-----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, OAeMvm+NFnocDArZlqcT0cb+L+bpchErCglyn3svqmxlDShZsJ31gywR6iUvfyhh TFkVpUlTAHKWIM86roQX3w== 0000944695-02-000019.txt : 20020814 0000944695-02-000019.hdr.sgml : 20020814 20020814144541 ACCESSION NUMBER: 0000944695-02-000019 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 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: 02734990 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 form10q063002.txt 2ND QUARTER 2002 FORM 10-Q 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, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from: to ____________ Commission file number: 1-13754 ALLMERICA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 04-3263626 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 440 Lincoln Street, Worcester, Massachusetts 01653 (Address of principal executive offices) (Zip Code) (508) 855-1000 (Registrant's telephone number, including area code) _________________________________________________________________ (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date: 53,090,634 shares of common stock outstanding, as of August 1, 2002. 40 Total Number of Pages Included in This Document Exhibit Index is on Page 41 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 - 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 - 36 Item 3. Quantitative and Qualitative Disclosures About Market Risk 37 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 38 Item 6. Exhibits and Reports on Form 8-K 39 SIGNATURES 40 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) 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- Revenues Premiums................................................... $ 577.4 $ 562.0 $ 1,160.0 $ 1,125.5 Universal life and investment product policy fees.... 98.8 99.2 194.8 199.6 Net investment income................................ 149.6 165.7 300.1 331.5 Net realized investment losses....................... (63.8) (67.3) (76.1) (84.7) Other income............................................... 36.4 35.6 68.9 69.2 ----------- ----------- ------------ ----------- Total revenues................................... 798.4 795.2 1,647.7 1,641.1 ----------- ----------- ------------ ----------- Benefits, losses and expenses Policy benefits, claims, losses and loss adjustment expenses................................................. 517.1 521.4 1,053.5 1,078.1 Policy acquisition expenses................................ 258.8 114.3 370.3 230.4 Net gains on derivative instruments........................ (14.1) (0.4) (30.4) (2.9) Other operating expenses................................... 149.7 144.4 302.3 283.2 ----------- ----------- ------------ ----------- Total benefits, losses and expenses.................. 911.5 779.7 1,695.7 1,588.8 ----------- ----------- ------------ ----------- (Loss) income before federal income taxes.................. (113.1) 15.5 (48.0) 52.3 ----------- ----------- ------------ ----------- Federal income tax benefit (expense) Current................................................. 13.2 22.8 3.4 28.2 Deferred................................................ 48.4 (21.1) 48.7 (32.9) ----------- ----------- ------------ ----------- Total federal income tax benefit (expense)............ 61.6 1.7 52.1 (4.7) ----------- ----------- ------------ ----------- (Loss) income before minority interest and cumulative effect of change in accounting principle................. (51.5) 17.2 4.1 47.6 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) ----------- ----------- ------------ ----------- (Loss) income before cumulative effect of change in accounting principle.................................... (55.5) 13.2 (3.9) 39.6 Cumulative effect of change in accounting principle (less applicable income tax benefit of $2.0 and $1.7 for the six months ended June 30, 2002 and 2001)............ - - (3.7) (3.2) ----------- ----------- ------------ ----------- Net (loss) income....................................... $ (55.5) $ 13.2 $ (7.6) $ 36.4 =========== =========== ============ =========== PER SHARE DATA Basic (Loss) income before cumulative effect of change in accounting principle................................ $ (1.05) $ 0.25 $ (0.07) $ 0.75 Cumulative effect of change in accounting principle (less applicable income tax benefit of $0.04 and $0.03 for the six months ended June 30, 2002 and 2001).... - - (0.07) (0.06) ----------- ----------- ------------ ----------- Net (loss) income................................... $ (1.05) $ 0.25 $ (0.14) $ 0.69 =========== =========== ============ =========== Weighted average shares outstanding .................. 52.9 52.6 52.8 52.6 =========== =========== ============ =========== Diluted (Loss) income before cumulative effect of change in accounting principle................................. $ (1.05) $ 0.25 $ (0.07) $ 0.75 Cumulative effect of change in accounting principle (less applicable income tax benefit of $0.04 and $0.03 for the six months ended June 30, 2002 and 2001) - - (0.07) (0.06) ----------- ----------- ------------ ----------- Net (loss) income .................................. $ (1.05) $ 0.25 $ (0.14) $ 0.69 =========== =========== ============ =========== Weighted average shares outstanding................. 52.9 53.1 52.8 53.1 =========== =========== ============ =========== 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) 2002 2001 - ---------------------------------------------------------------------------------------------------------------------- Assets Investments: Fixed maturities-at fair value (amortized cost of $8,797.3 and $9,294.0).. $ 8,938.3 $ 9,401.7 Equity securities-at fair value (cost of $53.3 and $61.2)................. 54.7 62.1 Mortgage loans............................................................ 309.0 321.6 Policy loans.............................................................. 372.6 379.6 Other long-term investments............................................... 170.3 161.2 ---------- ----------- Total investments....................................................... 9,844.9 10,326.2 ---------- ----------- Cash and cash equivalents.................................................... 376.1 350.2 Accrued investment income.................................................... 143.2 152.3 Premiums, accounts and notes receivable, net................................. 584.6 628.4 Reinsurance receivable on paid and unpaid losses, benefits and unearned premiums............................................ 1,422.5 1,426.8 Deferred policy acquisition costs............................................ 1,802.9 1,784.2 Deferred federal income taxes................................................ 220.6 168.1 Goodwill..................................................................... 131.2 139.2 Other assets................................................................. 577.0 522.3 Separate account assets...................................................... 14,054.3 14,838.4 ---------- ----------- Total assets.............................................................. $ 29,157.3 $ 30,336.1 ========== =========== Liabilities Policy liabilities and accruals: Future policy benefits.................................................... $ 4,291.7 $ 4,099.6 Outstanding claims, losses and loss adjustment expenses................... 3,042.1 3,029.8 Unearned premiums......................................................... 1,057.2 1,052.5 Contractholder deposit funds and other policy liabilities................. 1,178.2 1,763.9 ---------- ----------- Total policy liabilities and accruals................................... 9,569.2 9,945.8 ---------- ----------- Expenses and taxes payable................................................... 830.6 934.1 Reinsurance premiums payable................................................. 102.4 125.3 Trust instruments supported by funding obligations........................... 1,635.2 1,518.6 Short-term debt.............................................................. 74.4 83.3 Long-term debt............................................................... 199.5 199.5 Separate account liabilities................................................. 14,054.3 14,838.4 ---------- ----------- Total liabilities......................................................... 26,465.6 27,645.0 ---------- ----------- Minority interest: Mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company.................... 300.0 300.0 ---------- ----------- Commitments and contingencies (Note 10) Shareholders' equity Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued - - Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million shares issued............................................................. 0.6 0.6 Additional paid-in capital................................................... 1,759.1 1,758.4 Accumulated other comprehensive loss......................................... (13.6) (13.7) Retained earnings............................................................ 1,044.7 1,052.3 Treasury stock at cost (7.3 and 7.5 million shares).......................... (399.1) (406.5) ---------- ----------- Total shareholders' equity................................................ 2,391.7 2,391.1 ---------- ----------- Total liabilities and shareholders' equity.............................. $ 29,157.3 $ 30,336.1 ========== =========== 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) 2002 2001 - -------------------------------------------------------------------------------------------------------------------- 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............................................... 1,758.4 1,765.3 Unearned compensation related to restricted stock and other........... 0.7 (1.8) --------- ---------- Balance at end of period..................................................... 1,759.1 1,763.5 --------- ---------- Accumulated Other Comprehensive Income Net unrealized appreciation (depreciation) on investments: Balance at beginning of period............................................... 28.4 (5.2) Net appreciation on available-for-sale securities......................... 22.3 72.6 Provision for deferred federal income taxes.......................... (7.8) (25.4) --------- ---------- 14.5 47.2 --------- ---------- Net (depreciation) appreciation on derivative instruments................. (22.2) 5.5 Benefit (provision) for deferred federal income taxes................ 7.8 (1.9) --------- ---------- (14.4) 3.6 --------- ---------- Balance at end of period................................................... 28.5 45.6 --------- ---------- Minimum Pension Liability: Balance at beginning and end of period..................................... (42.1) - --------- ---------- Total accumulated other comprehensive (loss) income........................ (13.6) 45.6 --------- ---------- Retained earnings Balance at beginning of period............................................... 1,052.3 1,068.7 Net (loss) income....................................................... (7.6) 36.4 --------- ---------- Balance at end of period..................................................... 1,044.7 1,105.1 --------- ---------- Treasury Stock Balance at beginning of period............................................... (406.5) (420.3) Shares reissued at cost............................................... 7.4 8.2 --------- ---------- Balance at end of period..................................................... (399.1) (412.1) --------- ---------- Total shareholders' equity............................................ $ 2,391.7 $ 2,502.7 ========= ========== 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) 2002 2001 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Net (loss) income.................................. $ (55.5) $ 13.2 $ (7.6) $ 36.4 Other comprehensive income (loss): Available-for-sale securities: Net appreciation (depreciation) during the period................................... 123.2 (42.4) 22.3 72.6 (Provision) benefit for deferred federal income taxes............................. (43.1) 14.8 (7.8) (25.4) ----------- ----------- ----------- ----------- Total available-for-sale securities............. 80.1 (27.6) 14.5 47.2 ----------- ----------- ----------- ----------- Derivative instruments: Net (depreciation) appreciation during the period.................................. (35.1) 14.4 (22.2) 5.5 Benefit (provision) for deferred federal income taxes............................ 12.3 (5.0) 7.8 (1.9) ----------- ----------- ----------- ----------- Total derivative instruments.................... (22.8) 9.4 (14.4) 3.6 ----------- ----------- ----------- ----------- Other comprehensive income (loss).................. 57.3 (18.2) 0.1 50.8 ----------- ----------- ----------- ----------- Comprehensive income (loss)........................ $ 1.8 $ (5.0) $ (7.5) $ 87.2 =========== =========== =========== =========== 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) 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities Net (loss) income....................................................... $ (7.6) $ 36.4 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Net realized losses.................................................. 76.1 84.7 Gains on derivative instruments...................................... (30.4) (2.9) Net amortization and depreciation.................................... 11.6 8.9 Deferred federal income taxes........................................ (48.7) 32.9 Change in deferred acquisition costs................................. (30.3) (86.0) Change in premiums and notes receivable, net of reinsurance payable......................................... 5.2 (18.1) Change in accrued investment income.................................. 9.1 (1.3) Change in policy liabilities and accruals, net....................... 206.0 409.9 Change in reinsurance receivable..................................... 4.3 19.3 Change in expenses and taxes payable................................. (15.0) (171.3) Other, net........................................................... (30.7) (34.8) ------------- ------------- Net cash provided by operating activities...................... 149.6 277.7 ------------- ------------- Cash flows from investing activities Proceeds from disposals and maturities of available-for-sale fixed maturities............................................................ 1,972.3 870.9 Proceeds from disposals of equity securities............................ 13.4 26.9 Proceeds from disposals of other investments............................ 15.9 30.0 Proceeds from mortgages matured or collected............................ 13.1 48.1 Proceeds from collections of installment finance and notes receivable... 170.1 99.5 Purchase of available-for-sale fixed maturities......................... (1,525.7) (1,726.0) Purchase of equity securities........................................... (0.7) (9.7) Purchase of other investments........................................... (21.0) (11.9) Disbursements to fund installment finance and notes receivable.......... (154.5) (113.8) Capital expenditures.................................................... (3.5) (14.6) Other, net.............................................................. - 1.4 ------------- ------------- Net cash provided by (used in) investing activities............ 479.4 (799.2) ------------- ------------- Cash flows from financing activities Deposits and interest credited to contractholder deposit funds.......... 109.9 153.0 Withdrawals from contractholder deposit funds........................... (692.2) (270.7) Deposits to trust instruments supported by funding obligations.......... 81.3 895.3 Withdrawals from trust instruments supported by funding obligations..... (94.2) (71.2) Change in short-term debt............................................... (8.9) 12.7 Treasury stock reissued at cost......................................... 1.0 4.0 ------------- ------------- Net cash (used in) provided by financing activities............ (603.1) 723.1 ------------- ------------- Net change in cash and cash equivalents.................................... 25.9 201.6 Cash and cash equivalents, beginning of period............................. 350.2 281.1 ------------- ------------- Cash and cash equivalents, end of period................................... $ 376.1 $ 482.7 ============= ============= 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, 2002 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 2001 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 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 became effective for fiscal years beginning after December 15, 2001 for all goodwill and other intangible assets held at the date of adoption. The Company adopted Statement No. 142 on January 1, 2002. In accordance with the transition provisions of this statement, the Company recorded a $3.7 million charge, net-of-taxes, in earnings, to recognize the impairment of goodwill related to two of its non-insurance subsidiaries. The Company utilized a discounted cash flow model to value these subsidiaries. 8 Effective January 1, 2002, the Company ceased its amortization of goodwill in accordance with Statement No. 142. Amortization expense in the second quarter and the first six months of 2001 was $1.0 million and $2.0 million, respectively, net-of-taxes. In accordance with Statement No. 142, the following table provides income before the cumulative effect of a change in accounting principle, net (loss) income, and related per-share amounts as of June 30, 2002 and 2001, as reported and adjusted as if the Company had ceased amortizing goodwill effective January 1, 2001.
