over prior year. In addition, homeowners' rates increased 4.0% over prior year and policies in force increased 2.6% since September 30, 1999. The increase in the workers' compensation line is primarily the result of a 7.7% rate increase over the prior year. Partially offsetting these increases is $5.3 million of ceded premiums under the aforementioned aggregate excess of loss reinsurance treaty in 2000. Segment Income Risk Management's segment income increased $9.9 million, or 20.0%, to $59.4 million for the quarter ended September 30, 2000. The improvement in segment income is primarily attributable to net premiums earned growth of approximately $13.0 million primarily as a result of commercial lines rate increases. In addition, loss adjustment expenses decreased $9.1 million and policy acquisition and other operating expenses decreased $5.5 million for the quarter ended September 30, 2000. These decreases are primarily the result of continued efficiencies gained through consolidation of claims and underwriting processes. Underwriting results were also favorably impacted by improved current year claims activity in the commercial multiple peril and personal automobile lines and a $4.2 million decrease in catastrophe losses to $16.0 million for the third quarter of 2000. Partially offsetting these favorable items is a $27.4 million decrease in favorable development on prior years' loss and loss adjustment expense reserves primarily in the commercial multiple peril and personal automobile lines. Results were also favorably impacted by $2.6 million due to the aforementioned aggregate excess of loss reinsurance treaty. The following table summarizes the results of operations for the distribution channels of the Risk Management segment. Operating results for the distribution channels represent statutory underwriting profit (loss). Statutory underwriting results differ from GAAP underwriting results primarily due to the deferral and amortization of certain expenses. Segment income represents the aggregate of statutory underwriting results, GAAP net investment income, other income and expenses, and other statutory to GAAP adjustments.
(Unaudited) Quarter Ended September 30, 2000 Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other Total Statutory underwriting profit (loss) $ 0.0 $ 6.3 $ (4.9) $ (3.6) $ (2.2) ----------------------------------------- Reconciliation to segment income: Net investment income 55.2 Other income and expenses, net 3.3 Other Statutory to GAAP adjustments 3.1 ------ Segment income $59.4 ====== Statutory net premiums written $388.0 $161.8 $ 10.6 $ 1.1 $561.5 ------------------------------------------------ Statutory combined ratio 98.6 93.6 149.2 N/M 98.8 ------------------------------------------------ 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 Page 19
(Unaudited) Quarter Ended September 30, 1999 Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other Total Statutory underwriting (loss) profit $(3.6) $(7.7) $(3.3) $ 1.8 $(12.8) --------------------------------------- Reconciliation to segment income: Net investment income 54.3 Other income and expenses, net 0.9 Other Statutory to GAAP adjustments 7.1 ------- Segment income $ 49.5 ======= Statutory net premiums written $357.5 $153.5 $ 9.6 $ 3.0 $ 523.6 ----------------------------------------------- Statutory combined ratio 99.9 103.2 132.2 N/M 101.3 ----------------------------------------------- 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 Standard Markets Standard Markets' net premiums written increased $30.5 million, or 8.5%, to $388.0 million for the quarter ended September 30, 2000. This improvement is primarily attributable to increases of $14.8 million, or 12.7%, $5.2 million, or 7.2%, $5.1 million, or 12.1%, and $3.8 million, or 7.6%, in the personal automobile, commercial multiple peril, homeowners, and commercial automobile lines, respectively. The increase in the personal automobile line is primarily the result of an 11.8% increase in policies in force in the Northeast since September 30, 1999 and a 1.0% rate increase in Massachusetts. These favorable items are partially offset by a 7.6% decrease in policies in force in the Midwest over the prior year. The increase in commercial multiple peril net premiums written is primarily due to rate increases of 16.0% and 5.4% in Michigan and New York, respectively, and a 2.3% increase in policies in force since September 30, 1999. In addition, homeowners' rates increased 7.2% in Michigan over the prior year and policies in force increased 1.8% since September 30, 1999. The increase in commercial automobile net premiums written is primarily the result of rate increases of 7.5%, 2.0%, and 13.8% in Michigan, Massachusetts, and New York, respectively, partially offset by a 2.3% decrease in policies in force since September 30, 1999. Partially offsetting these increases is $3.6 million of ceded premiums under the aggregate excess of loss reinsurance treaty in 2000. Standard Markets' underwriting results improved $3.6 million to breakeven for the quarter ended September 30, 2000 compared to a $3.6 million underwriting loss in the same period in 1999. This is primarily attributable to a $5.4 million decrease in underwriting expenses for the third quarter of 2000 as a result of reductions in employee related expenses and efficiencies gained through process consolidations. In addition, catastrophe losses decreased $3.6 million to $9.2 million for the third quarter of 2000. Results were also favorably impacted by $2.7 million as a result of the aforementioned aggregate excess of loss reinsurance treaty. Partially offsetting these favorable items is a decrease in favorable development on prior years' loss reserves primarily in the commercial multiple peril line and increased current year claims frequency and severity in the workers' compensation, homeowners, and commercial automobile lines over the same period in 1999. Sponsored Markets Sponsored Markets' net premiums written increased $8.3 million, or 5.4%, to $161.8 million for the quarter ended September 30, 2000. This increase is primarily attributable to a $7.9 million, or 6.9%, increase in the personal automobile line resulting from a 3.9% increase in policies in force over the same period in 1999 and the aforementioned Massachusetts rate increase. In addition, homeowners' net premiums written increased $3.7 million, or 10.9%, primarily attributable to a 7.2% Michigan rate increase and a 3.5% increase in policies in force since September 30, 1999. Partially offsetting these increases is $1.7 million of ceded premiums under the aggregate excess of loss reinsurance treaty in 2000. Page 20 Sponsored Markets' underwriting results improved $14.0 million to an underwriting profit of $6.3 million for the quarter ended September 30, 2000. The improvement in underwriting results is primarily attributable to a $10.5 million decrease in loss adjustment expenses. This is the result of a decrease in legal fees and employee related expenses in third