-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PbioHC/XBw28+gFC1XbQf5SnCCQV/dv9dn4F/5SeA/9TomN1cWkXFh8e9/E2sMix r/hIB1lnadNOva8VkAa+dw== 0000944695-01-500026.txt : 20010815 0000944695-01-500026.hdr.sgml : 20010815 ACCESSION NUMBER: 0000944695-01-500026 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLMERICA FINANCIAL CORP CENTRAL INDEX KEY: 0000944695 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 043263626 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13754 FILM NUMBER: 1710353 BUSINESS ADDRESS: STREET 1: 440 LINCOLN ST CITY: WORCESTER STATE: MA ZIP: 01653 BUSINESS PHONE: 5088551000 MAIL ADDRESS: STREET 1: 440 LINCOLN ST CITY: WORCESTER STATE: MA ZIP: 01653 10-Q 1 form10q0630.txt FORM 10-Q 063001 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: June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from:___________ to ____________ Commission file number: 1-13754 ALLMERICA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 04-3263626 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 440 Lincoln Street, Worcester, Massachusetts 01653 (Address of principal executive offices) (Zip Code) (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: 52,811,161 shares of common stock outstanding, as of August 1, 2001. 38 Total Number of Pages Included in This Document Exhibit Index is on Page 39 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 - 17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 - 34 Item 3. Quantitative and Qualitative Disclosures About Market Risk 35 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 36 Item 6. Exhibits and Reports on Form 8-K 37 SIGNATURES 38 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, -------------------------------------------- (In millions, except per share data) 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------ Revenues Premiums $ 562.0 $ 528.4 $1,125.5 $1,051.9 Universal life and investment product policy fees 99.2 102.7 199.6 205.2 Net investment income 165.7 160.4 331.5 315.9 Net realized investment losses (67.3) (23.7) (84.7) (70.8) Other income 36.0 36.2 72.1 70.7 --------- --------- ---------- --------- Total revenues 795.6 804.0 1,644.0 1,572.9 --------- --------- ---------- --------- Benefits, losses and expenses Policy benefits, claims, losses and loss adjustment expenses 521.4 480.1 1,078.1 969.3 Policy acquisition expenses 114.3 115.4 230.4 233.1 Other operating expenses 144.4 128.2 283.2 248.5 Restructuring costs - 20.3 - 20.3 --------- --------- ---------- --------- Total benefits, losses and expenses 780.1 744.0 1,591.7 1,471.2 --------- --------- ---------- --------- Income before federal income taxes 15.5 60.0 52.3 101.7 --------- --------- ---------- --------- Federal income tax (benefit) expense Current (22.8) 1.5 (28.2) (5.2) Deferred 21.1 6.9 32.9 21.1 --------- --------- ---------- --------- Total federal income tax (benefit) expense (1.7) 8.4 4.7 15.9 --------- --------- ---------- --------- Income before minority interest and cumulative effect of change in accounting principle 17.2 51.6 47.6 85.8 Minority interest: Distributions on mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company (4.0) (4.0) (8.0) (8.0) --------- --------- ---------- --------- Income before cumulative effect of change in accounting principle 13.2 47.6 39.6 77.8 Cumulative effect of change in accounting principle (less applicable income tax benefit of $1.7 for the six months ended June 30, 2001) - - (3.2) - --------- --------- ---------- --------- Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8 ========= ========= ========== ========= PER SHARE DATA Basic Income before cumulative effect of change in accounting principle $ 0.25 $ 0.89 $ 0.75 $ 1.45 Cumulative effect of change in accounting principle (less applicable income tax benefit of $0.03 for the six months ended June 30, 2001) - - (0.06) - --------- --------- ---------- --------- Net income $ 0.25 $ 0.89 $ 0.69 $ 1.45 ========= ========= ========== ========= Weighted average shares outstanding 52.6 53.4 52.6 53.7 ========= ========= ========== ========= Diluted Income before cumulative effect of change in accounting principle $ 0.25 $ 0.88 $ 0.75 $ 1.43 Cumulative effect of change in accounting principle (less applicable income tax benefit of $0.03 for the six months ended June 30, 2001) - - (0.06) - --------- --------- ---------- --------- Net income $ 0.25 $ 0.88 $ 0.69 $ 1.43 ========= ========= ========== ========= Weighted average shares outstanding 53.1 54.1 53.1 54.2 ========= ========= ========== ========= The accompanying notes are an integral part of these consolidated financial statements.
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ALLMERICA FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, (In millions, except per share data) 2001 2000 - -------------------------------------------------------------------------------- ---------- ---------- Assets Investments: Fixed maturities-at fair value (amortized cost of $8,910.8 and $8,153.7) $ 9,031.3 $ 8,118.0 Equity securities-at fair value (cost of $69.4 and $60.0) 75.1 85.5 Mortgage loans 568.8 617.6 Policy loans 384.6 381.3 Other long-term investments 162.3 193.2 ---------- ---------- Total investments 10,222.1 9,395.6 ---------- ---------- Cash and cash equivalents 482.7 281.1 Accrued investment income 156.7 155.4 Premiums, accounts and notes receivable, net 630.6 618.1 Reinsurance receivable on paid and unpaid losses, benefits and unearned premiums 1,404.5 1,423.8 Deferred policy acquisition costs 1,684.9 1,608.2 Deferred federal income taxes 46.1 103.8 Other assets 714.8 564.6 Separate account assets 16,095.1 17,437.4 ---------- ---------- Total assets $ 31,437.5 $ 31,588.0 ========== ========== Liabilities Policy liabilities and accruals: Future policy benefits $ 3,906.0 $ 3,617.4 Outstanding claims, losses and loss adjustment expenses 2,874.1 2,880.9 Unearned premiums 1,024.7 981.6 Contractholder deposit funds and other policy liabilities 2,170.8 2,193.1 ---------- ---------- Total policy liabilities and accruals 9,975.6 9,673.0 ---------- ---------- Expenses and taxes payable 747.3 768.6 Reinsurance premiums payable 102.4 122.3 Trust instruments supported by funding obligations 1,445.6 621.5 Short-term debt 69.3 56.6 Long-term debt 199.5 199.5 Separate account liabilities 16,095.1 17,437.4 ---------- ---------- Total liabilities 28,634.8 28,878.9 ---------- ---------- Minority interest: Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company 300.0 300.0 ---------- ---------- Commitments and contingencies (Note 12) Shareholders' equity Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued - - Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million shares issued 0.6 0.6 Additional paid-in capital 1,763.5 1,765.3 Accumulated other comprehensive income (loss) 45.6 (5.2) Retained earnings 1,105.1 1,068.7 Treasury stock at cost (7.6 million and 7.7 million shares) (412.1) (420.3) ---------- ---------- Total shareholders' equity 2,502.7 2,409.1 ---------- ---------- Total liabilities and shareholders' equity $ 31,437.5 $ 31,588.0 ========== ========== The accompanying notes are an integral part of these consolidated financial statements.
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ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Unaudited) Six Months Ended June 30, ------------------------- (In millions) 2001 2000 - ----------------------------------------------------------------------------------------------------- Preferred Stock Balance at beginning and end of period $ - $ - -------- ---------- Common Stock Balance at beginning and end of period 0.6 0.6 -------- ---------- Additional paid-in capital Balance at beginning of period 1,765.3 1,770.5 Unearned compensation related to restricted stock and other (1.8) (8.2) -------- ---------- Balance at end of period 1,763.5 1,762.3 -------- ---------- Accumulated Other Comprehensive Income Net unrealized appreciation (deppreciation) on investments Balance at beginning of period (5.2) (75.3) Net appreciation on available-for-sale securities and derivative instruments 78.1 17.6 Provision for deferred federal income taxes (27.3) (6.0) -------- ---------- Other comprehensive income 50.8 11.6 -------- ---------- Balance at end of period 45.6 (63.7) -------- ---------- Retained earnings Balance at beginning of period 1,068.7 882.2 Net income 36.4 77.8 -------- ---------- Balance at end of period 1,105.1 960.0 -------- ---------- Treasury Stock Balance at beginning of period (420.3) (337.8) Shares purchased at cost - (46.8) Shares reissued at cost 8.2 14.0 -------- ---------- Balance at end of period (412.1) (370.6) -------- ---------- Total shareholders' equity $ 2,502.7 $ 2,288.6 ======== ========== The accompanying notes are an integral part of these consolidated financial statements.
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ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ---------------------------------------------------- (In millions) 2001 2000 2001 2000 - --------------------------------------------------- ---------------------------- ----------------------- Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8 Other comprehensive (loss) income: Available-for-sale securities: Net (depreciation) appreciation during the period (42.4) (22.3) 72.6 17.6 Benefit (provision) for deferred federal income taxes 14.8 8.0 (25.4) (6.0) --------- --------- -------- -------- Total available-for-sale securities (27.6) (14.3) 47.2 11.6 --------- --------- -------- -------- Derivative instruments: Net appreciation during the period 14.4 - 5.5 - Provision for deferred federal income taxes (5.0) - (1.9) - --------- --------- -------- -------- Total derivative instruments 9.4 - 3.6 - --------- --------- -------- -------- Other comprehensive (loss) income (18.2) (14.3) 50.8 11.6 --------- --------- -------- -------- Comprehensive (loss) income $ (5.0) $ 33.3 $ 87.2 $ 89.4 ========= ========= ======== ======== The accompanying notes are an integral part of these consolidated financial statements.
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ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, -------------------------- (In millions) 2001 2000 - ---------------------------------------------------------------------------------------------------------- Cash flows from operating activities Net income $ 36.4 $ 77.8 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Net realized losses 84.7 70.8 Net amortization and depreciation 8.9 13.9 Deferred federal income taxes 32.9 21.1 Change in deferred acquisition costs (86.0) (116.7) Change in premiums and notes receivable, net of reinsurance payable (32.4) (28.2) Change in accrued investment income (1.3) 2.7 Change in policy liabilities and accruals, net 409.9 (98.9) Change in reinsurance receivable 19.3 (23.5) Change in expenses and taxes payable (171.3) (39.7) Separate account activity, net - (0.3) Other, net (37.7) (7.3) ---------- ----------- Net cash provided by (used in) operating activities 263.4 (128.3) ---------- ----------- Cash flows from investing activities Proceeds from disposals and maturities of available-for-sale fixed maturities 870.9 1,504.9 Proceeds from disposals of equity securities 26.9 11.8 Proceeds from disposals of other investments 30.0 27.9 Proceeds from mortgages matured or collected 48.1 40.5 Purchase of available-for-sale fixed maturities 1,726.0) (2,001.8) Purchase of equity securities (9.7) (0.8) Purchase of other investments (11.9) (58.7) Capital expenditures (14.6) (6.3) Other, net 1.4 - ---------- ----------- Net cash used in investing activities (784.9) (482.5) ---------- ----------- Cash flows from financing activities Deposits and interest credited to contractholder deposit funds 153.0 629.9 Withdrawals from contractholder deposit funds (270.7) (469.5) Deposits to trust instruments supported by funding obligations 895.3 352.9 Withdrawals from trust instruments supported by funding obligations (71.2) - Change in short-term debt 12.7 6.4 Treasury stock purchased at cost - (46.8) Treasury stock reissued at cost 4.0 14.0 ---------- ----------- Net cash provided by financing activities 723.1 486.9 ---------- ----------- Net change in cash and cash equivalents 201.6 (123.9) Cash and cash equivalents, beginning of period 281.1 464.8 ---------- ----------- Cash and cash equivalents, end of period $ 482.7 $ 340.9 ========== =========== The accompanying notes are an integral part of these consolidated financial statements.