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ------------------------------------------------------------------------ (In millions, except per share data) 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ Reported (loss) income before cumulative effect of change in accounting principle................................. $ (55.5) $ 13.2 $ (3.9) $ 39.6 Goodwill amortization................................... - 1.0 - 2.0 --------------- -------------- -------------- ------------ Adjusted (loss) income before cumulative effect of change in accounting principle................................. $ (55.5) $ 14.2 $ (3.9) $ 41.6 =============== ============== ============== ============ Reported net (loss) income................................. $ (55.5) $ 13.2 $ (7.6) $ 36.4 Goodwill amortization................................... - 1.0 - 2.0 --------------- -------------- -------------- ------------ Adjusted net (loss) income................................. $ (55.5) $ 14.2 $ (7.6) $ 38.4 =============== ============== ============== ============ Per Share Information Basic Reported (loss) income before cumulative effect of change in accounting principle................................. $ (1.05) $ 0.25 $ (0.07) $ 0.75 Goodwill amortization................................... - 0.02 - 0.04 --------------- -------------- -------------- ------------ Adjusted (loss) income before cumulative effect of change in accounting principle................................. $ (1.05) $ 0.27 $ (0.07) $ 0.79 =============== ============== ============== ============ Reported net (loss) income................................. $ (1.05) $ 0.25 $ (0.14) $ 0.69 Goodwill amortization................................... - 0.02 - 0.04 --------------- -------------- -------------- ------------ Adjusted net (loss) income................................. $ (1.05) $ 0.27 $ (0.14) $ 0.73 =============== ============== ============== ============ Diluted Reported (loss) income before cumulative effect of change in accounting principle................................. $ (1.05) $ 0.25 $ (0.07) $ 0.75 Goodwill amortization................................... - 0.02 - 0.04 --------------- -------------- -------------- ------------ Adjusted (loss) income before cumulative effect of change in accounting principle................................. $ (1.05) $ 0.27 $ (0.07) $ 0.79 =============== ============== ============== ============ Reported net (loss) income................................. $ (1.05) $ 0.25 $ (0.14) $ 0.69 Goodwill amortization................................... - 0.02 - 0.04 --------------- -------------- -------------- ------------ Adjusted net (loss) income................................. $ (1.05) $ 0.27 $ (0.14) $ 0.73 =============== ============== ============== ============
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("Statement No. 133"), which establishes accounting and reporting standards for derivative instruments. Statement No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on the type of hedge transaction. For fair value hedge transactions in which the Company is hedging changes in an asset's, liability's or firm commitment's fair value, changes in the fair value of the derivative instruments will generally be offset in the income statement by changes in the hedged item's fair value. For cash flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified into earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. To the extent any hedges are determined to be ineffective, all or a portion of the change in value of the derivative will be recognized currently in earnings. This statement 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. 9 3. Discontinued Operations During the second quarter of 1999, the Company approved a plan to exit its group life and health insurance business, consisting of its Employee Benefit Services ("EBS") business, its Affinity Group Underwriters ("AGU") business and its accident and health assumed reinsurance pool business ("reinsurance pool business"). During the third quarter of 1998, the Company ceased writing new premiums in the reinsurance pool business, subject to certain contractual obligations. Prior to 1999, these businesses comprised substantially all of the former Corporate Risk Management Services segment. Accordingly, the operating results of the discontinued segment, including its reinsurance pool business, have been reported in the Consolidated Statements of Income as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB Opinion No. 30"). In the third quarter of 1999, the operating results from the discontinued segment were adjusted to reflect the recording of additional reserves related to accident claims from prior years. The Company also recorded a $30.5 million loss, net-of-taxes, on the disposal of this segment, consisting of after tax losses from the run-off of the group life and health business of approximately $46.9 million, partially offset by net proceeds from the sale of the EBS business of approximately $16.4 million. Subsequent to the measurement date of June 30, 1999, approximately $8.2 million of the aforementioned $46.9 million loss has been generated from the operations of the discontinued business. In March of 2000, the Company transferred its EBS business to Great-West Life and Annuity Insurance Company of Denver. As a result of this transaction, the Company has received consideration of approximately $27 million, based on renewal rights for existing policies. The Company retained policy liabilities estimated at $79.1 million at June 30, 2002 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, 2002 and 2001, the discontinued segment had assets of approximately $307.9 million and $435.8 million, respectively, consisting primarily of invested assets and reinsurance recoverables, and liabilities of approximately $364.5 million and $424.7 million, respectively, consisting primarily of policy liabilities. Revenues for the discontinued operations were $5.2 million and $10.8 million for the quarters ended June 30, 2002 and 2001, respectively, and $12.0 million and $19.8 million for the six months ended June 30, 2002 and 2001, respectively. 4. Significant Transactions In the fourth quarter of 2001, the Company recognized a pre-tax charge of $2.7 million related to severance and other employee related costs resulting from the reorganization of its technology support group. Approximately 82 positions have been eliminated as a result of this restructuring plan, of which 81 employees have been terminated as of June 30, 2002. The Company has made payments of $2.2 million related to this restructuring plan as of June 30, 2002. 5. Federal Income Taxes It is the Company's policy to estimate taxes for interim periods based on estimated annual effective tax rates which are derived, in part, from expected annual pre-tax income. However, the federal income tax benefit for the six months ended June 30, 2002 has been computed based on the first half of 2002 as a discrete period due to the uncertainty regarding the Company's ability to reliably estimate pre-tax income for the remainder of the year. The Company cannot reliably estimate pre-tax income for the second half of 2002 principally due to the impact of the equity markets on the Company, including possible additional amortization of deferred policy acquisition costs. Because of this uncertainty, the Company is unable to develop a reasonable estimate of the annual effective tax rate for the full year 2002. In addition, during the six months ended June 30, 2002, the Company recognized a benefit of $12.1 million related to a settlement of certain prior years' federal income tax returns. Federal income tax expense for the six months ended June 30, 2001 has been computed using estimated effective tax rates. The rates, in 2001, were revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates. 10 6. Other Comprehensive Income (Loss) The following table provides a reconciliation of gross unrealized gains (losses) to the net balance shown in the Statements of Comprehensive Income:
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ------------------------------------------------------------ (In millions) 2002 2001 2002 2001 - ----------------------------------------------------------------------------------------------------------------------------- Unrealized gains (losses) on available-for-sale securities: Unrealized holding gains (losses) arising during period (net of income tax (expense) benefit of $(28.8) million and $29.3 million for the quarters ended June 30, 2002 and 2001 and $7.0 million and $(8.1) million for the six months ended June 30, 2002 and 2001).................................. $ 51.5 $ (78.3) $ (12.9) $ (14.5) Less: reclassification adjustment for losses included in net income (net of income tax benefit of $14.3 million and $14.5 million for the quarters ended June 30, 2002 and 2001 and $14.8 million and $17.3 million for the six months ended June 30, 2002 and 2001)........................................ (28.6) (50.7) (27.4) (61.7) --------- --------- ---------- ---------- Total unrealized gains (losses) on available-for-sale securities........................................................... 80.1 (27.6) 14.5 47.2 --------- --------- ---------- ---------- Unrealized (losses) gains on derivative instruments: Unrealized holding gains arising during period (net of income tax (expense) benefit of $(36.0) million and $5.1 million for the quarters ended June 30, 2002 and 2001 and $(31.2) million and $0.9 million for the six months ended June 30, 2002 and 2001).................................. 63.2 9.1 57.9 1.6 Less: reclassification adjustment for gains (losses) included in net income (net of income tax (expense) benefit of $(48.3) million and $(0.1) million for the quarters ended June 30, 2002 and 2001 and $(39.0) million and $1.0 million for the six months ended June 30, 2002 and 2001)......................................................... 86.0 (0.3) 72.3 (2.0) --------- --------- ---------- ---------- Total unrealized (losses) gains on derivative instruments........... (22.8) 9.4 (14.4) 3.6 --------- --------- ---------- ---------- Other comprehensive income (loss)................................... $ 57.3 $ (18.2) $ 0.1 $ 50.8 ========= ========= ========== ==========
11 7. Closed Block Summarized financial information of the Closed Block is as follows for the periods indicated:
(Unaudited) June 30, December 31, (In millions) 2002 2001 ------------------------------------------------------------------------------------------------------ Assets Fixed maturities-at fair value (amortized cost of $518.9 and $498.1)............................................................ $ 526.1 $ 504.2 Mortgage loans....................................................... 51.0 55.7 Policy loans......................................................... 177.2 182.1 Cash and cash equivalents............................................ - 9.2 Accrued investment income............................................ 14.1 14.6 Deferred policy acquisition costs.................................... 8.8 10.4 Other assets......................................................... 7.8 6.2 --------- --------- Total assets...................................................... $ 785.0 $ 782.4 ========= ========= Liabilities Policy liabilities and accruals...................................... $ 793.5 $ 798.2 Policyholder dividends............................................... 24.4 30.7 Other liabilities.................................................... 17.0 7.0 --------- --------- Total liabilities................................................. $ 834.9 $ 835.9 ========= ========= Excess of Closed Block liabilities over assets designated to the Closed Block......................................................... $ 49.9 $ 53.5 Amounts included in accumulated other comprehensive income: Net unrealized investment losses, net of deferred federal income tax benefit of $2.1 million and $8.8 million.......................... (4.0) (16.4) --------- --------- Maximum future earnings to be recognized from Closed Block assets and liabilities............................................... $ 45.9 $ 37.1 ========= =========
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ----------------------- --------------------- (In millions) 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ Revenues Premiums............................................................. $ 6.4 $ 7.3 $ 30.8 $ 32.4 Net investment income................................................ 13.1 13.6 26.0 27.6 Net realized investment losses....................................... (1.7) (1.2) (1.8) (1.2) -------- --------- ------- ------- Total revenues.................................................... 17.8 19.7 55.0 58.8 -------- --------- ------- ------- Benefits and expenses Policy benefits...................................................... 13.7 14.0 47.6 47.5 Policy acquisition expenses.......................................... 0.7 0.1 1.2 0.1 Other operating expenses............................................. 0.1 - 0.4 0.3 -------- --------- ------- ------- Total benefits and expenses....................................... 14.5 14.1 49.2 47.9 -------- --------- ------- ------- Contribution from the Closed Block............................. $ 3.3 $ 5.6 $ 5.8 $ 10.9 ======== ========= ======= =======
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. 12 8. Segment Information The Company offers financial products and services in two major areas: Risk Management and Asset Accumulation. Within these broad areas, the Company conducts business principally in three operating segments. These segments are Risk Management, Allmerica Financial Services and Allmerica Asset Management. The separate financial information of each segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. A summary of the Company's reportable segments is included below. The Risk Management Segment sells property and casualty insurance products through independent agents and brokers primarily in the Northeast, Midwest and Southeast United States. In addition, the Risk Management Segment offers property and casualty (automobile and homeowners) insurance through employer sponsored programs, affinity groups and other organizations. 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, universal life and traditional life insurance products, as well as group retirement products. Allmerica Financial Services also includes brokerage and non-institutional investment advisory services. Through its Allmerica Asset Management segment, the Company offers GICs, also referred to as funding agreements, which are investment contracts that can contain either short-term or long-term maturities and are issued to institutional buyers or to various business or charitable trusts. Also, this segment includes a Registered Investment Advisor, providing investment advisory services primarily to affiliates and to third parties, such as money market and other fixed income clients. In addition to the three operating segments, the Company has a Corporate segment, which consists primarily of cash, investments, corporate debt, Capital Securities (mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company) and corporate overhead expenses. Corporate overhead expenses reflect costs not attributable to a particular segment, such as those generated by certain officers and directors, technology, finance, human resources and legal. Management evaluates the results of the aforementioned segments based on a pre-tax and pre-minority interest basis. In addition, segment (loss) income is adjusted for certain items which management believes are not indicative of the Company's core operations. Segment (loss) income excludes items such as net realized investment gains and losses, including certain losses on derivative instruments, because fluctuations in these gains and losses are determined by interest rates, financial markets and the timing of sales. Also, segment (loss) income excludes net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes and certain other items, which in each case, are neither normal nor recurring. Although the items excluded from segment (loss) income may be significant components in understanding and assessing the Company's financial performance, management believes segment (loss) income enhances an investor's understanding of the Company's results of operations by highlighting net (loss) income attributable to the normal, recurring operations of the business, consistent with industry practice. However, segment (loss) income should not be construed as a substitute for net (loss) income determined in accordance with generally accepted accounting principles. 13 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) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- Segment revenues: Risk Management....................................... $ 626.7 $ 617.0 $ 1,241.4 $ 1,218.3 ---------- ---------- ----------- --------- Asset Accumulation: Allmerica Financial Services.................. 204.8 204.3 419.7 427.5 Allmerica Asset Management.................... 31.8 41.6 64.0 81.3 ---------- ---------- ----------- --------- Subtotal...................................... 236.6 245.9 483.7 508.8 ---------- ---------- ----------- --------- Corporate............................................. 1.5 1.5 3.2 2.5 Intersegment revenues................................. (2.6) (1.9) (4.5) (3.8) ---------- ---------- ----------- --------- Total segment revenues............................. 862.2 862.5 1,723.8 1,725.8 Adjustments to segment revenues: Net realized losses................................... (63.8) (67.3) (76.1) (84.7) ---------- ---------- ----------- --------- Total revenues..................................... $ 798.4 $ 795.2 $ 1,647.7 $ 1,641.1 ========== ========== =========== ========= Segment (loss) income before federal income taxes, minority interest and cumulative effect of change in accounting principle: Risk Management....................................... $ 51.6 $ 41.5 $ 90.6 $ 57.7 ---------- ---------- ----------- --------- Asset Accumulation: Allmerica Financial Services....................... (113.8) 42.6 (84.1) 86.9 Allmerica Asset Management......................... 5.1 4.4 10.2 10.4 ---------- ---------- ----------- --------- Subtotal.......................................... (108.7) 47.0 (73.9) 97.3 ---------- ---------- ----------- --------- Corporate............................................. (15.2) (15.6) (31.6) (31.8) ---------- ---------- ----------- --------- Segment (loss) income before federal income taxes and minority interest............................ (72.3) 72.9 (14.9) 123.2 Adjustments to segment (loss) income: Net realized investment losses, net of amortization... (57.4) (65.5) (66.0) (81.5) Gains on derivatives.................................. 14.1 0.4 30.4 2.9 Sales practice litigation............................. 2.5 7.7 2.5 7.7 ---------- ---------- ----------- --------- (Loss) income before federal income taxes, minority interest and cumulative effect of change in accounting principle........................... $ (113.1) $ 15.5 $ (48.0) $ 52.3 ========== ========== =========== =========
Identifiable Assets Deferred Acquisition Costs - --------------------------------------------------------------------------------------------------------------------------------- (Unaudited) (Unaudited) June 30, December 31, June 30, December 31, (In millions) 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- Risk Management............................. $ 6,096.5 $ 6,239.8 $ 205.0 $ 199.0 ------------- -------------- -------------- -------------- Asset Accumulation Allmerica Financial Services............. 20,642.0 21,113.0 1,597.9 1,585.2 Allmerica Asset Management............... 2,326.9 2,829.3 - - ------------- -------------- -------------- -------------- Subtotal.............................. 22,968.9 23,942.3 1,597.9 1,585.2 Corporate................................... 91.9 154.0 - - ------------- -------------- -------------- -------------- Total.................................... $ 29,157.3 $ 30,336.1 $ 1,802.9 $ 1,784.2 ============= ============== ============== ==============
14 9. Earnings Per Share The following table provides share information used in the calculation of the Company's basic and diluted earnings per share:
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ----------------------------- ---------------------------- (In millions) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- Basic shares used in the calculation of earnings per share....... 52.9 52.6 52.8 52.6 Dilutive effect of securities (1): Employee stock options.............................. - 0.3 - 0.3 Non-vested stock grants............................. - 0.2 - 0.2 ---------- ---------- ---------- ---------- Diluted shares used in the calculation of earnings per share 52.9 53.1 52.8 53.1 ========== ========== ========== ========== (1) Excludes 0.4 million shares due to antidilution for the quarter and six months ended June 30, 2002.
10. Commitments and Contingencies Litigation In 1997, a lawsuit on behalf of a putative class was instituted against the Company alleging fraud, unfair or deceptive acts, breach of contract, misrepresentation, and related claims in the sale of life insurance policies. In November 1998, the Company and the plaintiffs entered into a settlement agreement and in May 1999, the Federal District Court in Worcester, Massachusetts approved the settlement agreement and certified the class for this purpose. AFC recognized a $31.0 million pre-tax expense in 1998 related to this litigation. The Company recognized a pre-tax benefit of $2.5 million and $7.7 million in 2002 and 2001, respectively, resulting from the refinement of cost estimates. Although the Company believes that it has appropriately recognized its obligation under the settlement, this estimate may be revised based on the amount of reimbursement actually tendered by AFC's insurance carriers, and based on changes in the Company's estimate of the ultimate cost of the benefits to be provided to members of the class. The Company has been named a defendant in various other legal proceedings arising in the normal course of business. In the Company's opinion, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised. 15 PART I ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the interim consolidated results of operations and financial condition of the Company should be read in conjunction with the interim Consolidated Financial Statements and related footnotes included elsewhere herein and the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the 2001 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 (loss) income includes the results of each segment of the Company, which management evaluates on a pre-tax and pre-minority interest basis. In addition, net (loss) income is adjusted for certain items which management believes are not indicative of the Company's core operations. Adjusted net (loss) income excludes items such as net realized investment gains and losses, including certain losses on derivative instruments, because fluctuations in these gains and losses are determined by interest rates, financial markets and the timing of sales. Also, adjusted net (loss) income excludes net gains and losses on disposals of businesses, discontinued operations, extraordinary items, the cumulative effect of accounting changes and certain other items, which in each case, are neither normal nor recurring. Although the items excluded from adjusted net (loss) income may be significant components in understanding and assessing the Company's financial performance, management believes adjusted net (loss) income enhances an investor's understanding of the Company's results of operations by highlighting net (loss) income attributable to the normal, recurring operations of the business, consistent with industry practice. However, adjusted net (loss) income should not be construed as a substitute for net (loss) income determined in accordance with generally accepted accounting principles. The Company's consolidated net income for the second quarter of 2002 decreased $68.7 million, to a net loss of $55.5 million, compared to net income of $13.2 million for the same period in 2001. The decline in the second quarter resulted primarily from a decrease in adjusted net income of $86.6 million, partially offset by a decrease of net realized investment losses of $12.5 million, and an increase in gains on derivative instruments of $8.8 million, net of taxes. Consolidated net income for the first six months of 2002 decreased $44.0 million, to a net loss of $7.6 million, compared to net income of $36.4 million for the first six months of 2001. The reduction resulted primarily from a decrease in adjusted net income of $78.4 million, partially offset by a $20.5 million decrease in net realized investment losses and a $17.8 million increase in gains on derivative instruments, net of taxes. 16 The following table reflects adjusted net (loss) income and a reconciliation to consolidated net (loss) income. Adjusted net (loss) income consists of segment (loss) income, federal income taxes on segment income and minority interest on Capital Securities (mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures of the Company).
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, --------------------------- -------------------------- (In millions) 2002 2001 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Segment (loss) income before federal income taxes and minority interest: Risk Management.......................................... $ 51.6 $ 41.5 $ 90.6 $ 57.7 ------------ ----------- ----------- ------------ Asset Accumulation: Allmerica Financial Services......................... (113.8) 42.6 (84.1) 86.9 Allmerica Asset Management........................... 5.1 4.4 10.2 10.4 ------------ ----------- ----------- ------------ (108.7) 47.0 (73.9) 97.3 Corporate................................................ (15.2) (15.6) (31.6) (31.8) ------------ ----------- ----------- ------------ Segment (loss) income before federal income tax benefit (expense) and minority interest........... (72.3) 72.9 (14.9) 123.2 Federal income tax benefit (expense) on segment (loss) income............................................. 48.6 (10.0) 40.6 (19.1) Minority interest on Capital Securities.................. (4.0) (4.0) (8.0) (8.0) ------------ ----------- ----------- ------------ Adjusted net (loss) income.................................... (27.7) 58.9 17.7 96.1 Adjustments (net of taxes and amortization, as applicable): Net realized investment losses........................... (38.5) (51.0) (42.9) (63.4) Net gains on derivatives................................. 9.1 0.3 19.7 1.9 Sales practice litigation................................ 1.6 5.0 1.6 5.0 ------------ ----------- ----------- ------------ (Loss) income before cumulative effect of change in accounting principle..................................... (55.5) 13.2 (3.9) 39.6 Cumulative effect of change in accounting principle, net of applicable taxes........................... - - (3.7) (3.2) ------------ ----------- ----------- ------------ Net (loss) income............................................. $ (55.5) $ 13.2 $ (7.6) $ 36.4 ============ =========== =========== ============
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 The Company's segment income before federal taxes and minority interest decreased $145.2 million, to a loss of $72.3 million, in the second quarter of 2002. This decrease was primarily attributable to a decrease of $156.4 million from the Allmerica Financial Services segment, partially offset by an increase in income from the Risk Management segment of $10.1 million. The decrease in Allmerica Financial Services' segment reflects the cumulative effect of the significant, persistent decline in equity market values during the most recent two and one half years, particularly the relatively significant decline during the second quarter of 2002. The decline resulted in additional amortization of the deferred policy acquisition cost ("DAC") asset of $137.1 million, increased guaranteed minimum death benefits ("GMDB") of $18.9 million, as well as reduced fees and other income from certain products. The increase in Risk Management segment income is primarily attributable to a benefit of approximately $18 million of estimated net premium rate increases, an approximate $12 million improvement in current accident year non-catastrophe claims activity and a decrease in catastrophe losses of $6.7 million. Partially offsetting these items is a $13.6 million decrease in favorable development on prior years reserves and an increase in policy acquisition expenses. The federal income tax benefit on segment loss was $48.6 million for the second quarter of 2002 compared to an income tax expense of $10.0 million for the second quarter of 2001. The increase in the tax benefit is primarily the result of the loss recognized by the Allmerica Financial Services segment, as well as a $12.1 million favorable settlement of certain prior years' federal income tax returns. 17 Net realized losses on investments, after taxes, were $38.5 million in the second quarter of 2002, resulting primarily from impairments of fixed maturities and equity securities and losses related to the termination of certain derivative instruments, partially offset by gains recognized from the sale of fixed maturities. During the second quarter of 2001, the Company recognized net realized losses on investments, after taxes, of $51.0 million, primarily due to impairments of fixed maturities, partially offset by gains from sales of equity securities. Net gains on derivatives, after taxes, increased $8.8 million, to $9.1 million in the second quarter of 2002, resulting primarily from the aforementioned termination of certain derivatives. The Company recognized a benefit of $1.6 million and $5.0 million, net of taxes, in the second quarters of 2002 and 2001, respectively, as a result of refining cost estimates related to a class action lawsuit. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 The Company's segment income before federal income taxes and minority interest decreased $138.1 million to a loss of $14.9 million, in the first six months of 2002. This decrease was primarily attributable to lower income from the Allmerica Financial Services segment of $171.0 million, partially offset by an increase in income from the Risk Management segment of $32.9 million. The decrease in Allmerica Financial Services' segment income reflects the aforementioned persistent decline in equity market values during the most recent two and one half years, particularly the relatively significant decline during the second quarter. The decline resulted in additional amortization of the DAC asset of $137.1 million, increased GMDB costs of $29.8 million, as well as reduced fees and other income from certain products. The increase in Risk Management segment income is primarily attributable to a benefit of approximately $30 million of estimated net premium rate increases, an approximate $21 million decrease in current accident year non-catastrophe claims and $9.2 million decrease in the adverse development of prior years' reserves. Partially offsetting these items is an increase in policy acquisition expenses and a decrease in net investment income of $7.2 million. The federal income tax benefit on segment loss was $40.6 million for the first six months of 2002 compared to an income tax expense of $19.1 million for the same period of 2001. The increase in the tax benefit is primarily the result of the loss recognized by the Allmerica Financial Services segment, as well as a $12.1 million favorable settlement of certain prior years' federal income tax returns. Net realized losses on investments, after taxes, were $42.9 million for the six months of 2002, resulting primarily from impairments of fixed maturities and equity securities and losses related to the termination of certain derivative instruments, partially offset by gains recognized from the sale of fixed maturities. During the first six months of 2001, net realized losses on investments, after taxes, of $63.4 million resulted primarily from impairments of fixed maturities. Net gains on derivatives, after taxes, increased $17.8 million, to $19.7 million in the first six months of 2002, resulting primarily from the aforementioned termination of certain derivatives. During the first quarter of 2002, the Company recognized a $3.7 million loss, net-of-taxes, upon adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. 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. 18 Risk Management The following table summarizes the results of operations for the Risk Management segment:
(Unaudited) (Unaudited) Quarter Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ (In millions) 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------- Segment revenues Net premiums written.................................... $ 572.1 $ 581.4 $ 1,127.0 $ 1,148.1 ========== ========= ========== ========== Net premiums earned..................................... $ 570.6 $ 554.4 $ 1,128.7 $ 1,092.4 Net investment income................................... 50.8 53.0 102.6 109.8 Other income............................................ 5.3 9.6 10.1 16.1 ---------- --------- ---------- ---------- Total segment revenues.................... 626.7 617.0 1,241.4 1,218.3 ---------- --------- ---------- ---------- Losses and operating expenses Losses and LAE (1)...................................... 419.5 426.1 840.6 864.0 Policy acquisition expenses............................. 105.9 99.1 210.5 195.5 Other operating expenses................................ 49.7 50.3 99.7 101.1 ---------- ---------- ---------- ---------- Total losses and operating expenses.......... 575.1 575.5 1,150.8 1,160.6 ---------- ---------- ---------- ---------- Segment income............................................... $ 51.6 $ 41.5 $ 90.6 $ 57.7 ========== ========== ========== ========== (1) Includes policyholders' dividends of $0.5 million and $1.9 million for the quarters ended June 30, 2002 and 2001, respectively, and $0.2 million and $4.0 million for the six months ended June 30, 2002 and 2001, respectively.