quarter 2000. In addition, underwriting expenses decreased $2.8 million for the third quarter of 2000. Results were also favorably impacted by $1.0 million due to the aforementioned aggregate excess of loss reinsurance treaty. Partially offsetting these favorable items is an increase in current year claims activity in the homeowners line. Specialty Markets Specialty Markets' net premiums written increased $1.0 million, or 10.4%, to $10.6 million for the quarter ended September 30, 2000. This increase is primarily attributable to a $1.8 million increase in the workers' compensation line, primarily resulting from an increase of 18.6% in policies in force over the same period in 1999. This increase is partially offset by increased ceded premiums due to greater utilization of reinsurance in the other commercial liability line. The Company continually assesses the profitability of each individual program and seeks to exit programs that do not meet established Company underwriting guidelines. Specialty Markets' underwriting results deteriorated $1.6 million to an underwriting loss of $4.9 million for the quarter ended September 30, 2000. The deterioration in underwriting results is primarily the result of an increase in current year claims frequency in the commercial automobile line compared to the same period in 1999. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 Premium Risk Management's net premiums earned increased $92.0 million, or 6.3%, to $1,543.8 million for the nine months ended September 30, 2000. Results reflected ceded premiums of $5.3 million and $21.9 million under the aggregate excess of loss reinsurance treaty for 2000 and 1999, respectively. Excluding the impact of this treaty, net premiums earned increased $75.4 million, or 5.1%. This is primarily attributable to increases of $18.8 million, or 13.1%, $18.0 million, or 12.4%, and $16.4 million, or 2.4%, in the workers' compensation, commercial automobile, and personal automobile lines, respectively. The increase in the workers' compensation line is the result of 27.9% and 7.5% rate increases over prior year in the states of Maine and Michigan, respectively. The increase in commercial automobile net premiums earned is primarily the result of the aforementioned Michigan, Massachusetts, and New York rate increases since September 30, 1999. The increase in the personal automobile line is primarily the result of a 4.9% increase in policies in force since September 30, 1999 and a 1.0% Massachusetts rate increase over prior year. Commercial multiple peril net premiums earned increased as well, by $11.6 million, or 5.4%, attributable to a 16.0% Michigan rate increase and a 2.3% increase in policies in force since September 30, 1999. In addition, homeowners' earned premium increased $11.1 million, or 5.8%, resulting primarily from a 7.2% rate increase in Michigan and a 2.6% increase in policies in force since September 30, 1999. Segment Income Risk Management's segment income increased $21.8 million, or 16.2%, to $156.4 million for the nine months ended September 30, 2000. Net benefits of $2.6 and $16.9 million are included in segment income as a result of the aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. Excluding the impact from this treaty, the total improvement of $36.1 million in segment income is primarily attributable to net premiums earned growth of approximately $44.0 million primarily as a result of commercial lines rate increases. In addition, catastrophe losses decreased $24.1 million to $49.0 million for the nine months ended September 30, 2000, compared to $73.1 million for the same period in 1999. Policy acquisition and other operating expenses decreased $14.4 million, excluding $1.1 million and $4.3 million favorable impacts in 2000 and 1999, respectively, from the aforementioned aggregate excess of loss treaty. This decrease is primarily the result of continued efficiencies gained through consolidation of underwriting processes. Partially offsetting these favorable items is a $54.1 million decrease in favorable development on prior years' loss and loss adjustment expense reserves primarily in the commercial multiple peril and personal automobile lines. The following table summarizes the results of operations for the distribution channels of the Risk Management segment. Operating results for the distribution channels represent statutory underwriting profit (loss). Statutory underwriting results differ from GAAP underwriting results primarily due to the deferral and amortization of certain expenses. Segment income represents the aggregate of statutory underwriting results, GAAP net investment income, other income and expenses, and other statutory to GAAP adjustments. Page 21
(Unaudited) Nine Months Ended September 30, 2000 Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other Total Statutory underwriting (loss) profit $ (32.8) $ 8.7 $ (4.7) $(6.8) $ (35.6) --------------------------------------- Reconciliation to segment income: Net investment income 164.8 Other income and expenses, net 8.7 Other Statutory to GAAP adjustments 18.5 -------- Segment income $ 156.4 ======== Statutory net premiums written $1,150.2 $464.5 $ 28.9 $ 3.8 $1,647.4 ------------------------------------------------ Statutory combined ratio 101.3 96.4 114.8 N/M 100.5 ------------------------------------------------ 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
(Unaudited) Nine Months Ended September 30, 1999 Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other Total Statutory underwriting (loss) profit $ (27.5) $(15.3) $ (3.4) $0.7 $ (45.5) --------------------------------------- Reconciliation to segment income: Net investment income 167.8 Other income and expenses, net 4.2 Other Statutory to GAAP adjustments 8.1 --------- Segment income $ 134.6 ========= Statutory net premiums written $1,051.5 $419.6 $ 31.0 $3.3 $1,505.4 ------------------------------------------------ Statutory combined ratio 101.6 102.1 115.1 N/M 102.0 ------------------------------------------------ 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 Standard Markets Standard Markets' net premiums written increased $98.7 million, or 9.4%, to $1,150.2 million for the nine months ended September 30, 2000. Results reflected ceded premiums of $3.6 million and $9.3 million under the aggregate excess of loss reinsurance treaty for 2000 and 1999, respectively. Excluding the impact from this treaty, net premiums written increased $93.0 million, or 8.8%, resulting from increases of $26.5 million, or 7.4%, $20.2 million, or 9.5%, $19.7 million, or 13.5%, and $9.6 million, or 8.4%, in the personal automobile, commercial multiple peril, commercial automobile, and homeowners lines, respectively. The increase in the personal automobile line is primarily the result of a 6.0% policies in force increase and a 1.0% rate increase in Massachusetts since September 30, 1999. In addition, the commercial multiple peril line experienced a 16.0% rate increase in Michigan and policies in force increased 