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"); Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); The Hanover Insurance Company ("Hanover"); Citizens Insurance Company of America ("Citizens"), and other insurance and non-insurance subsidiaries. All significant intercompany accounts and transactions have been eliminated. The 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 six months ended June 30, 2001, 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 2000 Annual Report to Shareholders, as filed on Form 10-K with the Securities and Exchange Commission. 2. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"), which requires that goodwill and intangible assets that have indefinite useful lives no longer be amortized over their useful lives, but instead be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. In addition, the statement provides specific guidance for testing the impairment of intangible assets. Additional financial statement disclosures about goodwill and other intangible assets, including changes in the carrying amount of goodwill, carrying amounts by classification of amortized and non-amortized assets, and estimated amortization expenses for the next five years, are also required. This statement is effective for fiscal years beginning after December 15, 2001 for all goodwill and other intangible assets held at the date of adoption. Certain provisions of this statement are also applicable for goodwill and other intangible assets acquired after June 30, 2001, but prior to adoption of this statement. The Company is currently assessing the impact of the adoption of Statement No. 142. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("Statement No. 141"), which requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. It further specifies the criteria that intangible assets must meet in order to be recognized and reported apart from goodwill. The implementation of Statement No. 141 is not expected to have a material effect on the Company's financial statements. In December 2000, the American Institute of Certified Public Accountants issued Statement of Position 00-3, "Accounting by Insurance Enterprises for Demutualization and Formations of Mutual Insurance Holding Companies and For Certain Long-Duration Participating Contracts" ("SoP No. 00-3"). SoP No. 00-3 requires that closed block assets, liabilities, revenues and expenses be displayed together with all other assets, liabilities, revenues and expenses of the insurance enterprise based on the nature of the particular item, with appropriate disclosures relating to the closed block. In addition, the SoP provides guidance on the accounting for participating contracts issued before and after the date of demutualization, recording of closed block earnings and related policyholder dividend liabilities, and the accounting treatment for expenses and equity balances at the date of demutualization. This statement became effective for fiscal years beginning after December 15, 2000. The adoption of SoP No. 00-3 did not have a material impact on the Company's financial position or results of operations. Certain prior year amounts have been reclassified to conform to the required presentation in the current year. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"), which establishes accounting and reporting standards for derivative instruments. Statement No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on the type of hedge transaction. For fair value hedge transactions in which the Company is hedging changes in an asset's, liability's or firm commitment's fair value, changes in the fair value of the derivative instruments will generally be offset in the income statement by changes in the hedged item's fair value. For cash flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the 8 derivative instrument that are reported in other comprehensive income will be reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. To the extent any hedges are determined to be ineffective, all or a portion of the change in value of the derivative will be recognized currently in earnings. This statement became effective for fiscal years beginning after June 15, 2000. The Company adopted Statement No. 133 on January 1, 2001. In accordance with the transition provisions of the statement, the Company recorded a $3.2 million charge, net-of-taxes, in earnings to recognize all derivative instruments at their fair values. This adjustment represents net losses that were previously deferred in other comprehensive income on derivative instruments that do not qualify for hedge accounting. The Company recorded an offsetting gain in other comprehensive income of $3.3 million, net-of-tax, to recognize these derivative instruments. 3. Summary of New Significant Accounting Policies Accounting for Derivatives and Hedging Activities All derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair value of a recognized asset or liability ("fair value" hedge); (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); (3) a foreign-currency fair value or cash flow hedge ("foreign currency" hedge); or (4) "held for trading". Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). Changes in the fair value of derivatives that are highly effective and that are designated and qualify as foreign currency hedges are recorded in either current period earnings or other comprehensive income, depending on whether the hedge transaction is a fair value hedge or a cash flow hedge. Lastly, changes in the fair value of derivative trading instruments are reported in current period earnings. The Company may hold financial instruments that contain "embedded" derivative instruments. The Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the financial instrument, or host contract, and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a fair-value, cash-flow, or foreign currency hedge, or as a trading derivative instrument. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value, cash flow, or foreign currency hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below. The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item, including forecasted transactions; (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is no longer designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the balance sheet at its fair value, and the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings. 9 4. 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 business and its accident and health assumed reinsurance pool business ("reinsurance pool business"). During the third quarter of 1998, the Company ceased writing new premiums in the reinsurance pool business, subject to certain contractual obligations. Prior to 1999, these businesses comprised substantially all of the former Corporate Risk Management Services segment. Accordingly, the operating results of the discontinued segment, including its reinsurance pool business, have been reported in the Consolidated Statements of Income as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB Opinion No. 30"). In the third quarter of 1999, the operating results from the discontinued segment were adjusted to reflect the recording of additional reserves related to accident claims from prior years. The Company also recorded a $30.5 million loss, net of taxes, on the disposal of this segment, consisting of after-tax losses from the run-off of the group life and health business of approximately $46.9 million, partially offset by net proceeds from the sale of the EBS business of approximately $16.4 million. Subsequent to a measurement date of June 30, 1999, approximately $17.1 million of the aforementioned $46.9 million loss has been generated from the operations of the discontinued business. In March of 2000, the Company transferred its EBS business to Great-West Life and Annuity Insurance Company of Denver and received consideration of approximately $26 million, based on renewal rights for existing policies. The Company retained policy liabilities estimated at $120.6 million at June 30, 2001 related to this business. As permitted by APB Opinion No. 30, the Consolidated Balance Sheets have not been segregated between continuing and discontinued operations. At June 30, 2001 and 2000, the discontinued segment had assets of approximately $435.8 million and $534.4 million, respectively, consisting primarily of invested assets and reinsurance recoverables, and liabilities of approximately $424.7 million and $470.8 million, respectively, consisting primarily of policy liabilities. Revenues for the discontinued operations were $10.8 million and $58.2 million for the quarters ended June 30, 2001 and 2000, respectively, and $19.8 million and $135.7 million for the six months ended June 30, 2001 and 2000, respectively. 5. Significant Transactions As of June 30, 2001, the Company has repurchased approximately $436.3 million, or approximately 8 million shares, of its common stock under programs authorized by the Board of Directors (the "Board"). As of June 30, 2001, the Board had authorized total stock repurchases of $500.0 million, leaving approximately $63.7 million available to the Company for future repurchases. During the second quarter of 2000, the Company adopted a formal company-wide restructuring plan. This plan is the result of a corporate initiative that began in the fall of 1999, intended to reduce expenses and enhance revenues. This plan consists of various initiatives including a series of internal reorganizations, consolidations in home office operations, consolidations in field offices, changes in distribution channels and product changes. As a result of the Company's restructuring plan, it recognized a pre-tax charge of $21.4 million during 2000. Approximately $5.7 million of this charge relates to severance and other employee related costs resulting from the elimination of approximately 360 positions, of which 235 employees have been terminated as of June 30, 2001. All levels of employees, from staff to senior management, were affected by the restructuring. In addition, approximately $15.7 million of this charge relates to other restructuring costs, consisting of one-time project costs, lease cancellations and the present value of idle leased space. As of June 30, 2001, the Company has made payments of approximately $20.6 million related to this restructuring plan, of which approximately $5.4 million relates to severance and other employee related costs. 10 6. Investments A. Derivative Instruments The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate or foreign currency volatility. The operations of the Company are subject to risk resulting from interest rate fluctuations to the extent that there is a difference between the amount of the Company's interest-earning assets and the amount of interest-bearing liabilities that are paid, withdrawn, mature or re-price in specified periods. The principal objective of the Company's asset/liability management activities is to provide maximum levels of net investment income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Company. The Company has developed an asset/liability management approach tailored to specific insurance or investment product objectives. The investment assets of the Company are managed in over 20 portfolio segments consistent with specific products or groups of products having similar liability characteristics. As part of this approach, management develops investment guidelines for each portfolio consistent with the return objectives, risk tolerance, liquidity, time horizon, tax and regulatory requirements of the related product or business segment. Management has a general policy of diversifying investments both within and across all portfolios. The Company monitors the credit quality of its investments and its exposure to individual markets, borrowers, industries, and sectors. The Company uses derivative financial instruments, primarily interest rate swaps and futures contracts, with indices that correlate to balance sheet instruments to modify its indicated net interest sensitivity to levels deemed to be appropriate. Specifically, for floating rate funding agreements that are matched with fixed rate securities, the Company manages the risk of cash flow variability by hedging with interest rate swap contracts designed to pay fixed and receive floating interest. Under interest rate swap contracts, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated on an agreed-upon notional principal amount. Additionally, the Company uses exchange traded financial futures contracts to hedge against interest rate risk on anticipated guaranteed investment contract ("GIC") sales and other funding agreements, as well as the reinvestment of fixed maturities. The Company is exposed to interest rate risk from the time of sale of the GIC until the receipt of the deposit and purchase of the underlying asset to back the liability. Similarly, the Company is exposed to interest rate risk on fixed maturities reinvestments from the time of maturity until the purchase of new fixed maturities. The Company only trades futures contracts with nationally recognized brokers, which the Company believes have adequate capital to ensure that there is minimal danger of default. As a result of the Company's issuance of trust instruments supported by funding obligations denominated in foreign currencies, as well as the Company's investment in securities denominated in foreign currencies, the Company's operating results are exposed to changes in exchange rates between the U.S. dollar and the Swiss Franc, Japanese Yen, British Pound and Euro. From time to time, the Company may also have exposure to other foreign currencies. To mitigate the short-term effect of changes in currency exchange rates, the Company regularly hedges by entering into foreign exchange swap contracts to hedge its net foreign currency exposure. Additionally, the Company enters into compound currency/interest rate swap contracts to hedge foreign currency and interest rate exposure on specific trust instruments supported by funding obligations. Under these swap contracts, the Company agrees to exchange interest and principal related to foreign fixed income securities and trust obligations payable in foreign currencies, at current exchange rates, for the equivalent payment in U.S. dollars translated at a specific currency exchange rate. By using derivative instruments, the Company is exposed to credit risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain (including any accrued receivable) in a derivative. The Company regularly assesses the financial strength of its counterparties and generally enters into forward or swap agreements with counterparties rated "A" or better by nationally recognized rating agencies. Depending on the nature of the derivative transaction, bilateral collateral arrangements may be required. The Company's derivative activities are monitored by management, who review portfolio activities and risk levels. Management also oversees all derivative transactions to ensure that the types of transactions entered into and the results obtained from those transactions are consistent with the Company's risk management strategy and with Company policies and procedures. Fair Value Hedges The Company enters into compound foreign currency/interest rate swaps to convert its foreign denominated fixed rate trust instruments supported by funding obligations to U.S. dollar floating rate instruments. For the six months ended June 30, 2001, the Company recognized a net gain of $1.3 million (reported as other income in the Consolidated Statements of Income), which represented the ineffective portion of all fair value hedges. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. 11 Cash Flow Hedges The Company enters into various types of interest rate swap contracts to hedge exposure to interest rate fluctuations. Specifically, for floating rate funding agreement liabilities that are matched with fixed rate securities, the Company manages the risk of cash flow variability by hedging with interest rate swap contracts. Under these swap contracts, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated on an agreed-upon notional principal amount. The Company also purchases long futures contracts and sells short futures contracts on margin to hedge against interest rate fluctuations associated with the sale of GICs and other funding agreements, as well as the reinvestment of fixed maturities. The Company is exposed to interest rate risk from the time of sale of the GIC until the receipt of the deposit and purchase of the underlying asset to back the liability. Similarly, the Company is exposed to interest rate risk on reinvestments of fixed maturities from the time of maturity until the purchase of new fixed maturities. The Company uses U.S. Treasury Note Futures to hedge this risk. The Company also enters into foreign currency swap contracts to hedge foreign currency exposure on specific fixed income securities, as well as compound foreign currency/interest rate swap contracts to hedge foreign currency and interest rate exposure on specific trust instruments supported by funding obligations. Under these swap contracts, the Company agrees to exchange interest and principal related to foreign fixed maturities and trust obligations payable in foreign currencies, at current exchange rates, for the equivalent payment in U.S. dollars translated at a specific currency exchange rate. For the six months ended June 30, 2001, the Company recognized a net gain of $1.6 million, (reported as other income in the Consolidated Statements of Income), which represented the total ineffectiveness of all cash flow hedges. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. Gains and losses on derivative contracts that are reclassified from accumulated other comprehensive income to current period earnings are included in the line item in which the hedged item is recorded. As of June 30, 2001, $98.5 million of the deferred net losses on derivative instruments accumulated in other comprehensive income could be recognized in earnings during the next twelve months depending on the forward interest rate and currency rate environment. Transactions and events that (1) are expected to occur over the next twelve months and (2) will necessitate reclassifying to earnings these derivatives gains (losses) include (a) the re-pricing of variable rate trust instruments supported by funding obligations, (b) the interest payments (receipts) on foreign denominated trust instruments supported by funding obligations and foreign securities, (c) the anticipated sale of GICs and other funding agreements, and (d) the anticipated reinvestment of fixed maturities. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments on variable-rate debt) is 12 months. Trading Activities The Company enters into insurance portfolio-linked and credit default swap contracts for investment purposes. Under the insurance portfolio-linked swap contracts, the Company agrees to exchange cash flows according to the performance of a specified underwriter's portfolio of insurance business. As with interest rate swap contracts, the primary risk associated with insurance portfolio-linked swap contracts is the inability of the counterparty to meet its obligation. Under the terms of the credit default swap contracts, the Company assumes the default risk of a specific high credit quality issuer in exchange for a stated annual premium. In the case of default, the Company will pay the counterparty par value for a pre-determined security of the issuer. The primary risk associated with these transactions is the default risk of the underlying companies. The Company regularly assesses the financial strength of its counterparties and the underlying companies in default swap contracts, and generally enters into forward or swap agreements with companies rated "A" or better by nationally recognized rating agencies. Because the underlying principal of swap contracts is not exchanged, the Company's maximum exposure to counterparty credit risk is the difference in payments exchanged, which at June 30, 2001, was $0.2 million. The Company does not require collateral or other security to support financial instruments with credit risk. These products are not linked to specific assets and liabilities on the balance sheet or to a forecasted transaction, and therefore do not qualify for hedge accounting. The swap contracts are marked to market with any gain or loss recognized currently. The fair values of swap contracts outstanding were $(0.3) million at June 30, 2001 and December 31, 2000. The net amount receivable or payable under insurance portfolio-linked swap contracts is recognized when the contracts are marked to market. The net increase (decrease) in realized investment gains related to these contracts was $0.1 million, $(0.7) million and $(0.2) million for the six months ended June 30, 2001 and the years ended December 31, 2000 and 1999, respectively. 12 The stated annual premium under credit default swap contracts is recognized currently in net investment income. There was no net increase to investment income related to credit default swap contracts for the six months ended June 30, 2001; however, there was a net increase of $0.2 million and $0.4 million for the years ended December 31, 2000 and 1999, respectively. B. Impact of Defaults on Net Investment Income The Company had fixed maturity securities with a carrying value of $19.6 million, $7.5 million and $3.7 million on non-accrual status at June 30, 2001, December 31, 2000 and June 30, 2000, respectively. The effect of non-accruals, compared with amounts that would have been recognized in accordance with the original terms of the investments, was a reduction in net investment income of $6.8 million and $1.7 million for the six months ended June 30, 2001 and 2000, respectively. 7. Federal Income Taxes Federal income tax expense for the six months ended June 30, 2001 and 2000, 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. 8. Other Comprehensive (Loss) Income The following table provides a reconciliation of gross unrealized (losses) gains to the net balance shown in the Statements of Comprehensive Income:
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, --------------------- ------------------- (In millions) 2001 2000 2001 2000 - ------------------------------------------------------------------ ---------- ---------- ---------- -------- Unrealized (losses) gains on available-for-sale securities: Unrealized holding losses arising during period (net of income tax (benefit) of $(29.3) million and $(17.9) million for the quarters ended June 30, 2001 and 2000 and $8.1 million and $(16.9) million for the six months ended June 30, 2001 and 2000) $ (78.3) $ (35.7) $ (14.5) $ (46.9) Less: reclassification adjustment for losses included in net income (net of income tax benefit of $14.5 million and $9.9 million for the quarters ended June 30, 2001 and 2000 and $17.3 million and $22.9 million for the six months months ended June 30, 2001 and 2000) (50.7) (21.4) (61.7) (58.5) -------- -------- -------- ------- Total available-for-sale securities (27.6) (14.3) 47.2 11.6 -------- -------- -------- ------- Unrealized gains on derivative instruments: Unrealized holding gains arising during period (net of income tax of $5.1 million and $0.9 million for the quarter and six months ended June 30, 2001) 9.1 - 1.6 - Less: reclassification adjustment for losses included in net income (net of income tax (benefit) of $0.1 million and $(1.0) million for the quarter and six months ended June 30, 2001) (0.3) - (2.0) - -------- -------- -------- ------- Total derivative instruments 9.4 - 3.6 - -------- -------- -------- ------- Other comprehensive (loss) income $ (18.2) $ (14.3) $ 50.8 $ 11.6 ======== ======== ======== =======
13 9. Closed Block Included in the Consolidated Statements of Income is a net pre-tax contribution from the Closed Block of $5.6 million and $10.9 million for the quarter and six months ended June 30, 2001, respectively, compared to $1.6 million and $4.8 million for the quarter and six months ended June 30, 2000, respectively. Summarized financial information of the Closed Block is as follows:
(Unaudited) June 30, December 31, (In millions) 2001 2000 ------------------------------------------------------------------------------------- Assets Fixed maturities-at fair value (amortized cost of $410.2 and $400.3) $ 413.8 $ 397.5 Mortgage loans 142.8 144.9 Policy loans 189.5 191.7 Cash and cash equivalents 0.9 1.9 Accrued investment income 14.8 14.6 Deferred policy acquisition costs 10.6 11.0 Other assets 5.9 6.4 --------- ------- Total assets $ 778.3 $ 768.0 ========= ======= Liabilities Policy liabilities and accruals $ 810.4 $ 808.9 Policyholder dividends 16.3 20.0 Other liabilities 3.5 0.8 --------- ------- Total liabilities $ 830.2 $ 829.7 ========= ======= Excess of Closed Block liabilities over assets designated to the Closed Block $ 51.9 $ 61.7 Amounts included in accumulated other comprehensive income: Net unrealized investment losses, net of deferred federal income tax benefit of $1.5 million and $1.3 million (2.8) (2.5) --------- ------- Maximum future earnings to be recognized from Closed Block assets and liabilities $ 49.7 $ 59.2 ========= =======
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, --------------------- --------------------- (In millions) 2001 2000 2001 2000 - ------------------------------------------------------------ -------- ---- ------- ---- ------- ----- ------- Revenues Premiums $ 7.3 $ 8.3 $ 32.4 $ 34.3 Net investment income 13.6 13.8 27.6 27.0 Net realized investment losses (1.2) (3.3) (1.2) (3.6) -------- ------- ------- ------- Total revenues 19.7 18.8 58.8 57.7 -------- ------- ------- ------- Benefits and expenses Policy benefits 14.0 16.9 47.5 51.7 Policy acquisition expenses 0.1 0.4 0.1 1.0 Other operating expenses - (0.1) 0.3 0.2 -------- ------- ------- ------- Total benefits and expenses 14.1 17.2 47.9 52.9 -------- ------- ------- ------- Contribution from the Closed Block $ 5.6 $ 1.6 $ 10.9 $ 4.8 ======== ======= ======= =======
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. 14 10. 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 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 and to a lesser extent, certain group retirement products. Through its Allmerica Asset Management segment, the Company offers its customers the option of investing in 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. 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 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. 15 Summarized below is financial information with respect to business segments for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, -------------------------- ------------------------- (In millions) 2001 2000 2001 2000 - --------------------------------------------------------------------------------------------------------------- Segment revenues: Risk Management $ 617.0 $ 579.4 $ 1,218.3 $ 1,136.9 -------- -------- -------- -------- Asset Accumulation: Allmerica Financial Services 204.3 213.2 427.5 442.5 Allmerica Asset Management 41.6 34.9 81.3 64.2 -------- -------- -------- -------- Subtotal 245.9 248.1 508.8 506.7 -------- -------- -------- -------- Corporate 1.5 1.7 2.5 2.7 Intersegment revenues (1.9) (1.5) (3.8) (2.6) -------- -------- -------- -------- Total segment revenues 862.5 827.7 1,725.8 1,643.7 Adjustments to segment revenues: Net realized losses (67.3) (23.7) (84.7) (70.8) Gains on derivatives 0.4 - 2.9 - -------- -------- -------- -------- Total revenues $ 795.6 $ 804.0 $ 1,644.0 $ 1,572.9 ======== ======== ======== ======== Segment income (loss) before federal income taxes, minority interest and cumulative effect of change in accounting principle: Risk Management $ 41.5 $ 53.9 $ 57.7 $ 97.0 -------- -------- -------- -------- Asset Accumulation: Allmerica Financial Services 42.6 55.5 86.9 109.9 Allmerica Asset Management 4.4 4.6 10.4 9.7 -------- -------- -------- -------- Subtotal 47.0 60.1 97.3 119.6 -------- -------- -------- -------- Corporate (15.6) (12.2) (31.8) (26.7) -------- -------- -------- -------- Segment income before federal income taxes and minority interest 72.9 101.8 123.2 189.9 Adjustments to segment income: Net realized investment losses, net of amortization (65.5) (21.5) (81.5) (67.9) Gains on derivatives 0.4 - 2.9 - Sales practice litigation 7.7 - 7.7 - Restructuring costs - (20.3) - (20.3) -------- -------- -------- -------- Income before federal income taxes, minority interest and cumulative effect of change in accounting principle $ 15.5 $ 60.0 $ 52.3 $ 101.7 ======== ======== ======== ========
Identifiable Assets Deferred Acquisition Costs - ------------------------------------------ ----------------------------------------------------------------- (Unaudited) (Unaudited) June 30, December 31, June 30, December 31, (In millions) 2001 2000 2001 2000 - ------------------------------------------ ----------------- ---------------- ------------- ------------- Risk Management $ 6,065.6 $ 6,186.6 $ 198.3 $ 187.2 ------------ ------------ ------------ ----------- Asset Accumulation Allmerica Financial Services 22,088.7 23,082.5 1,486.5 1,420.8 Allmerica Asset Management 3,122.7 2,238.4 0.1 0.2 ------------ ------------ ------------ ----------- Subtotal 25,211.4 25,320.9 1,486.6 1,421.0 Corporate 160.5 80.5 - - ------------ ------------ ------------ ----------- Total $ 31,437.5 $ 31,588.0 $ 1,684.9 $ 1,608.2 ============ ============ ============ ===========
16 11. 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 Six Months Ended June 30, June 30, --------------------------------------------- (In millions, except per share data) 2001 2000 2001 2000 - ----------------------------------------------------------------- --------------------- ----------------------- Basic shares used in the calculation of earnings per share 52.6 53.4 52.6 53.7 Dilutive effect of securities: Employee stock options 0.3 0.4 0.3 0.3 Non-vested stock grants 0.2 0.3 0.2 0.2 -------- -------- -------- -------- Diluted shares used in the calculation of earnings per share 53.1 54.1 53.1 54.2 ======== ======== ======== ======== Per share effect of dilutive securities on income from continuing operations before cumulative effect of change in accounting principle $ - $ 0.01 $ - $ 0.02 ======== ======== ======== ======== Per share effect of dilutive securities on net income $ - $ 0.01 $ - $ 0.02 ======== ======== ======== ========
12. 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. In the second quarter of 2001, the Company recognized a pre-tax benefit of $7.7 million resulting from the refinement of cost estimates. Although the Company believes that the remaining expense reflects appropriate recognition of its obligation under the settlement, this estimate may be revised based on the amount of reimbursement actually tendered by AFC's insurance carriers, and based on changes in the Company's estimate of the ultimate cost of the benefits to be provided to members of the class. The Company has been named a defendant in various other legal proceedings arising in the normal course of business. In the Company's opinion, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised. 17 PART I - FINANCIAL INFORMATION 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 2000 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 First Allmerica Financial Life Insurance Company ("FAFLIC") and Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"), AFC's principal life insurance and annuity companies; The Hanover Insurance Company ("Hanover") and Citizens Insurance Company of America ("Citizens"), AFC's principal property and casualty companies; and certain other insurance and non-insurance subsidiaries. Description of Operating Segments The Company offers financial products and services in two major areas: Risk Management and Asset Accumulation. Within these broad areas, the Company conducts business principally in three operating segments. These segments are Risk Management, Allmerica Financial Services, and Allmerica Asset Management. The separate financial information of each segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Results of Operations Consolidated Overview Consolidated net income includes the results of each segment of the Company, which management evaluates on a pre-tax and pre-minority interest basis. In addition, net income also includes certain items which management believes are not indicative of overall operating trends, such as net realized investment gains and losses, net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes and certain other items. While these items may be significant components in understanding and assessing the Company's financial performance, management believes that the presentation of "Adjusted Net Income", which excludes these items, enhances understanding of the Company's results of operations by highlighting net income attributable to the normal, recurring operations of the business. However, adjusted net income should not be construed as a substitute for net income determined in accordance with generally accepted accounting principles. The Company's consolidated net income for the second quarter of 2001 decreased $34.4 million, or 72.3%, to $13.2 million, compared to the same period in 2000. The reduction in net income in the second quarter resulted primarily from an increase in net realized investment losses of $37.3 million and a decrease in adjusted net income of $15.6 million. Consolidated net income for the first six months of 2001 decreased $41.4 million, or 53.2%, to $36.4 million, compared to the first six months of 2000. The reduction in net income resulted primarily from a decrease in adjusted net income of $44.8 million and an increase in net realized investment losses of $13.5 million. Net income in 2000 also included a restructuring charge of $13.2 million. 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. 18
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, --------------------------------------- (In millions) 2001 2000 2001 2000 - --------------------------------------------------------------------------------------------------- Segment income (loss) before federal income taxes and minority interest: Risk Management $ 41.5 $ 53.9 $ 57.7 $ 97.0 -------- -------- -------- -------- Asset Accumulation: Allmerica Financial Services 42.6 55.5 86.9 109.9 Allmerica Asset Management 4.4 4.6 10.4 9.7 -------- -------- -------- -------- Subtotal 47.0 60.1 97.3 119.6 Corporate (15.6) (12.2) (31.8) (26.7) -------- -------- -------- -------- Segment income before federal income taxes and minority interest 72.9 101.8 123.2 189.9 Federal income taxes on segment income (10.0) (23.3) (19.1) (41.0) Minority interest on preferred dividends (4.0) (4.0) (8.0) (8.0) -------- -------- -------- -------- Adjusted net income 58.9 74.5 96.1 140.9 Adjustments (net of taxes and amortization, as applicable): Net realized investment losses (51.0) (13.7) (63.4) (49.9) Gains on derivatives 0.3 - 1.9 - Sales practice litigation 5.0 - 5.0 - Restructuring costs - (13.2) - (13.2) -------- -------- -------- -------- Income before cumulative effect of change in accounting principle 13.2 47.6 39.6 77.8 Cumulative effect of change in accounting principle, net of applicable taxes - - (3.2) - -------- -------- -------- -------- Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8 ======== ======== ======== ========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 The Company's segment income before federal income taxes and minority interest decreased $28.9 million, or 28.4%, to $72.9 million in the second quarter of 2001. This decrease is primarily attributable to lower income from the Allmerica Financial Services and Risk Management segments of $12.9 million and $12.4 million, respectively. The decrease in Allmerica Financial Services' segment income was primarily due to declines in asset-based fees, principally resulting from a decrease in the market value of assets under management in the variable product lines, and to lower brokerage income. The decrease is also attributable to an increase in policy benefits and other operating expenses, net of lower deferred acquisition costs. Risk Management's segment income decreased $12.4 million primarily due to an approximate increase of $28 million in current accident year losses and a reduction in favorable loss and loss adjustment expense ("LAE")reserve development of $22.0 million, partially offset by rate increases of approximately $34 million. The effective tax rate for segment income was 13.7% for the second quarter of 2001 compared to 22.9% for the second quarter of 2000. The decrease in the tax rate is primarily due to lower underwriting income resulting in an increase in the proportion of tax-exempt investment income to pre-tax income, as well as the dividends received deduction associated with the Company's variable products. Net realized losses on investments, after taxes, were $51.0 million in the second quarter of 2001, resulting primarily from impairments of fixed maturities, partially offset by gains from sales of equity securities. Most of these impairments occurred in the Company's portfolio of high-yield bonds. During the second quarter of 2000, the Company recognized net realized losses on investments, after taxes, of $13.7 million, primarily due to impairments of fixed maturities and to the sale of securities pursuant to the Company's tax strategy to increase portfolio yields. The Company recognized a benefit of $5.0 million, net of taxes, in the second quarter of 2001 as a result of refining cost estimates related to a class action lawsuit. 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. 19 Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 The Company's segment income before federal income taxes and minority interest decreased $66.7 million, or 35.1%, to $123.2 million in the first six months of 2001. This decrease is primarily attributable to lower income from the Risk Management and Allmerica Financial Services segments of $39.3 million and $23.0 million, respectively. The decrease in Risk Management segment income was primarily attributable to decreased favorable loss and LAE reserve development of $85.2 million and to an increase in current year claims severity. These decreases were partially offset by premium rate increases of approximately $54 million and decreased catastrophe losses of $10.9 million. Allmerica Financial Services' segment income decreased $23.0 million principally due to lower asset-based fees, primarily resulting from a decrease in the market value of assets under management in the variable product lines, and to lower brokerage income. The decrease is also attributable to higher policy benefits and other operating expenses, partially offset by lower deferred policy acquisition costs. The effective tax rate for segment income was 15.5% for the first six months of 2001 compared to 21.6% for the first six months of 2000. The decrease in the tax rate is primarily due to lower underwriting income resulting in an increase in the proportion of tax-exempt investment income to pre-tax income, as well as the dividends received deduction associated with the Company's variable products. Net realized losses on investments after taxes were $63.4 million in the first six months of 2001 resulting primarily from impairments of fixed maturities. During the first six months of 2000, net realized losses on investments after taxes of $49.9 million resulted primarily from after tax realized losses of $38.1 million due to the sale of $1.1 billion of fixed income securities in order to reinvest the proceeds in higher yielding securities. In addition, the Company recognized $14.7 million in after tax realized losses from impairments of fixed maturities in 2000. During the first quarter of 2001, the Company recognized a $3.2 million loss, net of taxes, upon adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities". Segment Results The following is management's discussion and analysis of the Company's results of operations by business segment. The segment results are presented before taxes and minority interest and other items which management believes are not indicative of overall operating trends, including realized gains and losses. Risk Management The following table summarizes the results of operations for the Risk Management segment for the periods indicated:
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, --------------------------------------------- (In millions) 2001 2000 2001 2000 - --------------------------------------------------------------------------------------------------- Segment revenues Net premiums written $ 581.4 $ 562.2 $ 1,148.1 $ 1,089.8 ======== ======= ========= ========== Net premiums earned $ 554.4 $ 519.6 $ 1,092.4 $ 1,016.6 Net investment income 53.0 54.4 109.8 109.6 Other income 9.6 5.4 16.1 10.7 -------- ------- --------- ---------- Total segment revenues 617.0 579.4 1,218.3 1,136.9 Losses and operating expenses Losses and LAE (1) 426.1 383.6 864.0 759.3 Policy acquisition expenses 99.1 93.9 195.5 186.0 Other operating expenses 50.3 48.0 101.1 94.6 -------- ------- --------- ---------- Total losses and operating expenses 575.5 525.5 1,160.6 1,039.9 -------- ------- --------- ---------- Segment income $ 41.5 $ 53.9 $ 57.7 $ 97.0 ======== ======= ========= ========== (1) Includes policyholders' dividends of $1.9 million and $3.7 million for the quarters ended June 30, 2001 and 2000, respectively, and $4.0 million and $6.4 million for the six months ended June 30, 2001 and 2000, respectively.