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 Risk Management's segment income increased $10.1 million to $51.6 million for the second quarter of 2002. The increase in segment income is primarily attributable to a benefit of approximately $18 million of net premium rate increases. Net premium rate increases reflect base rate actions, discretionary pricing adjustments, inflation and changes in exposure; net of estimated impact of loss inflation and policy acquisition costs. Second quarter of 2002 segment income also reflected a decrease in current year non-catastrophe claims activity primarily in the commercial multiple peril, workers' compensation and personal automobile lines. In addition, catastrophe losses decreased $6.7 million, to $8.6 million for the second quarter of 2002, compared to $15.3 million for the same period in 2001. Partially offsetting these items is a $13.6 million decrease in favorable development on prior years' reserves, from $3.8 million of favorable development in the second quarter of 2001 to $9.8 million of adverse development in the same period in 2002. The adverse development in 2002 is primarily the result of increased claims severity, primarily in the workers' compensation and personal automobile lines. Segment income also reflected a decrease in net investment income of $2.2 million for the quarter ended June 30, 2002. Policy acquisition expenses increased as a result of the aforementioned net premium rate increases and due to an increase in premium tax expenses. Other operating expenses in 2002 were consistent with the prior period despite the decrease in written policies, primarily due to certain underwriting initiatives and employee related expenses. Underwriting 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. In 2002, the Company reorganized its Risk Management segment. Under the new structure, the Risk Management segment manages its operations through two lines of business based upon product offerings and identified as Personal Lines and Commercial Lines. Personal Lines include personal automobile, homeowners and other personal policies, while Commercial Lines include workers' compensation, commercial automobile, commercial multiple peril and other commercial policies. 19
The following tables summarize the results of operations for the Risk Management segment: (Unaudited) Quarter Ended June 30, -------------------------------------------------------------------- 2002 2001 -------------------------------- -------------------------------- Statutory Statutory Net Net Premiums Statutory Premiums Statutory (In millions, except ratios) Written Loss Ratios Written Loss Ratios - ------------------------------------------------------------------------ -------------------------------- Personal automobile................... $ 267.2 68.4 $ 244.9 67.2 Homeowners............................ 94.4 64.1 81.8 78.8 Other personal........................ 12.5 45.9 12.7 22.4 Total personal........................ 374.1 66.7 339.4 68.3 ----------- ------------- ----------- ------------- Workers' compensation................. 37.4 83.4 51.3 79.6 Commercial automobile................. 49.0 66.9 75.0 63.4 Commercial multiple peril............. 84.3 50.5 87.4 72.2 Other commercial...................... 27.9 38.7 26.8 51.1 ----------- ------------- ----------- ------------- Total commercial...................... 198.6 60.3 240.5 69.3 ----------- ------------- ----------- ------------- Total................................. $ 572.7 64.4 $ 579.9 68.7 =========== ------------- =========== ------------- Statutory combined ratio (1): Personal lines........................ 100.9 99.9 Commercial lines...................... 102.8 108.2 ----------- ----------- Total................................. 101.6 103.3 ----------- ----------- Statutory underwriting loss: Personal lines........................ $ (6.7) $ (2.5) Commercial lines...................... (2.3) (22.9) ----------- ----------- Total................................. (9.0) (25.4) Reconciliation to segment income: Net investment income................. 50.8 53.0 Other income and expenses, net........ 4.2 6.2 Other Statutory to GAAP adjustments... 5.6 7.7 ----------- ----------- Segment income........................... $ 51.6 $ 41.5 =========== =========== - ------------------------------------------------------------------------------------------------------------- (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.
Personal Lines Personal lines' net premiums written increased $34.7 million, or 10.2%, to $374.1 million for the second quarter of 2002. This is primarily the result of increases of $22.3 million, or 9.1%, and $12.6 million, or 15.4%, in the personal automobile and homeowners lines, respectively. The increase in the personal automobile line is primarily the result of 2.0% and 0.6% net premium rate increases in Michigan and Massachusetts, respectively, and an overall increase of 2.1% in policies in force since June 30, 2001. The increase in the homeowners line resulted primarily from rate increases of 19.6% and 9.9% in Michigan and Massachusetts, respectively, in addition to an overall increase of 1.1% in policies in force since June 30, 2001. Personal lines' underwriting results declined $4.2 million to an underwriting loss of $6.7 million for the second quarter of 2002. The decline in underwriting results is primarily attributable to approximately $10 million of increased policy acquisition expenses, primarily related to increased cession expenses for mandatory assigned risk personal automobile business in New York. Management expects this cession expense to increase by approximately $10 million as compared to 2001 due to unsatisfactory underwriting results in this personal auto assigned risk pool. Policy acquisition expenses were also unfavorably affected by increased premium taxes in 2002. Underwriting results were also unfavorably affected by a $6.9 million decrease in favorable development, from $3.7 million of favorable development for the second quarter of 2001 to $3.2 million of adverse development for the same period in 2002. This decrease is primarily related to increased claims severity on prior years' reserves in the personal automobile line. Partially offsetting these items is approximately $7 million of estimated net premium rate increases in 2002. In addition, catastrophe losses decreased $5.8 million, to $6.2 million for the second quarter of 2002, compared to $12.0 million for the same period in 2001. 20 Commercial Lines Commercial lines' net premiums written decreased $41.9 million, or 17.4%, to $198.6 million for the second quarter of 2002. This is primarily the result of the Company's termination of 377 agencies and the withdrawal of commercial lines' underwriting capacity from an additional 314 agencies during the fourth quarter of 2001. As a group, these agencies historically produced unsatisfactory loss ratios. In addition, the Company has seen a reduction in premium levels from active agents as re-underwriting efforts to target specific classes of business and strengthen underwriting guidelines continue. Management believes that premium level reductions from continuing agents may continue to unfavorably affect future premiums. Policies in force decreased 18.6%, 17.7% and 4.3% in the workers' compensation, commercial automobile, and commercial multiple peril lines, respectively, since June 30, 2001 primarily as the result of the aforementioned agency management actions. Partially offsetting these decreases in policies in force were rate increases in all of the commercial lines since June 30, 2001. Commercial lines' underwriting results improved $20.6 million, or 90.0%, to an underwriting loss of $2.3 million in the second quarter of 2002. The improvement in underwriting results is primarily attributable to approximately $11 million of estimated net premium rate increases during the second quarter of 2002. In addition, a decrease in current year non-catastrophe claims severity in the commercial multiple peril and workers' compensation lines of approximately $7 million and $5 million, respectively, favorably affected results in 2002. Second quarter of 2002 underwriting results reflected approximately $2 million and $1.3 million of decreased underwriting expenses and policyholder dividends, respectively, compared to the same period in 2001. In addition, catastrophe losses decreased $0.9 million, to $2.4 million for the second quarter of 2002, compared to $3.3 million for the same period in 2001. Partially offsetting these items is a $6.7 million decrease in favorable development on prior years' reserves, from $0.1 million of favorable development in the second quarter of 2001 to $6.6 million of adverse development for the same period in 2002. In addition, increased current year claims severity in the commercial automobile line unfavorably affected underwriting results in the second quarter of 2002. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 Risk Management's segment income increased $32.9 million, or 57.0%, to $90.6 million for the six months ended June 30, 2002. The increase in segment income is primarily attributable to approximately $30 million of estimated net premium rate increases. In addition, personal lines non-catastrophe weather related losses decreased approximately $15 million for the six months ended June 30, 2002, compared to the same period in the prior year. Adverse development on prior years' reserves improved $9.2 million to $6.4 million for the six months ended June 30, 2002, from $15.6 million for the same period in 2001. This improvement includes approximately $15 million of weather related adverse development on prior years' reserves during the six months ended June 30, 2001. Also, segment income for the six months ended June 30, 2002 was favorably affected by approximately $6 million of estimated improved current accident year non-catastrophe claims activity, primarily in commercial lines. In addition, policyholder dividends decreased $3.8 million when comparing the six months ended June 30, 2002 to the same period in 2001. Catastrophe losses decreased $2.3 million, to $19.8 million for the six months ended June 30, 2002, compared to $22.1 million for the same period in 2001. Partially offsetting these items is a decrease in net investment income of $7.2 million for the six months ended June 30, 2002. Policy acquisition expenses increased as a result of the aforementioned net premium rate increases and due to an increase in premium tax expenses. Other operating expenses in 2002 were consistent with the prior year despite the decrease in written policies, due to certain underwriting initiatives and employee related expenses. 21
The following tables summarize the results of operations for the Risk Management segment: (Unaudited) Six Months Ended June 30, -------------------------------------------------------------------- 2002 2001 -------------------------------- -------------------------------- Net Net Premiums Statutory Premiums Statutory (In millions, except ratios) Written Loss Ratios Written Loss Ratios - ------------------------------------------------------------------------ -------------------------------- Personal automobile................... $ 552.4 70.6 $ 511.4 72.5 Homeowners............................ 159.9 64.9 140.3 78.4 Other personal........................ 21.1 49.1 21.4 24.8 ----------- ------------- ----------- ------------- Total personal........................ 733.4 68.6 673.1 72.3 ----------- ------------- ----------- ------------- Workers' compensation................. 79.4 79.5 108.4 82.6 Commercial automobile................. 100.5 64.5 136.3 67.5 Commercial multiple peril............. 164.0 56.1 175.9 70.0 Other commercial...................... 49.6 32.8 51.5 41.6 ----------- ------------- ----------- ------------- Total commercial...................... 393.5 60.4 472.1 69.2 ----------- ------------- ----------- ------------- Total................................. $ 1,126.9 65.5 $ 1,145.2 71.0 =========== ------------- =========== ------------- Statutory combined ratio (1): Personal lines........................ 103.0 103.7 Commercial lines...................... 103.2 108.3 ----------- ----------- Total................................. 102.9 105.4 ----------- ----------- Statutory underwriting loss: Personal lines........................ $ (28.4) $ (29.4) Commercial lines...................... (3.9) (45.8) ----------- ----------- Total................................. (32.3) (75.2) Reconciliation to segment income: Net investment income................. 102.6 109.8 Other income and expenses, net........ 7.6 9.7 Other Statutory to GAAP adjustments... 12.7 13.4 ----------- ----------- Segment income........................... $ 90.6 $ 57.7 =========== =========== - ---------------------------------------------------------------------------------------------------------------- (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.
Personal Lines Personal lines' net premiums written increased $60.3 million, or 9.0%, to $733.4 million for the six months ended June 30, 2002. This is primarily the result of increases of $41.0 million, or 8.0%, and $19.6 million, or 14.0%, in the personal automobile and homeowners lines, respectively. The increase in the personal automobile line is primarily the result of 2.0% and 0.6% net premium rate increases in Michigan and Massachusetts, respectively, and an overall increase of 2.1% in policies in force since June 30, 2001. The increase in the homeowners line resulted primarily from rate increases of 19.6% and 9.9% in Michigan and Massachusetts, respectively, in addition to an overall increase of 1.1% in policies in force since June 30, 2001. Personal lines' underwriting results improved $1.0 million, or 3.4%, to an underwriting loss of $28.4 million for the six months ended June 30, 2002. The improvement in underwriting results is primarily attributable to a $12.7 million decrease in adverse development in 2002 and the aforementioned combined effect of adverse weather, in 2001 and mild weather in 2002. Underwriting results for the six months ended June 30, 2002 also reflected approximately $10 million of estimated net premium rate increases. In addition, catastrophe losses decreased $2.5 million, to $15.7 million for the six months ended June 30, 2002, compared to $18.2 million for the same period in 2001. These items are partially offset by increased policy acquisition expenses, primarily related to the aforementioned increases in cession expenses for New York assigned risk business and premium tax expenses. Underwriting results were also unfavorably affected by increased current year claims severity in the personal automobile line in the six months ended June 30, 2002. 22 Commercial Lines Commercial lines' net premiums written decreased $78.6 million, or 16.6%, to $393.5 million for the six months ended June 30, 2002. This is primarily the result of the Company's aforementioned agency management actions and the continuing re-underwriting efforts. As a result of these actions, policies in force decreased 18.6%, 17.7% and 4.3% in the workers' compensation, commercial automobile, and commercial multiple peril lines, respectively, since June 30, 2001. Partially offsetting these decreases in policies in force were rate increases in all of the commercial lines since June 30, 2001. Commercial lines' underwriting results improved $41.9 million, or 91.5%, to an underwriting loss of $3.9 million for the six months ended June 30, 2002. The improvement in underwriting results is primarily attributable to approximately $20 million of net premium rate increases during the six months ended June 30, 2002. In addition, approximately $5 million of decreases in current year claims severity in both the commercial automobile and commercial multiple peril lines favorably affected results in 2002. The six months ended June 30, 2002 underwriting results also included a net benefit, when compared to the same period in 2001, as the result of exiting historically unprofitable business under the aforementioned agency management actions. In addition, the six months ended June 30, 2002 underwriting results reflected approximately $6 million and $2.5 million of decreased underwriting expenses and policyholder dividends, respectively, compared to the same period in 2001. Partially offsetting these favorable items is a $3.5 million decrease in development on prior years' reserves to $2.3 million of adverse development for the six months ended June 30, 2002 from $1.2 million of favorable development for the same period in 2001. Investment Results Net investment income before tax declined $7.2 million, or 6.6%, to $102.6 million for the six months ended June 30, 2002. The decrease in net investment income primarily reflects the impact of defaults on high yield bonds, a reduction in average pre-tax yields on debt securities and the transfer of assets to the Corporate segment and the Allmerica Financial Services segment. Average pre-tax yields on debt securities decreased to 6.4% in 2002 compared to 6.9% in 2001 due to the shift from higher yielding below investment grade securities to lower yielding, but higher quality investment grade securities. Due to the current interest rate environment, management expects its investment yield to be negatively affected by lower prevailing fixed maturity investment rates in 2002. In addition, management expects that defaults in the fixed maturities portfolio may continue to negatively impact investment income. 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 frequency, and judicial theories of liability and policy coverage, and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation and other liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, and where the technological, judicial and political climates involving these types of claims are changing. The Company regularly adjusts its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in results of operations as adjustments to losses and LAE. Often these adjustments are recognized in periods subsequent to the period in which the underlying loss event occurred. These types of subsequent adjustments are described as "prior year reserve development". Such development can be either favorable or unfavorable on the financial results of the Company. 23 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) 2002 2001 - --------------------------------------------------------------------------------------------------- Reserve for losses and LAE, beginning of period............... $ 2,921.5 $ 2,719.1 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of current year............. 834.1 844.4 Increase in provision for insured events of prior years.. 6.4 15.6 ------------ ------------ Total incurred losses and LAE.............................. 840.5 860.0 ------------ ------------ Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year........................................... 346.2 342.6 Losses and LAE attributable to insured events of prior years................................................. 468.9 486.8 ------------ ------------ Total payments............................................. 815.1 829.4 ------------ ------------ Change in reinsurance recoverable on unpaid losses......... (8.0) 1.8 ------------ ------------ Reserve for losses and LAE, end of period..................... $ 2,938.9 $ 2,751.5 ============ ============
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were increased by $6.4 million for the six months ended June 30, 2002. This reflects $16.8 million of increased prior years' loss reserves, partially offset by $10.4 million of decreased prior years' LAE reserves. For the six months ended June 30, 2001, prior years' reserves were increased by $15.6 million. This reflects $43.9 million of increased prior years' loss reserves, partially offset by $28.3 million of decreased prior years' LAE reserves. The adverse loss reserve development in 2002 is primarily the result of increased non-catastrophe claims severity on prior years' reserves in the workers' compensation, personal automobile, homeowners, and commercial automobile lines, partially offset by a decrease in commercial multiple peril non-catastrophe claims severity. The adverse loss reserve development in 2001 was primarily related to fourth quarter 2000 non-catastrophe weather related claims in Michigan. These claims primarily affected the personal automobile and homeowners lines. The adverse loss development in 2001 is also attributable to an increase in commercial lines' loss costs in the 1999 and 2000 accident years. The favorable LAE reserve development in both 2002 and 2001 is primarily attributable to claims process improvement initiatives taken by the Company over the past four years. Since 1997, the Company has lowered claim settlement costs through increased utilization of in-house attorneys and consolidation of claims offices. These measures are complete. 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. Recently, the Company has experienced increasing medical costs associated with personal auto injury protection ("PIP") and workers' compensation claims. This increase is reflected in the Company's reserve estimates but continued increases 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 and policy coverage, political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies and (v) internal estimates of required reserves, management believes that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on the results of operations. Environmental Reserves Although the Company does not specifically underwrite policies that include environmental damage and toxic tort liability, the Company may be required to defend such claims. Loss and LAE reserves for all direct business written by its property and casualty companies related to environmental damage and toxic tort liability, included in the reserve for losses and LAE, were $21.1 million and $24.3 million, net of reinsurance of $12.0 million and $9.5 million for the six months ended June 30, 24 2002 and 2001, respectively. Loss and LAE reserves for assumed reinsurance pool business with environmental damage and toxic tort liability were $38.6 million and $9.5 million for the six month ended June 30, 2002 and 2001, respectively. These reserves relate to pools in which the Company has terminated its participation; however, the Company continues to be subject to claims related to prior years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, there can be no assurance that these reserves will be sufficient. The increase in assumed reinsurance pool business environmental damage and toxic tort liability reserves is primarily related to a $33.0 million fourth quarter of 2001 adjustment for a voluntary excess and casualty reinsurance pool (Excess and Casualty Reinsurance Association "ECRA"). 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, notwithstanding the evolution of case law expanding liability in environmental claims, recorded reserves related to these claims are adequate. In addition, the Company is not aware of any litigation or pending claims that may result in additional material liabilities in excess of recorded reserves. The environmental liability could be revised in the near term if the estimates used in determining the liability are revised. 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) 2002 2001 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Segment revenues Premiums.................................................. $ 6.8 $ 7.6 $ 31.3 $ 33.1 Fees................................................... 98.8 99.2 194.8 199.6 Net investment income.................................. 72.7 72.0 143.4 143.2 Other income........................................... 26.5 25.5 50.2 51.6 --------- --------- --------- ---------- Total segment revenues.................................... 204.8 204.3 419.7 427.5 Policy benefits, claims and losses........................ 97.7 78.5 204.9 172.2 Policy acquisition and other operating expenses........... 220.9 83.2 298.9 168.4 --------- --------- --------- ---------- Segment (loss) income .................................... $ (113.8) $ 42.6 $ (84.1) $ 86.9 ========= ========= ========= ==========