2.3% since September 30, 1999. The increase in commercial automobile net premiums written is primarily the result of rate increases of 7.5%, 2.0%, and 13.8% in Michigan, Massachusetts, and New York, respectively, partially offset by a 2.3% decrease in policies in force since September 30, 1999. Homeowners' net premiums written increased as a result of a 7.2% rate increase in Michigan and a 1.8% increase in policies in force over the prior year. Also, net premiums written increased $8.9 million, or 5.9%, for the nine months ended September 30, 2000 in the workers' compensation line. This increase is primarily the result of 27.9% and 7.5% rate increases in Maine and Michigan, respectively, since September 30, 1999. Page 22 Standard Markets' underwriting results deteriorated $5.3 million, or 19.3%, to an underwriting loss of $32.8 million for the nine months ended September 30, 2000. Net benefits of $2.7 million and $7.5 million are included in underwriting results relating to the aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. Excluding the impact from this treaty, the total deterioration of $0.5 million in underwriting results is primarily attributable to a decrease in favorable development on prior years' loss reserves in the commercial multiple peril and personal automobile lines and increased claims activity in the workers' compensation line. Partially offsetting these unfavorable items are a decrease in underwriting expenses over prior year and improved current year claims frequency in the commercial multiple peril line. In addition, catastrophe losses decreased $9.8 million to $32.0 million for the nine months ended September 30, 2000, compared to $41.8 million for the same period in 1999. Sponsored Markets Sponsored Markets' net premiums written increased $44.9 million, or 10.7%, To $464.5 million for the nine months ended September 30, 2000. Results reflected ceded premiums of $1.7 million and $12.6 million under the aggregate excess of loss reinsurance treaty for 2000 and 1999, respectively. Excluding the impact of this treaty, net premiums written increased $34.0 million, or 7.9%, primarily attributable to a $25.2 million, or 7.4%, increase in the personal automobile line. This is primarily the result of a 3.9% 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 $8.7 million, or 10.5%, primarily attributable to the aforementioned 7.2% Michigan rate increase and a 3.5% increase in policies in force since September 30, 1999. Sponsored Markets' underwriting results improved $24.0 million to an underwriting profit of $8.7 million for the nine months ended September 30, 2000. Net benefits of $1.0 million and $9.9 million are included in underwriting results as a result of the aggregate excess of loss reinsurance treaty in 2000 and 1999, respectively. Excluding the impact from this treaty, the total improvement of $32.9 million in underwriting results is primarily attributable to a $14.1 million decrease in catastrophe losses to $17.0 million for the nine months ended September 30, 2000, compared to $31.1 million for the same period in 1999. In addition, a $9.7 million decrease in loss adjustment expenses resulting from a decrease in legal fees and employee related expenses in 2000 contributed to this improvement. Also, underwriting expenses decreased $7.4 million as the result of reductions in employee related expenses and efficiencies gained through process consolidations. Improved current year claims severity in the homeowners line also contributed to underwriting results for the nine months ended September 30, 2000. Partially offsetting these favorable items is a decrease in favorable development on prior years' loss reserves in the personal automobile line. Specialty Markets Specialty Markets' net premiums written decreased $2.1 million, or 6.8%, to $28.9 million for the nine months ended September 30, 2000. This decrease is primarily attributable to a 5.6% decrease in policies in force since September 30, 1999. In addition, an increase in ceded premiums resulting from greater utilization of reinsurance in the other commercial 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. Specialty Markets' underwriting results deteriorated $1.3 million to an underwriting loss of $4.7 million for the nine months ended September 30, 2000. The deterioration in underwriting results is primarily the result of an increase in current year claims activity in the commercial automobile line. Investment Results Net investment income before tax was $164.8 million and $167.8 million for the nine months ended September 30, 2000 and 1999, respectively. This primarily reflects a reduction in average invested assets of $195.4 million, or 5.1%, to $3,643.7 million in 2000, compared to $3,839.1 million in 1999; partially offset by higher yields. This reduction in average invested assets is due to transfers of cash and securities of $108.0 million and $350.0 million to the corporate segment during the second quarter of 2000 and 1999, respectively. Average pre-tax yields on debt securities increased to 6.8% in 2000 compared to 6.6% in 1999. Page 23 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 ("LAE") with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claim severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation and other liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, and where the technological, judicial and political climates involving these types of claims are changing. The Company regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Changes in prior reserve estimates are reflected in results of operations in the 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:
(Unaudited) Nine Months Ended September 30, (In millions) 2000 1999 Reserve for losses and LAE, beginning of period $2,615.9 $2,597.3 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 1,224.8 1,208.3 Decrease in provision for insured events of prior years (87.5) (141.9) --------- --------- Total incurred losses and LAE 1,137.3 1,066.4 --------- --------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 589.1 587.2 Losses and LAE attributable to insured events of prior years 561.7 517.2 --------- --------- Total payments 1,150.8 1,104.4 --------- --------- Change in reinsurance recoverable on unpaid losses 44.5 62.2 --------- --------- Reserve for losses and LAE, end of period $2,646.9 $2,621.5 ========= =========
