-----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, KTcb7TRETU3yHAaqkDFEE7o/Wab6lv3K0dY/b06WfzknMtYbfrTG+20jEEPDW08a PKQN9abfGuiO1wdM0S9QtA== 0000944695-96-000028.txt : 19961118 0000944695-96-000028.hdr.sgml : 19961118 ACCESSION NUMBER: 0000944695-96-000028 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NYSE 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: 96664584 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 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: September 30, 1996 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: 50,134,651 shares of common stock outstanding, as of September 30, 1996. 33 Total Number of Pages Included in This Document TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Statements of Income 3 Consolidated Statements of Shareholders' Equity 4 Consolidated Balance Sheets 5 Consolidated Statements of Cash Flows 6 Notes to Interim Consolidated Financial Statements 7 - 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 - 31 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 32 SIGNATURES 33 PART I - FINANCIAL INFORMATION ITEM I - FINANCIAL STATEMENTS ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions, except per share data) 1996 1995 1996 1995 REVENUES Premiums $557.1 $562.4 $1,658.4 $1,675.3 Universal life and investment product policy fees 49.9 43.1 144.9 128.0 Net investment income 173.9 181.6 501.8 542.8 Net realized investment (losses) gains (0.6) 18.4 53.3 24.1 Realized gain on sale of mutual fund processing business 0.0 0.0 0.0 20.7 Other income 26.0 17.3 76.6 65.2 -------- -------- -------- -------- Total revenues 806.3 822.8 2,435.0 2,456.1 -------- -------- -------- -------- BENEFITS, LOSSES AND EXPENSES Policy benefits, claims,losses and loss adjustment expenses 475.6 498.5 1,461.0 1,514.3 Policy acquisition expenses 117.3 119.8 358.1 355.2 Other operating expenses 124.3 114.7 361.7 349.5 -------- -------- -------- -------- Total benefits, losses and expenses 717.2 733.0 2,180.8 2,219.0 -------- -------- -------- -------- Income before federal income taxes 89.1 89.8 254.2 237.1 -------- -------- -------- -------- Federal income tax expense (benefit) Current 32.7 23.8 77.0 75.3 Deferred (11.5) 9.0 (19.0) (0.1) -------- -------- -------- -------- Total federal income tax expense 21.2 32.8 58.0 75.2 -------- -------- -------- -------- Income before minority interest and extraordinary item 67.9 57.0 196.2 161.9 Minority interest (21.2) (22.2) (59.6) (58.0) -------- -------- -------- -------- Income before extraordinary item 46.7 34.8 136.6 103.9 Extraordinary item- demutualization expenses 0.0 (4.7) 0.0 (10.7) -------- -------- -------- -------- Net income $ 46.7 $ 30.1 $ 136.6 $ 93.2 ======== ======== ======== ======== PER SHARE DATA Net income $ 0.93 $ 2.72 ======== ======== Dividends declared to shareholders $ 0.05 $ 0.15 ======== ======== Weighted average shares outstanding 50.1 50.1 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. Page 3 ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited) Nine Months Ended September 30, (In millions) 1996 1995 COMMON STOCK Balance at beginning and end of period $ 0.5 $ 0.0 -------- -------- ADDITIONAL PAID-IN-CAPITAL Balance at beginning and end of period 1,382.5 0.0 -------- -------- RETAINED EARNINGS Balance at beginning of period 38.2 1,071.4 Net income 136.6 93.2 Dividends to shareholders (7.5) 0.0 Balance at end of period -------- -------- 167.3 1,164.6 -------- -------- NET UNREALIZED APPRECIATION ON INVESTMENTS Balance at beginning of period 153.0 (79.0) Net (depreciation) appreciation on available-for-sale securities (139.2) 360.5 Benefit (provision) for deferred federal income taxes 48.7 (126.2) Minority interest 20.2 (64.4) ---------- --------- Balance at end of period 82.7 90.9 Total shareholders' equity $1,633.0 $1,255.5 ========== =========
The accompanying notes are an integral part of these consolidated financial statements. Page 4
ALLMERICA FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, December 31, (In millions, except per share data) 1996 1995 ASSETS Investments: Fixed maturities-at fair value (amortized cost of $7,635.3 and $7,467.9) $7,731.4 $7,739.3 Equity securities-at fair value (cost of $326.6 and $410.6) 438.0 517.2 Mortgage loans 690.4 799.5 Real estate 145.4 179.6 Policy loans 130.6 123.2 Other long-term investments 111.4 71.9 ---------- ---------- Total investments 9,247.2 9,430.7 ---------- ---------- Cash and cash equivalents 164.2 289.5 Accrued investment income 158.2 163.2 Deferred policy acquisition costs 816.3 735.7 Reinsurance receivables: Future policy benefits 104.2 97.1 Outstanding claims, losses and loss adjustment expenses 763.9 799.6 Unearned premiums 45.2 43.8 Other 56.0 58.9 ---------- ---------- Total reinsurance receivables 969.3 999.4 ---------- ---------- Deferred federal income taxes 113.0 81.2 Premiums, accounts and notes receivable 557.1 526.7 Other assets 309.3 363.6 Closed Block assets 807.5 818.9 Separate account assets 5,586.8 4,348.8 ---------- ---------- Total assets $18,728.9 $17,757.7 ========== ========== LIABILITIES Policy liabilities and accruals: Future policy benefits $2,628.3 $2,639.3 Outstanding claims, losses and loss adjustment expenses 3,057.7 3,081.3 Unearned premiums 848.0 800.9 Contractholder deposit funds and other policy liabilities 2,142.0 2,737.4 -------- -------- Total policy liabilities and accruals 8,676.0 9,258.9 Expenses and taxes payable 601.9 603.0 Reinsurance premiums payable 51.6 42.0 Short-term debt 326.1 31.2 Deferred federal income taxes 14.8 47.8 Long-term debt 202.2 202.3 Closed Block liabilities 890.4 902.0 Separate account liabilities 5,581.5 4,337.8 ---------- ---------- Total liabilities 16,344.5 15,425.0 ---------- ---------- Minority interest 751.4 758.5 ---------- ---------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued 0.0 0.0 Common stock, $0.01 par value, 300.0 million shares authorized, 50.1 million shares issued and outstanding 0.5 0.5 Additional paid-in-capital 1,382.5 1,382.5 Unrealized appreciation on investments, net 82.7 153.0 Retained earnings 167.3 38.2 -------- -------- Total shareholders' equity 1,633.0 1,574.2 ---------- ---------- Total liabilities and shareholders' equity $18,728.9 $17,757.7 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. Page 5
ALLMERICA FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended September 30, (In millions) 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES Net income $136.6 $93.2 Adjustments to reconcile net income to net cash provided by operating activities: Minority interest 59.6 58.0 Net realized gains (53.5) (44.8) Deferred federal income taxes (18.9) (0.1) Changes in assets and liabilities: Deferred policy acquisition costs (55.7) (31.4) Premiums and notes receivable, net of reinsurance payable (20.4) (64.5) Accrued investment income 6.3 2.3 Policy liabilities and accruals, net (31.3) 85.1 Reinsurance receivable 30.2 (22.2) Expenses and taxes payable 8.3 59.2 Separate account activity, net 5.6 0.4 Other, net 78.4 44.5 ---------- --------- Net cash provided by operating activities 145.2 179.7 ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of available- for-sale fixed maturities 2,025.2 1,147.1 Proceeds from maturities and calls of available-for-sale fixed maturities 1,058.3 804.5 Proceeds from maturities of held-to-maturity fixed maturities 0.0 238.0 Proceeds from disposals of equity securities 218.3 77.3 Proceeds from disposals of other investments 60.3 9.7 Proceeds from mortgages matured or collected 122.9 157.2 Purchase of available-for-sale fixed maturities (3,282.8) (2,212.6) Purchase of held-to-maturity fixed maturities 0.0 (49.2) Purchase of equity securities (81.1) (172.6) Purchase of other investments (91.1) (10.2) Proceeds from sale of mutual fund processing business 0.0 32.8 Capital expenditures (8.0) (10.1) Other activities, net 2.6 0.0 ---------- --------- Net cash provided by investing activities 24.6 11.9 ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Deposits and interest credited to contractholder deposit funds 241.6 357.7 Withdrawals from contractholder deposit funds (790.4) (765.4) Change in short-term debt 294.9 (6.4) Dividends paid to shareholders (10.4) (3.1) Subsidiary treasury stock purchased, at cost (42.0) (13.1) ---------- --------- Net cash used in financing activities (306.3) (430.3) ---------- --------- Net decrease in cash and cash equivalents (136.5) (238.7) Net change in cash held in the Closed Block 11.2 0.0 Cash and cash equivalents, beginning of period 289.5 539.7 ---------- --------- Cash and cash equivalents, end of period $164.2 $301.0 ========== =========
The accompanying notes are an integral part of these consolidated financial statements. Page 6 ALLMERICA FINANCIAL CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation First Allmerica Financial Life Insurance Company ("FAFLIC", formerly State Mutual Life Assurance Company of America ["State Mutual"]) was organized as a mutual life insurance company until October 16, 1995. FAFLIC converted to a stock life insurance company pursuant to a plan of reorganization effective October 16, 1995 and became a wholly owned subsidiary of Allmerica Financial Corporation ("AFC" or the "Company"). The consolidated financial statements have been prepared as if FAFLIC were organized as a stock life insurance company for all periods presented. Thus, generally accepted accounting principles for stock life insurance companies have been applied for all periods presented. The interim consolidated financial statements of AFC include the accounts of AFC, FAFLIC, its wholly owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC", formerly SMA Life Assurance Company), non-insurance subsidiaries (principally brokerage and investment advisory subsidiaries), and Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned non-insurance holding company). The Closed Block assets and liabilities at September 30, 1996 and December 31, 1995 are presented in the consolidated financial statements as single line items. Results of operations for the Closed Block for the nine month and three month periods ended September 30, 1996 are included in other income in the consolidated financial statements. Prior to demutualization such amounts are presented line by line in the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated. Minority interest relates to the Company's investment in Allmerica P&C and its subsidiary, The Hanover Insurance Company ("Hanover"). Hanover's 82.5%-owned subsidiary is Citizens Corporation, the holding company for Citizens Insurance Company of America ("Citizens"). Minority interest also includes an amount related to the minority interest in Citizens Corporation. The accompanying interim consolidated financial statements reflect, in the opinion of the Company's management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and results of operations. Certain reclassifications have been made to the 1995 consolidated statements of income in order to conform to the 1996 presentation. The results of operations for the nine months and quarter ended September 30, 1996 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 1995 Annual Report to Shareholders, as filed on Form 10-K to the Securities and Exchange Commission. 2. Federal Income Taxes Federal income tax expense for the periods ended September 30, 1996 and 1995, has been computed using estimated effective tax rates for the AFC and Allmerica P&C tax-paying groups. These rates are revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates. Page 7 3. Closed Block Included in other income in the Consolidated Statements of Income in the third quarter and first nine months of 1996 is a net pre-tax contribution from the Closed Block of $1.9 million and $7.9 million, respectively. Summarized financial information of the Closed Block is as follows:
(Unaudited) September 30, December 31, 1996 1995 (In millions) ASSETS Fixed maturities, at fair value (amortized cost of $450.0 and $447.4) $450.2 $458.0 Mortgage loans 77.9 57.1 Policy loans 233.6 242.4 Cash and cash equivalents 6.4 17.6 Accrued investment income 15.2 16.6 Deferred policy acquisition costs 21.8 24.5 Other assets 2.4 2.7 -------- -------- Total assets $807.5 $818.9 ======== ======== LIABILITIES Policy liabilities and accruals $880.5 $899.2 Other liabilities 9.9 2.8 -------- -------- Total liabilities $890.4 $902.0 ======== ======== (Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, 1996 1996 REVENUES Premiums $10.4 $50.9 Net investment income 13.3 39.4 Net realized investment (losses) gains (0.2) 0.2 -------- -------- Total revenues 23.5 90.5 -------- -------- BENEFITS AND EXPENSES Policy benefits 20.7 79.8 Policy acquisition expenses 0.7 2.3 Other operating expenses 0.2 0.5 -------- -------- Total benefits and expenses 21.6 82.6 -------- -------- Contribution from the Closed Block $ 1.9 $ 7.9 ======== ========
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. 4. Segment Information The Company offers financial products and services in two major areas: Risk Management and Retirement and Asset Management. Within these broad areas, the Company operates principally in five segments. The Risk Management group includes two segments: Regional Property and Casualty and Corporate Risk Management Services. The Regional Property and Casualty segment includes property and casualty insurance products, such as automobile insurance, homeowners' insurance, commercial multiple peril insurance, and workers' compensation insurance. These products are offered by Allmerica P&C through its operating subsidiaries, Hanover and Citizens. Substantially all of the Regional Property and Casualty segment's earnings are generated in Michigan and the Northeast (Connecticut, Massachusetts, New York, New Jersey, New Hampshire, Rhode Island, Vermont and Maine). The Corporate Risk Management Services segment includes group life and health insurance products and services which assist employers in administering employee benefit programs and in managing the related risks. Page 8 The Retirement and Asset Management group includes three segments: Retail Financial Services, Institutional Services and Allmerica Asset Management. The Retail Financial Services segment includes variable annuities, variable universal life, traditional and health insurance products distributed via retail channels to individuals across the country. The Institutional Services segment includes primarily group retirement products such as 401(k) plans, tax-sheltered annuities and GIC contracts which are distributed to institutions across the country via worksite marketing and other arrangements. Allmerica Asset Management is a Registered Investment Advisor which provides investment advisory services to other institutions, such as insurance companies and pension plans. In addition to the five operating segments, the Company also has a Corporate segment, which consists primarily of Senior Debentures and a portion of the net proceeds from the Company's initial public offering. Summarized below is financial information with respect to business segments for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions, except per share data) 1996 1995 1996 1995 Revenues: Risk Management Regional Property and Casualty $ 539.3 $ 540.3 $ 1,634.9 $ 1,569.9 Corporate Risk Management Services 90.7 82.0 267.1 235.8 --------- --------- --------- --------- Subtotal 630.0 622.3 1,902.0 1,805.7 --------- --------- --------- --------- Retirement and Asset Management Retail Financial Services 112.2 123.0 332.7 383.3 Institutional Services 63.8 76.3 198.6 263.8 Allmerica Asset Management 1.7 1.2 6.2 3.3 --------- --------- --------- --------- Subtotal 177.7 200.5 537.5 650.4 --------- --------- --------- --------- Corporate 0.5 0.0 1.8 0.0 Eliminations (1.9) 0.0 (6.3) 0.0 --------- --------- --------- --------- Total $ 806.3 $ 822.8 $ 2,435.0 $ 2,456.1 ========= ========= ========= ========= Income (loss) from continuing operations before income taxes: Risk Management Regional Property and Casualty $ 57.8 $ 63.2 $ 162.4 $ 157.8 Corporate Risk Management Services 3.7 5.1 11.2 9.9 --------- --------- --------- --------- Subtotal 61.5 68.3 173.6 167.7 --------- --------- --------- --------- Retirement and Asset Management Retail Financial Services 18.9 11.9 54.0 27.7 Institutional Services 12.7 9.0 38.3 40.0 Allmerica Asset Management 0.0 0.6 0.5 1.7 --------- --------- --------- --------- Subtotal 31.6 21.5 92.8 69.4 --------- --------- --------- --------- Corporate (4.0) 0.0 (12.2) 0.0 --------- --------- --------- --------- Total $ 89.1 $ 89.8 $ 254.2 $ 237.1 ========= ========= ========= =========
(Unaudited) As of As of September December 31, 30, 1996 1995 Identifiable assets: Risk Management Regional Property and Casualty $ 5,773.6 $ 5,741.8 Corporate Risk Management Services 519.7 458.9 --------- --------- Subtotal 6,293.3 6,200.7 --------- --------- Retirement and Asset Management Retail Financial Services 8,490.5 7,218.6 Institutional Services 3,898.6 4,280.9 Allmerica Asset Management 2.9 2.1 --------- --------- Subtotal 12,392.0 11,501.6 Corporate 43.6 55.4 --------- --------- Total $18,728.9 $17,757.7 ========= =========
Page 9 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. INTRODUCTION The results of operations for Allmerica Financial Corporation and subsidiaries ("AFC" or "the Company") include the accounts of AFC, First Allmerica Financial Life Insurance Company ("FAFLIC", formerly State Mutual Life Assurance Company of America ["State Mutual"]), its wholly owned life insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company ("AFLIAC", formerly SMA Life), Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned non-insurance holding company), The Hanover Insurance Company ("Hanover", a wholly owned subsidiary of Allmerica P&C), Citizens Corporation ("Citizens", an 82.5%-owned subsidiary of Hanover), Citizens Insurance Company of America (a wholly owned subsidiary of Citizens) and certain other insurance and non-insurance subsidiaries. CLOSED BLOCK On completion of its demutualization, FAFLIC established a Closed Block for the payment of future benefits, policyholders' dividends and certain expenses and taxes relating to certain classes of policies. FAFLIC allocated to the Closed Block an amount of assets expected to produce cash flows which, together with anticipated revenues from the Closed Block business, are reasonably expected to be sufficient to support the Closed Block business. The Closed Block includes only those revenues, benefit payments, dividends and premium taxes considered in funding the Closed Block and excludes many costs and expenses associated with operating the Closed Block and administering the policies included therein. Since many expenses related to the Closed Block were excluded from the calculation of the Closed Block contribution, the contribution from the Closed Block does not represent the actual profitability of the Closed Block. As a result of such exclusion, operating costs and expenses outside the Closed Block are disproportionate to the business outside the Closed Block. The contribution from the Closed Block is included in 'Other income' in the interim Consolidated Financial Statements. The pre-tax contribution from the Closed Block was $1.9 million for the quarter ended and $7.9 million for the nine months ended September 30, 1996. Page 10 FAFLIC's conversion to a stock life insurance company, which was completed October 16, 1995, and the establishment of the Closed Block have affected the presentation of the Company's interim Consolidated Financial Statements. For comparability with the prior period, the following table presents the results of operations of the Closed Block combined with the results of operations outside the Closed Block for the quarter ended and the nine months ended September 30, 1996. Management's discussion and analysis addresses the results of operations as combined unless otherwise noted.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 REVENUES Premiums $567.6 $562.4 $1,709.3 $1,675.3 Universal life and investment product policy fees 49.9 43.1 144.9 128.0 Net investment income 187.2 181.6 541.2 542.8 Net realized investment (losses) gains (0.8) 18.4 53.5 24.1 Realized gain on sale of mutual fund processing business 0.0 0.0 0.0 20.7 Other income 24.1 17.3 68.7 65.2 -------- -------- -------- -------- Total revenues 828.0 822.8 2,517.6 2,456.1 -------- -------- -------- -------- BENEFITS, LOSSES AND EXPENSES Policy benefits, claims, losses and loss adjustment expenses 496.3 498.5 1,540.8 1,514.3 Policy acquisition expenses 118.1 119.8 360.4 355.2 Other operating expenses 124.5 114.7 362.2 349.5 -------- -------- -------- -------- Total benefits, losses and expenses 738.9 733.0 2,263.4 2,219.0 -------- -------- -------- -------- Income before federal income taxes 89.1 89.8 254.2 237.1 -------- -------- -------- -------- Federal income tax expense (benefit) Current 32.7 23.8 77.0 75.3 Deferred (11.5) 9.0 (19.0) (0.1) -------- -------- -------- -------- Total federal income tax expense 21.2 32.8 58.0 75.2 -------- -------- -------- -------- Income before minority interest and extraordinary item 67.9 57.0 196.2 161.9 Minority interest (21.2) (22.2) (59.6) (58.0) -------- -------- -------- -------- Income before extraordinary item 46.7 34.8 136.6 103.9 Extraordinary item - demutualization expenses 0.0 (4.7) 0.0 (10.7) -------- -------- -------- -------- Net Income $46.7 $30.1 $136.6 $93.2 ======== ======== ======== ========
Page 11 Results of Operations Consolidated Overview Quarter Ended September 30, 1996 Compared to Quarter Ended September 30 ,1995 The Company's consolidated net income for the third quarter increased $16.6 million, or 55.1%, to $46.7 million, compared to the same period in 1995. Net income includes certain items which management believes are not indicative of overall operating trends. The following table reflects consolidated net income adjusted for these items, all net of taxes and minority interest.