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 Segment income decreased $156.4 million, to a loss of $113.8 million, during the second quarter of 2002. The decrease reflects the cumulative effect of the significant, persistent decline in equity market values during the most recent two and one half years, particularly the relatively significant decline during the quarter. The decline resulted in additional amortization of the DAC asset of $137.1 million, increased GMDB costs of $18.9 million, as well as reduced fees and other income from certain products. Segment revenues increased $0.5 million, or 0.2%, in the second quarter of 2002, primarily due to higher income from transaction-based and asset-based fees. Total other income increased $1.0 million, or 3.9%, to $26.5 million primarily due to higher asset-based fees. Fee income decreased $0.4 million, or 0.4%, to $98.8 million, primarily due to lower group annuity and group variable universal life fees which decreased $3.1 million and $0.5 million, respectively. The decline in group annuity fees was primarily due to lower average invested assets resulting from the Company's exit from the defined contribution group retirement business in 2001. This decrease was partially offset by a $3.2 million increase in individual variable universal life fees principally due to higher insurance fees and additional deposits. A decline in the market value of average individual annuity separate account assets under management resulted in a $4.6 million decrease in annuity fee income, offset by an increase of $5.2 million from additional deposits and insurance fees resulting from new sales. Policy benefits, claims and losses increased $19.2 million, or 24.5%, to $97.7 million in the second quarter of 2002, primarily due to increased GMDB related to variable annuities. The GMDB feature provides annuity contract holders with a guarantee that the benefit received at death will be no less than a prescribed minimum amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a 25 contract anniversary, or more typically the greatest of these values. To the extent that the guaranteed minimum death benefit is higher than the current account value at the time of death, the Company incurs a cost. This results in increased annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. As of June 30, 2002 the difference between the GMDB and the current account value (the "net amount at risk") for all existing contracts was $3.8 billion. In the second quarter of 2002, the GMDB expense increased $18.9 million, to $22.1 million, primarily due to the effects of the prolonged decline in the financial markets. Unless equity market values appreciate from June 30, 2002 levels, the Company expects GMDB expenses to further increase and segment income to be unfavorably affected during the remainder of 2002. At the equity market values as of June 30, 2002, the expected GMDB expense for the year ending December 31, 2002 would be approximately $76 million to $81 million. For each one percent change, either increase or decrease in the S&P 500 Index, the net amount at risk is estimated to increase or decrease by $100 million, and the GMDB cost for a twelve-month period is estimated to increase or decrease by approximately $2 million to $2.5 million. Policy acquisition and other operating expenses increased $137.7 million, to $220.9 million in the second quarter of 2002. This consists of an increase in policy acquisition expenses of $140.6 million and a decrease in other operating expenses of $2.9 million. The increase in policy acquisition expenses resulted almost entirely from three separate adjustments to amortization of DAC totaling $141.9 million. First, the Company reduced its estimate of future gross profits expected from existing variable annuity contracts and variable life insurance policies, resulting in additional amortization of $137.1 million. The change in estimate resulted from the significant decline in the equity markets during the quarter. Although short-term market volatility does not change the Company's assessment of long-term, future profitability, the Company considers the recent declines to be suggestive of a permanent, partial reduction in future profitability. Should the equity markets remain at, or decline from, levels existing at June 30, 2002, additional amortization would be recognized. The converse is also true; a significant market recovery would result in reduced or negative amortization. At the current and expected equity market valuations, the Company's reversion-to-the-mean accounting policy for DAC amortization assumes appreciation in separate account values of 3% in each future quarter. In any quarter, to the extent the change in separate account values deviates from the 3% assumption, for each 1% of deviation there would be an adjustment to DAC amortization equal to $3 million to $5 million in the quarter. Accordingly, if equity market values at September 30, 2002 remain the same as those at June 30, 2002, the Company expects additional DAC amortization in the third quarter of 2002 of approximately $9 million to $15 million. The remaining two adjustments to DAC amortization result from the Company's increasing its estimate of the long-term GMDB, which increased DAC amortization by $13.3 million in the second quarter, and from the Company's changing its estimate of future fees from certain annuity contracts, which decreased DAC amortization by $8.5 million in the second quarter. The $2.9 million decrease in other operating expenses is primarily due to the Company's exit from the defined contribution group retirement business in July 2001. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 Segment income decreased $171.0 million, to a loss of $84.1 million, in the first six months of 2002. The decrease reflects the cumulative effect of the significant, persistent decline in equity market values during the most recent two and one half years, particularly the relatively steep decline during the second quarter. The decline resulted in additional amortization of the DAC asset of $137.1 million, increased GMDB of $29.8 million, as well as reduced fees and other income from certain products. Segment revenues decreased $7.8 million, or 1.8%, in the first six months of 2002, primarily due to lower asset-based fees and other income. Fee income decreased $4.8 million, or 2.4%, to $194.8 million, primarily due to lower group annuity and group variable universal life fees which decreased $5.1 million and $1.1 million, respectively. The decline in group annuity fees was primarily due to lower average invested assets resulting from the Company's exit from the defined contribution group retirement business. A decline in the market value of average separate account assets under management resulted in a $9.8 million decrease in fee income, partially offset by an increase of $7.3 million from additional deposits and insurance fees. In addition, non-variable universal life policy fees decreased $1.4 million in the first six months of 2002, 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 $5.3 million increase in fees from variable universal life policies, primarily due to additional deposits. Other income decreased $1.4 million, or 2.7%, to $50.2 million. This decline 26 was primarily due to decreased investment management fees resulting from depreciation in variable product assets under management. Policy benefits, claims and losses increased $32.7 million, or 19.0%, to $204.9 million in the first six months of 2002, primarily due to increased GMDB related to variable annuities. In the first six months of 2002, the GMDB expense increased $29.8 million primarily due to the effects of the prolonged decline in the financial markets. Policy benefits, claims and losses also increased due to interest credited on general account assets. Policy acquisition and other operating expenses increased $130.5 million, to $298.9 million in the first half of 2002. This consists of an increase in policy acquisition expenses of $131.1 million and a decrease in other operating expenses of $0.6 million. The increase in policy acquisition expenses resulted entirely from the aforementioned three separate adjustments to amortization of DAC, representing a total of $141.9 million of additional amortization. The decrease in other operating expenses is due to the Company's exit from the defined contribution group retirement business in July 2001, partially offset by higher technology expenses. 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) 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------ Insurance: Traditional life.................... $ 7.0 $ 7.8 $ 29.3 $ 24.0 Universal life...................... 3.7 4.8 7.9 9.4 Variable universal life............. 69.9 43.0 133.2 101.3 Individual health................... 0.1 0.1 0.1 0.2 Group variable universal life....... 0.6 20.9 25.9 59.3 ---------- ---------- ---------- --------- Total insurance............... 81.3 76.6 196.4 194.2 ---------- ---------- ---------- --------- Annuities: Separate account annuities.......... 804.5 480.9 1,382.3 979.3 General account annuities........... 254.8 326.0 461.9 556.4 Retirement investment accounts...... 1.6 1.6 3.5 3.9 ---------- ---------- ---------- --------- Total individual annuities... 1,060.9 808.5 1,847.7 1,539.6 Group annuities..................... 13.0 70.3 37.4 165.2 ---------- ---------- ---------- --------- Total annuities............... 1,073.9 878.8 1,885.1 1,704.8 ---------- ---------- ---------- --------- Total premiums and deposits.............. $ 1,155.2 $ 955.4 $ 2,081.5 $ 1,899.0 ========== ========== ========== =========
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 For the quarter ended June 30, 2002, total premiums and deposits increased $199.8 million, or 20.9%, to $1,155.2 million. These increases are primarily due to higher separate account annuity deposits partially offset by lower general account annuity and group annuity deposits. The higher annuity deposits into the Company's separate accounts were primarily due to a continued emphasis by Scudder Investments ("Scudder") on marketing and sales of the Company's annuity products. General account annuity deposits were higher in 2001 principally due to a promotional annuity program offered for a limited period in 2001. Group annuity deposits decreased due to the Company's exit from the defined contribution retirement plan business and cessation of marketing activities for new defined benefit retirement business. Variable universal life deposits increased in the quarter due to increased sales of specialty variable life products. Group variable universal life deposits decreased in the quarter due to the cessation of marketing activities for this product. Annuity products are distributed primarily through three distribution channels: (1) "Agency", which consists of the Company's career agency force; (2) "Select", which consists of a network of third party broker-dealers; and (3) "Partners", which includes distributors of the mutual funds advised by Scudder, Pioneer Investment Management, Inc. ("Pioneer") and Delaware Management Company ("Delaware"). Agency, Select, and Partners represented, respectively, approximately 18%, 31%, and 51% of individual annuity deposits in the second quarter of 2002, and Scudder represented 47% of all individual annuity deposits. During the second quarter of 2001, Agency, Select, and Partners represented, respectively, approximately 24%, 42%, and 34% of individual annuity deposits, and Scudder represented 25% of all individual annuity deposits. The 27 Company's ability to distribute its products through the Partner channel is highly dependent on its relationships with Scudder and Pioneer, respectively, and, through both the Partner and Select channels, on its relationships and reputation with the broker-dealer firms which distribute the products. Selling agreements with broker-dealer firms, including those appointed through Scudder and Pioneer, are generally terminable by either party upon 30 days notice. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 For the six months ended June 30, 2002, total premiums and deposits increased $182.5 million, or 9.6%, to $2,081.5 million. These increases are primarily due to higher annuity deposits into the Company's separate accounts resulting, in part, from the aforementioned selling emphasis by Scudder. These increases were partially offset by lower general account annuity deposits resulting from the aforementioned promotional annuity program offered in 2001 and lower group annuity deposits resulting from the Company's decision to cease marketing activities for new group retirement business. Variable universal life deposits increased due to increased sales of specialty variable life products. Group variable universal life deposits decreased due to the cessation of marketing activities for this product. Agency, Select, and Partners represented, respectively, approximately 20%, 33%, and 47% of individual annuity deposits in the first six months of 2002, and Scudder represented 41% of all individual annuity deposits. During the first six months of 2001, Agency, Select, and Partners represented, respectively, approximately 25%, 40%, and 35% of individual annuity deposits, and Scudder represented 25% of all individual annuity deposits. 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) 2002 2001 2002 2001 - ----------------------------------------------------------------------------------------------------------------------- Interest margins on GICs: Net investment income............................... $ 24.9 $ 39.5 $ 51.4 $ 76.4 Interest credited................................... 22.6 35.6 46.2 67.6 --------- --------- ---------- --------- Net interest margin.................................... 2.3 3.9 5.2 8.8 --------- --------- ---------- --------- Fees and other income External............................................. 5.6 1.1 10.2 2.8 Internal............................................. 1.4 1.3 2.7 2.7 Other operating expenses............................... (4.2) (1.9) (7.9) (3.9) --------- --------- ---------- --------- Segment income......................................... $ 5.1 $ 4.4 $ 10.2 $ 10.4 ========= ========= ========== ========= Average GIC deposits outstanding $ 2,271.4 $ 2,942.7 $ 2,370.5 $ 2,600.2 ========= ========= ========== =========
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 Segment income increased $0.7 million, or 15.9%, to $5.1 million during the second quarter of 2002. This increase is primarily due to the inclusion of earnings related to Allmerica's premium financing subsidiary, AMGRO, which was previously included in the Risk Management segment, in Allmerica Asset Management's (AAM) results beginning in 2002. Also, segment income increased due to increased earnings related to asset management services provided to external clients, partially offset by decreased earnings on GICs. Earnings on GICs decreased $1.6 million primarily due to withdrawals of short-term funding agreements and to lower net investment income. Net investment income declined primarily due to the shift from higher yielding below investment grade securities to lower yielding, but higher quality investment grade securities during 2002 and 2001, and to the effect of defaults on certain bonds supporting GIC obligations. An increase in earnings from asset management services provided to external clients resulted from new external assets under management. At March 31, 2002, the Company held $478.4 million of short-term funding agreements with put features which allow the policyholder to cancel the contract prior to maturity. During the second quarter of 2002, payments related to short-term funding agreement withdrawals were approximately $190 million. Also, during the second quarter of 2002, the Company was notified of approximately $105 million of additional withdrawals. Payments related to these withdrawal notifications are expected in the third quarter of 2002. Subsequent to June 30, 2002, the Company was notified of approximately $185 million of additional withdrawals which represent the remaining outstanding short-term funding agreements with put features. Payments related to these subsequent withdrawal notifications are expected in the fourth quarter of 2002. Management expects income from the GIC product line to be unfavorably affected in future periods due to short-term funding agreement withdrawals. In addition, management does not expect to pursue future sales of short-term or long-term funding agreements. 28 Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 Segment income decreased $0.2 million, or 1.9%, to $10.2 million in the first six months of 2002. This decrease is primarily due to decreased earnings on GICs, partially offset by the inclusion of earnings related to Allmerica's premium financing subsidiary, AMGRO, in AAM's results beginning in 2002 and an increase in fees and other income related to external clients. Earnings on GICs decreased in 2002 primarily due to withdrawals of short-term funding agreements and to lower net investment income. Net investment income declined primarily due to the shift from higher yielding below investment grade securities to lower yielding, but higher quality investment grade securities during 2002 and 2001, and to the effect of the aforementioned bond defaults. The increase in external fees and other income primarily resulted from the aforementioned increase in other external assets under management from additional deposits. At December 31, 2001, the Company held $761.8 million of short-term funding agreements with put features which allow the policyholder to cancel the contract prior to maturity. During the first six months of 2002, payments related to short-term funding agreement withdrawals were approximately $476 million. Also, during the second quarter of 2002, the Company was notified of approximately $105 million of additional withdrawals. Payments related to these withdrawal notifications are expected in the third quarter of 2002. Subsequent to June 30, 2002, the Company was notified of approximately $185 million of additional withdrawals which represent the remaining short-term funding agreements with put features. Payments related to these subsequent withdrawal notifications are expected in the fourth quarter of 2002. 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) 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------- Segment revenues Net investment income.............................. $ 1.5 $ 1.5 $ 3.2 $ 2.5 Interest expense................................... 3.8 3.8 7.6 7.6 Other operating expenses........................... 12.9 13.3 27.2 26.7 ---------- ---------- ---------- --------- Segment loss......................................... $ (15.2) $ (15.6) $ (31.6) $ (31.8) ========== ========== ========== =========
Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001 The segment loss decreased $0.4 million, or 2.6%, to $15.2 million in the second quarter of 2002, primarily resulting from state tax credits recognized by the holding company, partially offset by increased spending in corporate overhead costs. Interest expense for both periods relates principally to the interest paid on the Senior Debentures of the Company. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 Segment loss decreased $0.2 million, or 0.6%, to $31.6 million in the first six months of 2002, primarily resulting from state tax credits recognized by the holding company and higher net investment income. These increases were partially offset by increased spending in corporate overhead costs. Interest expense for both periods relates to the interest paid on the Senior Debentures of the Company. 29 Investment Portfolio The Company held general account investment assets diversified across several asset classes, as follows:
(Unaudited) June 30, 2002 December 31, 2001 --------------------------------- -------------------------------- Carrying % of Total Carrying % of Total (In millions) Value Carrying Value Value Carrying Value - -------------------------------------------------- ------------- ------------------- ------------- ------------------ Fixed maturities (1)............................ $ 8,938.3 87.5% $9,401.7 88.1% Equity securities (1)........................... 54.7 0.5 62.1 0.6 Mortgages....................................... 309.0 3.0 321.6 3.0 Policy loans.................................... 372.6 3.6 379.6 3.5 Cash and cash equivalents....................... 376.1 3.7 350.2 3.3 Other long-term investments..................... 170.3 1.7 161.2 1.5 ------------- ------------------- ------------- ------------------ Total...................................... $10,221.0 100.0% $10,676.4 100.0% ============= =================== ============= ================== - --------------------------------------------------------------------------------------------------------------------- (1) The Company carries fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets decreased $455.4 million, or 4.3%, to $10.2 billion during the first six months of 2002. This decrease consisted primarily of reductions in fixed maturities of $463.4 million, principally due to short-term funding agreement withdrawals in the Allmerica Asset Management segment. The Company's fixed maturity portfolio is comprised primarily of 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 89.5% and 90.7% of the Company's total fixed maturity portfolio at June 30, 2002 and December 31, 2001, 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. The average yield on fixed maturities was 6.8% and 7.4% for the six months ended June 30, 2002 and 2001, respectively. This decline reflects the shift from higher yielding below investment grade securities to lower yielding, but higher quality investment grade securities, as well as lower prevailing fixed maturity investment rates since the first quarter of 2001. Due to the current interest rate environment, management expects its investment yield to be negatively affected by lower prevailing fixed maturity investment rates in 2002. As of June 30, 2002 and December 31, 2001, approximately $515.1 million and $509.8 million, respectively, of the Company's fixed maturities were invested in non-publicly traded securities. Fair values of non-publicly traded securities are determined by either a third party broker or by internally developed pricing models, including the use of discounted cash flow analyses. Principally as a result of the Company's exposure to below investment grade securities, the Company recognized $59.4 million and $95.2 million of realized losses on other-than-temporary impairments of fixed maturities during the first six months of 2002 and 2001, respectively. Other-than-temporary impairments in 2002 included $10.4 million from securitized investment portfolios and $9.5 million related to securities issued by Worldcom and affiliated companies. Other-than-temporary impairments in 2001 included a $21.9 million loss from a securitized investment portfolio. The losses reflect the continued deterioration of high-yield securities in our portfolio. In addition, the Company recognized $8.0 million of realized losses on other-than-temporary impairments of equity securities during the first six months of 2002. In the Company's determination of other-than-temporary impairments, management considers several factors and circumstances including the issuer's overall financial condition, the issuer's credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer's securities remains below the Company's cost, and with respect to fixed maturity investments, any factors that might raise doubt about the issuer's ability to pay all amounts due according to the contractual terms. The Company applies these factors to all securities. Other-than-temporary impairments are recorded as a realized loss, which serves to reduce net income and earnings per share. Temporary losses are recorded as unrealized losses, which do not impact net income and earnings per share but reduce other comprehensive income. In addition, the Company had fixed maturity securities with a carrying value of $39.5 million and $9.8 million on non-accrual status at June 30, 2002 and December 31, 2001, respectively. No assurance can be given that the fixed maturity impairments will, in-fact, be adequate to cover future losses or that substantial additional impairments will not be required in the future. The effect of holding securities for which income is not accrued, compared with amounts that would have been recognized in accordance with the original terms of the investments, was a reduction in net investment income of $9.2 million and $6.8 million for the six months ended June 30, 2002 and 2001, respectively. This includes the impact of securities held as of the 30 aforementioned financial statement dates, as well as securities sold during those periods. Management expects that defaults in the fixed maturities portfolio may continue to negatively impact investment income. The gross unrealized losses on our fixed maturities and equity securities are viewed as being temporary as it is management's assessment that these securities will recover in the near-term and, further, that the Company has the intent and ability to retain such investments for a period of time sufficient to allow for this anticipated recovery in market value. The risks inherent in the assessment methodology include the risk that market factors may differ from management's expectations; management may decide to subsequently sell a security for unforeseen liquidity needs; or the credit assessment or equity characteristics may change from the Company's original assessment and the Company may determine that a sale at the current value would maximize recovery on such investments. To the extent that there are such adverse changes, the unrealized loss would then be realized and the Company would record a charge to earnings. Of the $185.1 million gross unrealized losses of fixed maturities as of June 30, 2002, approximately $34.9 million relates to fixed maturity obligations of the U.S. Treasury, U.S. government and agency securities, states and political subdivisions. An additional $57.8 million of gross unrealized losses relates to holdings of investment grade fixed maturities in a variety of industries and sectors, while approximately $92.4 million relates to holdings of below investment grade fixed maturities in a variety of industries and sectors. Substantially all below investment grade securities with an unrealized loss have been rated by either the NAIC, S&P or Moody's as of June 30, 2002. Also, $2.3 million in gross unrealized losses related to equity securities. 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, 2002 Compared to Quarter Ended June 30, 2001 The provision for federal income taxes was a benefit of $61.6 million during the second quarter of 2002, compared to a benefit of $1.7 million during the same period in 2001. These provisions resulted in consolidated effective federal tax rates of (54.5%) and (11.0%) for the quarters ended June 30, 2002 and 2001, respectively. It is the Company's policy to estimate taxes for interim periods based on estimated annual effective tax rates which are derived, in part, from expected annual pre-tax income. However, the federal income tax benefit for 2002 has been computed based on the first half of 2002 as a discreet period due to the uncertainty regarding the Company's ability to reliably estimate pre-tax income for the remainder of the year. The Company cannot reliably estimate pre-tax income for the second half of 2002 principally due to the impact of the equity markets on the Company, including possible additional amortization of DAC. The large benefit in the current quarter is primarily due to the significant loss recognized by the AFS segment. The benefit also reflects a $12.1 million favorable settlement of certain prior years' federal income tax returns. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 The provision for federal income taxes was a benefit of $52.1 million during the first six months of 2002, compared to an expense of $4.7 million during the same period in 2001. These provisions resulted in consolidated effective federal tax rates of (108.5%) and 9.0% for the six months ended June 30, 2002 and 2001, respectively. The large benefit in the current period is primarily due to the significant loss recognized by the AFS segment. The benefit also reflects a $12.1 million favorable settlement of certain prior years' federal income tax returns. Critical Accounting Policies The discussion and analysis of the Company's financial condition and results of operations are based upon the consolidated financial statements. These statements have been prepared in accordance with generally accepted accounting principles which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following critical accounting policies, among others, are those which management believes affect the more significant judgments and estimates used in the preparation of the Company's financial statements. Additional information about the Company's significant accounting policies may be found in Note 1, "Summary of Significant Accounting Policies" to the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the period ended December 31, 2001. 31 Property & Casualty Insurance Loss Reserves The amount of loss and loss adjustment expense reserves (the "loss reserves") is determined based on an estimation process that is very complex and uses information obtained from both company specific and industry data, as well as general economic information. The estimation process is highly judgmental, and requires the Company to continuously monitor and evaluate the life cycle of claims on type-of-business and nature-of-claim bases. Using data obtained from this monitoring and assumptions about emerging trends, the Company develops information about the size of ultimate claims based on its historical experience and other available market information. The most significant assumptions used in the estimation process, which vary by line of business, include determining the trend in loss costs, the expected consistency in the frequency and severity of claims incurred but not yet reported to prior year claims, changes in the timing of the reporting of losses from the loss date to the notification date, and expected costs to settle unpaid claims. Because the amount of the loss reserves is sensitive to the Company's assumptions, the Company does not completely rely on only one estimate to determine its loss reserves. Rather, the Company develops several estimates using generally recognized actuarial projection methodologies that result in a range of reasonably possible loss reserve outcomes; the Company's best estimate is within that range. When trends emerge that the Company believes affect the future settlement of claims, the Company would react accordingly by adjusting its reserves. Reserve adjustments are reflected in the Consolidated Statements of Income as adjustments to losses and loss adjustment expenses. Often, these adjustments are recognized in periods subsequent to the period in which the underlying loss event occurred. These types of subsequent adjustments are disclosed and discussed separately as "prior year reserve development". Such development can be either favorable or unfavorable to the financial results of the Company. Property & Casualty Reinsurance Recoverables The Company shares a significant amount of insurance risk of the primary underlying contracts with various insurance entities through the use of reinsurance contracts. As a result, when the Company experiences loss events that are subject to the reinsurance contract, reinsurance recoverables are recorded. The amount of the reinsurance recoverable can vary based on the size of the individual loss or the aggregate amount of all losses in a particular line, book of business or an aggregate amount associated with a particular accident year. The valuation of losses recoverable depends on whether the underlying loss is a reported loss, or an incurred but not reported loss. For reported losses, the Company values reinsurance recoverable at the time the underlying loss is recognized, in accordance with contract terms. For incurred but not reported losses, the Company estimates the amount of reinsurance recoverable based on the terms of the reinsurance contracts and historical reinsurance recovery information and applies that information to the gross loss reserve estimates. The most significant assumption the Company uses is the average size of the individual losses for those claims that have occurred but have not yet been recorded by the Company. The reinsurance recoverable is based on reasonable estimates and is disclosed separately on the financial statements. However, the ultimate amount of the reinsurance recoverable is not known until all losses are settled. Variable Products' Deferred Policy Acquisition Costs Deferred policy acquisition costs consist of commissions, underwriting costs and other costs, which vary with, and are primarily related to, the production of insurance deposits. Acquisition costs related to the Company's variable products (variable universal life and variable annuities) are recorded on the balance sheet and amortized through the income statement in proportion to total estimated gross profits over the expected life of the contracts. The Company's estimated gross profits are based on assumptions including mortality, persistency, asset growth rates and expenses associated with policy maintenance. The principal source of earnings for these policies are from asset-based fees, which can vary in relation to changes in the equity markets. At each balance sheet date, the Company evaluates the historical and expected future gross profits. Any adjustment in estimated profit requires that the amortization rate be revised retroactively to the date of policy/annuity issuance. The cumulative difference related to prior periods is recognized as a component of the current periods' amortization, along with amortization associated with the actual gross profits of the period. Lower actual gross profits in a period would typically result in less amortization expense in that period. The converse would also be true. However, if lower gross profits were to continue into the future, additional amortization of the existing DAC asset may occur. The Company periodically reviews the DAC asset to determine if it is recoverable from future income. If DAC is determined to be unrecoverable, such costs are expensed at the time of determination. The amount of DAC considered realizable would be reduced in the near term if the estimate of ultimate or future gross profits is reduced. The amount of DAC amortization would be revised if any of the estimates discussed above are revised. Other-Than-Temporary Impairments The Company employs a systematic methodology to evaluate declines in market values below cost or amortized cost for its investments. This methodology ensures that available evidence concerning the declines is evaluated in a disciplined manner. 32 In determining whether a decline in market value below amortized cost is other-than-temporary, the Company evaluates the length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the issuer's financial performance, including earnings trends, dividend payments, and asset quality; any specific events which may influence the operations of the issuer; general market conditions; and, the financial condition and prospects of the issuer's market and industry. The Company applies judgment in assessing whether the aforementioned factors have caused an investment to decline in value to be other-than-temporary. When an other-than-temporary decline in value is deemed to have occurred, the Company reduces the cost basis of the investment to the new estimated realizable value. This reduction is permanent and is recognized as a realized investment loss. Liquidity and Capital Resources Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, AFC's primary source of cash is dividends from its insurance subsidiaries. However, dividend payments to AFC by its insurance subsidiaries are subject to limitations imposed by state regulators, such as the requirement that cash dividends be paid out of unreserved and unrestricted earned surplus and restrictions on the payment of "extraordinary" dividends, as defined. Further, in connection with the transfer of FAFLIC's ownership of the Company's property and casualty subsidiaries to AFC in 1999, it was agreed with the Massachusetts Commissioner of Insurance (the "Massachusetts Commissioner") that FAFLIC's risk based capital would be maintained at 225%, or higher, of the "Company Action Level", which is the level of risk based capital generally required by state regulation. The agreement provided that the Massachusetts Commissioner would have the authority to require FAFLIC to increase its risk based capital to at least 225% under a plan approved by the Commissioner in the event that FAFLIC reported risk based capital below 225% through the year 2005. During the first six months of 2002, AFC did not receive any dividend payments from its insurance subsidiaries. In July 2002, AFC received $92 million of dividends from its property and casualty businesses. Additional dividends from the Company's property and casualty insurance subsidiaries prior to July 2003 would be considered "extraordinary" and would require prior approval from the respective state regulators. The Company does not expect dividend payments from its life insurance subsidiaries. During the first six months of 2002, AFC contributed $40 million to FAFLIC. In August 2002, AFC contributed an additional $158 million to FAFLIC. These contributions were made in order to maintain FAFLIC's statutory surplus at levels in consideration of its financial ratings with rating agencies and the agreement with the Massachusetts Commissioner described above. Such capital contributions were made due to the negative impact on statutory surplus of increased GMDB reserves, an increased level of realized investment losses and the level of premiums and deposits. The statutory surplus of the life companies is highly sensitive to movements in the equity markets. This is due to the required methodology for calculating GMDB ("Actuarial Guideline 34") reserves for statutory accounting purposes. As of June 30, 2002, the level of net GMDB reserves in the life companies was approximately $180 million. The increase of these reserves does not result directly in cash losses to the Company, but it does result in a reduction in statutory surplus. For each one percent decline in the S&P 500 stock index, the expected increase in required statutory GMDB reserves is approximately $6 million to $8 million. Any increase in required reserves would result in an equal decrease in the statutory surplus. Any increase in the S&P 500 Index would result in a decrease in required statutory GMDB reserves, as well as an increase in surplus, but to a lesser extent, due to the impact of the GMDB reinsurance with an independent reinsurer, discussed below. Management expects that additions to the statutory surplus of FAFLIC may be required. Such additions could be funded by "extraordinary" dividends from the property and casualty insurance subsidiaries, borrowing under the existing syndicated credit agreement, reinsurance contracts, raising debt or equity in the public or private markets, or an internal reorganization of certain insurance entities. The Company could also reduce sales of variable insurance products to help maintain statutory capital and risk based capital levels. In 2001, AFLIAC agreed to cede its GMDB costs in excess of $40 million, but not to exceed $80 million, annually for a three year period, to an independent reinsurer. Under a related agreement, AFC agreed to reimburse these costs to the reinsurer. Through the six months ended June 30, 2002, AFLIAC incurred GMDB costs of approximately $47.2 million and ceded approximately $7.2 million under the agreement. Management believes that unless equity market values appreciate from June 30, 2002 levels, AFC will be required to reimburse additional GMDB costs. 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 33 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 $149.6 million and $277.7 million during the first six months of 2002 and 2001, respectively. Net cash was higher in 2001 compared to 2002 primarily as a result of the promotional annuity program with enhanced crediting rates of 7% in 2001, which attracted higher deposits into the Company's general accounts. This decrease in 2002 was partially offset by lower loss and LAE payments in 2002 in the property and casualty business. Net cash provided by investing activities was $479.4 million for the first six months of 2002, compared to net cash used in investing activities of $799.2 million for the same period of 2001. The $1.3 billion increase in cash provided is primarily the result of net sales of fixed maturities in 2002 due to funding agreement withdrawals. In 2001, net purchases of fixed maturities resulted from the investment of net deposits from funding agreements. Net cash used in financing activities was $603.1 million during the first six months of 2002, compared to net cash provided by financing activities of $723.1 million for the same period of 2001. The decrease in 2002 is primarily due to net funding agreement withdrawals, including trust instruments supported by funding obligations, of $595.2 million as compared to net deposits of $706.4 million in 2001. Management believes the holding company of AFC has the ability to meet its obligations including, but not limited to, interest on the Senior Debentures and Capital Securities, and dividends, when and if declared by the Board of Directors, on the common stock. Whether the Company will pay dividends in the future depends upon the earnings and financial condition of AFC. Based on current trends, the Company expects to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements. The Company's insurance subsidiaries maintain a high degree of liquidity within the investment portfolio in fixed maturity investments, common stock and short-term investments. AFC has $150.0 million available under a committed syndicated credit agreement which expires on May 23, 2003. 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, 2002, no amounts were outstanding under this agreement. The Company had $74.4 million of commercial paper borrowings outstanding at June 30, 2002. These borrowings are used in connection with AMGRO's premium financing business, which is included in the Allmerica Asset Management segment, and for short-term funding requirements in the Allmerica Financial Services segment. The Company also funds the premium financing business through sales of receivables generated by this business. Contingencies The Company's insurance subsidiaries are routinely engaged in various legal proceedings arising in the normal course of business, including claims for extracontractual or punitive damages. Additional information on other litigation and claims may be found in Note 10 "Commitments and Contingencies - Litigation" to the consolidated financial statements. In the opinion of management, none of such contingencies are expected to have a material effect on the Company's consolidated financial position, although it is possible that the results of operations in a particular quarter or annual period could be materially affected by an unfavorable outcome. Recent Developments Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers meaningful information on specific insurance companies. Higher ratings generally indicate financial stability and a stronger ability to pay claims. Management believes that strong ratings are important factors in marketing the Company's products to its agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Insurance company ratings are assigned to an insurer based upon factors relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. During August 2002, Standard & Poor's rating service revised downward its financial strength rating of the property & casualty companies from "AA-" (Very Strong) to "A+" (Strong) with a negative outlook as well as the life insurance companies from "AA-" (Very Strong) to "A" (Strong) with a stable outlook. In addition, Standard & Poor's downgraded its senior debt rating for the Company from "A-" (Strong) to "BBB" (Good) with a stable outlook. 34 During July 2002, Moody's rating service revised downward its financial strength rating of Hanover Insurance Company from "A1" (Good) to "A2" (Good) with a negative outlook as well as the life insurance companies from "A1" (Good) to "A3" (Good) with a stable outlook. In addition, Moody's downgraded its senior debt rating for the Company from "A3" (Good) to "Baa2" (Adequate) and downgraded its short-term insurance financial strength rating of FAFLIC from "P1" (Superior) to "P2" (Strong) with a stable outlook. Additionally, during July 2002, A.M. Best rating service revised downward its financial strength ratings of the life insurance companies from "A" (Excellent) to "A-" (Excellent). In addition, AFC's senior debt ratings were downgraded from "a-" to "bbb+" with a negative outlook; the capital securities rating was downgraded from "bbb+" to "bbb" with a negative outlook; and the commercial paper rating was lowered from AMB-1 to AMB-2. A.M. Best maintained its financial strength ratings for the property and casualty companies, but assigned a negative outlook. Rating downgrades from current levels may adversely affect the Company's product sales. In addition, certain rating downgrades from current levels could precipitate the payment of funds held by the Company related to its aggregate excess of loss reinsurance treaty. Rating downgrades from current levels may adversely affect the cost and availability of any additional debt financing. The financial position and results of operations of the Allmerica Financial Services segment are highly dependent on equity market valuations. From its peak in March 2000 when the S&P 500 index was at 1,527.46 points, the market has declined 35.2% at June 30, 2002 to 989.82 points. Of this decrease, 13.7%, or 157.57 points, occurred during the second quarter of 2002 alone. As of August 13, 2002, the S&P 500 index was at 884.21 points, down 10.7% from June 30, 2002. As noted elsewhere in this Management's Discussion and Analysis, the decline in equity market valuations have resulted in, and continue to result in, among other things, increased GMDB expenses, lower fee income, higher DAC amortization and higher statutory capital reserve requirements. These declines, together with the increasing competitiveness in the variable product retirement market, may result in changes in the Allmerica Financial Services business segment or the Company, some of which could be material. 