20 Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 Risk Management's segment income declined $12.4 million, or 23.0%, to $41.5 million for the quarter ended June 30, 2001. The decrease in segment income is primarily attributable to a $42.5 million increase in losses and loss adjustment expenses. This is primarily the result of approximately a $28 million increase in current accident year losses in the second quarter, primarily in the commercial multiple peril and homeowners lines as a result of increased claims severity in both lines. In addition, losses and loss adjustment expenses increased as a result of a $22.0 million decrease in favorable development on prior years' reserves, to $3.9 million of favorable development in the second quarter of 2001. Partially offsetting these items are approximately $34 million of rate increases, primarily in the commercial lines. Improved current year claims severity in the commercial automobile line also favorably impacted results. In addition, catastrophe losses decreased $2.5 million, to $15.3 million for the second quarter of 2001, compared to $17.8 million for the same period in 2000. Policy acquisition and other operating expenses have increased consistent with the growth in earned premium. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Risk Management's segment income decreased $39.3 million, or 40.5%, to $57.7 million for the six months ended June 30, 2001. The decrease in segment income is primarily attributable to increased losses and loss adjustment expenses resulting from an $85.2 million decrease in favorable development on prior years' reserves, to $15.6 million of adverse development for the six months ended June 30, 2001 from $69.6 million of favorable development for the same period in 2000. The decrease in favorable development is primarily related to the Company's having captured, in prior periods, the accumulated benefits of its claim processing redesign efforts. These efforts resulted in reduced reserves related to prior accident years, primarily in the personal automobile line in the Northeast, and lower claims settlement costs. Increased current year claims severity in the commercial multiple peril line also contributed to the decline in results. Partially offsetting these items are approximately $54 million of rate increases, primarily in commercial lines. Improved current year claims severity in the commercial automobile and workers' compensation lines also favorably impacted results. In addition, catastrophe losses decreased $10.9 million, to $22.1 million for the six months ended June 30, 2001, compared to $33.0 million for the same period in 2000. Distribution Channel Results Distribution channel results are reported using statutory accounting principles, which are prescribed by state insurance regulators. The primary difference between statutory and generally accepted accounting principles ("GAAP") is the deferral of certain underwriting costs under GAAP that are amortized over the life of the policy. Under statutory accounting principles, these costs are recognized when incurred or paid. Management reviews the operations of this business based upon statutory results. Quarter Ended June 30, 2001 Compared to Quarter Ended Ended June 30, 2000 The following table summarizes the results of operations for the distribution channels of the Risk Management segment: 21
(Unaudited) Quarter Ended June 30, 2001 ----------------------------------------------------------- Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other(2) Total - --------------------------------------------------------------------------------------------------- Statutory net premiums written $ 394.7 $ 161.4 $ 23.5 $ 0.3 $ 579.9 ----------------------------------------------------------- Statutory combined ratio(1) 106.0 96.3 95.0 N/M 103.3 ----------------------------------------------------------- Statutory underwriting (loss) profit $ (26.2) $ 4.6 $ (2.8) $ (1.0) $ (25.4) ----------------------------------------------------------- Reconciliation to segment income: Net investment income 53.0 Other income and expenses, net 6.2 Other Statutory to GAAP adjustments 7.7 ------- Segment income $ 41.5 ======= - --------------------------------------------------------------------------------------------------- (Unaudited) Quarter Ended June 30, 2000 ----------------------------------------------------------- Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other (2) Total - --------------------------------------------------------------------------------------------------- Statutory net premiums written $ 393.0 $ 151.1 $ 11.9 $ 2.4 $ 558.4 ----------------------------------------------------------- Statutory combined ratio (1) 101.5 98.5 79.5 N/M 100.4 ----------------------------------------------------------- Statutory underwriting (loss) profit $ (14.5) $ 0.4 $ 1.5 $ (0.8) $ (13.4) ----------------------------------------------------------- Reconciliation to segment income: Net investment income 54.4 Other income and expenses, net 2.8 Other Statutory to GAAP adjustments 10.1 ------- Segment income $ 53.9 ======= - ---------------------------------------------------------------------------------------------------- (1) Statutory combined ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of the ratio of incurred claims and claim expenses to premiums earned and the ratio of underwriting expenses incurred to premiums written. Federal income taxes, net investment income and other non-underwriting expenses are not reflected in the statutory combined ratio. (2) Includes results from certain property and casualty business which the Company has exited. The decline in underwriting results is primarily attributable to unprofitable business in California. N/M - Not meaningful
Standard Markets Standard Markets' net premiums written increased $1.7 million to $394.7 million for the quarter ended June 30, 2001. This improvement is primarily attributable to increases of $3.4 million, or 4.3% and $2.7 million, or 4.6%, in the commercial multiple peril and commercial automobile lines, respectively. The increase in the commercial multiple peril line is primarily the result of a 4.5% increase in policies in force since June 30, 2000 and 8.7% and 6.0% rate increases in Michigan and New York, respectively. Commercial automobile's net premiums written increased primarily as a result of 5.9%, 4.9%, and 6.7% rate increases in Michigan, Massachusetts, and New York, respectively, partially offset by a 6.9% decrease in policies in force since June 30, 2000. Partially offsetting these favorable items is a $3.6 million, or 6.7%, decrease in workers' compensation's net premiums written due to the non-renewal of several large unprofitable commercial accounts in 2001. In addition, personal automobile net premiums written decreased $0.5 million, as a result of net rate decreases of 5.4% and 1.4% in Massachusetts and Michigan, respectively, partially offset by a 5.7% increase in policies in force since June 30, 2000. Management believes that net rate reductions may continue to unfavorably impact future premiums in Massachusetts. 22 Standard Markets' underwriting results declined $11.7 million to an underwriting loss of $26.2 million for the quarter ended June 30, 2001 compared to the same period in 2000. This is primarily attributable to the aforementioned decrease in favorable development on prior years' loss reserves. An increase in current year claims activity in the commercial multiple peril and workers compensation lines also contributed to the decline in underwriting results. Catastrophe losses increased $2.4 million to $10.5 million for the second quarter of 2001, compared to $8.1 million for the same period in 2000. Partially offsetting these unfavorable items are approximately $24 million of rate increases, primarily in the commercial lines. A decrease in current year claims severity in the commercial automobile line also favorably impacted results in the second quarter of 2001. In addition, excluding the impact of growth in earned premium, policy acquisition and other underwriting expenses and loss adjustment expenses decreased as a result of expense management initiatives. Sponsored Markets Sponsored Markets' net premiums written increased $10.3 million, or 6.8%, to $161.4 million for the quarter ended June 30, 2001. This improvement is primarily due to increases of $5.3 million, or 16.1%, and $4.8 million, or 4.2%, in the homeowners and personal automobile lines, respectively. Homeowners' net premiums written increased primarily due to a 4.7% growth in policies in force and an 8.0% Michigan rate increase compared to the same period in 2000. Personal automobile's net premiums written increased as a result of a 4.9% growth in policies in force, partially offset by the aforementioned Massachusetts and Michigan net rate reductions. Sponsored Markets' underwriting results improved $4.2 million to an underwriting profit of $4.6 million for the quarter ended June 30, 2001. The improvement in underwriting results is primarily attributable to approximately $10 million of rate increases and an improvement in current year claims severity in the personal automobile line. In addition, catastrophe losses decreased $4.9 million to $4.8 million in the second quarter of 2001. Partially offsetting these favorable items is approximately a $15 million decrease in favorable development on prior years' reserves. In addition, increased current year claim activity in the homeowners line unfavorably impacted second quarter 2001 results. Specialty Markets Specialty Markets' net premiums written increased $11.6 million to $23.5 million for the quarter ended June 30, 2001. This improvement is primarily attributable to increases of $8.5 million and $3.8 million in the commercial automobile and commercial multiple peril lines, respectively. Commercial automobile's net premiums written increased primarily as a result of significant growth in policies in force since June 30, 2000 and a decrease in the utilization of reinsurance. The increase in commercial multiple peril's net premiums written is primarily the result of a decrease in the utilization of reinsurance and a 6.3% growth in policies in force since June 30, 2000. Specialty Markets' underwriting results declined $4.3 million to an underwriting loss of $2.8 million for the quarter ended June 30, 2001. The decline in underwriting results is primarily the result of an increase in current accident year claims severity in the commercial multiple peril line. In addition, an absence of ceding commission income from business that has not been renewed unfavorably impacted results. 23 Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 The following table summarizes the results of operations for the distribution channels of the Risk Management segment:
(Unaudited) Six Months Ended June 30, 2001 - ---------------------------------------------------------------------------------------------------- Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other (2) Total - ---------------------------------------------------------------------------------------------------- Statutory net premiums written $ 787.5 $ 322.9 $ 34.2 $ 0.6 $ 1,145.2 ---------------------------------------------------------- Statutory combined ratio (1) 105.1 104.2 107.3 N/M 105.4 ---------------------------------------------------------- Statutory underwriting loss $ (47.2) $ (15.9) $ (5.9) $ (6.2) $ (75.2) ---------------------------------------------------------- Reconciliation to segment income: Net investment income 109.8 Other income and expenses, net 9.7 Other Statutory to GAAP adjustments 13.4 -------- Segment income $ 57.7 ======== - ---------------------------------------------------------------------------------------------------- (Unaudited) Six Months Ended June 30, 2000 ------------------------------------------------------------ Standard Sponsored Specialty (In millions, except ratios) Markets Markets Markets Other(2) Total - ---------------------------------------------------------------------------------------------------- Statutory net premiums written $ 762.2 $ 302.7 $ 18.3 $ 2.7 $ 1,085.9 ---------------------------------------------------------- Statutory combined ratio (1) 102.6 97.7 95.6 N/M 101.4 ---------------------------------------------------------- Statutory underwriting (loss) profit $ (32.8) $ 2.4 $ 0.2 $ (3.2) $ (33.4) ---------------------------------------------------------- Reconciliation to segment income: Net investment income 109.6 Other income and expenses, net 5.4 Other Statutory to GAAP adjustments 15.4 -------- Segment income $ 97.0 ======== - ---------------------------------------------------------------------------------------------------- (1) Statutory combined ratio is a common industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of the ratio of incurred claims and claim expenses to premiums earned and the ratio of underwriting expenses incurred to premiums written. Federal income taxes, net investment income and other non-underwriting expenses are not reflected in the statutory combined ratio. (2) Includes results from certain property and casualty business which the Company has exited. The decline in underwriting results is primarily attributable to unprofitable business in California. N/M - Not meaningful
Standard Markets Standard Markets' net premiums written increased $25.3 million, or 3.3%, to $787.5 million for the six months ended June 30, 2001. This improvement is primarily attributable to increases of $13.8 million, or 8.9%, $8.5 million, or 7.6%, and $3.3 million, or 1.3%, in the commercial multiple peril, commercial automobile and personal automobile lines, respectively. The increase in the commercial multiple peril line is primarily the result of a 4.5% increase in policies in force since June 30, 2000 and 8.7% and 6.0% rate increases in Michigan and New York, respectively. Commercial automobile's net premiums written increased primarily as a result of 5.9%, 4.9%, and 6.7% rate increases in Michigan, Massachusetts, and New York, respectively. These favorable items are partially offset by a 6.9% decrease in policies in force since June 30, 2000 in the commercial automobile line. Personal automobile's net premiums written increased as a result of an 8.5% growth in policies in force in the Northeast, partially offset by net rate decreases of 5.4% and 1.4% in Massachusetts and Michigan, respectively, and a 5.1% decrease in policies in force in the Midwest since June 30, 2000. Partially offsetting these favorable 24 items is a $1.1 million, or 1.0%, decrease in workers' compensation's net premiums written due to the non-renewal of several unprofitable large commercial accounts in 2001. Standard Markets' underwriting losses increased $14.4 million, or 43.9%, to an underwriting loss of $47.2 million for the six months ended June 30, 2001. This is primarily attributable to the aforementioned decrease in favorable development on prior years' reserves. An increase in current year claims activity in the commercial multiple peril line also contributed to the decline in underwriting results. In addition, increased current accident year claims frequency in the homeowners line unfavorably impacted results. Partially offsetting these unfavorable items are approximately $48 million of rate increases, primarily in the commercial lines. A decrease in current year claims severity in the workers' compensation, personal automobile, and commercial automobile lines also favorably impacted results for the six months ended June 30, 2001. Catastrophe losses decreased $11.2 million to $11.6 million for the six months ended June 30, 2001, compared to $22.8 million for the same period in 2000. In addition, policy acquisition and other underwriting expenses and loss adjustment expenses decreased as a result of expense management initiatives. Sponsored Markets Sponsored Markets' net premiums written increased $20.2 million, or 6.7%, to $322.9 million for the six months ended June 30, 2001. This improvement is primarily due to increases of $11.2 million, or 4.6%, and $8.6 million, or 15.9%, in the personal automobile and homeowners lines, respectively. Personal automobile's net premiums written increased as a result of a 4.9% growth in policies in force, partially offset by the aforementioned Massachusetts and Michigan net rate reductions. Homeowners' net premiums written increased primarily due to a 4.7% growth in policies in force and an 8.0% Michigan rate increase compared to the same period in 2000. Sponsored Markets' underwriting results declined $18.3 million, to an underwriting loss of $15.9 million, for the six months ended June 30, 2001. The decline in underwriting results is primarily attributable to approximately a $25 million decrease in favorable development on prior years' reserves. This is partially offset by approximately $6 million of rate increases and improvement in current year claims severity in the homeowners and personal automobile lines. Specialty Markets Specialty Markets' net premiums written increased $15.9 million, or 86.9%, to $34.2 million for the six months ended June 30, 2001. This improvement is primarily attributable to increases of $10.2 million and $4.9 million in the commercial automobile and commercial multiple peril lines, respectively. Commercial automobile's net premiums written increased primarily as a result of a significant growth in policies in force since June 30, 2000 and a decrease in the utilization of reinsurance. The increase in commercial multiple peril's net premiums written is primarily the result of a decrease in the utilization of reinsurance and a 6.3% growth in policies in force over the prior year. Specialty Markets' underwriting results declined $6.1 million, to an underwriting loss of $5.9 million, for the six months ended June 30, 2001. The decline in underwriting results is primarily the result of an increase in current accident year claims severity in the commercial multiple peril line as a result of large losses. In addition, an absence of ceding commission income from business that has not been renewed also unfavorably impacted results. Investment Results Net investment income before tax was $53.0 million and $54.4 million for the quarters ended June 30, 2001 and 2000, respectively. The decline of $1.4 million, or 2.6%, is primarily due to the impact of defaulted bonds. Net investment income before tax was $109.8 million and $109.6 million for the six months ended June 30, 2001 and 2000, respectively. The increase in net investment income in 2001, compared to 2000, primarily reflects higher yields, offset by a reduction in average invested assets. Reserve for Losses and Loss Adjustment Expenses The Risk Management segment maintains reserves for its property and casualty products to provide for the Company's ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claim severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation and other liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, and where the technological, judicial and political climates involving these types of claims are changing. 25 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) Six Months Ended June 30, ------------------------ (In millions) 2001 2000 - ------------------------------------------------------------------ ------------- ------------ Reserve for losses and LAE, beginning of period $ 2,719.1 $ 2,615.9 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year 844.4 821.5 Increase (decrease) in provision for insured events of prior years 15.6 (69.6) ----------- ----------- Total incurred losses and LAE 860.0 751.9 ----------- ----------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 342.6 341.8 Losses and LAE attributable to insured events of prior years 486.8 421.8 ----------- ----------- Total payments 829.4 763.6 ----------- ----------- Change in reinsurance recoverable on unpaid losses 1.8 18.0 ----------- ----------- Reserve for losses and LAE, end of period $ 2,751.5 $ 2,622.2 =========== ===========