(Unaudited) Quarter Ended September 30, (In millions) 1996 1995 Net income $ 46.7 $ 30.1 Adjustments: Net realized investment gains (1.6) (9.3) Extraordinary item - demutualization expenses 0.0 4.7 Differential earnings tax adjustment (2.4) 6.4 -------- -------- Adjusted net income $ 42.7 $ 31.9 ======== ========
The Company's adjusted net income increased $10.8 million, or 33.9%, to $42.7 million in the third quarter of 1996, compared to the same period in 1995. This increase is primarily attributable to a pre-tax increase of $12.5 million in the Retail Financial Services segment and an after-tax and minority interest increase of $3.7 million in the Regional Property and Casualty segment. These increases were partially offset by pre-tax adjusted net losses in the Corporate segment of $3.8 million in the quarter ended September 30, 1996 primarily due to the interest expense on the Company's 7 5/8% Senior Debentures issued in October 1995. The increase in the Retail Financial Services segment relates primarily to increased variable products' fee revenue and income earned on proceeds from the Company's October, 1995 inital public offering. The increase in the Regional Property and Casualty segment was due primarily to a $5.7 million arbitrated settlement from a voluntary pool, a $4.0 million reapportionment of an involuntary pool and a change in estimated equity in earnings from a limited partnership of $6.7 million. These items were mostly offset by a decrease in favorable claims experience on the prior accident years at Hanover, where favorable development decreased from $25.6 million in the third quarter of 1995 to $13.0 million in the third quarter of 1996. The Company expects reduced favorable reserve development at Hanover to continue to impact future earnings. Premium revenue remained relatively stable, increasing $5.2 million, or 0.9%, to $567.6 million in the third quarter of 1996. Premiums in the Corporate Risk Management Services segment increased $5.3 million, or 7.5%, to $75.7 million due to increases in group dental, group life and reinsurance coverages totaling $6.6 million. Premium revenue in the Regional Property and Casualty segment was relatively flat, decreasing $1.7 million, or 0.4%, to $472.7 million. Universal life and investment-type product policy fees increased $6.8 million, or 15.8%, to $49.9 million during the third quarter of 1996. This reflected additional deposits and appreciation on variable products account balances. Net realized losses on investments were $0.8 million in the third quarter of 1996, compared to net realized gains of $18.4 million in 1995. This change is primarily attributable to increased losses on sales of fixed maturities and equity securities of $20.5 million and $3.1 million, respectively, due to less favorable market conditions in the third quarter of 1996, partially offset by additional gains on sales of real estate of $7.1 million. Net investment income increased $5.6 million, or 3.1%, to $187.2 million during the third quarter of 1996 compared to the same period in 1995. Income on investments financed with repurchase agreements ("pre-invested assets") in 1996 totaled approximately $9.5 million during the third quarter and income on the proceeds of the initial public offering and from the issuance of Senior Debentures in October 1995 was approximately $6.8 million. Additionally, there was a $6.7 million change in estimated equity in earnings from a limited partnership in 1996. These increases were partially offset by a decrease of $13.8 million resulting from a reduction in invested assets due to declining GIC deposits. Since March 1995, when S&P lowered the claims-paying ratings of FAFLIC to A+ (Good), sales of traditional GICs have substantially ceased. Additionally, income on mortgage loans and real estate decreased due to reductions in these portfolios. Page 12 Other income increased $6.8 million to $24.1 million for the quarter ended September 30, 1996. This increase was primarily attributable to an arbitrated settlement on a reinsurance contract of $2.9 million in the Regional Property and Casualty segment, a $2.2 million increase in investment management income in the Retail Financial Services segment and a $2.5 million increase in administrative fees in the Corporate Risk Management Services segment. Policy benefits, claims, losses and loss adjustment expenses remained relatively stable, decreasing $2.2 million, or 0.4% to $496.3 million during the third quarter of 1996. This decrease is primarily attributable to decreased policy benefits of $15.2 million, or 28.6%, in the Institutional Services segment primarily attributable to the continuing decline of Guaranteed Investment Contracts ("GICs") during 1996, as well as a $4.0 million, or 5.4% decrease in Retail Financial Services due primarily to reserve strengthening in the disability insurance line in 1995 and improved morbidity experience in this line during 1996. These increases were partially offset by an $11.5 million, or 3.5%, increase in losses and loss adjustment expenses ("LAE") in the Company's Regional Property and Casualty segment primarily as a result of a decrease in favorable claims experience on prior accident years at Hanover. Additionally, Corporate Risk Management Services benefits increased $5.5 million, or 11.7% in the third quarter of 1996, principally due to premium growth and less favorable loss experience. Policy acquisition expenses consist primarily of commissions, premium taxes and other policy issuance costs. Policy acquisition expenses decreased $1.7 million, or 1.4%, to $118.1 million during the quarter ended September 30, 1996 compared to the same period in 1995. This was primarily due to a decrease of $3.2 million, or 3.0%, to $102.8 million in the Regional Property and Casualty segment due primarily to the reapportionment of a involuntary pool and an increase in deferrable costs attributable to premiums assumed in a reinsurance contract. This decrease was partially offset by an increase in the Retail Financial Services segment of $1.3 million, or 10.5%, to $13.7 million, primarily due to growth in variable products. Other operating expenses increased $9.8 million, or 7.9%, to $124.5 million in the third quarter of 1996 compared to the same period in 1995. This change was primarily due to short-term borrowing costs of $6.2 million incurred in 1996, $3.8 million of interest paid on the Company's Senior Debentures and increased commissions and claims processing expenses of $4.1 million in the Corporate Risk Management segment. These increases were partially offset by a $4.0 million decrease in the Regional Property and Casualty segment primarily attributable to reduced employee related expenses and commissions. Federal income tax expense decreased $11.6 million in the third quarter of 1996, while the effective tax rate decreased from 36.6% to 23.8% in the same period. For the life insurance subsidiaries, a decrease in the effective rate from 63.4% to 28.4% resulted primarily from a differential earnings charge of $6.4 million during the third quarter of 1995 compared to a differential earnings benefit of $2.4 million for the same period in 1996. For the Regional Property and Casualty subsidiaries, a slight decrease in the effective rate from 25.3% to 21.3% reflects a higher underwriting loss and a greater proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves provided for revisions in estimated prior year tax liabilities in the third quarter of 1995. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 The Company's consolidated net income for the nine months ended September 30, 1996 increased $43.4 million, or 46.6%, to $136.6 million, compared to the same period in 1995. Net income includes certain items which management believes are not indicative of overall operating trends. The following table reflects consolidated net income adjusted for these items, all net of taxes and minority interest.