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $87.5 million and $141.9 million for the nine months ended September 30, 2000 and 1999, respectively, reflecting favorable development on reserves for both losses and LAE. Favorable development on prior years' loss reserves was $39.6 million and $76.8 million for the nine months ended September 30, 2000 and 1999, respectively. This decrease of $37.2 million is primarily due to decreased personal automobile favorable development in the Northeast and deterioration in prior accident years in the commercial multiple peril line. Favorable development on prior years' LAE reserves was $47.9 million and $65.1 million for the nine months ended September 30, 2000 and 1999, respectively. The favorable development in both periods is primarily attributable to claims process improvement initiatives taken by the Company over the past two years. Page 24 Reserves established for current year losses and LAE consider the factors that resulted in the recent favorable development of prior years' loss and LAE reserves. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in prior years and the Company expects continued reductions in the amount of favorable development in future years. Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation on the Company varies by product. Property and casualty insurance premiums are established before the amount of losses and LAE, and the extent to which inflation may affect such expenses, are known. Consequently, the Company attempts, in establishing rates, to anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserving position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short- term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. Reinsurance The Risk Management segment maintains a reinsurance program designed to protect against large or unusual losses and allocated LAE activity. This includes excess of loss reinsurance and catastrophe reinsurance. The Company determines the appropriate amount of reinsurance based on the Company's evaluation of the risks accepted and analyses prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. Based on its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, the Company believes that its reinsurers are financially sound. Catastrophe reinsurance serves to protect the ceding insurer from significant aggregate losses arising from a single event such as windstorm, hail, hurricane, tornado, riot or other extraordinary events. Effective January 1, 2000, the Company modified its catastrophe program. Under this new program, AFC retains $45.0 million of loss per hurricane occurrence and $25.0 million of loss per occurrence for all other exposures, 10% of all aggregate loss amounts in excess of $45.0 million, or $25.0 million for non- hurricane losses, up to $65.0 million, 20% of all aggregate loss amounts in excess of $65.0 million up to $230.0 million and all amounts in excess of $230.0 million. In 1999, the Company retained $45.0 million of loss per occurrence, 10% of all aggregate loss amounts in excess of $45.0 million up to $230.0 million and all amounts in excess of $230.0 million under its catastrophe reinsurance program. Additionally, effective January 1, 2000, the Company purchased a property catastrophe aggregate treaty which provides for annual aggregate coverage totaling 80% of $50.0 million in excess of $60.0 million for catastrophe losses. The Company's retention will be calculated cumulatively, in the aggregate, on a quarterly basis with the aggregate losses comprised of all catastrophe losses that exceed $0.5 million each loss occurrence. The maximum contribution from the Company for any one-loss occurrence for the purposes of calculating the aggregate retention will be $25.0 million. Under the Company's casualty reinsurance program, the reinsurers are responsible for 43% of the amount of each loss in excess of $0.5 million per occurrence up to $0.5 million and 100% of the amount of each loss in excess of $1.0 million per occurrence up to $30.5 million for general liability and workers' compensation. Additionally, this reinsurance covers workers' compensation losses in excess of $30.5 million to $60.5 million per occurrence. Amounts in excess of $60.5 million, in the workers' compensation line, are retained 100% by the Company, while amounts in excess of $30.5 million, in the general liability line, are retained 100% by the Company. Page 25 Effective January 1, 1999, the Company entered into a Whole Account Aggregate Excess of Loss reinsurance agreement. The reinsurance agreement provided accident year coverage for the three years 1999 to 2001 for the Company's property and casualty business, and was subject to cancellation or commutation annually at the Company's option. In accordance with the provisions of this contract, the Company exercised its option to cancel this contract effective January 1, 2000. The program covered losses and allocated LAE, including those incurred but not yet reported, in excess of a specified whole account loss and allocated LAE ratio. The annual and aggregate coverage limits for losses and allocated LAE are $150.0 million and $300.0 million, respectively. The effect of this agreement on results of operations in each reporting period is based on losses and allocated LAE ceded, reduced by a sliding scale premium of 50-67.5% depending on the size of the loss, and increased by a ceding commission of 20% of ceded premium. In addition, net investment income is reduced for amounts credited to the reinsurer. As a result of this agreement, the Company recognized no benefit for the third quarter of 1999, a net benefit of $16.9 million for the nine months ended September 30, 1999, and a net benefit of $15.9 million for the year ended December 31, 1999, based on annual estimates of losses and allocated LAE for accident year 1999. A net benefit of $2.6 million has been recognized in the first nine months of 2000 related to accident year 1999. The effect of this agreement on the results of operations in future periods is not currently determinable, as it will be based both on future losses and allocated LAE 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 arrangement 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, including the Closed Block, for the Allmerica Financial Services segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Segment revenues Premiums $ 7.9 $ 8.3 $ 43.2 $ 44.7 Fees 110.9 91.4 316.1 262.9 Investment and other income 97.4 100.5 297.4 291.2 ------ ------ ------ ------ Total segment revenues 216.2 200.2 656.7 598.8 Policy benefits, claims and losses 80.6 71.2 241.3 245.4 Policy acquisition and other operating expenses 78.9 74.3 248.8 202.1 ------ ------ ------ ------ Segment income $ 56.7 $ 54.7 $166.6 $151.3 ====== ====== ====== ======