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were increased by $15.6 million and decreased $69.6 million for the six months ended June 30, 2001 and 2000, respectively. During the first six months of 2001, estimated loss reserves for claims occurring in prior years increased $43.9 million. During the first six months of 2000, favorable development on prior years' loss reserves was $38.2 million. This $82.1 million change is primarily the result of an increase in commercial lines loss cost, and the Company having captured, in 1999 and 2000, the accumulated benefits of its claims redesign efforts. These efforts resulted in reduced reserves related to prior accident years, primarily in the personal automobile line in the Northeast. The adverse development in 2001 also reflects additional losses related to fourth quarter 2000 non-catastrophe weather related claims in Michigan. These claims primarily impacted the personal automobile, workers' compensation, and commercial multiple peril lines. Favorable development on prior year's loss adjustment expense reserves was $28.3 million and $31.4 million for the six months ended June 30, 2001 and 2000, respectively. The favorable development in both periods is primarily attributable to claims process improvement initiatives taken by the Company over the past three years. Since 1997, the Company has lowered claim settlement costs through increased utilization of in-house attorneys and consolidation of claims offices. These measures are substantially complete. Reserves established for current year losses and LAE consider the factors that resulted in the favorable development of prior years' loss and LAE reserves during 2000 and earlier years. Accordingly, current year reserves are modestly lower, relative to those initially established for similar exposures in years prior to 2000, and the Company currently expects no significant adverse or favorable development for the remainder of the year. Due to the nature of the business written by the Risk Management segment, the exposure to environmental liabilities is relatively small and therefore its reserves are relatively small compared to other types of liabilities. Loss and LAE reserves related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $33.9 million and $39.5 million, net of reinsurance of $9.5 million and $11.0 million in the first six months of 2001 and 2000, respectively. The Company does not specifically underwrite policies that include this coverage, but as case law expands policy provisions and insurers' liability beyond the intended coverage, the Company may be required to defend such claims. The Company estimated its ultimate liability for these claims based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not significant, their existence gives rise to uncertainty and are discussed because of the possibility that they may become significant. The Company currently believes that recorded reserves related to these claims are adequate. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. 26 Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation on the Company varies by product. Property and casualty insurance premiums are established before the amount of losses and LAE, and the extent to which inflation may affect such expenses are known. Consequently, the Company attempts, in establishing rates and reserves, to anticipate the potential impact of inflation in the projection of ultimate costs. The impact of inflation has been relatively insignificant in recent years. However, inflation could contribute to increased losses and LAE in the future. The Company regularly reviews its reserving techniques, its overall reserving position and its reinsurance. Based on (i) review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. Asset Accumulation Allmerica Financial Services The following table summarizes the results of operations for the Allmerica Financial Services segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, -------------------- ------------------ (In millions) 2001 2000 2001 2000 - --------------------------------------------------------------------- ------------------ Segment revenues Premiums $ 7.6 $ 8.8 $ 33.1 $ 35.3 Fees 99.2 102.7 199.6 205.2 Net investment income 72.0 72.4 143.2 145.4 Other income 25.5 29.3 51.6 56.6 -------- -------- ------- -------- Total segment revenues 204.3 213.2 427.5 442.5 Policy benefits, claims and losses 78.5 71.0 172.2 162.7 Policy acquisition and other operating expenses 83.2 86.7 168.4 169.9 -------- -------- ------- -------- Segment income $ 42.6 $ 55.5 $ 86.9 $ 109.9 ======== ======== ======= ========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 Segment income decreased $12.9 million, or 23.2%, to $42.6 million during the second quarter of 2001. This decrease reflects lower asset-based fee and other income, as well as an increase in policy benefits and other operating expenses, net of lower deferred acquisition costs. The decline in asset-based fees and other income is principally attributable to a decrease in the market value of assets under management in the variable product lines, and to lower brokerage income. Segment revenues decreased $8.9 million, or 4.2%, in the second quarter of 2001, primarily due to lower asset-based fees and other income. Oher income decreased $3.8 million, or 13.0%, to $25.5 million. This decline was primarily due to lower brokerage income resulting from a decrease in mutual fund and general securities transaction volumes as well as decreased investment management fees due to depreciation in variable product assets under management. Fee income decreased $3.5 million, or 3.4%, to $99.2 million primarily as a result of variable annuity fees which decreased $4.4 million, or 7.5%. A decline in the market value of average variable annuity assets under management resulted in decreased fee income of $6.7 million. This was partially offset by fees of $2.3 million from additional variable annuity deposits. This decrease in fee income was partially offset by a $1.3 million increase in individual variable universal life policy fees, primarily due to additional deposits. A decline in net investment income, which primarily resulted from the impact of defaulted bonds, was substantially offset by additional income from the investment of higher general account deposits, including approximately $300 million of deposits from the introduction of a promotional annuity program. This program offered an enhanced crediting rate of 7% for new general account deposits, for up to one year. The Company completed this program in the second quarter of 2001. (See "Investment Portfolio") 27 Policy benefits, claims and losses increased $7.5 million, or 10.6%, to $78.5 million, primarily due to an increase in general account deposits, including the introduction of the aforementioned promotional annuity program. This increase is also attributable to less favorable mortality experience in the individual variable universal life product line. Policy acquisition and other operating expenses decreased $3.5 million, or 4.0%, to $83.2 million in the second quarter of 2001. Policy acquisition expenses decreased $7.8 million due to a refinement in the methodology used by the Company's deferred policy acquisition cost valuation system, as well as lower annuity profits. Partially offsetting this decrease was a $4.3 million increase in other operating expenses resulting primarily from increased distribution and technology costs. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Segment income decreased $23.0 million, or 20.9%, to $86.9 million during the first six months of 2001. This decrease primarily reflects lower asset-based fee and other income, as well as an increase in policy benefits and other operating expenses, net of lower deferred acquisition costs. The decline in asset-based fees and other income is principally attributable to a decrease in the market value of assets under management in the variable product lines, and to lower brokerage income. Segment revenues decreased $15.0 million, or 3.4%, in the first six months of 2001, primarily due to lower asset-based fees and other income. Fee income decreased $5.6 million, or 2.7%, to $199.6 million, primarily due to variable annuity fees which decreased $6.9 million, or 5.9%. A decline in the market value of average variable annuity assets under management resulted in a $10.8 million decrease in fee income, partially offset by an increase of $3.9 million from additional deposits. In addition, non-variable universal life policy fees decreased $1.5 million in the first six months of 2001, primarily due to a decline in average invested assets resulting from the continued shift in focus to variable life insurance and annuity products. These decreases in fee income were partially offset by a $3.1 million increase in fees from variable universal life policies, primarily due to additional deposits. Other income decreased $5.0 million, or 8.8%, to $51.6 million. This decline was primarily due to lower brokerage income resulting from a decrease in mutual fund and general securities transaction volumes, as well as decreased investment management fees resulting from depreciation in variable product assets under management. Net investment income declined $2.2 million primarily due to the impact of defaulted bonds and to lower average mortgage investments and yields. This decline was partially offset by additional income from the investment of higher general account deposits, including deposits from the aforementioned promotional annuity program. Policy benefits, claims and losses increased $9.5 million, or 5.8%, to $172.2 million in the first six months of 2001, primarily due to an increase in general account deposits, including the introduction of the aforementioned promotional annuity program, and to less favorable mortality experience in the individual variable universal life product line. These increases were partially offset by more favorable mortality experience in the traditional life line of business. Policy acquisition and other operating expenses decreased $1.5 million, or 0.9%, to $168.4 million in the first six months of 2001. Policy acquisition expenses decreased $13.0 million due to the aforementioned refinement in the methodology used by the Company's deferred policy acquisition cost valuation system, as well as lower annuity profits. Partially offsetting this decrease was an $11.5 million increase in other operating expenses primarily from increased distribution and technology costs. 28 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 Six Months Ended June 30, June 30, ---------------------------------------------- (In millions) 2001 2000 2001 2000 ------------------------------------------ ----------------------------------------------- Insurance: Traditional life $ 7.8 $ 9.0 $ 24.0 $ 25.6 Universal life 4.8 4.7 9.4 10.5 Variable universal life 43.0 51.5 101.3 102.7 Individual health 0.1 - 0.2 0.1 Group variable universal life 20.9 18.6 59.3 30.1 -------- -------- --------- --------- Total insurance 76.6 83.8 194.2 169.0 -------- -------- --------- --------- Annuities: Separate account annuities 480.9 676.5 979.3 1,355.4 General account annuities 326.0 125.4 556.4 264.1 Retirement investment accounts 1.6 2.6 3.9 6.1 -------- -------- --------- --------- Total individual annuities 808.5 804.5 1,539.6 1,625.6 Group annuities 70.3 90.7 165.2 259.3 -------- -------- --------- --------- Total annuities 878.8 895.2 1,704.8 1,884.9 -------- -------- --------- --------- Total premiums and deposits $ 955.4 $ 979.0 $ 1,899.0 $ 2,053.9 ======== ======== ========= =========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 Total premiums and deposits decreased $23.6 million, or 2.4%, to $955.4 million. These decreases are primarily due to lower separate account, group annuity and variable universal life deposits, partially offset by higher general account deposits. The Company believes that the lower separate account, group annuity, and variable universal life deposits reflect an industry-wide trend resulting from a general decline in the equity markets. In addition, group annuity deposits decreased due to the Company's decision to cease marketing activities for new group retirement business. Partially offsetting these decreases were higher annuity deposits into the Company's general account, resulting in part, from the aforementioned promotional annuity program. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 For the six months ended June 30, 2001, total premiums and deposits decreased $154.9 million, or 7.5%, to $1,899.0 million. These decreases are primarily due to lower separate account and group annuity deposits resulting from the aforementioned general decline in the equity markets and to the Company's decision to cease marketing activities for new group retirement business. Partially offsetting these decreases were higher annuity deposits into the Company's general account resulting, in part, from the aforementioned promotional annuity program. Annuity products are distributed primarily through three distribution channels: (1) "Agency", which consists of the Company's career agency force; (2) "Select", which consists of a network of third party broker-dealers; and (3) "Partners", which includes distributors of the mutual funds advised by Zurich Scudder Investments ("Zurich-Scudder"), Pioneer Investment Management, Inc. and Delaware Management Company ("Delaware"). Select, Partners, and Agency represented, respectively, approximately 40%, 35%, and 25% of individual annuity deposits in the second quarter and first six months of 2001, and Zurich-Scudder represented 25% of all individual annuity deposits. During the second quarter and first six months of 2000, Select, Partners, and Agency represented, respectively, approximately 25%, 45%, and 30% of individual annuity deposits. The increase in deposits within the Select channel resulted primarily from the aforementioned promotional annuity program which was only available in the Select channel. 29 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 Six Months Ended June 30, June 30, ----------------------------------------------- (In millions) 2001 2000 2001 2000 - --------------------------------------------------------------------------------- Interest margins on GICs Net investment income $ 39.5 $ 32.1 $ 76.4 $ 58.5 Interest credited 35.6 28.5 67.6 50.9 -------- -------- --------- ------- Net interest margin 3.9 3.6 8.8 7.6 -------- -------- --------- ------- Fees and other income External 1.1 1.5 2.8 3.1 Internal 1.3 1.3 2.7 2.6 Other operating expenses (1.9) (1.8) (3.9) (3.6) -------- -------- --------- ------- Segment income $ 4.4 $ 4.6 $ 10.4 $ 9.7 ======== ======== ========= =======
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 Segment income decreased $0.2 million, or 4.3%, to $4.4 million during the second quarter of 2001. This decline is primarily due to a decrease in fee and other income related to external clients, partially offset by increased earnings on guaranteed investment contracts ("GICs"). Lower investment management fees related to external clients resulted from decreased fees from the management of a securitized investment portfolio, partially offset by an increase in other external fixed income assets under management. Other external assets under management grew in the second quarter of 2001 due to increased business from new and existing money market and fixed income fund clients. Earnings from GICs increased in the second quarter primarily due to additional long-term funding agreement deposits of approximately $300.0 million, partially offset by lower investment income due to defaults of certain bonds supporting GIC obligations. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Segment income increased $0.7 million, or 7.2%, to $10.4 million in the first six months of 2001. This increase is primarily due to increased earnings on GICs, partially offset by a decrease in fees and other income related to external clients. Earnings on GICs increased in 2001 primarily due to additional long-term funding agreement deposits of $1.1 billion, partially offset by lower investment income due to the aforementioned bond defaults. The decrease in external fees and other income primarily resulted from the aforementioned decrease in fees from the management of a securitized investment portfolio, partially offset by an increase in other external assets under management from additional deposits. Corporate The following table summarizes the results of operations for the Corporate segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, -------------------------------------------- (In millions) 2001 2000 2001 2000 - -------------------------------------------------------------------------------- Segment revenues Net investment income $ 1.5 $ 1.7 $ 2.5 $ 2.7 Interest expense 3.8 3.8 7.6 7.6 Other operating expenses 13.3 10.1 26.7 21.8 -------- -------- -------- ------- Segment loss $ (15.6) $ (12.2) $ (31.8) $ (26.7) ======== ======== ======== =======
30 Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 Segment loss increased $3.4 million, or 27.9%, to $15.6 million in the second quarter of 2001 primarily due to the timing of corporate overhead costs and certain corporate overhead expenses previously allocated to other operating segments. Interest expense for both periods relates to the interest paid on the Senior Debentures of the Company. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Segment loss increased $5.1 million, or 19.1%, to $31.8 million in the first six months of 2001 primarily due to the timing of corporate overhead costs and certain corporate overhead expenses previously allocated to other operating segments. Interest expense for both periods relates to the interest paid on the Senior Debentures of the Company. Investment Portfolio The Company held general account investment assets diversified across several asset classes, as follows:
(Unaudited) June 30, 2001 December 31, 2000 ---------------------------------------------------------- Carrying % of Total Carrying % of Total (Dollars in millions) Value Carrying Value Value Carrying Value - --------------------------------------------------------------------------------------------------- Fixed maturities (1) $ 9,031.3 84.4% $ 8,118.0 83.9% Equity securities (1) 75.1 0.7 85.5 0.9 Mortgages 568.8 5.3 617.6 6.4 Policy loans 384.6 3.6 381.3 3.9 Cash and cash equivalents 482.7 4.5 281.1 2.9 Other long-term investments 162.3 1.5 193.2 2.0 ------------ ------------- ------------- ------------ Total $ 10,704.8 100.0% $ 9,676.7 100.0% ============ ============= ============= ============ (1) The Company carries fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets increased $1.0 billion, or 10.6%, to $10.7 billion during the first six months of 2001. This increase consisted primarily of additional fixed maturities of $913.3 million and additional cash and cash equivalents of $201.6 million. The increases in fixed maturities and cash and cash equivalents are primarily due to the investment of funds received from the sale of GICs by the Allmerica Asset Management segment, as well as the aforementioned promotional annuity program in the Allmerica Financial Services segment. 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 89.2% and 88.1% of the Company's total fixed maturity portfolio at June 30, 2001 and December 31, 2000, respectively. The average yield on fixed maturities was 7.4% and 7.3% for the six months ended June 30, 2001 and 2000, respectively. Although management expects that new funds will be invested primarily in investment grade fixed maturities, the Company may invest a portion of new funds in below investment grade fixed maturities or equity interests. As a result of the Company's exposure to below investment grade securities, the Company recognized $95.2 million and $19.9 million of realized losses on other than temporary impairments of fixed maturities during the first six months of 2001 and 2000, respectively. The losses reflect the continued deterioration of the high-yield market. The recognition of these losses followed the review of recent defaults on interest payments, financial information from issuers, estimated future cash flows and other trends in the high-yield market. No assurance can be given that the fixed maturity impairments will, in-fact, be adequate to cover future losses or that substantial additional impairments will not be required in the future. In addition, the Company had fixed maturity securities with a carrying value of $19.6 million and $7.5 million on non-accrual status at June 30, 2001 and December 31, 2000, respectively. The effect of non-accruals, compared with amounts that would have been recognized in accordance with the original terms of the investments, was a reduction in net investment income of $6.8 million and $1.7 million for the six months ended June 30, 2001 and 2000, respectively. Management expects that defaults in the fixed maturities portfolio will continue to negatively impact investment income. 31 Income Taxes AFC and its domestic subsidiaries (including certain non-insurance operations) file a consolidated United States federal income tax return. Entities included within the consolidated group are segregated into either a life insurance or a non-life insurance company subgroup. The consolidation of these subgroups is subject to certain statutory restrictions on the percentage of eligible non-life tax losses that can be applied to offset life company taxable income. Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000 The provision for federal income taxes before minority interest, discontinued operations and the effect of a change in accounting principle was a $1.7 million benefit during the second quarter of 2001 compared to an $8.4 million expense during the same period in 2000. These provisions resulted in consolidated effective federal tax rates of (11.0%) and 14.0% for the quarters ended June 30, 2001 and 2000, respectively. The decrease in the rate is primarily due to increased realized losses in the second quarter of 2001, to lower underwriting income resulting in an increase in the proportion of tax-exempt investment income to pre-tax income, and to an increase in the dividends received deduction associated with the Company's variable products. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 The provision for federal income taxes before minority interest, discontinued operations and the effect of a change in accounting principle was $4.7 million during the first six months of 2001 compared to $15.9 million during the same period in 2000. These provisions resulted in consolidated effective federal tax rates of 9.0% and 15.6% for the six months ended June 30, 2001 and 2000, respectively. The decrease in the rate is primarily due to lower underwriting income in the first six months of 2001 resulting in an increase in the proportion of tax-exempt investment income to pre-tax income, as well as to an increase in the dividends received deduction associated with the Company's variable products. 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 six months of 2001, AFC received $100.0 million of dividends from its property and casualty businesses. Additional dividends from the Company's insurance subsidiaries in 2001 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 $263.4 million during the first six months of 2001, compared to net cash used in operating activities of $128.3 million for the same period of 2000. The increase in 2001 is primarily the result of funds received from the aforementioned promotional annuity program, an increase in premiums received from the property and casualty business and decreased federal income tax payments. These increases in cash were partially offset by increased loss and LAE payments in the property and casualty business. Net cash used in investing activities was $784.9 million and $482.5 million during the first six months of 2001 and 2000, respectively. The increase in cash used in 2001 is primarily due to a $358.2 million year over year increase in net purchases of fixed maturites primarily due to the timing of investing new funding agreement deposits and from additional deposits into the general account, including those related to the aforementioned promotional annuity program. The increased use of cash was partially offset by a decline in the purchase of other investments. 32 Net cash provided by financing activities was $723.1 million and $486.9 million during the first six months of 2001 and 2000, respectively. The increase in 2001 is primarily due to an increase in net funding agreement deposits, including trust instruments supported by funding obligations, of $193.1 million and a $46.8 million year over year reduction in cash used for the Company's share repurchase program. In the opinion of management, AFC has sufficient funds at the holding company or available through dividends from its insurance subsidiaries, or through available credit facilities to meet its obligations to pay interest on the Senior Debentures, Capital Securities and dividends, when and if declared by the Board of Directors, on the common stock. Based on current trends, the Company expects to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements. The Company maintains a high degree of liquidity within the investment portfolio in fixed maturity investments, common stock and short-term investments. AFC has $215.0 million available under a committed syndicated credit agreement which expires on May 24, 2002. Borrowings under this agreement are unsecured and incur interest at a rate per annum equal to, at the Company's option, a designated base rate or the eurodollar rate plus applicable margin. At June 30, 2001, no amounts were outstanding under this agreement. The Company had $69.3 million of commercial paper borrowings outstanding at June 30, 2001. These borrowings are used in connection with the Company's premium financing business, which is included in the Risk Management segment. Contingencies The Company's insurance subsidiaries are routinely engaged in various legal proceedings arising in the normal course of business, including claims for punitive damages. Additional information on other litigation and claims may be found in Note 12 "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 2001 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes", "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, 2000. 33 Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) adverse catastrophe experience and severe weather; (ii) adverse loss development for events the Company has insured in either the current or in prior years or adverse trends in mortality and morbidity; (iii) heightened competition, including the intensification of price competition, the entry of new competitors, and the introduction of new products by new and existing competitors, or as the result of consolidation within the financial services industry and the entry of additional financial institutions into the insurance industry; (iv) adverse state and federal legislation or regulation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, and tax treatment of insurance and annuity products, as well as continued compliance with state and federal regulations; (v) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) difficulties in recruiting new or retaining existing career agents, wholesalers and partnership relations to support the sale of variable products; (viii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (ix) loss or retirement of key executives; (x) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (xi) changes in the Company's liquidity due to changes in asset and liability matching; (xii) restrictions on insurance underwriting, based on genetic testing and other criteria; (xiii) adverse changes in the ratings obtained from independent rating agencies, such as Moody's, Standard and Poor's and A.M. Best; (xiv) lower appreciation on or decline in value of the Company's managed investments or the investment markets in general, resulting in reduced variable product sales, assets and related fees and increased surrenders; (xv) possible claims relating to sales practices for insurance products; (xvi) failure of a reinsurer of the Company's policies to pay its liabilities under reinsurance contracts; (xvii) earlier than expected withdrawals from the Company's general account annuities, GICs (including funding agreements), and other insurance products; (xviii) changes in the mix of assets comprising the Company's investment portfolio and the fluctuation of the market value of such assets; (xix) losses resulting from the Company's participation in certain reinsurance pools; (xx) adverse results of regulatory audits related to the Company's prior years' federal income tax filings; (xxi) losses due to foreign currency fluctuations; (xxii) the inability to realize expense savings and enhanced revenues from restructuring initiatives and (xxiii) defaults in debt securities held by the Company. 34 PART I - FINANCIAL INFORMATION ITEM 3 QUANTITATIVE AND QUALITATIVE DICLOSURES ABOUT MARKET RISK Our market risks, and the ways we manage them, are summarized in management's discussion and analysis of financial condition and results of operations as of December 31, 2000, included in the Company's Form 10-K for the year ended December 31, 2000. There have been no material changes in the first six months of 2001 to such risks or our management of such risks. 35 PART II - OTHER INFORMATION ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS This registrant's annual shareholder's meeting was held on May 15, 2001. All five directors nominated for re-election by the Board of Directors were named in proxies for the meeting, which proxies were solicited pursuant to Regulations 14A of the Securities and Exchange Act of 1934. VOTES FOR WITHHELD Michael P. Angelini 39,432,378 248,014 Robert P. Henderson 39,522,201 158,191 Terrence Murray 39,527,872 152,520 John F. O'Brien 39,532,335 148,057 Herbert M. Varnum 39,529,033 151,359 The other directors whose terms were continued after the Annual Meeting are Mr. E. Gordon Gee, Mr. Samuel J. Gerson, Ms. Gail L. Harrison, Mr. M Howard Jacobson, Mr. Wendell J. Knox, Mr. Robert J. Murray and Mr. John R. Towers. Shareholders ratified the appointment of PricewaterhouseCoopers LLP as the Independent Public Accountants of the Company for 2001: for 39,383,311; against 208,500; abstain 88,581. 36 PART II - OTHER INFORMATION ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits EX-10.38 Amendment to the Credit Agreement dated as of May 25, 2001 between the Registrant and the Chase Manhattan Bank EX-10.39 Stock Pledge and Loan Agreement dated as of February 5, 2001 between AMGRO, Inc., a subsidiary of the Registrant, and Robert P. Restrepo, Jr. (b) Reports on Form 8-K None 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Allmerica Financial Corporation Registrant Dated August 14, 2001 /s/John F. O'Brien ------------------ John F. O'Brien President and Chief Executive Officer Dated August 14, 2001 /s/Edward J. Parry III ---------------------- Edward J. Parry III Vice President, Chief Financial Officer and Principal Accounting Officer 38 EXHIBIT INDEX Exhibit Number Exhibit 10.38 Amendment to the Credit Agreement dated as of May 25, 2001 between the Registrant and the Chase Manhattan Bank. 10.39 Stock Pledge and Loan Agreement dated as of February 5, 2001 between AMGRO, Inc., a subsidiary of the Registrant, and Robert P. Restrepo, Jr. 39 EX-10 3 chase.txt CHASE MANHATTAN AMENDED CREDIT AGREEMENT Exhibit 10.38 EXECUTION COPY AMENDMENT NO. 2 dated as of May 25, 2001 (this "Amendment No. 2") to the Credit Agreement referred to below, among ALLMERICA FINANCIAL CORPORATION, a Delaware corporation (the "Company"), and each of the LENDERS that is a signatory hereto. W I T N E S S E T H: WHEREAS, the Company, the Lenders and The Chase Manhattan Bank, as Administrative Agent, are parties to a 364-Day Credit Agreement dated as of May 29, 1998 (as amended by the Amendment and Restatement dated as of May 28, 1999 and Amendment No. 1 dated as of May 26, 2000 and as in effect on the date hereof, the "Credit Agreement"). WHEREAS, the aggregate Commitments under the Credit Agreement will be increased to $215,000,000 and the lenders listed under the caption "New Lenders" on the signature pages hereto (collectively, the "New Lenders") wish to become parties to the Credit Agreement as Lenders having the respective Commitments set forth opposite their names on Schedule I attached to this Amendment No. 2, effective as of the date hereof, and in that connection the parties hereto desire to amend the Credit Agreement in certain respects. NOW, THEREFORE, in consideration of the foregoing premises and the mutual agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree to amend the Credit Agreement as follows: Section 1. Definitions. Terms defined in the Credit Agreement but not herein have the meanings given them in the Credit Agreement. Section 2. Amendments. Subject to the satisfaction of the conditions precedent set forth below, effective as of the date hereof the Credit Agreement shall be amended as follows: 2.01. General. References in the Credit Agreement to "this Agreement" or words of similar import (including indirect references to the Credit Agreement) shall be deemed to be references to the Credit Agreement as amended hereby. 2.02. Definitions. (a) The definition of "Applicable Margin" in Section 1.01 of the Credit Agreement shall be amended in its entirety to read as follows: "Applicable Margin" shall mean (i) with respect to Eurodollar Loans that have not been converted to Term Loans pursuant to Section 2.10 hereof, 0.22% per annum and (ii) with respect to Eurodollar Loans that have been converted to Term Loans pursuant to Section 2.10 hereof, the applicable rate per annum set forth below under the caption "Applicable Margin" based upon the ratings by Moody's and S&P, respectively, applicable on such date to the Index Debt: 2
Index Debt Applicable Category Ratings Margin 1 greater than or equal to A2 / A 0.30% 2 A3 / A- 0.35% 3 less than or equal to Baa1 / BBB + 0.50%
For purposes of the foregoing, (i) if either Moody's or S&P shall not have in effect a rating for the Index Debt (other than by reason of the circumstances referred to in the last sentence of this definition), then such rating agency shall be deemed to have established a rating in Category 3; (ii) if the ratings established or deemed to have been established by Moody's and S&P for the Index Debt shall fall within different Categories, the Applicable Margin shall be based on the higher of the two ratings unless one of the two ratings is two or more Categories lower than the other, in which case the Applicable Margin shall be determined by reference to the Category next below that of the higher of the two ratings; and (iii) if the ratings established or deemed to have been established by Moody's and S&P for the Index Debt shall be changed (other than as a result of a change in the rating system of Moody's or S&P), such change shall be effective as of the date on which it is first announced by the applicable rating agency. Each change in the Applicable Margin shall apply during the period commencing on the effective date of such change and ending on the date immediately preceding the effective date of the next such change. If the rating system of Moody's or S&P shall change, or if either such rating agency shall cease to be in the business of rating corporate debt obligations, the Company and the Lenders shall negotiate in good faith to amend this definition to reflect such changed rating system or the unavailability of ratings from such rating agency and, pending the effectiveness of any such amendment, the Applicable Margin shall be determined by reference to the rating most recently in effect prior to such change or cessation. (b) The definition of "Commitment Termination Date" in Section 1.01 of the Credit Agreement shall be amended in its entirety to read as follows: "Commitment Termination Date" shall mean May 24, 2002, as such date may be extended pursuant to Section 2.09 hereof. (c) The definition of "Loans" in Section 1.01 of the Credit Agreement shall be amended by deleting the words "Section 2.01" and replacing them with the words "Sections 2.01 and 2.10". 3 (d) The following new definitions shall be added to Section 1.01 of the Credit Agreement in their proper respective alphabetical locations: "Index Debt" means senior, unsecured, long-term indebtedness for borrowed money of the Company that is not guaranteed by any other Person or subject to any other credit enhancement. "Moody's" means Moody's Investors Service, Inc. "S&P" means Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. "Term Loan" has the meaning set forth in Section 2.10 hereof. 2.03. Fees. Section 2.04 of the Credit Agreement shall be amended in its entirety to read as follows (and the Table of Contents shall be amended accordingly): "2.04. Fees. (a) Facility Fee. The Company agrees to pay to the Administrative Agent for account of each Lender a facility fee on the amount of such Lender's Commitment (whether or not utilized) for the period from and including the date hereof to but not including the earlier of the date such Commitment is terminated and the Commitment Termination Date, at a rate per annum equal to the Applicable Loan Fee Percentage; provided that, if such Lender continues to have Loans outstanding after the termination of its Commitment (including, without limitation, as a result of the conversion of Loans pursuant to Section 2.10 hereof), then such facility fee shall continue to accrue on the aggregate daily amount of such Lender's Loans from and including the date its Commitment terminates to but excluding the date such Loans are paid in full. Accrued facility fees shall be payable on each Quarterly Date in arrears and on (i) if no conversion of Loans is effected pursuant to Section 2.10 hereof, the earlier of the date the Commitments are terminated and the Commitment Termination Date or (ii) if such conversion is effected, the maturity date of the Term Loans as specified in Section 2.10 hereof. (b) Utilization Fee. The Company agrees to pay to the Administrative Agent for account of each Lender a utilization fee, for each day that the aggregate principal amount of the Loans (including the Term Loans) shall exceed 50% of the aggregate Commitments (or at any time following the conversion of Loans to Term Loans pursuant to Section 2.10 hereof or the termination of the Commitments for any other reason, the aggregate Commitments in effect immediately prior to such conversion or termination, as the case may be), at a rate per annum equal to 0.05% of the aggregate outstanding principal amount of such Lender's Loans for such day. Accrued utilization fees (if any) shall be payable on each date facility fees are payable." 4 2.04. Conversion to Term Loans. The following new Section 2.10 shall be inserted immediately after Section 2.09 of the Credit Agreement: "2.10. Conversion to Term Loans. Notwithstanding anything to the contrary contained in Section 3.01 hereof, the Company may, by notice to the Administrative Agent not later than 11:00 a.m. (New York City time) three Business Days prior to the Commitment Termination Date, convert all Loans made to the Company that are outstanding on the Commitment Termination Date into term loans (such converted loans, "Term Loans") having a maturity date which is the first anniversary of the Commitment Termination Date; provided that, both on the date of such notice and on the Commitment Termination Date, (i) no Default shall have occurred and be continuing and (ii) the representations and warranties of the Company set forth in Section 7 hereof shall be true and complete with the same force and effect as if made on and as of the date of such conversion (or, if any such representation or warranty is stated to relate solely to a specific date, as of such specific date); and provided, further, that after giving effect to such conversion the Lenders shall have no further obligation to make any additional Loans. Each Term Loan shall bear interest, until the payment in full thereof, at the rates that Loans of the same Type bear pursuant to this Agreement and shall otherwise constitute a Loan for all purposes of this Agreement. The Company hereby promises to pay to the Administrative Agent for account of the Lenders, on such maturity date (or, if such maturity date does not fall on a Business Day, the next preceding Business Day), the unpaid principal amount of all outstanding Term Loans." 2.05. Pro Rata Treatment. Section 4.02 of the Credit Agreement shall be amended by deleting the words "loan fees" in the third line thereof and replacing them with the words "facility fees and utilization fees". 2.06. Computations. Section 4.03 of the Credit Agreement shall be amended by deleting the words "and loan fees" in the first line thereof and replacing them with the words: ", facility fees and utilization fees". 2.07. Financial Condition. (a) Section 7.02(a) of the Credit Agreement shall be amended by deleting the year "1997" in the first and last sentences thereof and replacing it with the year "2000" in each case. (b) Section 7.02(b) of the Credit Agreement shall be amended by deleting the year "1997" in the third and sixth lines thereof and replacing it with the year "2000" in each case. 2.08. Use of Proceeds. Section 8.09 of the Credit Agreement shall be amended by inserting the words "or its subsidiaries" immediately after the word "Company" in the second line thereof. 5 2.09. Events of Default. Section 9(a) of the Credit Agreement shall be amended by deleting the words "loan fee" in the third line thereof and replacing them with the words "facility fee or utilization fee". 