(Unaudited) Nine Months Ended September 30, (In millions) 1996 1995 Net income $ 136.6 $ 93.2 Adjustments: Net realized investment gains (23.9) (11.7) Realized gain on sale of mutual fund processing business 0.0 13.4 Contingency payment from sale of mutual fund processing business (3.1) 0.0 Extraordinary item - demututaliztion expenses 0.0 10.7 Differential earnings tax adjustment (8.3) 7.7 --------- -------- Adjusted net income $ 101.3 $ 86.5 ========= ========
Page 13 The increase in adjusted net income of $14.8 million is primarily attributable to pre-tax increases of $29.3 million and $8.9 million in the Retail Financial Services and Institutional Services segments, respectively, partially offset by a pre-tax loss of $11.8 million and an after-tax decrease of $5.6 million in the Corporate and Regional Property and Casualty segments, respectively. The increase in the Retail Financial Services segment resulted primarily from increased fees from strong variable product growth and income earned on proceeds from the Company's October, 1995 inital public offering. The increase in the Institutional Services segment related principally to exiting certain unprofitable businesses in 1995. These increases were partially offset by losses in the Corporate segment primarily due to the interest expense on the Company's 7 5/8% Senior Debentures issued in October 1995. Additionally, the Regional Property and Casualty segment's adjusted net income decreased primarily due to severe weather-related claims during the first six months of 1996, partially offset by a $5.7 million arbitrated settlement from a voluntary pool, a $4.0 million reapportionment of an involuntary pool and a change in estimated equity in earnings from a limited partnership of $6.7 million. Premium revenue increased $34.0 million, or 2.0%, to $1,709.3 million during the first nine months of 1996. Premiums in the Corporate Risk Management Services segment increased $22.2 million, or 11.0%, to $224.6 million due to increases in group dental, group life, and reinsurance coverages totaling $18.4 million as well as increases of $3.6 million in stop loss products. Property and casualty premiums earned increased $16.5 million, or 1.2%, to $1,407.5 million. This increase is primarily attributable to price increases in the homeowners' line at Hanover and price increases in the personal automobile and homeowners' lines at Citizens. A 1.6 % increase in policies in force in the homeowners' line at Hanover and modest increases in policies in force in the personal automobile line at Hanover partially offset by rate decreases in this line, also contributed to the increase in net premiums earned. Premiums in the Retail Financial Services segment decreased $4.5 million, or 5.5%, to $77.2 million, primarily reflecting the Company's shift in focus from traditional life insurance products to variable life insurance and annuity products. Universal life and investment product policy fees increased $16.9 million, or 13.2%, to $144.9 million during the first nine months of 1996. This resulted from additional deposits and appreciation on variable products account balances. Net investment income before taxes decreased $1.6 million, or 0.3%, to $541.2 million during the first nine months of 1996. This decrease primarily reflects a reduction in invested assets due to declining GIC deposits resulting in a decline in investment income of $42.5 million. This decrease was offset by approximately $17.3 million of income on proceeds from the Company's initial public offering and from the issuance of Senior Debentures in October 1995, as well as approximately $14.3 million in income from pre-invested assets and a $6.7 million adjustment in 1996 related to a change in estimated equity in earnings from a limited partnership. The average gross yield of the fixed maturity investment portfolio decreased from 7.3% in the first nine months of 1995 to 7.2% for the same period in 1996. Net realized gains on investments were $53.5 million and $24.1 million, before taxes, and $34.8 million and $15.7 million, after taxes, in the first nine months of 1996 and 1995, respectively. In 1996, the Regional Property and Casualty segment revised its investment strategy, resulting in the sale of a substantial portion of its equity portfolio and the purchase of tax-exempt securities. Consequently, Regional Property and Casualty segment realized gains increased $20.1 million, to $29.8 million on an after-tax basis for the nine months ended September 30, 1996. These sales are consistent with the segment's strategy to maximize after-tax net investment income. Results in the first nine months of 1995 included a $20.7 million pre-tax gain from the March 1995 sale of the Company's mutual fund processing business. Other income increased $3.5 million, or 5.4%, to $68.7 million in the first nine months of 1996. Other income attributable to the Corporate Risk Management Services segment increased $6.2 million, primarily from growth in Administrative Services Only ("ASO") and contract fees. Other income from the Retail Financial Services segment increased $5.9 million, primarily attributable to increased investment management income. Additionally, other income in the Allmerica Asset Management and Regional Property and Casualty segments increased $2.9 million and $2.6 million, respectively. These increases were partially offset by decreases in the Institutional Services segment resulting primarily from the sale of the mutual fund processing business in March of 1995 which had contributed revenues of approximately $13.6 million in that year. Other income in 1996 also included a non-recurring $4.8 million pre-tax contingent payment related to the sale. Policy benefits, claims, losses and loss adjustment expenses increased $26.5 million, or 1.7%, to $1,540.8 million during the first nine months of 1996. This increase is primarily attributable to a $59.8 million, or 6.2%, increase in losses and LAE in the Company's Regional Property and Casualty segment as a result of catastrophe losses and severe weather during the first six months of 1996. Additionally, a $14.9 million, or 10.4%, increase in the Corporate Risk Management Services segment resulted primarily from product growth. These increases were partially offset by decreased policy benefits of $44.9 million, or 26.7%, in the Institutional Services segment primarily resulting from the continuing decline of GICs during 1996. Page 14 Policy acquisition expenses consist primarily of commissions, premium taxes and other policy issuance costs. Policy acquisition expenses increased $5.2 million, or 1.5%, to $360.4 million during the first nine months of 1996. This was primarily due to an increase of $5.8 million, or 1.9%, to $313.3 million in the Regional Property and Casualty segment reflecting growth in net premiums earned. Other operating expenses increased $12.7 million, or 3.6%, to $362.2 million in the first nine months of 1996 compared to the same period in 1995 primarily due to increased expenses in the Corporate Risk Management Services, Corporate and Retail Financial Services segments. Other operating expenses in the Corporate Risk Management Services segment increased $14.8 million, or 18.3%, to $95.6 million in 1996 as a result of increased commissions, claims processing expenses and field office expenses, resulting from the increased volume of both premiums and claims. Other operating expenses in the Retail Financial Services segment increased $9.7 million, or 12.3%, to $88.5 million in 1996, primarily from an increase in short-term borrowing costs of $9.0 million. Additionally, the Company incurred $14.0 million of other operating expenses in the Corporate segment in the first nine months of 1996, principally related to interest paid on the Company's Senior Debentures. These increases were partially offset by a decrease of $18.6 million in the Institutional services segment related to the sale of the mutual fund processing business in March 1995, and by a decrease of $5.3 million in the Regional Property and Casualty segment resulting from lower employee related expenses. Federal income tax expense decreased $17.2 million in the first nine months of 1996, while the effective tax rate decreased from 31.8% to 22.8% in the same period. For the life insurance subsidiaries, a decrease in the effective rate from 50.8% to 27.9% resulted primarily from a differential earnings benefit of $8.3 million in the first nine months of 1996 versus a differential earnings charge $7.7 million in the same period of 1995. For the property and casualty subsidiaries, a slight decrease in the effective rate from 22.2% to 20.0% resulted from a higher underwriting loss and a greater proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves provided for revisions of estimated prior tax liabilities in the first nine months of 1995. Segment Results The following is management's discussion and analysis of the Company's results of operations by business segment. The Company offers financial products and services in two major areas: Risk Management and Retirement and Asset Management. Within these broad areas, the Company conducts business principally in five operating segments. These segments are Regional Property and Casualty; Corporate Risk Management Services; Retail Financial Services; Institutional Services; and Allmerica Asset Management. The Regional Property and Casualty segment consists of the Company's 59.5% ownership of Allmerica P&C; however, all property and casualty results presented include 100% of Allmerica P&C's pre-tax results of operations, consistent with the presentation in the Company's consolidated financial statements. The other segments are all owned and operated by FAFLIC and its wholly owned subsidiaries. In addition to the five operating segments, the Company also has a Corporate segment, which consists primarily of Senior Debentures and a portion of the net proceeds from the Company's initial public offering. These proceeds are invested in fixed maturities at September 30, 1996. Risk Management Regional Property and Casualty The following table summarizes the results of operations for the Regional Property and Casualty segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 Revenues Net premiums earned $472.7 $474.4 $1,407.5 $1,391.0 Net investment income 63.0 53.7 171.6 157.7 Net realized gains (1.6) 10.4 45.9 13.9 Other income 5.2 1.8 9.9 7.3 ------- ------- --------- --------- Total revenues 539.3 540.3 1,634.9 1,569.9 Losses and LAE 336.4 324.9 1,029.3 969.5 Policy acquisition and other operating expenses 145.1 152.2 443.2 442.6 ------- ------- --------- -------- Income before taxes $ 57.8 $ 63.2 $ 162.4 $ 157.8 ======= ======= ========= ========= Includes policyholders' dividends of $8.7 million and $7.0 million for the nine months ended September 30, 1996 and 1995, respectively, and $3.7 million and $2.6 million for the quarters ended September 30, 1996 and 1995, respectively.