Page 26 Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Segment income increased $2.0 million, or 3.7%, to $56.7 million during the third quarter of 2000. This reflects higher asset-based fee income driven by market appreciation and additional deposits in the variable annuity and variable universal life product lines, offset by higher policy benefits and policy acquisition and other operating expenses. Excluding the effect of several unusual items during each year, segment income in 2000 was essentially unchanged from the prior year. Segment revenues increased $16.0 million, or 8.0%, in the third quarter of 2000 primarily due to increased fees and other income. Fee income from variable annuity and individual variable universal life policies increased $13.3 million, or 19.3%, in the third quarter of 2000 due to market appreciation and additional deposits. Market appreciation generated approximately $6.8 million of this growth, while new deposits generated approximately $6.3 million. The growth in annuity deposits resulted from the introduction of a "bonus" product in the fourth quarter of 1999. Sales of bonus annuities totaled $329.4 million in the third quarter of 2000. Fees from the universal life product line increased $4.8 million, or 28.4%, in the third quarter of 2000, primarily due to changes in certain actuarial assumptions. Investment and other income decreased $3.1 million, or 3.1%, primarily due to a reduction in average invested assets resulting from transfers to the separate accounts in the annuity and group retirement product lines, as well as from cancellations of certain accounts in the group retirement business. This decrease was partially offset by higher brokerage income due to an increase in trading volume in mutual fund and general securities transactions and to increased investment management fees resulting from appreciation and additional deposits in variable product assets under management. Policy benefits, claims and losses increased $9.4 million, or 13.2%, to $80.6 million in the third quarter of 2000. This increase is due primarily to a strengthening of universal life and Closed Block reserves in the current period which resulted in an increase in policy benefits of approximately $5.5 million. The increase is also attributable to less favorable mortality experience, primarily in the Closed Block. These increases were partially offset by lower participation in an annuity program introduced in 1998, which provided for a limited time, enhanced crediting rates on general account deposits. In addition, there was a reduction in interest credited on group retirement products due to cancellations of certain accounts and asset transfers to the separate accounts. Policy acquisition and other operating expenses increased $4.6 million, or 6.2%, in the third quarter of 2000. Other operating expenses increased $6.3 million primarily from ongoing growth in the variable annuity and individual variable universal life product lines and increases in technology and distribution costs. Also, brokerage commissions and administrative expenses increased due to the aforementioned growth in trading volumes for mutual fund and general securities transactions. This increase was partially offset by a $1.7 million decline in policy acquisition expenses. Included in policy acquisition expenses were several unusual items, particularly approximately $33.8 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 a $3.3 million benefit from the refinement of an enhanced valuation system for the annuity line of business. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 Segment income increased $15.3 million, or 10.1%, to $166.6 million in the first nine months of 2000. This increase is primarily attributable to higher asset-based fee income driven by market appreciation and additional deposits in the variable product lines, partially offset by higher policy acquisition and other operating expenses. Segment revenues increased $57.9 million, or 9.7%, in 2000 primarily due to increased fees and other income. Fee income from variable annuities and individual variable universal life policies increased $45.4 million, or 23.3%, in the first nine months of 2000, primarily due to market appreciation and additional deposits. Market appreciation generated approximately $24.3 million of this growth, while new deposits generated approximately $20.8 million. The growth in annuity deposits resulted from the aforementioned introduction of a "bonus" product in the fourth quarter of 1999. Sales of bonus annuities, which totaled approximately $1.0 billion in the first nine months of 2000, were partially offset by a $134.7 million decrease in traditional annuity sales at third party mutual fund advisors within the broker-dealer and financial planner distribution channels. Fees from the universal life product line increased $3.4 million, or 6.6% in 2000, due to the aforementioned changes in certain actuarial assumptions. Page 27 Investment and other income increased $6.2 million, or 2.1%, in 2000. This increase is primarily due to higher brokerage income of $15.1 million attributable to an increase in mutual fund and general securities transaction volumes and to increased investment management fees of $6.7 million resulting from appreciation and additional deposits in variable product assets under management. These increases were partially offset by a $15.9 million decline in net investment income primarily due to decreased average invested assets resulting from transfers to the separate accounts in the annuity and group retirement product lines. Policy benefits, claims and losses decreased $4.1 million, or 1.7%, to $241.3 million in the first nine months of 2000. This decrease is due principally to the absence of a $5.4 million mortality reserve established in the variable annuity lines of business during the first quarter of 1999 and lower participation in the aforementioned enhanced crediting rate annuity program. Also contributing to this decrease is reduced interest credited on group retirement products due to the aforementioned cancellations of certain accounts and transfers to the separate accounts. These reductions were partially offset by the aforementioned strengthening of universal life and Closed Block reserves which resulted in approximately a $5.5 million increase in the period, as well as less favorable mortality experience primarily in the Closed Block. Policy acquisition and other operating expenses increased $46.7 million, or 23.1%, in the first nine months of 2000. Other operating expenses increased $26.2 million, primarily due to ongoing growth in the variable annuity and individual variable universal life product lines, and increases in technology and distribution costs. Also, brokerage commissions and administrative expenses increased due to the aforementioned growth in trading volumes for mutual fund and general securities transactions. Policy acquisition expenses increased $20.5 million, primarily due to continued growth in the annuity line of business. Included in policy acquisition expenses were the aforementioned assumption changes in the universal life, variable universal life and annuity product lines. In 1999, there was a one-time increase to the deferred acquisition cost asset of $13.5 million, resulting from the implementation of an enhanced valuation system for annuities. Statutory Premiums and Deposits The following table sets forth statutory premiums and deposits by product for the Allmerica Financial Services segment.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Insurance: Traditional life $ 13.3 $ 13.8 $ 57.0 $ 62.5 Universal life 0.7 21.5 44.1 54.1 Variable universal life 51.0 45.7 153.7 134.8 Individual health 0.1 0.1 0.2 0.2 Group variable universal life 13.7 13.0 43.8 30.6 ------- ------- -------- -------- Total insurance 88.8 94.1 298.8 282.2 ------- ------- -------- -------- Annuities: Individual annuities: Separate account annuities 617.7 429.9 1,973.1 1,439.0 General account annuities 123.5 201.5 387.6 663.3 Retirement investment accounts 2.1 4.0 8.2 13.5 ------- ------- -------- -------- Total individual annuities 743.3 635.4 2,368.9 2,115.8 Group annuities 119.2 107.9 378.5 302.2 ------- ------- -------- -------- Total annuities 862.5 743.3 2,747.4 2,418.0 ------- ------- -------- -------- Total premiums and deposits $ 951.3 $ 837.4 $3,046.2 $2,700.2 ======= ======= ======== ========