2.10. Assignments and Participations. (a) Section 11.06(b)(ii) of the Credit Agreement shall be amended by inserting the word "(a)," immediately after the word "clause" in the second line thereof. (b) The following new paragraph shall be inserted in Section 11.06(b) of the Credit Agreement immediately after the last paragraph thereof: "Notwithstanding anything to the contrary contained herein, any Lender (a "Granting Lender") may grant to a special purpose vehicle (an "SPV") of such Granting Lender, identified as such in writing from time to time by the Granting Lender to the Administrative Agent and the Company, the option to provide to the Company all or any part of any Loan that such Granting Lender would otherwise be obligated to make to the Company pursuant to Section 2.01 hereof, provided that (i) nothing herein shall constitute a commitment by any SPV to make any Loan, (ii) if an SPV elects not to exercise such option or otherwise fails to provide all or any part of such Loan, the Granting Lender shall be obligated to make such Loan pursuant to the terms hereof and (iii) the Company may bring any proceeding against either the Granting Lender or the SPV in order to enforce any rights of the Company hereunder. The making of a Loan by an SPV hereunder shall utilize the Commitment of the Granting Lender to the same extent, and as if, such Loan were made by the Granting Lender. Each party hereto hereby agrees that no SPV shall be liable for any payment under this Agreement for which a Lender would otherwise be liable, for so long as, and to the extent, the related Granting Lender makes such payment. In furtherance of the foregoing, each party hereto hereby agrees (which agreement shall survive the termination of this Agreement) that, prior to the date that is one year and one day after the payment in full of all outstanding commercial paper or other senior indebtedness of any SPV, it will not institute against, or join any other person in instituting against, such SPV any bankruptcy, reorganization, arrangement, insolvency or liquidation proceedings or similar proceedings under the laws of the United States or any State thereof arising out of any claim against such SPV under this Agreement. In addition, notwithstanding anything to the contrary contained in this Section, any SPV may with notice to, but without the prior written consent of, the Company or the Administrative Agent and without paying any processing fee therefor, assign all or a portion of its interests in any Loans to its Granting Lender or to any financial institutions (consented to by the Company and the Administrative Agent) providing liquidity and/or credit support (if any) with respect to commercial paper issued by such SPV to fund such Loans and such SPV may disclose, on a confidential basis in accordance with Section 11.13(b) hereof, confidential information with respect to the Company and its Subsidiaries to any rating agency, commercial paper dealer or provider of a surety, guarantee or credit liquidity enhancement to such SPV. This paragraph may not be 6 amended without the consent of any SPV at the time holding Loans under this Agreement." 2.11. Schedule of Commitments. Schedule I to the Credit Agreement shall be amended by being deleted and replaced in its entirety by Schedule I to this Amendment No. 2, and references in the Credit Agreement to "Schedule I hereto" or words of similar import (including indirect references to Schedule I to the Credit Agreement) shall be deemed to be references to Schedule I to this Amendment No. 2. Section 3. Representations and Warranties. The Company hereby represents and warrants to the Lenders and the Administrative Agent that, after giving effect to this Amendment No. 2, (a) the representations and warranties set forth in Section 7 of the Credit Agreement (as amended hereby) are true and correct as of the date hereof with the same force and effect as if made on and as of such date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date) and (b) no Default shall have occurred and be continuing. Section 4. Conditions Precedent. The amendments to the Credit Agreement set forth in Section 2 above shall become effective as of the date hereof upon receipt by the Administrative Agent of the following documents, each of which shall be satisfactory to the Administrative Agent (and, to the extent specified below, to each Lender) in form and substance: (a) Amendment No. 2. This Amendment No. 2, duly executed and delivered by the Company, the Lenders (including the New Lenders, which on and after the effective date of this Amendment No. 2 will be party to the Credit Agreement as amended hereby as a "Lender" and shall have all of the rights, and be subject to all of the obligations, of a Lender under the Credit Agreement as amended hereby) and the Administrative Agent. (b) Payments. Evidence of payment (or arrangements for payment) in full of all unpaid fees under the Credit Agreement, which shall have accrued to but not including the Commitment Termination Date as in effect immediately prior to the effectiveness of this Amendment No. 2. (c) Other Documents. Such other documents as the Administrative Agent, any Lender or special New York counsel to Chase may reasonably request. Section 5. Miscellaneous. Except as herein provided, the Credit Agreement shall remain unchanged and in full force and effect. This Amendment No. 2 may be executed in any number of counterparts, all of which taken together shall constitute one and the same amendatory instrument and any of the parties hereto may execute this Amendment No. 2 by signing any such counterpart and sending the same by telecopier, mail messenger or courier to the Administrative Agent or special New York counsel to Chase. This Amendment No. 2 shall be governed by, and construed in accordance with, the law of the State of New York. 7 IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 2 to be duly executed as of the day and year first above written. COMPANY ALLMERICA FINANCIAL CORPORATION By /s/ Mark C. McGivney --------------------- Name: Mark C. McGivney Title: Vice President and Treasurer 8 LENDERS THE CHASE MANHATTAN BANK By /s/ Marybeth Mullen -------------------- Name: Marybeth Mullen Title: Vice President DEUTSCHE BANK AG, NEW YORK AND/OR CAYMAN ISLANDS BRANCH By /s/ John S. McGill ------------------- Name: John S. McGill Title: Director By /s/ Ruth Leung --------------- Name: Ruth Leung Title: Director BANK ONE, NA (MAIN OFFICE CHICAGO) By /s/ Thomas A. Kiepura ---------------------- Name: Thomas A Kiepura Title: Assistant Vice President CREDIT SUISSE FIRST BOSTON By /s/ Jay Chall -------------- Name: Jay Chall Title: Director By /s/ Bill O'Daly ---------------- Name: Bill O'Daly Title: Vice President 9 FLEET NATIONAL BANK By/s/ Anita M. Presmarita ----------------------- Name: Anita M. Presmarita Title: Vice President THE BANK OF NEW YORK By /s/ Gary Overton ----------------- Name: Gary Overton Title: Vice President NEW LENDERS STATE STREET BANK AND TRUST COMPANY By /s/ Edward M. Anderson ----------------------- Name: Edward M. Anderson Title: Vice President BANK OF AMERICA, N.A. By /s/ Mehul D. Mehta ------------------- Name: Mehul D. Mehta Title: Vice President 10 SCHEDULE I Commitments The Chase Manhattan Bank $30,000,000 Deutsche Bank AG, New York and/or Cayman Islands Branch $40,000,000 BANK ONE, NA (Main Office Chicago) $30,000,000 Credit Suisse First Boston $30,000,000 Fleet National Bank $30,000,000 State Street Bank and Trust Company $25,000,000 Bank of America, N.A. $15,000,000 The Bank of New York $15,000,000 ------------ $215,000,000 EX-10 4 loan.txt LOAN AGREEMENT Exhibit 10.39 STOCK PLEDGE AND LOAN AGREEMENT STOCK PLEDGE AND LOAN AGREEMENT (this "Agreement" or this "Stock Pledge and Loan Agreement") is dated as of the 5th day of February, 2001, by and between ROBERT P. RESTREPO, JR. and MARY FRANCES RESTREPO, individually and collectively, residing at 6 Kenmore Road, Bloomfield, Connecticut 06000 (hereinafter, "Pledgor") and AMGRO, INC., a Massachusetts corporation with an address at 100 North Parkway, Worcester, Massachusetts 01605 (hereinafter, "AMGRO"). WHEREAS, Pledgor hereby applies to AMGRO for a loan and in consideration of AMGRO granting the same, Pledgor hereby agrees to the terms and conditions contained in this Agreement; and WHEREAS, at the time of the execution of this Agreement AMGRO has established a line of credit in favor of Pledgor in the principal amount of One Million Dollars ($1,000,000) (the "LOC"); and WHEREAS, the Pledgor has executed a Credit Line Promissory Note (hereinafter the "Note") providing for the repayment of the amount of the LOC, together with interest as set forth therein; and WHEREAS, a copy of the Note is attached hereto and incorporated herein by reference as Exhibit A; and WHEREAS, the Pledgor is now the sole record, legal and beneficial owner of a portion of the capital stock of Allmerica Financial Corporation ("AFC"), consisting of Restricted Common Stock (the "Restricted Stock"), and Unrestricted Common Stock (the "Unrestricted Stock") as set forth in Exhibit B, and WHEREAS, the Pledgor during the time the Note is outstanding may receive additional Restricted Stock which according to its terms may become Unrestricted Stock (the "Future Restricted Stock"); and WHEREAS, the Pledgor is now the sole record, legal and beneficial owner of Vested and Unvested Stock Options of AFC (in the aggregate hereinafter referred to as "Current Stock Options") as set forth in Exhibit B WHEREAS, the Pledgor during the time the Note is outstanding may receive additional Stock Options (the "Future Stock Options"); and WHEREAS, the Current Stock Options and the Future Stock Options are sometimes referred to herein as "Stock Options"; and WHEREAS, the Restricted Stock, the Future Restricted Stock and the Unrestricted Stock are sometimes referred to herein as the "Shares"; and WHEREAS, the parties agree that the Shares and the Stock Options should be assigned, 2 transferred and delivered to AMGRO in order to secure the obligations under the Note and this Agreement, and to secure the payment of the principal and interest on the Note pursuant to its terms and to the terms, provisions and conditions of this Stock Pledge and Loan Agreement; NOW, THEREFORE, in consideration of the LOC and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties covenant and agree as follows: 1. The Pledgor hereby assigns, transfers, and delivers to AMGRO all of the Pledgor's right, title and interest in and to the Shares, represented by the certificate number(s) specified on Exhibit B hereto, the Shares shall be duly endorsed in blank or with stock power attached, together with all of the Pledgor's right, title and interest in and to all dividends, income and issues therefrom, and all rights of preemption, or other rights attached thereto; TO HAVE AND TO HOLD such Shares, along with the dividends, income, issues and right to AMGRO, its successors and assigns, to its and their own use forever, but subject, nevertheless, to the terms, provisions and conditions which are set forth herein. 2. So long as the terms, provisions and conditions of this Agreement shall be kept and performed by the Pledgor, the Pledgor shall have the right to vote the Shares at all meetings of shareholders for the election of directors, held at any time while the LOC or any part thereof remains unpaid; and AMGRO shall, before any annual meeting or special meeting of shareholders for the election of directors, execute (upon written request by the Pledgor) such instruments as are reasonably necessary to appoint the Pledgor as proxy; PROVIDED, HOWEVER, that without the prior written consent of AMGRO, the Pledgor shall not vote the Shares or any of them, for the purpose of taking any action(s) which will dilute or diminish the value of the Shares pledged as security hereunder. AND PROVIDED FURTHER that, except as otherwise provided herein, all dividends and income hereafter declared on such shares during the term of this Agreement and received by as a result of its record ownership of such shares shall be paid over to the Pledgor immediately upon receipt. 3. The Pledgor hereby assigns, transfers, and delivers to AMGRO all of the Pledgor's right, title and interest in and to the Stock Options specified on Exhibit B hereto, together with all of the Pledgor's right, title and interest in and to issues therefrom, and all rights of preemptions, or other rights attached thereto. TO HAVE AND TO HOLD such Stock Options along with the issues and right to AMGRO, its successors and assigns, to its and their own use forever, but subject, nevertheless, to the terms, provisions and conditions which are set forth herein. 4. In the event that any action or event proscribed in Section 12, below, takes place, whether with or without the consent or participation of the Pledgor, then, at the option of 3 AMGRO, all principal and interest then owing to AMGRO from the Pledgor shall immediately become due and payable. 5. Pledgor warrants and covenants that Pledgor is the sole lawful owner and holder of the Shares and the Stock Options set forth above and has valid and marketable title thereto, free and clear of any claims, liens, restrictions or encumbrances of or by others, and the Pledgor has the absolute and unrestricted right, power, authority and capacity to pledge, assign, transfer and deliver such shares as herein provided, without prior consent of any other person or entity whatsoever, except, in each case, as specifically set forth in Exhibit C hereto, which Exhibit is expressly made a part hereof. 6. Pledgor covenants that, so long as any part of the LOC or any interest accrued thereon shall remain unpaid: (a) Pledgor shall and will, at all times, comply with all acts, laws, rules, regulations and orders of any national, state, legislative, executive, administrative or judicial body, commission or office exercising any power of regulation or supervision over the Pledgor, or over any part of the assets thereof; and (b) The Pledgor will not, and shall not attempt to, assign, transfer, mortgage, sell, hypothecate or pledge, in whole or in part, the Shares or the Stock Options, except as expressly provided herein; and (c) The Pledgor shall and will furnish to AMGRO such financial information as may be required under this Stock Pledge and Loan Agreement; and (e) The Pledgor shall and will (i) keep its property adequately insured at all times with responsible insurance companies against loss or damage by fire or other hazards, (ii) maintain adequate insurance at all times with responsible insurance carriers against liability on account of damage to persons and property, and (iii) maintain such other insurance as may be required by law or as may be reasonably required by AMGRO. 7. Pledgor covenants and agrees that Pledgor shall promptly pay and discharge, as they become due and payable, any and all attachments, liens, taxes, assessments and government charges imposed upon the Shares and/or the Stock Options pledged hereunder, or upon any part of them, the lien(s) of which might be held prior to the lien created hereby, so that the priority of the lien created hereby may be fully preserved, and that the Pledgor shall not and will not do or suffer any matter or thing whatsoever, by which the lien created hereby might be impaired, until the Note, together with all interest accrued thereon, and all other claims under this Stock Pledge and Loan Agreement, and/or the Note, shall be fully paid, satisfied and discharged. Pledgor further covenants and agrees to promptly pay and discharge, when due, all taxes, excepting taxes as to which payment may be deferred by reason of the circumstances that Pledgor is in good faith contesting the obligation and so notifies AMGRO in writing thereof, against Pledgor 4 and/or the assets and/or property thereof, including without limitation the Shares and/or Stock Options. AMGRO may, at its option, pay and discharge such taxes on Pledgor's behalf, any such payments to become immediately due and owing, plus interest, by the Pledgor to AMGRO. 8. Pledgor covenants that if any action at law or in equity, or any other proceeding, shall be commenced against the Pledgor, then, in such event, Pledgor will immediately, in writing, notify AMGRO of such action or proceeding. Pledgor hereby represents and warrants that there are no pending or threatened actions, suits or proceedings against Pledgor before any court or administrative agency which involve, individually or in the aggregate, a material amount not covered by insurance or which will, under current or foreseeable conditions, materially adversely affect the financial condition of Pledgor. 9. Pledgor covenants that, upon the request of AMGRO, Pledgor will take such steps and execute and deliver such financing statements and/or perform such further acts and deeds as shall be requested to effectuate the intention of this Agreement. Pledgor further covenants to file and record these presents and/or render the collateral security, whether now owned or hereafter acquired, subject to the terms, provisions and conditions contained herein. 10. If any liquidating dividend or dividends shall be received by AMGRO in respect of any of the shares of stock, any such dividend or dividends shall be applied first by AMGRO to the payment of the principal of the debt evidenced under the Note, subject to the terms and conditions of Section 2 hereof. 11. Pledgor covenants, warrants and represents that the Shares and/or Stock Options pledged under this Agreement shall be so noted on the books of AFC to AMGRO; that there are no restrictions upon the transfer of any of the Shares or Stock Options other than as may appear on the face of the certificate(s) thereof and/or as set forth in Exhibit C hereto; that the Pledgor has the absolute right to pledge the Shares and the Stock Options free from any encumbrances, restrictions or agreements, except as otherwise provided in Exhibit C hereto; and that there are no facts (either personally known to the Pledgor or which due diligence would have disclosed) which are not set forth in this Agreement or other documents heretofore delivered by the Pledgor and which would have a material, adverse effect upon the Pledgor's solvency. 12. In each, every and any case where one or more of the events listed below occurs, AMGRO may declare the principal and accrued interest of the Note to be immediately due and payable. Upon such declaration, the same shall become due and payable, in accordance with the terms and conditions contained in the Note and this Stock Pledge and Loan Agreement. These "Events of Default" are as follows: (a) failure in the payment or performance, when due or payable of any installment under the Note, which failure continues for more than five (5) days; or (b) the making by the Pledgor, at any time, of any misrepresentation to AMGRO for 5 the purpose of obtaining credit or an extension of credit; or (c) the death or legal incapacity of the Pledgor; or (d) insolvency of the Pledgor; or (e) the appointment of a receiver for any part of the property of the Pledgor; or (f) an assignment for the benefit of creditors by the Pledgor; or (g) the calling of a meeting of creditors of, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against, the Pledgor; or (h) any encumbrance of any of the Shares and/or Stock Options, or the voluntary or involuntary transfer of any of the Shares or Stock Options by way of sale, pledge, assignment, mortgage, transfer, creation of a security interest, levy, garnishment or other judicial process; or (i) such material change in the financial condition or affairs of the Pledgor as in the reasonable discretion of AMGRO impairs AMGRO's security or increases its risk; or (j) the Pledgor's employment with Allmerica and/or the affiliates and/or subsidiaries thereof, is terminated for any reason. (k) a Change in Control as defined in the AFC Long-Term Stock Incentive Plan occurs, and as a result of such Change in Control, Pledgor receives or is eligible to receive a payment in cash for the Shares and/or Stock Options. 13. Upon any of the aforementioned events of default, AMGRO may, immediately, without demand for payment, without advertising, and without notice to the Pledgor, each and all of which is, and are, expressly waived, sell any or all of the Shares and/or Stock Options pledged hereunder at a public or private sale, and apply the proceeds of such sale, as far as needed, toward the payment of the whole of the indebtedness, together with the interest and expenses of sale; and the Pledgor shall remain responsible for any deficiency remaining unpaid after such application; AND IT IS EXPRESSLY UNDERSTOOD AND AGREED THAT AMGRO OR AFC MAY ITSELF BE A PURCHASER AT ANY SUCH SALE OF THE WHOLE OR ANY PART, OF THE SHARES OF STOCK OR STOCK OPTIONS SOLD, FREE FROM ANY RIGHT, OR EQUITY OF REDEMPTION, SUCH RIGHT AND EQUITY BEING HEREBY EXPRESSLY WAIVED AND RELEASED. 14. (a) No remedy or right conferred by this Agreement upon, or reserved to, AMGRO is intended to be to the exclusion of any other remedy or right, but each and every such remedy or right shall be cumulative, and shall be in addition to every other remedy or 6 right given hereunder, and now or hereafter existing at law or in equity. (b) No delay or omission by AMGRO to exercise any remedy or right accruing upon any of the Events of Default shall impair any such remedy or right, nor be construed to be a waiver of any such right, nor an acquiescence in or to such default, nor shall it affect any subsequent default of the same, or of a different, nature. 