Page 15 Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995 INCOME BEFORE TAXES Income before taxes decreased $5.4 million, to $57.8 million in the third quarter of 1996, compared to the same period in 1995. Excluding realized gains and losses, income before taxes increased $6.6 million, to $59.4 million in the third quarter of 1996. The increase in income before taxes is primarily attributable to a $5.7 million arbitrated settlement from a voluntary pool and $4.0 million reapportionment of an involuntary pool. Net investment income increased $9.3 million, or 17.3% to $63.0 million, reflecting a change in estimated equity in earnings from a limited partnership of $6.7 million. This was offset by a $10.4 million increase in losses and loss adjustment expenses ("LAE") to $332.7 million in the third quarter of 1996, resulting from a $12.6 million decrease from $25.6 million in favorable claims experience on the prior accident years at Hanover. The Company expects reduced favorable development at Hanover to continue to impact future earnings. LINES OF BUSINESS RESULTS Personal Lines of Business The personal lines of business represented 61.4% and 60.1% of total net premiums earned in the third quarter of 1996 and 1995, respectively.
Hanover Citizens Consolidated For the Quarters Ended September 30, 1996 1995 1996 1995 1996 1995 (In millions) Net premiums earned $149.4 $148.9 $141.0 $136.1 $290.4 $285.0 Losses and loss adjustment expenses 107.6 94.5 96.5 105.6 204.1 200.1 Policy acquisition and other underwriting expenses 46.8 48.7 37.6 36.0 84.4 84.7 ------- ------- ------- ------- ------- ------- Underwriting (loss) profit $ (5.0) $ 5.7 $ 6.9 $ (5.5) $ 1.9 $ 0.2 ======= ======= ======= ======= ======= =======
Revenues Personal lines of business net premiums earned increased $5.4 million, to $290.4 million during the third quarter of 1996, compared to $285.0 million in the third quarter of 1995. Hanover's personal lines of business net premiums earned remained relatively flat at $149.4 million during the third quarter of 1996. Increases in earned premium resulting from rate increases and increases in policies in force in the homeowners line were offset by rate decreases in the personal automobile line and a lower participation in an involuntary pool. Hanover's premium growth in the personal automobile line has been impacted by a combined 16% rate decrease in Massachusetts during the past two years. Massachusetts currently accounts for approximately 36% of Hanover's personal automobile writings. Citizens' personal lines of business net premiums earned increased $4.9 million, or 3.6%, to $141.0 million in the third quarter of 1996. This increase is primarily attributable to price increases in the personal automobile and homeowners lines. This increase is partially offset by a 2.5% decrease in policies in force in the personal automobile line since December 31, 1995, attributable to continued strong competition in Michigan. Underwriting results The personal lines of business underwriting profit increased $1.7 million, to a profit of $1.9 million in the third quarter of 1996. Hanover's underwriting profit decreased $10.7 million to a loss of $5.0 million, while Citizens' underwriting loss increased $12.4 million to a profit of $6.9 million. Page 16 The decrease in Hanover's underwriting profit resulted primarily from a $13.1 million or 13.9% increase in losses and loss adjustment expenses to $107.6 million in the third quarter of 1996. This increase is primarily attributable to a $7.3 million increase in the personal automobile line due to an increase in claims severity. Homeowners' losses and LAE increased $4.9 million, primarily attributable to increased loss frequency and severity and a $2.2 million increase in catastrophe losses to $3.8 million. Citizens' underwriting results improved by $12.4 million, primarily attributable to a decrease in catastrophe losses. Catastrophe losses provided a $2.3 million benefit during the third quarter of 1996, resulting from a favorable re-estimation of catastrophe losses which occurred in the first half of 1996. Citizens incurred catastrophe losses of $6.9 million in the third quarter of 1995. Policy acquisition and other underwriting expenses at Hanover decreased $1.9 million, to $46.8 million, primarily due to decreased commission and assessment expenses reflecting the reapportionment of a involuntary pool and an increase in deferrable costs attributable to premiums assumed in a reinsurance contract. The reapportionment resulted in a decrease in Hanover's participation in an involuntary pool that currently has operating losses. Citizens' policy acquisition and other underwriting expenses increased $1.6 million, to $37.6 million in the third quarter of 1996. The increase is primarily attributable to the increase in net earned premium and expenses associated with an ongoing policy administration technology project, partially offset by decreases in employee related expenses and commissions. Commercial Lines of Business The commercial lines of business represented 38.6% and 39.9% of total net premiums earned in the third quarter of 1996 and 1995, respectively.
Hanover Citizens Consolidated For the Quarters Ended September 30, 1996 1995 1996 1995 1996 1995 (In millions) Net premiums earned $112.5 $116.0 $ 69.8 $ 73.4 $182.3 $189.4 Losses and loss adjustment expenses 83.5 82.5 45.1 39.7 128.6 122.2 Policy acquisition and other underwriting expenses 40.3 46.1 18.5 21.4 58.8 67.5 Policyholders' dividends 1.7 1.1 2.0 1.5 3.7 2.6 ------- ------- ------- ------- ------- ------- Underwriting (loss) profit $(13.0) $(13.7) $ 4.2 $ 10.8 $ (8.8) $ (2.9) ======= ======= ======= ======= ======= =======
Revenues Commercial lines of business net premiums earned decreased $7.1 million, to $182.3 million in the third quarter of 1996. Hanover's commercial lines of business net premiums earned decreased $3.5 million, to $112.5 million. This decrease is primarily attributable to a $4.3 million, or 15.7% decrease in earned premium in the workers' compensation line primarily resulting from rate decreases of 15.8% since January 1, 1995, in this line. Hanover's withdrawal from a large voluntary pool on December 1, 1995 also contributed to the decrease in net premiums earned. This was partially offset by a $2.1 million, or 8.4%, increase in earned premium, to $27.2 million in the commercial automobile line due to a 2.9% increase in policies in force. Citizens' commercial lines of business net premiums earned decreased $3.6 million, or 4.9%, to $69.8 million in the third quarter of 1996. This decrease was primarily attributable to rate decreases in the workers' compensation line at Citizens as a result of continuing competition in this line in Michigan. Rates in the workers' compensation line at Citizens were decreased 8.5%, 7.0% and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively. Continued competitive conditions in the workers' compensation line at both Hanover and Citizens may result in future price decreases that will impact growth in this line. In addition, Hanover's premium growth in the commercial lines of business may be impacted by continued competitive pricing as a result of soft market conditions combined with Hanover's effort to maintain its current underwriting standards. Page 17 Underwriting results The commercial lines of business underwriting loss increased $5.9 million, to a loss of $8.8 million in the third quarter of 1996. Hanover's underwriting loss improved $0.7 million, or 5.1%, to a loss of $13.0 million, while Citizens' underwriting profit decreased $6.6 million, to $4.2 million in the third quarter of 1996. Hanover's commercial lines of business losses and LAE increased $1.0 million, or 1.2%, to $83.5 million in the third quarter of 1996. This increase is primarily attributable to a $7.5 million increase, to $16.9 million, in losses and LAE in the workers' compensation line, reflecting a decrease in favorable claims experience on prior accident years. A $3.4 million increase in the commercial automobile line resulting from increased severity also contributed to the increase in losses and LAE. This was offset by decreased losses in the voluntary pools resulting from Hanover's withdrawal from a large voluntary pool on December 1, 1995. Citizens' underwriting profit decreased $6.6 million, to $4.2 million as a result of increased loss frequency in the commercial multiple peril and workers compensation lines. Catastrophe losses decreased $2.3 million to a benefit of $1.5 million. This benefit resulted from a favorable re-estimation of catastrophe losses which occurred in the first half of 1996. Losses and LAE in the commercial multiple peril line increased $2.9 million, or 31.5%, to $12.1 million and losses and LAE in the workers' compensation line increased $1.5 million, or 10.2%, to $16.2 million. Policy acquisition and other underwriting expenses in the commercial lines of business decreased $8.7 million, or 12.9%, to $58.8 million in the third quarter of 1996. Hanover's policy acquisition and other underwriting expenses decreased $5.8 million, or 12.6%, to $40.3 million, primarily attributable to a decrease in commissions and assessment expenses resulting from a reapportionment of an involuntary pool and the decrease in net earned premium. Citizens' policy acquisition and other underwriting expenses decreased $2.9 million, or 13.6%, to $18.5 million, resulting from decreases in net earned premium and decreases in employee related expenses and commissions. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 INCOME BEFORE TAXES Income before taxes for the nine months ended September 30, 1996 increased $4.6 million, or 2.9%, to $162.4 million, compared to the same period in 1995. The increase in income before taxes is primarily attributable to a $32.0 million increase in realized gains, primarily related to the sale of equity securities. This increase reflects the Company's decision during the first quarter of 1996 to increase the proportion of debt securities in the Regional Property and Casualty segment's portfolio. Excluding net realized gains, income before taxes decreased $27.4 million, to $116.5 million for the nine months ended September 30, 1996. Net income in the nine month period of 1996 was significantly impacted by catastrophes and other severe weather related losses. This resulted in a $58.1 million increase in losses and loss adjustment expenses to $1,020.6 million in the nine months ended September 30, 1996. Catastrophe losses in the nine months ended September 30, 1996 were $58.5 million, compared to $29.1 million in the comparable 1995 period. The increase in losses and LAE were partially offset by an increase in net investment income of $13.9 million, or 8.8%, to $171.6 million. This increase was partially a result of a change in estimated equity in earnings from a limited partnership of $6.7 million. Net investment income in the nine month period ended September 30, 1995 was unfavorably impacted by a $2.4 million charge related to the pre- refunding of municipal bonds. Net income during the nine month period ended September 30, 1996 was also favorably impacted by a $5.7 million arbitrated settlement from a voluntary pool during the third quarter of 1996. Page 18 LINES OF BUSINESS RESULTS Personal Lines of Business The personal lines of business represented 60.8% and 59.6% of total net premiums earned in the nine months ended September 30, 1996 and 1995, respectively.