35 Other Considerations/Forward-Looking Statements The Company wishes to caution readers that the following important factors, among others, in some cases have affected and in the future could affect, the Company's actual results and could cause the Company's actual results for 2002 and beyond to differ materially from historical results and from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in Management's Discussion and Analysis, the words "believes", "anticipated", "expects" and similar expressions are intended to identify forward looking statements. The Company describes these factors and considerations in greater detail in "Important Factors Regarding Forward-Looking Statements" filed as Exhibit 99-2 to the Company's Annual Report on Form 10-K for the period ended December 31, 2001. Such factors could also cause future results to differ from historical results. Factors that may cause actual results to differ materially from historical results and from those contemplated or projected, forecast, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) lower appreciation on or decline in value of the Company's managed investments or the investment markets in general, resulting in reduced variable product sales, assets and related variable product, management and brokerage fees, lapses and increased surrenders, increased DAC amortization, as well as increased cost of guaranteed minimum death benefits/decreased account balances supporting our guaranteed benefits products; (ii) adverse catastrophe experience and severe weather; (iii) adverse loss development for events the Company has insured in either the current or in prior years or adverse trends in mortality and morbidity; (iv) 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; (v) adverse state and federal legislation or regulation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, limitations on the ability to manage care and utilization, requirements to write certain classes of business and recent and future changes affecting the tax treatment of insurance and annuity products, as well as continued compliance with state and federal regulations; (vi) changes in interest rates causing a reduction of investment income or in the market value of interest rate sensitive investments; (vii) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (viii) difficulties in recruiting new or retaining existing career agents, wholesalers, broker-dealers and partnership relations to support the sale of variable products; (ix) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (x) loss or retirement of key executives; (xi) increases in costs, particularly those occurring after the time our products are priced and including construction, automobile, and medical and rehabilitation costs; (xii) changes in the Company's liquidity due to changes in asset and liability matching; (xiii) restrictions on insurance underwriting; (xiv) adverse changes in the ratings obtained from independent rating agencies, such as Fitch, Moody's, Standard and Poor's and A.M. Best, (xv) possible claims relating to sales practices for insurance products; (xvi) failure of a reinsurer of the Company's policies to pay its liabilities under reinsurance contracts or adverse effects on the cost and availability of reinsurance resulting from the September 11 terrorist attack; (xvii) earlier than expected withdrawals from the Company's general account annuities, GICs (including funding agreements), and other insurance products; (xviii) changes in the mix of assets comprising the Company's investment portfolio and the fluctuation of the market value of such assets; (xix) losses resulting from the Company's participation in certain reinsurance pools; (xx) losses due to foreign currency fluctuations; (xxi) defaults in debt securities held by the Company, and (xxii) higher employee benefit costs due to changes in market values of plan assets, interest rates and employee compensation levels. In addition, with respect to the Allmerica Financial Services segment, the Company has provided forward looking information relating to the impact of equity market values on certain financial metrics, including among other things, GMDB expenses, net amount at risk, DAC amortization and Actuarial Guideline 34 reserves for statutory accounting purposes. This information is an estimation only and is based upon matters as in effect on June 30, 2002. Actual amounts of these certain financial metrics would vary based upon numerous other factors, including but not limited to, variable product account values, allocation between separate and general accounts, mortality experience, surrender and withdrawal patterns, level of sales of variable insurance products, investment experience and performance of equity and financial markets throughout the period, as well as from period to period. 36 PART I - FINANCIAL INFORMATION ITEM 3 QUANTITATIVE AND QUALITATIVE DICLOSURES ABOUT MARKET RISK The Company's market risks, and the way the Company manages them, are summarized in management's discussion and analysis of financial condition and results of operations as of December 31, 2001, included in the Company's Form 10-K for the year ended December 31, 2001. There have been no material changes in the first six months of 2002 to such risks or the management of such risks. 37 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 14, 2002. All four 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 Samuel J.Gerson 41,984,070 420,255 Wendell J. Knox 41,558,561 845,764 Robert J. Murray 42,012,777 391,548 John R. Towers 41,559,284 845,041 The other directors whose terms were continued after the Annual Meeting are Mr. Michael P. Angelini, Mr. E. Gordon Gee, Ms. Gail L. Harrison, Mr. Robert P. Henderson, Mr. M Howard Jacobson, Mr. Terrence Murray, Mr. John F. O'Brien and Mr. Herbert M. Varnum. Shareholders ratified the appointment of PricewaterhouseCoopers LLP as the Independent Public Accountants of the Company for 2002: for 40,524,370; against 1,761,435; abstain 118,520. 38 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 27, 2002 between the Registrant and JPMorgan Chase Bank EX - 10.41 Stop/Loss Reinsurance Agreement effective September 30, 2001, between Allmerica Financial Life Insurance and Annuity Company and Lincoln National Reassurance Company EX - 10.42 Amended and Restated Put Option Agreement dated September 30, 2001 between Allmerica Financial Corporation and Old Fort Insurance Company, Ltd. EX - 99.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 EX - 99.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K None 39 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, 2002 /s/ John F. O'Brien John F. O'Brien President and Chief Executive Officer Dated August 14, 2002 /s/ Edward J. Parry III Edward J. Parry III Vice President, Chief Financial Officer and Principal Accounting Officer 40 EXHIBIT INDEX Exhibit Number Exhibit 10.38 Amendment to the Credit Agreement dated as of May 27, 2002 between the Registrant and JPMorgan Chase Bank 10.41 Stop/Loss Reinsurance Agreement effective September 30, 2001, between Allmerica Financial Life Insurance and Annuity Company and Lincoln National Reassurance Company 10.42 Amended and Restated Put Option Agreement dated September 30, 2001 between Allmerica Financial Corporation and Old Fort Insurance Company, Ltd. 99.1 Certification of the Chief Executive Officer prusuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 41 EX-10 3 loan-agrmt.txt AMENDMENT TO THE JPMORGAN CHASE CREDIT AGREEMENT Exhibit 10.38 AMENDMENT NO. 3 dated as of May 24, 2002 (this "Amendment No. 3") 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 JPMorgan Chase Bank ("JPMCB") (formerly known as 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, Amendment No. 1 dated as of May 26, 2000 and Amendment No. 2 dated as of May 25, 2001 and as in effect on the date hereof, the "Credit Agreement") and 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. (a) 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. (b) References in the Credit Agreement to "Chase" shall be deemed to be references to "JPMCB". 2.02. Definitions. (a) The first sentence of 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, 0.30% 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 - --------------- ---------------------- -------------------------- greater than or equal 1 to: A2 / A 0.40% - --------------- ---------------------- -------------------------- 2 A3 / A- 0.50% - --------------- ---------------------- -------------------------- less than or equal 3 to: Baa1 / BBB+ 0.625% - --------------- ---------------------- -------------------------- (b) The definition of "Chase" in Section 1.01 of the Credit Agreement shall be deleted in its entirety. (c) 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 23, 2003, as such date may be extended pursuant to Section 2.09 hereof. (d) The following new definition shall be added to Section 1.01 of the Credit Agreement in its proper alphabetical location: "JPMCB" shall mean JPMorgan Chase Bank. 2.03. Facility Fee. The last sentence of Section 2.04(a) of the Credit Agreement shall be amended in its entirety to read as follows: "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 and no Loans are otherwise outstanding thereafter, the earlier of the date the Commitments are terminated and the Commitment Termination Date or (ii) if such conversion is effected or any Loans are otherwise outstanding after the earlier of the date the Commitments are terminated and the Commitment Termination Date, the maturity date of the Term Loans as specified in Section 2.10 hereof (in the case of Term Loans) or the date such Loans are paid in full (in the case of any other Loans)." 2.04. Conversion to Term Loans. Section 2.10 of the Credit Agreement shall be amended by inserting the words "(other than in the last sentence of Section 7.02(a) hereof)" immediately after the word "hereof" in clause (ii) of the first proviso thereof. 2.05. Financial Condition. (a) Section 7.02(a) of the Credit Agreement shall be amended by deleting the year "2000" in the first and last sentences thereof and replacing it with the year "2001" in each case. 3 (b) Section 7.02(b) of the Credit Agreement shall be amended by deleting the year "2000" in the third and sixth lines thereof and replacing it with the year "2001" in each case. 2.06. Subsidiaries, Etc. Section 7.13 of the Credit Agreement shall be amended by deleting the words "Schedule II" in the first, sixth and eighth lines thereof and replacing them with the words "Schedule III" in each case. 2.07. Use of Proceeds. Section 8.09 of the Credit Agreement shall be amended by deleting the words "Schedule III" in the sixth line thereof and replacing them with the words "Schedule IV". 2.08. Assignments and Participations. Section 11.06(b)(i) of the Credit Agreement shall be amended in its entirety to read as follows: "(i) no such consent by the Administrative Agent shall be required in the case of any assignment to another Lender and no such consent by the Company shall be required in the case of any assignment to another Lender or an affiliate of a Lender;" 2.09. Schedules. Schedules I, II, III and IV to the Credit Agreement shall be amended by being deleted and replaced in their entirety by Schedules I, II, III and IV, respectively, to this Amendment No. 3, and references in the Credit Agreement to "Schedule I hereto", "Schedule II hereto", "Schedule III hereto" or "Schedule IV hereto" or words of similar import (including indirect references to any Schedule to the Credit Agreement) shall be deemed to be references to the applicable Schedule to this Amendment No. 3. 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. 3, (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. 3. This Amendment No. 3, duly executed and delivered by the Company, each of the Lenders 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. 3 and all other fees and amounts due and payable to the Administrative Agent or JPMCB on or prior to the effectiveness of this Amendment No. 3. 4 (c) Other Documents. Such other documents as the Administrative Agent, any Lender or special New York counsel to JPMCB 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. 3 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. 3 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 JPMCB. This Amendment No. 3 shall be governed by, and construed in accordance with, the law of the State of New York. 5 IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 3 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 6 LENDERS JPMORGAN CHASE BANK By /s/Marybeth Mullen Name: Marybeth Mullen Title: Vice President DEUTSCHE BANK AG, NEW YORK BRANCH By /s/Ruth Leung Name: Ruth Leung Title: Director By /s/John S. McGill Name: John S. McGill Title: Director BANK ONE, NA (MAIN OFFICE CHICAGO) By /s/Thomas A. Kiepura Name: Thomas A. Kiepura Title: Director FLEET NATIONAL BANK By /s/Anita M. Presmarita Name: Anita M. Presmarita Title: Vice President 7 THE BANK OF NEW YORK By /s/David Trick Name: David Trick Title: Vice President STATE STREET BANK AND TRUST COMPANY By /s/Lise Anne Boutiette Name: Lise Anne Boutiette Title: Vice President SCHEDULE I Commitments [See Section 2.01] JPMorgan Chase Bank $30,000,000 BANK ONE, NA (Main Office Chicago) $30,000,000 Deutsche Bank AG, New York and/or Cayman Islands Branch $25,000,000 Fleet National Bank $25,000,000 State Street Bank and Trust Company $25,000,000 The Bank of New York $15,000,000 ----------- $150,000,000 SCHEDULE II Indebtedness [See Section 8.06(b)]
(in millions) Amount Outstanding at Borrower Description Maturity Mar 31, 2002 - -------- ----------- -------- ------------ AFC 7 5/8% Senior Debentures Due 2025 $199.5 AFC Commercial Paper Program Annual $132.2 AFC Guarantee of the liquidation amount of the 8.207% of AFC Capital Trust
Synthetic Preferred and Other Swaps Maturity Notional Amt. - ----------------------------------- -------- ------------- Various Vanilla Swaps on floating rate GICs Various $582.5 Foreign Currency Swaps - ---------------------- Great British Pounds (hedge Inco Limited bond) 07/15/2006 $13.5 Euro GIC Swaps - -------------- Swap to hedge foreign currency exposure on Euro GICs Various $1,336.5 Futures Contracts - ----------------- Hedge GIC's - 2 yr. Treasury Notes 6/15/2002 $87.6 Hedge variable deferred compensation - S & P Index Futures 6/15/2002 $3.8
SCHEDULE III Subsidiaries [See Section 7.13] Direct and Indirect Subsidiaries of Allmerica Financial Corporation I. Allmerica Financial Corporation (Delaware) A. Allmerica Asset Management, Inc. (Massachusetts) a. Allmerica Financial Insurance Brokers, Inc. (Massachusetts) b. Citizens Insurance Company of Illinois (Illinois) c. The Hanover Insurance Company (New Hampshire) 1. Allmerica Financial Benefit Insurance Company (Michigan) 2. Allmerica Plus Insurance Agency, Inc. (Massachusetts) 3. The Hanover American Insurance Company (New Hampshire) 4. Hanover Texas Insurance Management Company, Inc. (Texas) 5. Citizens Insurance Company of Ohio (Ohio) 6. Citizens Insurance Company of America (Michigan) a. Sterling Risk Management Services, Inc. (Delaware) i. Citizens Management Inc. (Michigan) 7. Citizens Insurance Company of the Midwest (Indiana) 8. AMGRO, Inc. (Massachusetts) a. Lloyds Credit Corporation (Massachusetts) b. AMGRO Receivables Corporation (Delaware) 9. Massachusetts Bay Insurance Company (New Hampshire) 10. Allmerica Financial Alliance Insurance Company (New Hampshire) d. Allmerica Benefits, Inc. (Florida) e. Allmerica Asset Management, Limited (Bermuda) B. Financial Profiles, Inc. (California) C. Allmerica Funding Corp. (Massachusetts) D. First Allmerica Financial Life Insurance Company (Massachusetts) a. Allmerica Trust Company, N.A. (Federally Chartered) b. Advantage Insurance Network, Inc. (Delaware) c. Allmerica Financial Life Insurance and Annuity Company (Delaware) 1. Allmerica Investments, Inc. (Massachusetts) 2. Allmerica Investment Management Company, Inc. (Massachusetts) 3. Allmerica Financial Investment Management Services, Inc. (Massachusetts) 4. Allmerica Financial Services Insurance Agency, Inc. (Massachusetts) 5. Allmerica Investments Insurance Agency, Inc. of Alabama (Alabama) 6. Allmerica Investments Insurance Agency of Florida, Inc. (Florida) 7. Allmerica Investment Insurance Agency, Inc. of Georgia (Georgia) 8. Allmerica Investment Insurance Agency, Inc. of Kentucky (Kentucky) 9. Allmerica Investments Insurance Agency, Inc. of Mississippi (Mississippi) E. AFC Capital Trust I (Delaware) F. VeraVest, Inc. (Massachusetts) G. First Sterling Limited (Bermuda) a. First Sterling Reinsurance Company Limited (Bermuda) SCHEDULE IV Investment Company Act [See Section 7.10] None. EX-10 4 stop-loss.txt STOP/LOSS REINSURANCE AGREEMENT Exhibit 10.41 STOP LOSS REINSURANCE AGREEMENT Effective as of September 30, 2001, between ALLMERICA FINANCIAL LIFE INSURANCE AND ANNUITY COMPANY of Dover, Delaware, referred to in this Agreement as "Allmerica," and LINCOLN NATIONAL REASSURANCE COMPANY of Fort Wayne, Indiana, referred to in this Agreement as "Lincoln." TABLE OF CONTENTS Reinsurance Coverage 1 Exclusions 1 Reinsurance Premiums 1 Reports 2 Reimbursement of Losses 2 Acknowledgments 2 Experience Refund 3 Covenants 3 Audit 4 Insolvency 4 Offset 5 Errors 5 Arbitration 5 Deferred Acquisition Cost Tax Election 6 Entire Agreement 6 Parties to the Agreement 6 Effective Date 7 Definitions 7 Execution 8 COVERAGE SCHEDULE 9 REPORT SCHEDULE 11 EXPERIENCE REFUND SCHEDULE 12 ARBITRATION SCHEDULE 13 Reinsurance Coverage Lincoln shall reimburse Allmerica for Reinsured Claims. (Capitalized words are defined in either the "Definitions" article or the Schedules.) Exclusions A. The following items shall be excluded from the calculation of Net Retained Claims: (1) Claims for any benefit provided pursuant to the Policies other than claims for Covered Benefits. (2) Claims in excess of the Maximum Reimbursement Amount per life. (3) Claims resulting from Policies acquired by Allmerica after the Effective Date through merger, consolidation, purchase, assumption reinsurance or otherwise, unless Lincoln expressly agrees by means of an amendment to this Agreement that such Policies shall be reinsured. (4) Any loss adjustment or unusual expenses incurred by Allmerica in connection with the Policies. (5) Any punitive, exemplary, consequential or other extracontractual damages incurred by Allmerica in connection with the Policies. B. Notwithstanding any other provision, coverage of excess of loss reinsurance underwritten by Allmerica that covers any other excess of loss reinsurance ("XL on XL Reinsurance") is excluded from this Agreement. Losses and/or liabilities arising out of any XL on XL Reinsurance are specifically excluded from the coverage of this Agreement. The terms of this exclusion controls and supersedes any provisions of the Agreement which may be in conflict with this exclusion. Reinsurance Premiums As a condition precedent to Lincoln's obligation under this Agreement, Allmerica shall pay Lincoln a reinsurance premium of one million dollars ($1,000,000) each calendar quarter within thirty (30) days following the end of each calendar quarter. 1 Reports A. Allmerica shall notify Lincoln whenever it appears likely that Allmerica's aggregate claims under the Policies during the Coverage Period and Renewability will exceed the Attachment Point. B. Within thirty (30) days following the end of each calendar quarter, Allmerica shall submit a report to Lincoln in substantial conformity with the Report Schedule. C. If the report indicates that there are any incurred but unreported claims, claims in the course of settlement or resisted claims still to be settled, Allmerica shall submit updated reports within twenty (20) days of the end of each calendar quarter thereafter until all such items have been finally settled. Reimbursement of Losses A. Lincoln shall accept Allmerica's good faith settlement of claims under the Policies. However, when requested, Allmerica shall provide Lincoln with copies of any documentation within Allmerica's possession with respect to specific claims under the Policies or with respect to items used to compute Net Retained Claims or the Attachment Point. B. If a report submitted by Allmerica indicates an amount due from Lincoln pursuant to this Agreement, Lincoln shall pay the amount due within thirty (30) days after receiving the report, except that if Lincoln reasonably concludes that it needs to audit the validity of a claim made hereunder, the date on which a claim payment is due from Lincoln shall be extended until after the completion of Lincoln's audit. Acknowledgments A. Allmerica acknowledges having provided Lincoln with certain information used by Lincoln in making its underwriting decision to provide reinsurance for the Coverage Period and Renewability. B. Allmerica affirms that all assumptions made in this underwriting material were based upon informed judgment and are consistent with sound actuarial principles. Further, Allmerica affirms that all facts contained in the underwriting material were correct, complete and accurate as of the date of the underwriting material. 