15. AMGRO shall hold the Shares and Stock Options pledged hereunder as security to assure the Pledgor's obligations under the Note and this Stock Pledge and Loan Agreement, and the Shares shall remain so pledged to AMGRO until the Loan is repaid in full with interest, and upon such payment in full of the principal and interest under the Note AMGRO shall immediately re-deliver the Shares and Stock Options pledged hereunder to the Pledgor, duly indorsed, and this Agreement shall terminate. 16. All rights and remedies of AMGRO given hereunder, and now or hereafter existing at law or in equity, shall inure to the benefit of itself, its successors and assigns. All liabilities and all obligations, warranties and covenants of the Pledgor, whether evidenced hereby or by any other instrument, shall bind the Pledgor's heirs, legal representatives, successors, and assigns; 17. This Agreement and all rights, duties and obligations hereunder, including matters of construction, validity and performance, shall be governed by the laws of the Commonwealth of Massachusetts, exclusive of its conflicts of law provisions, and if any of the provisions of this Agreement shall contravene or be invalid under such law, such contravention or invalidity shall not invalidate the whole Agreement, but it shall be construed as if the same did not contain the particular provision or provisions held to be invalid by a court of competent jurisdiction, and the rights and obligations of the parties hereto shall be construed and enforced accordingly. 18. Neither this Agreement, nor any liabilities, obligations, warranties or covenants hereunder are assignable by the Pledgor, in whole or in part, without the express written permission of AMGRO; provided, however, that the same shall be binding upon and inure to the benefit of the Pledgor's executor(s), administrator(s) or other legal or personal representative(s) of the Pledgor's estate(s). 19. Any notice, request, instruction or other document to be given hereunder shall be in writing and, except as otherwise provided herein, shall be delivered personally, or sent by registered or certified mail as follows: (i) if, to AMGRO: President, AMGRO, Inc., 100 North Parkway, Worcester, Massachusetts 01653; (ii) if, to the Pledgor to: Robert P. Restrepo, 6 Kenmore Road, Bloomfield, Connecticut 06000; (iii) to such other addresses as either party hereto may hereinafter designate in writing to the other party. 20. The representations, warranties, covenants and agreements herein contained shall survive the execution of this Agreement until payment in full of the indebtedness under the Note. 7 21. This instrument and any other exhibits, and/or documents incorporated herein by reference shall represent the entire agreement between the parties hereto with respect to the subject matter hereof, and may not be altered, amended or modified except by an instrument in writing signed by the party(ies) to be bound. 22. At any time requested by AMGRO, the Pledgor shall perform such other acts and/or sign such other documents, instruments and/or certificates as AMGRO, in its discretion, shall deem necessary, proper or convenient to carry out the purposes and provisions of this Agreement. 23. Pledgor agrees to pay and save AMGRO harmless against liability from the payment of all out-of-pocket expenses arising in connection with this Agreement and any supple-mental agreement(s) hereto and the reasonable fees and expenses of counsel for AMGRO. The Pledgor shall pay to AMGRO on demand any and all expenses, including reasonable counsel fees, incurred or paid by AMGRO in protecting or enforcing its rights upon or under this Agreement or the Note. After deducting all of such expenses, the residue of any proceeds of collection or sale of the Shares and/or the Stock Options shall be applied to the payment of principal or interest (if any) on any obligations of Pledgor to AMGRO, and the Pledgor shall remain liable for any deficiency. Any excess shall be returned to the Pledgor. 24. The Pledgor waives presentment, demand, notice, protest, notice of acceptance of this Agreement, and all other demands and notices of any description. With respect to both the liability existing hereunder and under the terms of the Note, the Shares and the Stock Options, the Pledgor assents to any extension or postponement of the time of payment or any other indulgence, to any substitution, exchange or release of the Shares and/or Stock Options, to the acceptance of partial payments thereon and the settlement, compromise or adjustment of any thereof, all in such manner and at such time or times as AMGRO may deem advisable. 25. If at any time or times by assignment or otherwise, AMGRO transfers any obligations or any security therefor, such transfer shall carry with it AMGRO's powers and rights under this Agreement or any supplemental agreement hereto with respect to the obligations and/or security transferred and the transferee shall become vested with said powers and rights, whether or not they are specifically referred to in the transfer. If and to the extent that AMGRO retains any other obligation or security, AMGRO will continue to have the rights and powers herein set forth with respect thereto. 26. Whenever there is no outstanding obligation and no commitment on the part of AMGRO under any agreement which might give rise to an obligation, Pledgor may terminate this Agreement upon written notice to AMGRO. Prior to such termination, this shall be a continuing agreement in every respect. As used herein, the term "obligation" shall include any and all liabilities of the Pledgor to AMGRO of every kind and description, direct or indirect, absolute or contingent, due or to become due, now existing 8 or hereafter arising, regardless of how they arise or by what agreement or instrument they may be evidenced or whether evidenced by any agreement or instrument. In addition, such obligations shall include obligations to perform acts and refrain from taking action, as well as obligations to pay money. 27. The Pledgor shall at all times at the request of AMGRO make and deliver all further assurances and other instruments as may be desirable in the opinion of AMGRO to assure to AMGRO the interest(s) and the right(s) given, or intended to be given, to AMGRO hereunder. 28. All data, financial statements, books, records and/or other materials furnished by the Pledgor to AMGRO in connection with the Note or this Agreement are and have been accurate and complete, do fairly and accurately present the financial condition of the Pledgor, and do not omit or misstate any material information. 29. Any deposits, payments or other sums at any time credited by or due from AMGRO or the affiliates and/or subsidiaries of AMGRO to the Pledgor, and any cash, credits, securities or other property of the Pledgor in the possession of AMGRO or the affiliates and/or subsidiaries thereof may at all times be held and treated as security for the payment and performance of the obligations of the Pledgor under the Note and this Agreement. Regardless of the adequacy of the Shares and/or Stock Options, or any other collateral, any deposits, payments or other sums at any time credited by or due from AMGRO or the affiliates and/or subsidiaries of AMGRO to the Pledgor may, at AMGRO's discretion, be set off against any and all of the obligations of the Pledgor under the Note and this Agreement whether or not then matured or due. 30. A carbon, photocopy or other reproduction of this Agreement or any financing statement relating to this Agreement or the obligations arising hereunder shall be sufficient as a financing statement. 31. Except as disclosed, in writing, by the Pledgor to AMGRO, (a) all federal and other tax returns required to be filed by the Pledgor have been filed and all taxes required by such returns have been paid, and (b) Pledgor has not received any notice from the Internal Revenue Service or other taxing authority proposing or demanding additional or supplemental taxes. 32. AMGRO, by accepting the pledge of the Shares and Stock Options, or by releasing any or all of the Shares to the Pledgor, shall not be deemed to have assumed any obligation or liability to Pledgor or to any third party, and Pledgor agrees to indemnify, defend and hold AMGRO harmless in respect to any claim or proceeding arising out of any matter arising therefrom. 33. If after receipt of any payment of all or any part of the indebtedness of Pledgor to AMGRO is for any reason compelled to surrender such payment to any person or entity 9 because such payment is determined to be void or voidable as a preference, an impermissible setoff, or a diversion of funds, or for any other reason, the terms and conditions of this Agreement shall continue in full force and effect and Pledgor shall be liable for, and shall indemnify and hold AMGRO harmless for, the amount of such payment surrendered. The provisions of this Section shall be and remain effective notwithstanding any contrary action which may have been taken by AMGRO in reliance upon such payment, and any such contrary action so taken shall be without prejudice to AMGRO's rights hereunder and under the Note, and shall be deemed to have been conditioned upon such payment having become final and irrevocable. The provisions of this Section shall survive the termination of this Agreement. 10 PLEDGOR ACKNOWLEDGES THAT PLEDGOR HAS READ THIS AGREEMENT, THAT PLEDGOR UNDERSTANDS AND AGREES TO THE TERMS AND CONDITIONS CONTAINED IN THIS AGREEMENT AND THAT PLEDGOR HAS RECEIVED A COPY OF THIS AGREEMENT, WITH THE AFOREMENTIONED EXHIBITS A, B, AND C ATTACHED HERETO, ON TODAY'S DATE. IN WITNESS WHEREOF, the parties have executed this Agreement on the year and date first above written. ROBERT P. RESTREPO, JR. AMGRO, INC. /s/ Robert P. Restrepo, Jr. By: /s/ John P. Kavanaugh - --------------------------- ---------------------- Robert P. Restrepo, Jr. Title: President ----------- MARY FRANCES RESTREPO /s/ Mary Frances Restrepo - ------------------------- Mary Frances Restrepo Commonwealth of Massachusetts ) ) ss. County of Worcester ) On this 25th day of June, 2001, before me personally appeared John P. Kavanaugh, to me known, who being duly sworn did depose and say that (s)he is the President of AMGRO, INC. and that (s)he executed the foregoing instrument on behalf of the said AMGRO, INC. for the purposes therein expressed and as its free act and deed. (SEAL) /s/ Sandra L. Morin ------------------- Notary Public My Commission Expires: 8-16-2007 State of Massachusetts ) ) ss. County of Worcester ) On this 25th day of June, 2001, before me personally appeared Robert P. Restrepo, Jr., to me known, who being duly sworn did depose and say that he is the individual named above and that he executed the foregoing instrument on his behalf for the purposes expressed therein and as his free act and deed. 11 (SEAL) /s/ Sandra L. Morin ------------------- Notary Public My Commission Expires: 8-16-2007 State of Massachusetts ) ) ss. County of Worcester ) On this 25th day of June, 2001, before me personally appeared Mary Frances Restrepo, to me known, who being duly sworn did depose and say that she is the individual named above and that she executed the foregoing instrument on her behalf for the purposes expressed therein and as her free act and deed. (SEAL) /s/ Sandra L. Morin ------------------------------- Notary Public My Commission Expires: 8-16-2007 12 EXHIBIT A --------- CREDIT LINE PROMISSORY NOTE LENDER: AMGRO, Inc. 100 North Parkway Worcester, Massachusetts 01605 (hereinafter referred to as "Lender") BORROWERS: Robert P. Restrepo, Jr. Mary Frances Restrepo (the "Borrowers") DATE OF NOTE: February 5, 2001 MATURITY DATE: February 5, 2006 LOAN AMOUNT: ONE MILLION DOLLARS ($1,000,000.00) FOR VALUE RECEIVED, the Borrowers hereby promise to pay to Lender, or order, at Lender's address listed above (or such other address as Lender may notify Borrowers the PRINCIPAL sum of ONE MILLION DOLLARS ($1,000,000.00) and to pay interest thereon as set forth herein. MULTIPLE ADVANCE: The maximum amount that Borrowers may borrow under this Note shall be the Loan Amount of One Million Dollars ($1,000,000.00) specified above. As of May 10, 2001, Borrowers have reserved the amount of $126,468.00 and future principal advances are contemplated, subject to the terms and conditions herein contained. FUTURE ADVANCES: Future advances of PRINCIPAL shall be made upon request by Borrower. Notwithstanding the foregoing, however, Lender and Borrowers expressly agree that Lender may, if there is a default under the Pledge Agreement or if the collateral given pursuant to the terms of the Stock Pledge Agreement is not adequate security for this Note, limit or refrain from making future advances to Borrowers pursuant to the terms of this Note. No such limitation on, or failure to extend, future advances to Borrowers shall modify, limit or otherwise effect the Borrowers' duty and obligation to repay principal and interest on any amount(s) advanced to Borrowers by Lender pursuant to the terms hereof. PAYMENTS: Borrowers agree to pay, in full, any PRINCIPAL balance, and any accrued interest, at maturity on February 5, 2006 unless such date is extended in accordance with the terms hereof. Borrowers agree to pay interest on the PRINCIPAL balance(s) owing from time to time hereunder at the annual rate of 5.87%, compounded annually. PURPOSE: The purpose of this loan is for reconstruction and refurbishment of the premises 13 located at 757 Salisbury Street, Worcester, Massachusetts. STOCK PLEDGE AND LOAN AGREEMENT: The Stock Pledge and Loan Agreement (the "Pledge Agreement") between Lender and Borrowers is attached hereto as Exhibit A, and the terms and conditions of said Pledge Agreement are incorporated herein and made a part hereof by reference. MORTGAGE: The Mortgage between Lender and Borrowers is attached hereto as Exhibit B, (the "Mortgage") and the terms and conditions of said Mortgage are incorporated herein and made a part hereof by reference. WAIVER: Borrowers hereby waive presentment, demand for payment, notice of dishonor, protest and all other notices and demands in connection with the delivery, acceptance, performance, default, collection or endorsement of this Note. COLLECTION COSTS: Borrowers agree that, subject to any limitation imposed by applicable law, if this Note or any part or portion thereof is collected by suit, attorney, or collection agent, Borrowers shall pay in addition to any amount(s) due under this Note all expenses, including without limitation attorneys' fees and legal expenses, incurred by Lender in endeavoring to collect any amounts payable hereunder. INVALIDITY: If any of the provisions of this Note shall contravene, or be invalid under the laws of any jurisdiction where used, such contravention or invalidity shall not invalidate this Note in its entirety, but this Note shall be construed as if it did not contain the particular provision(s) held to be invalid in such particular jurisdiction, and the rights and obligations of Lender and Borrower shall be construed and enforced accordingly. DEFAULT: In the event of any default in the payment of any obligation when due hereunder, which such default is not cured within five (5) days of written notice from Lender to Borrower that same has become due or in the event of any default as defined in the Pledge Agreement, any and all obligations hereunder, including without limitation the payment of PRINCIPAL and interest thereon, shall, at the option of Lender, become immediately due and payable without notice or demand. In addition, Lender shall have all of the rights available to Lender under the Mortgage and the Pledge Agreement, at law, and in equity. TERMINATION OF EMPLOYMENT: In the event that Robert P. Restrepo's employment with First Allmerica Financial Life Insurance Company ("First Allmerica") and/or the subsidiaries and affiliates thereof is terminated for any reason by Robert P. Restrepo, Jr. or First Allmerica, any and all obligations hereunder, including without limitation the payment of PRINCIPAL and interest thereon, shall, at the option of Lender, become immediately due and payable without notice or demand. In addition, Lender shall have all of the rights available to Lender under the Mortgage and the Pledge Agreement at law, and in equity. CHANGE OF CONTROL: In the event a change in control (as said term is defined in the Allmerica Financial Corporation Long-Term Stock Incentive Plan) occurs and Robert P. Restrepo, Jr. receives or is eligible to receive a cash payment any and all obligations hereunder including, 14 without limitation, the payment of Principal and interest thereon, shall at the option of Lender become immediately due and payable without notice or demand. In addition, Lender shall have all of the rights available to Lender under the Mortgage and the Pledge Agreement, at law, and in equity. LATE PAYMENT: In the event that any monetary payment or obligation under this Note shall become overdue for a period in excess of ten (10) days, a "late charge" equal to four percent (4%) of such overdue payment or obligation may be charged by the Lender for the purpose of defraying expenses associated with delinquent payments. GOVERNING LAW: Any question arising with regard to this Note shall be governed by, and this Note shall be construed in accordance with, the laws of the Commonwealth of Massachusetts without regard to its provisions concerning conflict of laws. PREPAYMENT: Borrowers may prepay PRINCIPAL, in whole or in part, without penalty. BORROWERS ACKNOWLEDGE THAT IT HAS READ THIS NOTE, THAT IT UNDERSTANDS AND AGREES TO THE TERMS AND CONDITIONS CONTAINED IN THIS NOTE AND THAT IT HAS RECEIVED A COPY OF THIS NOTE, WITH THE AFOREMENTIONED LOAN AGREEMENT AND SECURITY AGREEMENT ATTACHED AS EXHIBIT A, AND THE MORTGAGE ATTACHED AS EXHIBIT B, ON TODAY'S DATE. Lender hereby acknowledges and agrees that Mary Frances Restrepo shall not be personally liable for the repayment of the indebtedness evidenced hereby. IN WITNESS WHEREOF, the Borrowers have signed this Note as of the day and year first above written. "Borrowers" ROBERT P. RESTREPO, JR. /s/ Robert P. Restrepo, Jr. - --------------------------- Robert P. Restrepo, Jr. MARY FRANCES RESTREPO /s/ Mary Frances Restrepo - --------------------------- Mary Frances Restrepo 15 Commonwealth of Massachusetts ) ) SS. County of Worcester ) June 25, 2001 On this 25th day of June, 2001 before me personally appeared Robert P. Restrepo, Jr., to me known and known by me to be the person who executed the foregoing instrument, and after being duly sworn he acknowledged that he executed the same as his free act and deed. (SEAL) /s/ Sandra L. Morin -------------------- Notary Public My Commission Expires: 8-16-2007 Commonwealth of Massachusetts ) ) SS. County of Worcester ) June 25, 2001 On this 25th day of June, 2001 before me personally appeared Mary Frances Restrepo, to me known and known by me to be the person who executed the foregoing instrument, and after being duly sworn she acknowledged that she executed the same as her free act and deed. (SEAL) /s/ Sandra L. Morin -------------------- Notary Public My Commission Expires: 8-16-2007 16 EXHIBIT B --------- Description of Stock Options and Shares
Shares - ------ Grant Date Number of Shares Certificate Number Type of Stock ---------- ---------------- ------------------ ------------- 05/26/98 6,000 Restricted until 05/26/01 05/26/98 10,000 Restricted until 05/26/01 02/21/99 2,000 Restricted until 02/21/02 09/10/00 3,796 Restricted until 03/10/03 Various Dates 12,000 Unrestricted but subject to margin loan(s) 02/18/01 5,000 Restricted until 2/18/04 Stock Options - ------------- Grant Date Number of Shares Grant Price Type of Stock ---------- ---------------- ----------- ------------- 05/26/98 7,810 $64.00 ISO's 02/21/99 42,190 $64.00 NQSO's 02/21/99 32,000 $52.0625 NQSO's 02/20/2000 30,750 $44.56 NQSO's 02/18/2001 32,500 $57.00 NQSO's
17 EXHIBIT C 12,000 shares purchased by Robert P. Restrepo, Jr. are currently subject to a margin loan from Merrill Lynch. The amount of this loan or loans is approximately $425,000. Amgro shall have a second lien on the 12,000 shares until the margin loan(s) are repaid. Once the margin loan(s) are satisfied, Amgro shall have a first lien on said shares. The parties acknowledge that the Merrill Lynch margin loan(s) will be satisfied by selling a portion of the shares. Robert P. Restrepo, Jr. agrees to satisfy the Merrill Lynch margin loans on the earlier of when the fair market value of Allmerica Financial Corporation shares equal $60 per share or December 31, 2001. -----END PRIVACY-ENHANCED MESSAGE-----