Page 28 Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Total premiums and deposits increased $113.9 million, or 13.6%, to $951.3 million. These increases are primarily due to higher separate account annuity deposits, partially offset by a decline in general account deposits. The growth in individual separate account annuity deposits results from the introduction of a bonus product in the fourth quarter of 1999. The bonus annuity product is distributed through third party mutual fund advisors and the broker-dealer distribution channels. These increases were partially offset by lower deposits from general account annuities due to the decreased utilization of the aforementioned annuity program with enhanced crediting rates. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 For the nine months ended September 30, 2000, total premiums and deposits increased $346.0 million, or 12.8%, to $3,046.2 million. These increases are primarily due to higher separate account and group annuity deposits, partially offset by a decline in general account annuity deposits. The growth in individual separate account annuity deposits results from the introduction of the aforementioned bonus product, partially offset by a decrease in traditional annuity sales at third party mutual fund advisors. In addition, group annuity deposits increased due to new sales and additional business from existing contracts. These increases were partially offset by lower deposits from general account annuities due to the decreased utilization of the aforementioned annuity program with enhanced crediting rates. Allmerica Asset Management The following table summarizes the results of operations for the Allmerica Asset Management segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Interest margins on GICs Net investment income $ 38.1 $ 38.7 $ 96.6 $ 107.0 Interest credited 33.4 33.6 84.3 91.7 ------- ------- ------- -------- Net interest margin 4.7 5.1 12.3 15.3 ------- ------- ------- -------- Other income (expenses) External fees and other income 1.7 1.4 4.8 4.4 Internal fees and other income 1.2 1.4 3.8 4.9 Other operating expenses (1.8) (2.2) (5.4) (6.4) ------- ------- ------- -------- Segment income $ 5.8 $ 5.7 $ 15.5 $ 18.2 ======= ======= ======= ========
Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Segment income increased $0.1 million, or 1.8%, to $5.8 million during the third quarter of 2000. This increase is primarily due to higher fee income related to external clients and decreased operating expenses. Income from assets under management grew in the third quarter of 2000 as a result of increased business from new and existing money market and other external fixed income fund clients. These increases were partially offset by a decrease in earnings on GICs resulting from 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 reflected uncertainties in the market resulting in greater redemptions for the industry overall. Management expects income from the GIC product line to be unfavorably impacted in future periods due to withdrawals experienced during the fourth quarter of 1999 and a diminished market for short-term funding agreement products. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 Segment income decreased $2.7 million, or 14.8%, to $15.5 million in the first nine months of 2000. This decline primarily reflects decreased earnings on GICs. Earnings on GICs decreased $3.0 million primarily due to the aforementioned short-term funding agreement withdrawals during the fourth quarter of 1999 and a shift to lower margin long-term funding agreements in 2000. Page 29 Corporate The following table summarizes the results of operations for the Corporate segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 2000 1999 2000 1999 Segment revenues Net investment income $ 2.2 $ 1.3 $ 4.9 $ 4.9 Interest expense 3.8 3.9 11.4 11.5 Other operating expenses 12.1 11.1 33.9 36.6 ------- ------- ------- ------- Segment loss $(13.7) $(13.7) $(40.4) $(43.2) ======= ======= ======= =======
Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Segment loss was consistent in the third quarter of 2000 as higher other operating expenses were offset by an increase in net investment income and a decrease in interest expense. Other operating expenses increased $1.0 million, primarily due to the timing of employee related expenses and other corporate overhead costs. Investment income increased $0.9 million during the third quarter of 2000 due to higher average invested assets. Average invested assets increased due to fewer sales of securities used to fund the Company's stock repurchase program and the absence in 2000 of a $125.0 million capital contribution made to FAFLIC from AFC. Interest expense for both periods relates primarily to the interest paid on the Senior Debentures of the Company. Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 Segment loss decreased $2.8 million, or 6.5%, to $40.4 million in the first nine months of 2000 primarily due to lower facilities, finance, and other corporate overhead costs. Interest expense for both periods relates primarily to the interest paid on the Senior Debentures of the Company. Investment Portfolio The Company had investment assets diversified across several asset classes, as follows:
(Unaudited) September 30, 2000 December 31, 1999 Carrying % of Total Carrying % of Total (Dollars in millions) Value Carrying Value Value Carrying Value Fixed maturities $8,015.8 83.1% $7,306.7 80.6% Equity securities 82.2 0.9 83.2 0.9 Mortgage loans 638.8 6.6 657.5 7.3 Policy loans 380.5 3.9 371.6 4.1 Cash and cash equivalents 337.0 3.5 464.8 5.1 Other long-term investments 195.2 2.0 180.0 2.0 -------- ------ -------- ------ Total $9,649.5 100.0% $9,063.8 100.0% ======== ====== ======== ====== Includes Closed Block invested assets with a carrying value of $747.0 million and $732.9 million at September 30, 2000 and December 31, 1999, respectively. The Company carries the fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets increased $585.7 million, or 6.5%, to $9.6 billion during the first nine months of 2000. This increase resulted primarily from increased fixed maturities of $709.1 million, partially offset by decreases of $127.8 million in cash and cash equivalents. The increase in fixed maturities is principally due to the investment of funds received from the sale of the Company's new long-term funding agreements. The decrease in cash and cash equivalents is