2 C. Allmerica affirms that all assumptions made in preparing its Annual Statement were based upon informed judgment and are consistent with sound actuarial principles. D. Allmerica affirms that there has been no Material Change in Allmerica's financial condition and the expected experience of the Policies between the dates of the underwriting material and Annual Statement and the beginning of the Coverage Period and Renewability. E. Allmerica acknowledges that Lincoln has relied on the underwriting material and Annual Statement when offering to provide reinsurance for the Coverage Period and Renewability. Experience Refund Lincoln shall pay Allmerica an Experience Refund if earned in accordance with the Experience Refund Schedule. Covenants A. Except as set forth in paragraph D below, during the Coverage Period and Renewability Allmerica shall not permit a Material Change to (1) its normal underwriting practices and procedures when issuing Policies; (2) its normal practices and procedures of investigating and administering claims; and (3) its method of determining any value used to compute Net Retained Claims when preparing its Annual Statement. B. Except as set forth in paragraph D, Allmerica shall not permit a Material Change in any other reinsurance, proportional or nonproportional, which it maintains on the Policies as of the beginning of the Coverage Period and Renewability, including any Material Change to its limit of retention on the Policies. C. Except as set forth in paragraph D, Allmerica shall not assign, sell, assumption reinsure or otherwise transfer any Policy if such transfer would effect a Material Change to Net Retained Claims. D. Allmerica shall promptly notify Lincoln in writing of its intent to take any action which, if performed, would breach one or more of the covenants contained in this article. If Lincoln determines that such action would not adversely affect its economic interests under this Agreement, it shall 3 consent to the action by Allmerica. If Lincoln becomes aware that any covenant contained in this article has been breached, it may notify Allmerica in writing that this Agreement is terminated from the beginning of the Coverage Period and Renewability. Audit Lincoln may audit, at any reasonable time and at its own expense, all records and procedures relating to reinsurance under this Agreement. Allmerica shall cooperate in the audit, including providing at its own expense at the office of Lincoln any information requested by Lincoln in advance of the audit. Insolvency A. In the event of the insolvency of Allmerica and the appointment of a conservator, liquidator or statutory successor of Allmerica, reinsurance shall be payable to such conservator, liquidator or statutory successor on the basis of claims allowed against Allmerica by any court of competent jurisdiction or by the conservator, liquidator or statutory successor of Allmerica without diminution because of the insolvency of Allmerica or because such conservator, liquidator or statutory successor has failed to pay all or a portion of any claims. B. In the event of the insolvency of Allmerica, the liquidator, receiver or other statutory successor of Allmerica agrees to give Lincoln written notice of the pendency of a claim on a Policy within a reasonable time after such claim is filed in the insolvency proceeding. During the pendency of such claim, Lincoln may investigate the claim and interpose in the proceeding where such claim is to be adjudicated in the name of Allmerica (its conservator, liquidator or statutory successor), but at its own expense, any defense or defenses which Lincoln may deem available to Allmerica or its conservator, liquidator or statutory successor. C. A proportionate share of the expense thus incurred by Lincoln shall be charged, subject to court approval, against Allmerica as part of the expense of liquidation. 4 Offset Any debts or credits, matured or unmatured, liquidated or unliquidated, regardless of when they arose or where incurred, in favor of or against either Allmerica or Lincoln with respect to this Agreement or any other reinsurance agreement between the parties, shall be offset and only the balance allowed or paid. If either Allmerica or Lincoln is under formal delinquency proceedings, this right of offset shall be subject to the laws of the state exercising primary jurisdiction over such delinquency proceedings. Errors Any Error made by either Allmerica or Lincoln in the administration of reinsurance under this Agreement shall be corrected by restoring both Allmerica and Lincoln to the positions they would have occupied had no such Error occurred. Arbitration A. If Allmerica and Lincoln cannot mutually resolve a dispute regarding the interpretation or operation of this Agreement, the dispute shall be decided through arbitration as set forth in the Arbitration Schedule. The arbitrators shall base their decision on the terms and conditions of this Agreement plus, as necessary, on the customs and practices of the insurance and reinsurance industry rather than solely on a strict interpretation of the applicable law. There shall be no appeal from their decision, except that either party may petition a court having jurisdiction over the parties and the subject matter to reduce the arbitrator's decision to judgment. B. The parties intend this article to be enforceable in accordance with the Federal Arbitration Act (9 U.S.C., Section 1) including any amendments to that Act which are subsequently adopted. In the event that either party refuses to submit to arbitration as required by paragraph A, the other party may request a United States Federal District Court to compel arbitration in accordance with the Federal Arbitration Act. Both parties consent to the jurisdiction of such court to enforce this article and to confirm and enforce the performance of any award of the arbitrators. 5 Deferred Acquisition Cost Tax Election A. Lincoln and Allmerica each acknowledge that it is subject to taxation under Subchapter "L" of the Internal Revenue Code of 1986 (the "Code"). B. With respect to this Agreement, Lincoln and Allmerica agree to the following pursuant to Section 1.848-2(g)(8) of the Income Tax Regulations issued December 1992, whereby (1) each party shall attach a schedule to its federal income tax return which identifies this Agreement for which the joint election under the Regulation has been made; (2) the party with net positive consideration, as defined in the Regulation promulgated under Code Section 848, for this Agreement for each taxable year, shall capitalize specified policy acquisition expenses with respect to this Agreement without regard to the general deductions limitation of Section 848(c)(1); (3) each party agrees to exchange information pertaining to the amount of net consideration under this Agreement each year to ensure consistency; and (4) this election shall be effective for the year that this Agreement was entered into and for all subsequent years that this Agreement remains in effect. Entire Agreement A. This Agreement represents the entire agreement between Allmerica and Lincoln and supersedes any prior oral or written agreements between the parties regarding its subject matter. B. No modification of this Agreement shall be effective unless set forth in a written amendment executed by both parties. C. A waiver of a right created by this Agreement shall constitute a waiver only with respect to the particular circumstance for which it is given and not a waiver of any future circumstance. Parties to the Agreement This is an Agreement for indemnity reinsurance solely between Allmerica and Lincoln. The acceptance of reinsurance under this Agreement shall not create any right or legal relation between Lincoln and any policyowner, insured or beneficiary under any Policy. 6 Effective Date The Effective Date of this Agreement is set forth in the Coverage Schedule. Definitions A. Annual Statement - the annual financial statement filed by Allmerica with the insurance regulatory body of its state, province or country of domicile computed in accordance with all applicable laws and regulations of such jurisdiction. B. Error - any isolated, inadvertent deviation from the terms of this Agreement resulting from the act or omission of an employee of either Allmerica or Lincoln whose principal function is administrative in nature. C. Material Change - a modification to a practice, procedure or condition which a prudent insurance executive would consider as likely to impact on experience under this Agreement. D. Net Retained Claims - claims for Covered Benefits incurred by Allmerica during the Treaty Year and retained by it at its own risk without benefit of reinsurance other than that provided pursuant to this Agreement. "Net Retained Claims" shall be computed in the same manner as that used to prepare Allmerica's Annual Statement and the underwriting material. They shall equal (1) paid claims incurred during the Treaty Year for Covered Benefits under the Policies; less (2) reinsurance proceeds deemed recoverable pursuant to other reinsurance agreements; less (3) amounts therein which exceed the Maximum Reimbursement Amount per Life. E. Reimbursement Percentage - the percentage specified in the Coverage Schedule used to compute the portion of Net Retained Claims in excess of the Attachment Point which are to be reimbursed by Lincoln. F. Reinsured Claims - the reimbursement percentage of Net Retained Claims incurred by Allmerica pursuant to the Policies during the Treaty Year which exceeds the Attachment Point, provided that Lincoln's reimbursement shall not exceed the Aggregate Maximum Reimbursement Amount. 7 Execution Allmerica and Lincoln, by their respective officers, executed this Agreement in duplicate on the dates shown below. As of the Effective Date, this Agreement consists of o this Stop Loss Reinsurance Agreement numbered 5; o a Coverage Schedule; o a Report Schedule; o an Experience Refund Schedule; and o an Arbitration Schedule. ALLMERICA FINANCIAL LIFE INSURANCE AND ANNUITY COMPANY Signed at ______________________ By______________________________ Title___________________________ Date____________________________ By______________________________ Title___________________________ Date____________________________ LINCOLN NATIONAL REASSURANCE COMPANY Signed at Fort Wayne, Indiana By______________________________ Vice President Date____________________________ By______________________________ Assistant Secretary Date____________________________ 8 COVERAGE SCHEDULE (Effective as of September 30, 2001) to Agreement Number 5 The following terms are to be read in conjunction with the Agreement: Effective Date: September 30, 2001 Coverage Period and Renewability: 12:01 a.m. on October 1, 2001, and ending on September 30, 2004, subject to the termination clause below. However, at the end of each calendar quarter the Coverage Period shall be extended by three (3) months, unless thirty (30) days advance written notice is given by one party to another of non-renewal. Treaty Year: Starts on the Effective Date and lasts one (1) calendar year. Treaty Year is renewed by one (1) calendar year at the end of each Treaty Year while the Coverage Period and Renewability is in effect. Termination: (1) Lincoln shall have the right to terminate this Agreement in the event of change in control of Allmerica. (2) Allmerica shall have the right to extraordinary termination of this Agreement at the end of any calendar quarter. Allmerica must give thirty (30) days advance written notice of extraordinary termination to Lincoln. In the event of extraordinary termination by Allmerica, payments for the calendar quarter, as outlined in the Report Schedule, due from Lincoln shall be made plus payment by Allmerica to Lincoln of the absolute value of the Experience Refund Loss Carryforward plus payment by Allmerica to Lincoln of the extraordinary termination fee. 9 The extraordinary termination fee shall be equal to the value in the following extraordinary termination schedule: Allmerica Extraordinary Terminates in Year Termination Fee ------------------ --------------- 2001 $300,000 2002 300,000 2003 200,000 2004+ 100,000 The extraordinary termination fee shall be waived if Allmerica is not given reserve credit by regulators in its domiciliary state. Policies: All variable annuities in force at the effective date. At the end of each calendar quarter, if there is not a notice of non-renewal, the date for allowing in force Policies is extended by three (3) months. Covered Benefits: Guaranteed Minimum Death Benefit, defined as excess of death benefit over account value at time of death. Aggregate Maximum Reimbursement Amount: Forty million dollars ($40,000,000) per Treaty Year. Maximum Reimbursement Amount per Life: One million dollars ($1,000,000). Attachment Point: Forty million dollars ($40,000,000) per Treaty Year. Reimbursement Percentage: One hundred percent (100%). 10 REPORT SCHEDULE (Effective as of September 30, 2001) to Agreement Number 5 Submitted By___________________ As of_________________ to Lincoln National Reassurance Company For the Coverage Period and Renewability from ______ to ______ 1. Total incurred claims for Covered Benefits 2. Reserve for claims in course of settlement, incurred but unreported claims, resisted claims, etc. 3. Incurred and paid claims for Covered Benefits [1 - 2] 4. Reinsurance recoverable from other reinsurance 5. Claims in excess of the Maximum Reimbursement Amount per Life 6. Net Retained Claims [3 - 4 - 5] 7. Attachment Point 8. Reimbursement Percentage 9. Excess claims (greater of zero dollars ($0) and [(6 - 7) * 8]) 10. Aggregate Maximum Reimbursement Amount 11. Total Reinsured Claims for Treaty Year at end of calendar quarter (lesser of 9 and 10) 12. Total Reinsured Claims for Treaty Year at beginning of calendar quarter 13. Reinsured Claims due from Lincoln for calendar quarter [11 - 12] 14. Reinsurance premium 15. Risk Premium Charge 16. Cumulative Experience Refund at beginning of quarter 17. Experience Refund Loss Carryforward at beginning of quarter 18. Cumulative Experience Refund at end of quarter (greater of zero dollars ($0) and [16 + 14 - 13 - 15 - 17]) 19. Experience Refund Loss Carryforward at end of quarter (greater of zero dollars ($0) and [- (16 + 14 - 13 - 15 - 17)]) 20. Experience Refund to Allmerica (greater of zero dollars ($0) and [18 - 16]) 21. Net payment due Lincoln (from Lincoln if negative) [14 - 13 - 18 + 16] 11 EXPERIENCE REFUND SCHEDULE (Effective as of September 30, 2001) to Agreement Number 5 A. Experience Refund 1. The Experience Refund shall be computed with respect to a Treaty Year and shall be calculated on an accrued basis each calendar quarter. The Cumulative Experience Refund shall be equal to the greater of zero dollars ($0) and the following formula amount: (a) Cumulative Experience Refund at end of prior calendar quarter; plus (b) Reinsurance premiums paid during calendar quarter; less (b) Reinsured Claims for calendar quarter; less (c) Risk Premium Charge for calendar quarter. 2. The Experience Refund due Allmerica from Lincoln shall equal the greater of zero dollars ($0) and the Cumulative Experience Refund at the end of the current calendar quarter less the Cumulative Experience Refund at the end of the prior calendar quarter. 3. If the formula amount for the Cumulative Experience Refund is negative, a loss carryforward shall be created. The Experience Refund Loss Carryforward shall equal the absolute value of such amount. The Experience Refund Loss Carryforward shall be deducted in the calculation of the Cumulative Experience Refund at the end of the next calendar quarter. B. Risk Premium Charge For each calendar quarter, the Risk Premium Charge is thirty-seven thousand five hundred dollars ($37,500) plus .25 percent (0.25%) of reserve credit taken plus reimbursement of cost, paid by Lincoln to its retrocessionaire, of letters of credit used to support reserve credit taken by Lincoln. 12 ARBITRATION SCHEDULE (Effective as of September 30, 2001) to Agreement Number 5 Any controversy or claim arising out of or relating to this Agreement shall be settled by arbitration. There must be three (3) arbitrators who must be impartial and must be present or former officers of life insurance or life reinsurance companies other than the parties or their affiliates. Each of the parties shall appoint one (1) of the arbitrators and these two (2) arbitrators shall select the third (the "Umpire"). In the event that either party should fail to choose an arbitrator within thirty (30) days following a written request by the other party to do so, the requesting party may choose two (2) arbitrators who shall in turn choose an Umpire before entering upon arbitration. If the two (2) arbitrators fail to agree upon the selection of an Umpire within thirty (30) days following their appointment, either party may ask ARIAS-US to appoint the Umpire. However, if ARIAS-US is unable to appoint an Umpire who is impartial and who is or was an officer of a life insurance or life reinsurance company other than the parties or their affiliates, then either party may ask a court to appoint the Umpire pursuant to the Uniform Arbitration Act or any similar statute empowering the court to appoint an arbitrator, in which case the requirement that the Umpire be a present or former officer of a life insurance or life reinsurance company shall be waived. The arbitrators shall decide all matters by majority vote. They shall establish the procedural rules for the arbitration and allocate among the parties the expenses of the arbitration. They shall interpret this Agreement as an honorable engagement and are not bound by the strict formalities of law. They are not empowered to assess punitive damages. The arbitration panel shall determine all arbitration schedules and procedural rules. Organizational and other meetings shall be held in Worcester, Massachusetts, unless the panel shall select another location. The award agreed by the arbitrators will be final, and judgement may be entered upon it in any court having jurisdiction. 13 EX-10 5 put-agrmt.txt AMENDED AND RESTATED PUT OPTION AGREEMENT Exhibit 10.42 AMENDED AND RESTATED PUT OPTION AGREEMENT Amended and Restated Put Option Agreement ("Agreement") effective as of September 30, 2001, between Old Fort Insurance Company, Ltd., a Bermuda company ("Old Fort") and Allmerica Financial Corporation, a Delaware corporation ("AFC"). WHEREAS, Old Fort and AFC wish to modify the terms of the Put Option Agreement between Old Fort and AFC dated as of September 30, 2001, as now in effect (the "Original Agreement"); WHEREAS, Old Fort is licensed to engage in insurance and reinsurance business by, among other things, establishing separate accounts for certain insurance or reinsurance contracts entered into, and all collateral agreements, pursuant to Old Fort Insurance Company, Ltd. (Separate Accounts) Act, 1999 ("Act"); and WHEREAS, pursuant to the Act, Old Fort has established a separate account ("Separate Account") (as that term is defined in the Act) for the transfer or credit of assets, reserves and other property relating to the Old Fort Retrocession Agreement (recited below) to the Separate Account with the effect that the said assets, reserves and other property should be legally segregated from the general assets of Old Fort and the assets of any other participants to Separate Accounts established in Old Fort. WHEREAS, pursuant to the reinsurance agreement dated as of September 30, 2001 ("Reinsurance Agreement") between Lincoln National Reassurance Company ("LNRAC"), an affiliate of Old Fort, and Allmerica Financial Life Insurance and Annuity Company ("Allmerica"), an affiliate of AFC, LNRAC has agreed to reinsure certain of the liability of Allmerica on policies of insurance as more fully described in the Reinsurance Agreement; and WHEREAS, pursuant to the retrocession agreement dated as of September 30, 2001 between LNRAC and Lincoln National Reinsurance Company Limited ("Lincoln"), an affiliate of Old Fort (the "Lincoln Retrocession Agreement"), LNRAC ceded the business in the Reinsurance Agreement to Lincoln; and WHEREAS, pursuant to the retrocession agreement dated as of September 30, 2001 between Lincoln and Old Fort (the "Old Fort Retrocession Agreement"), Lincoln ceded the business in the Lincoln Retrocession Agreement to Old Fort; and WHEREAS, in consideration of the foregoing and other good and valuable consideration, AFC agrees that it will from time to time purchase non-voting Preferred Shares - Class A, of par value U.S. $1.00 per share, the attributes of which are set forth in Exhibit A, issued by Old Fort on behalf of the Separate Account ("Preferred Shares - Class A") in accordance with the Resolutions to be adopted by Old Fort's Board of Directors on November 6, 2001, and upon the terms and conditions set forth in this Agreement, and AFC is willing to enter into this Agreement to purchase the Preferred Shares - Class A upon such terms and conditions. NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree to amend and restate the Original Agreement in its entirety as follows: ARTICLE 1 DEFINITIONS 1.1 Settlement Period: any calendar quarter during which the absolute value of the Experience Refund Loss Carry Forward, as defined in the Reinsurance Agreement, plus the total payments previously made by Old Fort for redemption of Preferred Shares - Class A, less the total of all payments previously made by AFC for Preferred Shares - Class A results in a positive number. 1.2 Settlement Amount: for any Settlement Period, equals the absolute value of the Experience Refund Loss Carry Forward plus the total payments previously made by Old Fort for redemption of Preferred Shares - Class A, less the total of all payments previously made by AFC for Preferred Shares - Class A. ARTICLE 2 PREFERRED SHARES 2.1 Purchase of Preferred Shares - Class A (a) For each Settlement Period, Old Fort shall have the right to sell, and AFC shall be obligated to purchase, Preferred Shares - Class A in accordance with the terms of this Agreement. (b) AFC hereby covenants and agrees that it will, subject to Section 2.1(e), subscribe for and purchase one Preferred Share - Class A within 10 days of receipt from Old Fort of a Notice of Settlement in the form of Exhibit B hereto, and Old Fort covenants and agrees that it will sell the Preferred Share - Class A to AFC for the purchase price calculated in the manner set forth in Section 2.1(d). AFC shall subscribe for the Preferred Shares - Class A by executing the Subscription Agreement attached hereto as Exhibit C. (c) Subject to Section 2.1(b), the closing of each purchase and sale of Preferred Shares - Class A will take place at such place and on such date as the parties may agree (the "Closing Date"). AFC will pay the purchase price to Old Fort by wire transfer of immediately available funds in United States Dollars on the Closing Date. (d) The purchase price for the Preferred Shares - Class A for any Settlement Period shall be an amount equal to the Settlement Amount for that Settlement Period. The total amount paid by AFC to purchase Preferred Shares - Class A for any one Treaty Year, as defined in the Reinsurance Agreement, shall not exceed U.S. $40,000,000. (e) The purchase of any Preferred Share - Class A by AFC is subject to the permission of the Bermuda Monetary Authority (Foreign Exchange Control). 