primarily due to the repurchase of AFC common stock under the stock repurchase program and to the timing of investment purchases. Page 30 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 87.2% and 84.4% of the Company's total fixed maturity portfolio at September 30, 2000 and December 31, 1999, respectively. The average yield on fixed maturities was 7.4% and 7.2% for the nine months ended September 30, 2000 and 1999, respectively. Although management expects that new funds will be invested primarily in investment grade fixed maturities, the Company may invest a portion of new funds in below investment grade fixed maturities or equity interests. Market Risk and Risk Management Policies 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 to hedge its net foreign currency exposure. The following table for the nine months ended September 30, 2000 provides 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 table summarizes information on instruments that are sensitive to foreign currency exchange rates, including securities denominated in foreign currencies, and foreign currency forward exchange agreements. For foreign currency denominated securities with contractual maturities, the table presents 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 table presents 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. Page 31
For the Nine Months Ended Fair September 30, 2000 There Value (Currencies in millions) 2000 2001 2002 2003 2004 after Total 9/30/2000 Fixed Interest Securities Denominated in Foreign Currencies: Fixed interest rate securities denominated in Swiss Francs 10.0 0.0 0.0 0.0 0.0 0.0 10.0 $ 6.7 Current forward foreign exchange rate 0.5798 0.0 0.0 0.0 0.0 0.0 0.5798 Fixed interest rate securities denominated in British Pounds 0.0 0.0 0.0 0.0 0.0 9.5 9.5 $ 18.3 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 1.4754 1.4754 Currency Swap Agreements Related to Fixed Interest Securities: Pay Swiss Francs Notional amount in foreign currency 10.0 0.0 0.0 0.0 0.0 0.0 10.0 $ (0.7) Average contract rate 0.6645 0.0 0.0 0.0 0.0 0.0 0.6645 Current forward foreign exchange rate 0.5798 0.0 0.0 0.0 0.0 0.0 0.5798 Pay British Pounds Notional amount in foreign currency 0.0 0.0 0.0 0.0 0.0 9.5 9.5 $ (1.3) Average contract rate 0.0 0.0 0.0 0.0 0.0 1.9800 1.9800 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 1.4754 1.4754 Liabilities Denominated in Foreign Currencies: Trust instruments supported by funding obligations denominated in Euros 0.0 150.0 0.0 0.0 0.0 262.3 412.3 $371.7 Current forward foreign exchange rate 0.0 0.8827 0.0 0.0 0.0 0.8827 0.8827 Trust instruments supported by funding obligations denominated in Yen 0.0 0.0 0.0 0.0 0.0 7,500.0 7,500.0 $ 69.5 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 0.0092 0.0092 Trust instruments supported by funding obligations denominated in Swiss Francs 0.0 0.0 0.0 0.0 0.0 70.0 70.0 $ 40.9 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 0.5798 0.5798 Trust instruments supported by funding obligations denominated in British Pounds 0.0 0.0 0.0 30.0 0.0 0.0 30.0 $ 44.5 Current forward foreign exchange rate 0.0 0.0 0.0 1.4754 0.0 0.0 1.4754 Currency Swap Agreements Related to Trust Obligations: Pay Euros Notional amount in foreign currency 0.0 150.0 0.0 0.0 0.0 262.3 412.3 $(48.4) Average contract rate 0.0 0.9596 0.0 0.0 0.0 0.9514 0.9544 Current forward foreign exchange rate 0.0 0.8827 0.0 0.0 0.0 0.8827 0.8827 Pay Yen Notional amount in foreign currency 0.0 0.0 0.0 0.0 0.0 7,500.0 7,500.0 $ (2.4) Average contract rate 0.0 0.0 0.0 0.0 0.0 0.0094 0.0094 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 0.0092 0.0092 Pay Swiss Francs Notional amount in foreign currency 0.0 0.0 0.0 0.0 0.0 70.0 70.0 $ (1.6) Average contract rate 0.0 0.0 0.0 0.0 0.0 0.5964 0.5964 Current forward foreign exchange rate 0.0 0.0 0.0 0.0 0.0 0.5798 0.5798 Pay British Pounds Notional amount in foreign currency 0.0 0.0 0.0 30.0 0.0 0.0 30.0 $ (1.5) Average contract rate 0.0 0.0 0.0 1.5000 0.0 0.0 1.5000 Current forward foreign exchange rate 0.0 0.0 0.0 1.4754 0.0 0.0 1.4754
Income Taxes AFC and its domestic subsidiaries (including certain non-insurance operations) file a consolidated United States federal income tax return. Entities included within the consolidated group are segregated into either a life insurance or a non-life insurance company subgroup. The consolidation of these subgroups is subject to certain statutory restrictions on the percentage of eligible non-life tax losses that can be applied to offset life company taxable income. Quarter Ended September 30, 2000 Compared to Quarter Ended September 30, 1999 Provision for federal income taxes before minority interest and discontinued operations was $13.1 million during the third quarter of 2000 compared to $14.4 million during the same period in 1999. These provisions resulted in consolidated effective federal tax rates of 16.5% and 18.6% for the quarters ended September 30, 2000 and 1999, respectively. The decrease in the rate is primarily due to increased realized losses in the third quarter of 2000 and to an increase in the proportion of tax-exempt interest income to pre-tax income. Although total tax-exempt interest income declined in the third quarter of 2000 as compared to the third quarter of 1999, its percentage of anticipated pre-tax income increased as a result of the aforementioned realized losses. Page 32 Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 The provision for federal income taxes before minority interest and discontinued operations was $29.0 million during the first nine months of 2000 compared to $84.1 million during the same period in 1999. These provisions resulted in consolidated effective federal tax rates of 16.0% and 22.6% for the nine months ended September 30, 2000 and 1999, respectively. The decrease in the rate is primarily due to realized losses in the first nine months of 2000 as compared to gains in the same period of 1999 and to an increase in the proportion of tax-exempt interest income to pre-tax income. Although total tax-exempt interest income decreased in the first nine months of 2000, its percentage of anticipated pre-tax income increased as a result of the aforementioned realized losses. 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 the first nine months of 2000, AFC received $108.0 million of dividends from its property and casualty businesses. Additional dividends from the Company's insurance subsidiaries in 2000 would be considered "extraordinary" and would require prior approval from the respective state regulators. 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 $197.5 million during the first nine months of 2000, compared to cash provided by operating activities of $15.3 million for the same period of 1999. The increase in 2000 is primarily the result of approximately $75.0 million of decreased federal income tax payments in the current period, as well as an increase in premium collections in the property and casualty business. The increase was partially offset by payments related to the Company's aforementioned new bonus annuity product. Net cash used in investing activities was $816.9 million during the first nine months of 2000, compared to cash provided by investing activities of $496.6 million during the same period in 1999. This $1.3 billion increase in cash used is primarily due to a $950.7 million year over year increase in purchases of fixed maturities, the absence in 2000 of $310.0 million of equity securities sales that occurred in January 1999, and the purchase of company owned life insurance totaling $64.9 million. Net cash provided by financing activities was $491.6 million during the first nine months of 2000, compared to cash used in financing activities of $71.9 million during the same period in 1999. The change is primarily due to a $191.3 million year over year reduction in cash used for the Company's share repurchase program, an increase in net funding agreement deposits, including trust instruments supported by funding obligations, of $170.0 million during the first nine months of 2000, and the absence of a $150.0 million repayment of short-term debt which occurred during the first quarter of 1999. AFC has sufficient funds at the holding company or available through dividends from FAFLIC and Allmerica P&C to meet its obligations to pay interest on the Senior Debentures, Capital Securities and dividends, when and if declared by the Board of Directors, on the common stock. On July 25, 2000, the Board of Directors declared an annual dividend of $0.25 per share on the issued and outstanding common stock of the Company, payable November 15, 2000 to shareholders of record at the close of business November 1, 2000. Whether the Company will pay dividends in the future depends upon the costs of administering a dividend program as compared to the benefits conferred, and upon the earnings and financial condition of AFC. Page 33 Based on current trends, the Company expects to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements. The Company maintains a high degree of liquidity within the investment portfolio in fixed maturity investments, common stock and short- term investments. AFC has $150.0 million available under a committed syndicated credit agreement, which expires on May 28, 2001. Borrowings under this agreement are unsecured and incur interest at a rate per annum equal to, at the Company's option, a designated base rate or the eurodollar rate plus applicable margin. At September 30, 2000, no amounts were outstanding under this agreement. The Company had $53.9 million of commercial paper borrowings outstanding at September 30, 2000. AFC had no repurchase agreements outstanding as of September 30, 2000. Contingencies The Company's insurance subsidiaries are routinely engaged in various legal proceedings arising in the normal course of business, including claims for punitive damages. Additional information on other litigation and claims may be found in Note 10 "Commitments and Contingencies - Litigation" to the consolidated financial statements. In the opinion of management, none of such contingencies are expected to have a material effect on the Company's consolidated financial position, although it is possible that the results of operations in a particular quarter or annual period would be materially affected by an unfavorable outcome. 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 2000 and beyond to differ materially from those expressed in any forward- looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes", "anticipated", "expects" and similar expressions are intended to identify forward looking statements. See "Important Factors Regarding Forward-Looking Statements" filed as Exhibit 99-2 to the Company's Annual Report on Form 10-K for the period ended December 31, 1999. Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) adverse catastrophe experience and severe weather; (ii) adverse loss development for events the Company insured in prior years or adverse trends in mortality and morbidity; (iii) heightened competition, including the intensification of price competition, the entry of new competitors, and the introduction of new products by new and existing competitors, or as the result of consolidation within the financial services industry and the entry of additional financial institutions into the insurance industry; (iv) adverse state and federal legislation or regulation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, and tax treatment of insurance and annuity products, as well as continued compliance with state and federal regulations; (v) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) difficulties in recruiting new career agents, wholesalers and new partnership relations to support the sale of variable products; (viii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (ix) loss or retirement of key executives; (x) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (xi) termination of provider contracts or renegotiations at less cost-effective rates or terms of payment; (xii) changes in the Company's liquidity due to changes in asset and liability matching; (xiii) restrictions on insurance underwriting, based on genetic testing and other criteria; (xiv) adverse changes in the ratings obtained from independent rating agencies, such as Moody's, Standard and Poor's, and A.M. Best, (xv) lower appreciation on or decline in value of the Company's managed investments or the investment markets in general, resulting in reduced variable products sales, assets and related fees and increased surrenders; (xvi) possible claims relating to sales practices for insurance products; (xvii) failure of a reinsurer of the Company's policies to pay its liabilities under reinsurance contracts; (xviii) earlier than expected withdrawals from the Company's general account annuities, GICs (including funding agreements), and other insurance products; (xix) changes in the mix of assets comprising the Company's investment portfolio and the fluctuation of the market value of such assets; (xx) losses resulting from the Company's participation in certain reinsurance pools; (xxi) adverse results of regulatory audits related to the Company's prior years' federal income tax filings, and (xxii) losses due to foreign currency fluctuations. Page 34 PART II - OTHER INFORMATION ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K (a) Exhibits EX - 27 Financial Data Schedule (b) Reports on Form 8K On July 27, 2000, Allmerica Financial Corporation announced its financial results for the six months ended June 30, 2000. Page 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Allmerica Financial Corporation Registrant Dated November 13, 2000 /s/ John F. O'Brien ----------------------------- John F. O'Brien President and Chief Executive Officer Dated November 13, 2000 /s/ Edward J. Parry III ----------------------------- Edward J. Parry III Vice President and Chief Financial Officer Page 36 EXHIBIT INDEX Exhibit Number Exhibit 27 Financial Data Schedule