2.2 Redemption. (a) Within ten (10) days following the date (the "Redemption Date") upon which AFC shall deliver to Old Fort a written request for redemption of all (but not less than all) of the Preferred Shares - Class A then held by AFC (which request shall be accompanied by share certificate(s) representing all such shares, duly endorsed for cancellation), Old Fort shall redeem all shares of Preferred Shares - Class A then held by AFC for a cash payment to AFC (made by wire transfer of immediately available funds in United States dollars) in an amount equal to the Redemption Amount (as hereinafter defined). The Redemption Amount shall be an amount equal to the greater of (i) zero (0) and (ii) (A) the cumulative aggregate total of all payments previously made by AFC in respect of the acquisition thereby of Preferred Shares - Class A pursuant to Article 2 hereof, reduced by (B) the cumulative aggregate total of all payments previously made by Old Fort for redemption of Preferred Shares - Class A pursuant to this Agreement reduced by (C) the absolute value of the Experience Refund Loss Carryforward plus (D) sixty-five percent (65%) of investment income earned on Separate Account assets, other than any Risk Premium Charges, as defined in the "Form of Retrocession Article" of the Old Fort Retrocession Agreement (hereinafter "Risk Premium Charges"), as shall have been maintained in the Separate Account, each determined as of a date as near as practicable to the Redemption Date. The foregoing shall be without prejudice to AFC's obligation to acquire additional Preferred Shares following any Redemption Date pursuant to Section 2.1 hereof. (b) Upon termination of this Agreement in accordance with Section 4.3, all Preferred Shares - Class A then held by AFC shall be redeemed by Old Fort in exchange for a payment by wire transfer of immediately available funds in United States dollars of an amount equal to the cumulative aggregate total of all payments previously made by AFC for Preferred Shares - Class A, less the cumulative aggregate total of all payments previously made by Old Fort for redemption of Preferred Shares - Class A, less the absolute value of the Experience Refund Loss Carryforward prior to reduction in this value for termination payments plus any amounts paid by Allmerica to LNRAC upon termination of the Reinsurance Agreement for the outstanding Experience Refund Loss Carryforward Amount plus sixty-five percent (65%) of investment income earned on Separate Account assets, other than any Risk Premium Charges as shall have been maintained in the Separate Account (the "Termination Amount"). Payment shall be made by Old Fort under this Section 2.2 only upon delivery to Old Fort of the certificates representing the Preferred Shares - Class A being redeemed. 2.3 No Resale. AFC shall not sell, exchange, transfer, assign, pledge, mortgage or hypothecate (whether for or without consideration) the Preferred Shares - Class A. 2.4 No Recourse. The Preferred Shares - Class A issued hereunder are a security which constitutes a separate class of the capital of Old Fort having rights and entitlements and being subject to limitations and restrictions which pertain exclusively to the Separate Account and the assets from time to time credited thereto; and in particular the Preferred Shares - Class A shall have no recourse to the assets of any other Separate Account established by the Company, or to the general assets of Old Fort not credited to any Separate Account, save as may expressly be provided by this Agreement. 2.5 Liquidation. In the event of the liquidation of Old Fort prior to the redemption of any Preferred Shares - Class A, the assets credited to the Separate Account shall (for the avoidance of doubt) be held by the liquidator of Old Fort subject to the terms of this Agreement. 2.6 Other Payments Upon Termination. In the event of termination of this Agreement pursuant to Section 4.3, if all Preferred Shares - Class A have been redeemed pursuant to Section 2.2, then Old Fort shall pay to AFC by wire transfer of immediately available funds in United States dollars an amount equal to the cumulative aggregate total of all payments previously made by AFC for Preferred Shares - Class A, less the cumulative aggregate total of all payments previously made by Old Fort for redemption of Preferred Shares - Class A, less the absolute value of the Experience Refund Loss Carryforward prior to reduction in this value for termination payments plus the aggregate of any amounts paid by Allmerica to LNRAC upon termination of the Reinsurance Agreement for the outstanding Experience Refund Loss Carryforward Amount, plus sixty-five percent (65%) of investment income earned on Separate Account assets, other than any Risk Premium Charges as shall have been maintained in the Separate Account (the "Other Termination Amount"). 2.7 Separate Account Investments. Assets held by the Separate Account shall be held in cash and Permitted Cash Equivalents. Permitted Cash Equivalents for this purpose shall mean as selected by Old Fort (i) debt instruments that are United States governmental obligations, commercial paper rated at least P1 by Moody's Investors Services, Inc.("Moody's") (or an equivalent rating from Moody's or any successor rating organization) or at least A1 from Standard and Poor's Corporation ("S&P")") (or an equivalent rating from S&P or any successor rating organization); (ii) certificates of deposit or interest-bearing accounts of any bank or trust company whose debt or the debt of whose parent holding company is rated at least A by Moody's (or an equivalent rating from Moody's or any successor rating organization) or at least A by S&P (or an equivalent rating from S&P or any successor rating organization); (iii) money market mutual funds, substantially all of which assets consist of the items described in clauses (i) or (ii) above and (iv) other investments proposed by Old Fort and approved in advance by AFC or its designee. ARTICLE 3 REPRESENTATIONS AND WARRANTIES 3.1 Representations and Warranties by the Parties. Each party hereto represents and warrants as follows: (a) Due Formation or Incorporation; Authorization of Agreement. Such party is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and has the power and authority to own its property and carry on its business as owned and carried on at the date hereof and as contemplated hereby. Such party is duly licensed or qualified to do business and is in good standing in each of the jurisdictions in which the failure to be so licensed or qualified would have a material adverse effect on its financial condition or its ability to perform its obligations hereunder. Each party has the power and authority to execute and deliver this Agreement and to perform its obligations hereunder and the execution, delivery and performance of this Agreement has been duly authorized by all necessary action. This Agreement constitutes the legal, valid and binding obligations of such party enforceable in accordance with its terms, subject to bankruptcy, insolvency, reorganization, moratorium or similar laws relating to creditors' rights and general principles of equity. b) No Conflict with Restrictions; No Default. Neither the execution, delivery or performance of this Agreement by such party (i) will conflict with, violate or result in a breach of any of the terms, conditions or provisions of any law, regulation, order, writ, injunction, decree, determination or award of any court, any governmental department, board, agency or instrumentality, domestic or foreign, or any arbitrator, applicable to such party, (ii) will conflict with, violate, result in a breach of or constitute a default under any of the terms, conditions or provisions of the articles of incorporation, bylaws or partnership agreement of such party, as the case may be, or of any agreement or instrument to which such party is a party or by which such party is or may be bound or to which any of its properties or assets is subject, (iii) will in any material respect conflict with, violate, result in a breach of, constitute a default under (whether with notice or lapse of time or both), accelerate or permit the acceleration of the performance required by, give to others any interests or rights or require any consent, authorization or approval under any indemnity, mortgage, lease agreement or instrument to which such party is a party or by which such party is or may be bound, or (iv) will result in the creation or imposition of any lien upon any of the properties or assets of such party. (c) Governmental Authorizations. Any registration, declaration or notification with, or consent, approval, license, permit or other authorization or order by, any governmental or regulatory authority domestic or foreign, that is required in connection with the valid execution, delivery acceptance and performance by such party under this Agreement has been completed, made, or obtained on or before the effective date of this Agreement. (d) Suitability of Investment. (i) AFC represents and warrants that it is an "accredited investor" within the meaning of Rule 501 of Regulation D promulgated under the Securities Act as presently in effect and is acquiring the Preferred Shares - Class A for its own account for investment purposes only and not with a view to the resale or distribution thereof; (ii) AFC will not, directly or indirectly, offer, sell, transfer, assign, exchange or otherwise dispose of all or any part of the Preferred Shares - Class A except to Old Fort in accordance with the provisions of this Agreement; (iii)AFC has been given the opportunity to obtain information and documents relating to Old Fort and to ask questions of and receive answers from representatives of Old Fort concerning Old Fort and the investment in the Preferred Shares - Class A; (iv) AFC has such knowledge and experience in financial, business and tax matters that it can, and it has, adequately analyzed the risks of an investment in the Preferred Shares - Class A and it has determined the Preferred Shares - Class A are a suitable investment for it and that it is able at this time, and in the foreseeable future, to bear the economic risk of a total loss of its investment; and (v) AFC is aware that there are substantial risks incident to an investment in the Preferred Shares - Class A. ARTICLE 4 MISCELLANEOUS 4.1 No registration of Preferred Shares - Class A. AFC is aware that the Preferred Shares - Class A have not been and will not be registered under the Securities Act of 1933, as amended (the "Securities Act"), that any offer and issuance of the Preferred Shares - Class A is intended to be exempt from registration under the Securities Act and the rules promulgated thereunder by the United States Securities and Exchange Commission, and that the Preferred Shares - Class A cannot be offered, sold, assigned, transferred or otherwise disposed of unless they are subsequently registered under the Securities Act or an exemption from such registration is available. AFC is also aware that sales or transfers of the Preferred Shares - Class A are and will be further restricted by state securities laws and that the certificates for the Preferred Shares - Class A will bear appropriate legends restricting their transfer pursuant to applicable laws and this Agreement. 4.2 Financial Statements. AFC shall promptly deliver to Old Fort copies of all of its filings with the United States Securities and Exchange Commission, shareholder communications, and such other information as Old Fort shall reasonably request. 4.3 Termination. This Agreement may be terminated by Old Fort by thirty (30) days written notice to AFC, and the Agreement shall terminate automatically in the event of, and as of the same date as, termination of the Reinsurance Agreement; provided that AFC's obligations under this Agreement shall not terminate unless and until Allmerica's and LNRAC's obligations under the Reinsurance Agreement, Lincoln's and LNRAC's obligations under the Lincoln Retrocession Agreement, Lincoln's and Old Fort's obligations under the Old Fort Retrocession Agreement, and Old Fort's and AFC's obligations under this Agreement have been fully satisfied. 4.4 Waiver of Defenses. To the extent permitted by law, AFC hereby waives all rights and defenses it may have to avoid its obligations under this Agreement. In particular, the obligations of AFC hereunder shall not be released, discharged or otherwise affected by: (a) any extension, renewal, settlement, compromise, waiver or release in respect of any obligation of LNRAC or Allmerica under the Reinsurance Agreement, by operation of law or otherwise; (b) any release, impairment, non-perfection or invalidity of any direct or indirect security for any obligation of LNRAC or Allmerica under the Reinsurance Agreement; (c) any change in the corporate existence, structure or ownership of LNRAC, Lincoln, Old Fort, Allmerica or AFC or any insolvency, bankruptcy, reorganization or other similar proceeding affecting LNRAC, Lincoln, Old Fort, Allmerica or AFC or any of their respective assets, or any resulting release or discharge of any obligation of LNRAC or Allmerica contained in the Reinsurance Agreement; (d) the existence of any claim, set-off or other rights which AFC may have at any time against Old Fort or any other person, whether in connection herewith or any unrelated transactions; (e) any invalidity or unenforceability relating to or against LNRAC or Allmerica for any reason under the Reinsurance Agreement or any provision of applicable law or regulation purporting to prohibit the payment by LNRAC or Allmerica of any amount payable by it under the Reinsurance Agreement; (f) a determination by any insurance regulatory authority that AFC should have been licensed as an insurer or is otherwise subject to the insurance laws of any such jurisdiction in connection with this Agreement or the transactions contemplated in this Agreement; or (g) any other act or omission to act or delay of any kind by any of the parties or any other person or any other circumstance whatsoever which might, but for the provisions of this Section, constitute a legal or equitable discharge of or defense to AFC's obligations hereunder. 4.5 Binding Effect, Successors and Assigns. The provisions of this Agreement will be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement or the benefits hereof or the obligations hereunder may not be assigned by any party hereto without the prior written consent of the other party hereto. 4.6 Amendment; Waiver. This Agreement may be amended only by a written instrument signed by the parties hereto. No waiver by either party hereto of any provision hereof will be effective unless set forth in a writing executed by the party so waiving. 4.7 Notices. All notices, requests, demands, waivers and other communications required or permitted to be given under this Agreement will be in writing and will be deemed to have been duly given when received either by (i) telecopy (the receipt of which is confirmed) or (ii) Express Mail, Federal Express or other courier service, as follows: If to Old Fort, to it at: Address: 1700 Magnavox Way P.O. Box 7808 Fort Wayne, IN 46801-7808 Attention: President Telecopy: 219-455-9040 If to AFC, to it at: Address: 440 Lincoln Street Worcester, MA 01653 Attention: Mark C. McGivney Vice President and Treasurer Telecopy: 508-852-4236 4.8 Counterparts. This Agreement may be executed in two or more counterparts, and by different parties on separate counterparts, each set of counterparts showing execution by all parties will be deemed an original, but all of which will constitute one and the same instrument. 4.9 Further Assurance. Each party hereto agrees to execute, acknowledge, deliver, file and record such further certificates, amendments, instruments, agreements and documents, and to do all such other acts and things, as may be required by law or as may be necessary or advisable to carry out the intent and purposes of this Agreement. 4.10 Rights Cumulative; Waiver. The rights and remedies of the parties hereto will be cumulative and not exclusive of any rights or remedies which either would otherwise have hereunder or at law or in equity or by statute, and no failure or delay by either party in exercising any right or remedy will impair any such right or remedy or operate as a waiver of such right or remedy, nor will any single or partial exercise of any power or right preclude such party's other or further exercise or the exercise of any other power or right. The waiver by any party hereto of a breach of any provision of this Agreement will not operate or be construed as a waiver of any preceding or succeeding breach and no failure by either party to exercise any right or privilege hereunder will be deemed a waiver of such party's rights or privileges hereunder or will be deemed a waiver of such party's rights to exercise the same at any subsequent time or times hereunder. 4.11 Governing Law. This Agreement will be governed by and construed and enforced in accordance with the laws of Bermuda. 4.12 Arbitration. If AFC and Old Fort cannot mutually resolve a dispute regarding the interpretation or operation of this Agreement, the dispute shall be decided through arbitration as set forth in Exhibit D. The arbitrators shall base their decision on the terms and conditions of this Agreement plus the Reinsurance Agreement, the Lincoln Retrocession Agreement and the Old Fort Retrocession Agreement, rather than solely on a strict interpretation of the applicable law. There shall be no appeal from their decision, except that either party may petition a court having jurisdiction over the parties and the subject matter to reduce the arbitrator's decision to judgment. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. OLD FORT INSURANCE COMPANY, LTD. By: /s/ Thomas E. Skillman Name: Thomas E. Skillman Title: Vice President ALLMERICA FINANCIAL CORPORATION By: /s/ Mark C. McGivney Name: Mark C. McGivney Title: Vice President EXHIBIT A ATTRIBUTES OF PREFERRED SHARES - CLASS A The Preferred Shares - Class A shall have the following rights, restrictions and other attributes: 1. VOTING Except in a case where a class vote is required by law or by the Bye-Laws of Old Fort, the holders of Preferred Shares - Class A shall have no right to vote or to receive notices of or attend at meetings of Old Fort. 2. DIVIDEND The holders of Preferred Shares - Class A shall be not be entitled to receive dividends. 3. REDEMPTION The holders of Preferred Shares - Class A shall enjoy redemption rights as set forth in Article 2 of the Put Option Agreement ("Agreement") of September 30, 2001 between Old Fort and AFC. 4. RETURN OF CAPITAL The holders of Preferred Shares - Class A shall enjoy return of capital rights as set forth in the Agreement. 5. TRANSFERABILITY The Preferred Shares - Class A will be non-transferable in accordance with Article 2 of the Agreement. 6. OTHER The holders of Preferred Shares - Class A shall have no pre-emptive, preferential or other right to purchase, subscribe for or take any other shares of Old Fort, whether now or hereafter authorised, or to purchase, subscribe for or take any other securities or obligations of Old Fort convertible into or carrying an option or right to vote or to purchase any other shares of Old Fort. EXHIBIT B NOTICE OF SETTLEMENT -------------------- To: Allmerica Financial Corporation ("AFC") From: Old Fort Insurance Company, Ltd. ("Old Fort") Attention: [ ] Date: [ ] Dear Sirs Separate Account No. [ ] of Old Fort We refer to the Notice of Settlement pursuant to section 2.1(b) of the Put Option Agreement between AFC and Old Fort dated September 30, 2001 (the "Agreement"). Capitalised terms in this Notice have the meanings given to them in the Agreement. 1. We refer to the Settlement Period for the calendar quarter as follows: [ ]. 2. We hereby certify that the Settlement Amount is [ ]. 3. The Settlement Amount has been calculated as follows: Experience Refund Loss Carry Forward $[ ] plus the total of all payments previously made by Old Fort for redemption of Preferred Shares - Class A Less: total of all payments previously made by AFC $[ ] for Preferred Shares - Class A _______ Settlement Amount $[ ] ======= Accordingly we hereby request payment of the Settlement Amount pursuant to section 2.1(b) of the Agreement. The above information is hereby certified true and correct. Authorised Signatory For and behalf of Old Fort Insurance Company, Ltd. EXHIBIT C SUBSCRIPTION SHEET ------------------ To: The Directors Old Fort Insurance Company, Ltd. ("the Company") _________________________________________________________________________ The undersigned subscriber hereby applies for the allotment to it of the number of Preferred Shares - Class A set opposite its below at a price calculated in accordance with Section 2.1(d) of the Put Option Agreement ("Agreement") as of September 30, 2001 between the Company and Allmerica Financial Corporation which is payable in accordance with Section 2.1 (b) of the Agreement and agrees that this subscription shall be final, binding and unconditional upon allotment; and that the Company need not issue a share certificate therefor until such shares are fully paid. The undersigned subscriber hereby represents and warrants to, and agrees with, the Company that the representations and warranties as contained in Article 3 of the Agreement remain true and accurate as of the date hereof. Subscriber Number of Shares Signature - ---------- ---------------- --------- Bermudian: No ____________________________________ Duly authorized for and on behalf of Allmerica Financial Corporation EXHIBIT D Any controversy or claim arising out of or relating to this Agreement will be settled by arbitration. There must be three (3) arbitrators who must be impartial and must be present or former officers of life insurance or life reinsurance companies other than the parties or their affiliates. Each of the parties will appoint one (1) of the arbitrators and these two (2) arbitrators will select the third (the "Umpire"). In the event that either party should fail to choose an arbitrator within thirty (30) days following a written request by the other party to do so, the requesting party may choose two (2) arbitrators who will in turn choose an Umpire before entering upon arbitration. If the two (2) arbitrators fail to agree upon the selection of an Umpire within thirty (30) days following their appointment, either party may ask ARIAS-US to appoint the Umpire. However, if ARIAS-US is unable to appoint an Umpire who is impartial and who is or was an officer of a life insurance or life reinsurance company other than the parties or their affiliates, then either party may ask a court to appoint the Umpire pursuant to the Uniform Arbitration Act or any similar statute empowering the court to appoint an arbitrator, in which case the requirement that the Umpire be a present or former officer of a life insurance or life reinsurance company shall be waived. The arbitrators will decide all matters by majority vote. They will establish the procedural rules for the arbitration and allocate among the parties the expenses of the arbitration. They shall interpret this Agreement as an honorable engagement and are not bound by the strict formalities of law. They are not empowered to assess punitive damages. The arbitration panel shall determine all arbitration schedules and procedural rules. Organizational and other meetings shall be held in Worcester, Massachusetts, unless the panel shall select another location. The award agreed by the arbitrators will be final, and judgement may be entered upon it in any court having jurisdiction. EX-99 6 certification-ceo.txt CEO CERTIFICATION Exhibit 99.1 CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as chief executive officer of Allmerica Financial Corporation (the "Company"), does hereby certify that to the undersigned's knowledge: 1) the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Company's Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John F. O'Brien John F. O'Brien President and Chief Executive Officer Dated: August 14, 2002 EX-99 7 certification-cfo.txt CFO CERTIFICATION Exhibit 99.2 CERTIFICATION PURSUANT TO SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as chief financial officer of Allmerica Financial Corporation (the "Company"), does hereby certify that to the undersigned's knowledge: 1) the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Company's Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Edward J. Parry, III Edward J. Parry, III Vice President and Chief Financial Officer Dated: August 14, 2002 -----END PRIVACY-ENHANCED MESSAGE-----