Hanover Citizens Consolidated For the Nine Months Ended September 30, 1996 1995 1996 1995 1996 1995 (In millions) Net premiums earned $442.2 $429.7 $413.3 $399.1 $855.5 $828.8 Losses and loss adjustment expenses 321.2 279.1 308.1 304.4 629.3 583.5 Policy acquisition and other underwriting expenses 146.1 136.8 110.2 108.8 256.3 245.6 ------- ------- ------- ------- ------- ------- Underwriting (loss) profit $(25.1) $ 13.8 $ (5.0) $(14.1) $(30.1) $ (0.3) ======= ======= ======= ======= ======= =======
Revenues Personal lines of business net premiums earned for the nine months ended September 30, 1996 increased $26.7 million, or 3.2%, to $855.5 million, compared to $828.8 million in the same period of 1995. Hanover's personal lines of business net premiums earned increased $12.5 million, or 2.9%, to $442.2 million during the nine months ended September 30, 1996. This increase is primarily attributable to price increases in the homeowners line and a 1.6% increase in policies in force in the homeowners line along with a modest increase in policies in force in the personal automobile line. Citizens' personal lines of business net premiums earned increased $14.2 million, or 3.6%, to $413.3 million in the nine months ended September 30, 1996. This increase is primarily attributable to price increases in the personal automobile and homeowners lines. Citizens' increase is partially offset by a 2.5% decrease in policies in force in the personal automobile line since December 31, 1995, attributable to continued strong competition in Michigan. Underwriting results The personal lines of business underwriting loss for the nine months ended September 30, 1996 increased $29.8 million, to a loss of $30.1 million. Hanover's underwriting results deteriorated $38.9 million to a loss of $25.1 million, while Citizens' underwriting loss improved $9.1 million to a loss of $5.0 million. Hanover's personal lines of business losses and LAE increased $42.1 million, or 15.1%, to $321.2 million in the nine months ended September 30, 1996. This increase is primarily attributable to a $23.9 million increase in losses and LAE in the homeowners line, resulting from increased catastrophes and severe weather. Losses and LAE in the personal automobile line increased $14.3 million, or 6.8%, to $223.2 million reflecting primarily increased loss frequency. Catastrophe losses in the personal lines of business increased $15.6 million, to $25.9 million in the nine months ended September 30, 1996 from $10.3 million during the comparable 1995 period. Citizens' underwriting loss decreased primarily as a result of the increase in net premiums earned in the personal automobile line and homeowners line of $8.6 million and $4.5 million, respectively. Favorable claims experience on current and prior years resulted in a $17.7 million decrease in losses and LAE in the personal automobile line. This decrease was offset by a $20.9 million increase in losses and LAE in the homeowners line as a result of increases in catastrophes of $8.5 million in this line. Policy acquisition and other underwriting expenses in the personal lines of business increased $10.7 million, or 4.4%, to $256.3 million in the nine months ended September 30, 1996. This increase is primarily attributable to an increase of $9.3 million, or 6.8%, to $146.1 million at Hanover for the nine months ended September 30, 1996. This increase is due to increases in net earned premium, a $3.3 million increase in group business expenses and a $2.2 million increase in expenses Page 19 associated with the policy administration technology project. Policy acquisition and other underwriting expenses in the personal lines of business at Citizens increased $1.4 million, to $110.2 million for the nine months ended September 30, 1996. This increase is primarily attributable to increases in net earned premium and expenses associated with an ongoing policy administration technology project, partially offset by decreases in employee related expenses. Commercial Lines of Business The commercial lines of business represented 39.2% and 40.4% of total net premiums earned in the nine months ended September 30, 1996 and 1995, respectively.
Hanover Citizens Consolidated For the Nine Months Ended September 30, 1996 1995 1996 1995 1996 1995 (In millions) Net premiums earned $338.9 $353.6 $213.1 $208.6 $552.0 $562.2 Losses and loss adjustment expenses 238.3 252.0 153.0 127.0 391.3 379.0 Policy acquisition and other underwriting expenses 128.4 140.8 52.1 56.2 180.5 197.0 Policyholders' dividends 3.1 2.8 5.6 4.2 8.7 7.0 ------- ------- ------- ------- ------- ------- Underwriting (loss) profit $(30.9) $(42.0) $ 2.4 $ 21.2 $(28.5) $(20.8) ======= ======= ======= ======= ======= =======
Revenues Commercial lines of business net premiums earned for the nine months ended September 30, 1996 decreased $10.2 million, or 1.8%, to $552.0 million. Hanover's commercial lines of business net premiums earned decreased $14.7 million, or 4.2%, to $338.9 million. This decrease is primarily attributable to Hanover's withdrawal from a large voluntary pool on December 1, 1995, and to rate decreases of 15.8% since January 1, 1995, in the workers compensation line. Citizens' commercial lines of business net premiums earned increased $4.5 million, or 2.2%, to $213.1 million in the nine months ended September 30, 1996. The increase is primarily attributable to a 9.5% increase in policies in force in the commercial multiple peril line since December 31, 1995. This growth continues to be offset by rate reductions in the workers compensation line as a result of continuing competition in this line. Rates in the workers' compensation line at Citizens were decreased 8.5%, 7.0% and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively. Underwriting results The commercial lines of business underwriting loss for the nine months ended September 30, 1996 increased $7.7 million, or 37.0% to a loss of $28.5 million. Hanover's underwriting loss improved $11.1 million, or 26.4%, to a loss of $30.9 million and Citizens' underwriting profit decreased $18.8 million, to a profit of $2.4 million in the nine months ended September 30, 1996. Hanover's commercial lines of business losses and LAE decreased $13.7 million, or 5.4%, to $238.3 million in the nine months ended September 30, 1996. This improvement is primarily attributable to a decrease of $8.7 million in the commercial automobile line as a result of favorable claims experience on the current and prior years and an $23.1 million decrease in losses in LAE resulting from the withdrawal of a large voluntary pool. However, losses and LAE in the workers' compensation line increased $7.9 million, to $40.7 million, primarily due to an increase in claims severity and a decrease in favorable claims experience on prior accident years. Commercial multiple peril losses and LAE increased $4.3 million, to $114.9 million due to unfavorable claims experience on prior accident years and an increase in catastrophes from $5.8 million in 1995 to $11.3 million in 1996. Citizens' underwriting profit decreased primarily due to increased claims activity in the commercial multiple peril line, resulting from severe weather and catastrophe losses which adversely impacted this line. Commercial multiple peril losses Page 20 and LAE increased $15.4 million, or 53.1%, to $44.4 million in the nine months ended September 30, 1996. Catastrophe losses were $1.5 million in this lines of business during the nine months ended September 30, 1996 compared to $0.8 million in the comparable period of 1995. Policy acquisition and other underwriting expenses in the commercial lines of business decreased $16.5 million, or 8.4%, to $180.5 million in the nine months ended September 30, 1996. Hanover's policy acquisition expenses and other underwriting expenses decreased $12.4 million, or 8.8%, to $128.4 million, primarily attributable to the decrease in net earned premium and a decrease in commissions and assessment expenses resulting from the reapportionment of an involuntary pool. This was partially offset by a $1.4 million increase associated with the policy administration technology project. Citizens' policy acquisition and other underwriting expenses in the commercial lines of business decreased $4.1 million, or 7.3%, to $52.1 million, primarily attributable to decreases in employee related expenses, partially offset by the effect of increases in net earned premium. INVESTMENT RESULTS Net investment income before taxes increased $13.9 million, or 8.8%, to $171.6 million during the first nine months of 1996 compared to $157.7 million in the comparable period of 1995. This increase was partially as a result of a change in estimated equity in earnings from a limited partnership of $6.7 million. Net investment income in 1995 was adversely impacted by a $2.4 million charge related to the pre-refunding of municipal bond securities. Average yields on debt securities remained constant at 6.3% for both nine month periods. Net investment income after taxes increased $11.6 million, to $138.9 million, primarily attributable to the increase in tax-exempt debt securities. During the first quarter of 1996, the Regional Property and Casualty segment revised its investment strategy, resulting in the sale of a substantial portion of its equity portfolio and the purchase of tax-exempt securities. This is consistent with this segment's strategy of maximizing after-tax net investment income. As a result of the sale of equity securities, the Regional Property and Casualty segment had realized gains of $45.9 million during the nine months ended September 30, 1996, compared to realized gains of $13.9 million in 1995. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The Regional Property and Casualty segment maintains reserves to provide for its estimated ultimate liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given point in time, of what management expects the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claim severity and judicial theories of liability and other factors. The inherent uncertainty of estimating insurance reserves is greater for certain types of property and casualty insurance lines, particularly workers' compensation and other liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, where the technological, judicial and political climates involving these types of claims are changing. Page 21 The Regional Property and Casualty segment regularly updates its reserve estimates as new information becomes available and further events occur which may impact the resolution of unsettled claims. Changes in prior reserve estimates are reflected in results of operations in the year such changes are determined to be needed and recorded. The table below provides a reconciliation of the beginning and ending reserve for unpaid losses and LAE as follows:
For the nine months ended September 30, (In millions) 1996 1995 Reserve for losses and LAE, beginning of period $2,896.0 $2,821.7 Incurred losses and LAE, net of reinsurance recoverable: Provision for insured events of the current year 1,100.9 1,042.8 Decrease in provision for insured events of prior years (80.3) (80.4) --------- --------- Total incurred losses and LAE 1,020.6 962.4 --------- --------- Payments, net of reinsurance recoverable: Losses and LAE attributable to insured events of current year 516.0 428.0 Losses and LAE attributable to insured events of prior years 504.7 491.0 --------- --------- Total payments 1,020.7 919.0 --------- --------- Change in reinsurance recoverable on unpaid losses (35.6) 7.9 --------- --------- Reserve for losses and LAE, end of period $2,860.3 $2,873.0 ========= =========
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $80.3 million and $80.4 million for the nine month periods ended September 30, 1996 and 1995, respectively. Citizens' favorable development increased $9.6 million, to $26.0 million, primarily attributable to reduced medical costs in the personal automobile line. Favorable development at Hanover during the nine month period decreased $9.7 million, to $54.3 million, primarily attributable to unfavorable development in the commercial multiple peril lines. During the third quarter of 1996, Hanover's favorable development decreased $12.6 million, to $13.0 million, primarily attributable to decreased favorable development in the workers compensation and commercial multiple peril lines. Although Hanover is experiencing decreases in favorable development in the workers compensation and commercial multiple peril lines, Hanover continues to experience increased favorable development in the personal automobile and commercial automobile lines. The Company expects reduced favorable development at Hanover to continue to impact future earnings. The Regional Property and Casualty segment regularly reviews its reserving techniques, its overall reserving position and its reinsurance. Based on (i) review of historical data, legislative enactment, judicial decisions, legal developments in impositions of damages, changes in political attitudes and trends in general economic conditions, (ii) review of per claim information, (iii) historical loss experience of the Company and the industry, (iv) the relatively short-term nature of most policies, and (v) periodic estimates of required reserves by an independent actuarial consulting firm, 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. Page 22 Corporate Risk Management Services The following table summarizes the results of operations for the Corporate Risk Management Services ("CRMS") lines of business for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 Premiums and premium equivalents Premiums $ 75.7 $ 70.4 $224.6 $202.4 Premium equivalents 145.9 130.2 432.4 379.3 -------- -------- -------- -------- Total premiums and premium equivalents $221.6 $200.6 $657.0 $581.7 ======== ======== ======== ======== Revenues Premiums $ 75.7 $ 70.4 $224.6 $202.4 Net investment income 5.8 4.9 16.0 12.8 Net realized gains 0.1 0.2 0.2 0.5 Other income 9.1 6.5 26.3 20.1 -------- -------- -------- -------- Total revenues 90.7 82.0 267.1 235.8 Policy benefits, claims and losses 52.5 47.0 158.0 143.1 Policy acquisition expenses 0.8 0.7 2.3 2.0 Other operating expenses 33.7 29.2 95.6 80.8 -------- -------- -------- -------- Income before taxes $ 3.7 $ 5.1 $11.2 $ 9.9 ======== ======== ======== ========
Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995 Income before taxes decreased $1.4 million, or 27.5%, to $3.7 million in the third quarter of 1996 compared to the third quarter of 1995, primarily due to increases in other operating expenses, partially offset by growth in ASO fees. Premium growth in the Company's fully insured group dental, reinsurance and group life product lines was offset by unfavorable claims experience during the quarter. Premiums increased $5.3 million, or 7.5%, to $75.7 million in the third quarter of 1996, primarily due to increases in fully insured group dental, reinsurance and group life product lines totaling $6.6 million. These increases were partially offset by decreases of $1.2 million in full indemnity medical products. Net investment income increased $0.9 million, or 18.4% in the third quarter of 1996, primarily due to income earned on proceeds from the Company's October, 1995 initial public offering. Other income increased $2.6 million, or 40%, to $9.1 million in the third quarter of 1996, due primarily to growth in ASO contract fees. Policy benefits, claims and losses increased $5.5 million, or 11.7%, to $52.5 million in the third quarter of 1996 compared to the same period in 1995. This increase is principally attributable to premium growth, as noted above, and to unfavorable loss experience in the fully insured group dental, group life, full indemnity medical and accidental death and dismemberment products, partially offset by favorable loss experience in the risk sharing product lines. Other operating expenses increased $4.5 million, or 15.4%, to $33.7 million in the third quarter of 1996, primarily due to increases in commissions and claims processing expenses to cover growth in premiums and claims volume. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 Income before taxes increased $1.3 million, or 13.1%, to $11.2 million in the first nine months of 1996 compared to the same period in 1995. This increase is primarily attributable to premium growth in the Company's fully insured group dental, group life and reinsurance product lines, partially offset by increases in policy benefits and operating expenses. Premiums increased $22.2 million, or 11.0%, to $224.6 million in the first nine months of 1996, primarily due to increases in fully insured group dental, group life, reinsurance and stop loss product lines totaling $21.8 million. These increases were partially offset by a decrease of $1.7 million in fully insured medical premiums. Page 23 Net investment income increased $3.2 million, or 25.0%, to $16.0 million in the first nine months of 1996, due to growth in invested assets, and to income earned on proceeds from the Company's October, 1995 initial public offering. Other income increased $6.2 million, or 30.8%, to $26.3 million in the first nine months of 1996, due primarily to growth in fees from ASO contracts. Policy benefits, claims and losses increased $14.9 million, or 10.4%, to $158.0 million in the first nine months of 1996 compared to the same period in 1995. This increase is principally related to increased premium growth. Unfavorable loss experience in the fully insured group dental, reinsurance, fully insured medical and accidental death and dismemberment product lines was offset by favorable experience in the group life, stop loss and risk sharing product lines. Other operating expenses increased $14.8 million, or 18.3%, to $95.6 million for the nine months ended September 30, 1996, due primarily to increases in commissions, claims processing expenses and field office expenses, resulting from the increased volume of both premiums and claims. Retirement and Asset Management Retail Financial Services The following table summarizes the results of operations for the Retail Financial Services lines of business for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 Revenues Premiums $ 19.2 $ 17.5 $ 77.2 $81.7 Fees 45.9 39.5 132.8 116.5 Net investment income 65.6 57.5 188.8 168.4 Net realized gains (losses) (4.5) 3.3 (4.7) 1.4 Other income 7.6 5.2 21.2 15.3 ------- ------- ------- ------- Total revenues 133.8 123.0 415.3 383.3 Policy benefits, claims and losses 69.5 73.5 230.1 233.4 Policy acquisition expenses 13.7 12.4 42.7 43.4 Other operating expenses 31.7 25.2 88.5 78.8 ------- ------- ------- ------- Income before taxes $ 18.9 $ 11.9 $ 54.0 $ 27.7 ======= ======= ======= =======
Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995 Income before taxes increased $7.0 million, or 58.8%, to $18.9 million in the third quarter of 1996 compared to the third quarter of 1995. This increase was primarily attributable to growth in variable products' fee revenue, income earned on the proceeds from the October, 1995 initial public offerings and a decrease in policy benefits. These increases were partially offset by realized losses on sales of investments and increased short-term borrowing costs. Premiums increased $1.7 million, or 9.7%, to $19.2 million, during the third quarter of 1996. This increase was primarily due to a $1.3 million increase in the disability income product line resulting from the timing of reinsurance contracts in 1995. The increase in fee revenue of $6.4 million, or 16.2%, to $45.9 million in the third quarter of 1996 is due to additional deposits and appreciation on variable products' account balances. Fees from annuities increased $4.1 million, or 40.2%, to $14.3 million in the third quarter of 1996. Fees from variable universal life policies increased $2.5 million, or 28.1%, to $11.4 million for the third quarter of 1996 Net investment income increased $8.1 million, or 14.1%, to $65.6 million in the third quarter of 1996 compared to the third quarter of 1995 resulting primarily from $5.2 million in income earned on proceeds from the Company's October, 1995 initial public offerings. Additionally, increases in repurchase agreements used to finance additions to the investment portfolio have resulted in increased investment income. Net realized gains of $3.3 million for the quarter ended September 30, 1995 decreased $7.8 million to net realized losses of $4.5 million for the quarter ended September 30, 1996. This change is principally related to $3.5 million of losses on Page 24 disposals of fixed maturities during the third quarter of 1996 versus $3.3 million of gains on disposals of fixed maturities for the third quarter of 1995, due to less favorable market interest rate conditions in the third quarter of 1996. Policy benefits, claims, and losses decreased $4.0 million, or 5.4%, to $69.5 million in the third quarter of 1996 compared to the same period in 1995. This resulted primarily from $2.8 million of reserve strengthening in the disability insurance line in 1995 and improved morbidity experience in this line during 1996. Other operating expenses increased $6.5 million, or 25.8%, to $31.7 million for the quarter ended September 30, 1996. This increase was primarily attributable to $4.7 million of additional interest expense in 1996 relating to short-term debt. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 Income before taxes increased $26.3 million, or 94.9%, to $54.0 million in the first nine months of 1996 compared to the same period in 1995. This increase was primarily attributable to growth in variable products' fee revenue, income earned on the proceeds from the October, 1995 initial public offerings and income on pre-invested assets, partially offset by increased short-term borrowing costs. The decrease in premiums of $4.5 million, or 5.5%, to $77.2 million in the first nine months of 1996 is primarily due to the Company's shift in focus from traditional life insurance products to variable life insurance and annuity products. Premiums from traditional life products decreased $3.9 million, or 7.0%, to $51.6 million in the first nine months of 1996. Premiums from individual health products decreased $0.8 million, or 3.1%, to $25.4 million in 1996. The increase in fee revenue of $16.3 million, or 14.0%, to $132.8 million in the first nine months of 1996 is due to additional deposits and appreciation on variable products account balances. Fees from annuities increased $14.2 million, or 55.3%, to $39.9 million in 1996. Fees from variable universal life policies increased $5.9 million, or 22.8%, to $31.8 million in the first nine months of 1996. These increases were partially offset by a continued decline in fees from non-variable universal life of $3.8 million. The Company expects fees on this product to decrease as policies in force and related contract values decline. Net investment income increased $20.4 million, or 12.1%, to $188.8 million in the first nine months of 1996 primarily from $13.6 million in income earned on proceeds from the Company's October, 1995 initial public offerings. Additionally, increases in repurchase agreements used to finance additions to the investment portfolio have resulted in a significant increase in investment income. Policy benefits, claims, and losses decreased $3.3 million, or 1.4%, to $230.1 million in the first nine months of 1996 compared to the same period in 1995. Decreases in individual health and non-variable universal life of $4.5 million and $3.5 million, respectively, resulted from improved morbidity and mortality experience in 1996. These decreases were partially offset by an increase in variable products' policy benefits of $3.0 million, which related primarily to growth in these product lines. Other operating expenses increased $9.7 million, or 12.3%, to $88.5 million for the nine months ended September 30, 1996. This increase was primarily attributable to $9.0 million of additional interest expense in 1996 relating to short-term debt. Page 25 Institutional Services The following table summarizes the results of operations for the Institutional Services segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended (In millions) September 30, September 30, 1996 1995 1996 1995 Revenues Fees, premiums, non-insurance and other income $6.4 $6.3 $23.6 $31.0 Net investment income GICs 22.5 36.3 76.2 118.7 Other 29.5 29.2 86.3 85.1 Net realized gains 5.4 4.5 12.5 8.3 Gain on sale of mutual fund processing business 0.0 0.0 0.0 20.7 ----- ----- ----- ----- Total revenues 63.8 76.3 198.6 263.8 Policy benefits, claims and losses GICs 20.3 33.2 71.0 107.8 Other 17.6 19.9 52.4 60.5 Policy acquisition expenses 0.7 0.7 2.1 2.3 Other operating expenses 12.5 13.5 34.8 53.2 ----- ----- ----- ----- Income before taxes $12.7 $9.0 $38.3 $40.0 ===== ===== ===== ===== Fees, premiums and non-insurance income includes fees from retirement services, mutual fund services, institutional 401(K) recordkeeping services, and other miscellaneous non-insurance related fees. In March 1995, the Company sold its mutual fund processing business.
Quarter Ended September 30, 1996 compared to Quarter Ended September 30, 1995 Income before taxes increased $3.7 million, or 41.1%, to $12.7 million for the third quarter of 1996 compared to the third quarter of 1995. This increase was primarily attributable to a decline in other policy benefits, claims and losses of $2.3 million as a result of cancellations of defined benefit and defined contribution plans. Additionally, a decrease of $1.0 million in other operating expenses resulted from exiting certain unprofitable businesses in 1995. An increase in realized investment gains of $0.9 million was offset by a decline in the interest margins on GICs of $0.9 million, due to declining GIC deposits. Net investment income related to GICs and interest credited to GIC contractholders have declined as a result of declining GIC deposits due to the downgrading in March 1995 of FAFLIC's S&P Rating to A+ (Good). As a result, sales of traditional GICs have substantially ceased. Management expects GIC deposits and related income to continue to decline. Net realized gains increased $0.9 million, to $5.4 million in the third quarter of 1996 primarily due to increased gains on the sale of real estate investments of $7.2 million, partially offset by additional losses of $4.5 million on sales of fixed maturity investments and to increased mortgage loan impairments of $2.0 million. Other policy benefits, claims and losses consist primarily of benefits provided by the Company's defined contribution and defined benefit plans, including annuity benefits for certain defined benefit plan participants electing that option. Other policy benefits, claims and losses decreased $2.3 million, or 11.6%, to $17.6 million for the third quarter of 1996, primarily due to reductions in interest credited to participants resulting from the aforementioned cancellations. Other operating expenses decreased $1.0 million, or 7.4%, to $12.5 million for the third quarter of 1996. This decrease was primarily attributable to exiting certain unprofitable recordkeeping businesses in 1995. Nine Months Ended September 30, 1996 Compared to Nine Months Ended September 30, 1995 Income before taxes decreased $1.7 million, or 4.3%, to $38.3 million for the nine months ended September 30, 1996 compared to the nine months ended September 30, 1995. This decrease was primarily attributable to the sale of the Company's mutual fund processing business in March 1995, resulting in a pre-tax gain of $20.7 million, partially offset by a pre-tax operating loss from that business of $4.8 million for the first nine months of 1995. Also, a non-recurring $4.8 million contingent payment related to the sale was received in 1996 and included in other income. Additionally, other policy benefits, claims and losses declined $8.1 million as a result of defined benefit and defined contribution plan cancellations and favorable mortality experience in the group annuity line. A decline in the interest margins on GICs of $5.7 million, due to declining GIC deposits was partially offset by an increase in realized investment gains of $4.2 million. Page 26 Fees, premiums, non-insurance and other income decreased $7.4 million, or 23.9%, to $23.6 million in the first nine months of 1996. This decrease was primarily attributable to a $13.6 million decrease in revenues from the mutual fund processing business, partially offset by the 1996 receipt of a non-recurring $4.8 million contingent payment related to the sale. Additionally, fee income increased $1.3 million from the appreciation of separate account balances in related defined benefit and defined contribution plans. Net investment income related to GICs and interest credited to GIC contractholders have declined during the first nine months of 1996 as a result of the aforementioned discontinuation of sales of traditional GICs. Other net investment income increased $1.2 million in the first nine months of 1996, primarily due to income earned on proceeds from the Company's October, 1995 initial public offering. Net realized gains increased $4.2 million, to $12.5 million in the first nine months of 1996. This change resulted primarily from increased gains from sales of real estate properties of $9.8 million, as well as decreases in impairments of other invested assets totaling $0.6 million. These increases were partially offset by losses on sales of bonds of $7.2 million. Other policy benefits, claims and losses consist primarily of benefits provided by the Company's defined contribution and defined benefit plans, including annuity benefits for certain defined benefit plan participants electing that option. Other policy benefits, claims and losses for defined benefit and defined contribution plans declined from $60.5 million in 1995 to $52.4 million in 1996. This was primarily due to reductions in the interest credited to participants resulting from the aforementioned cancellations, and to favorable mortality experience in the group annuity line. Other operating expenses decreased $18.6 million, or 35.0%, to $34.8 million in the first nine months of 1996. This decrease was primarily attributable to the sale of the mutual fund processing business, which incurred $18.4 million of operating expenses in the first nine months of 1995. Allmerica Asset Management The following table summarizes the results of operations for the Allmerica Asset Management segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 Fees and other income: External $0.3 $0.3 $0.8 $0.7 Internal 1.4 0.9 5.4 2.6 ----- ----- ----- ----- Total revenues 1.7 1.2 6.2 3.3 Other operating expenses 1.7 0.6 5.7 1.6 ----- ----- ----- ----- Income before taxes $0.0 $0.6 $0.5 $1.7 ===== ===== ===== =====
Since 1994, the Company has provided investment advisory and subadvisory services, primarily to affiliates, through its registered investment advisor, Allmerica Asset Management ("AAM"). In the second quarter of 1996, AAM finalized contracts with two related parties, FAFLIC and AFLIAC, to provide investment advisory services at cost. The internal fees and corresponding operating expenses related to these contracts totaled $0.7 million for the quarter ended, and $3.0 million for the nine months ended, September 30, 1996, respectively. Page 27 Corporate The following table summarizes the results of operations for the Corporate segment for the periods indicated.
(Unaudited) (Unaudited) Quarter Ended Nine Months Ended September 30, September 30, (In millions) 1996 1995 1996 1995 Revenues Investment and other income $0.7 $0.0 $2.2 $0.0 Realized loss (0.2) 0.0 (0.4) 0.0 ----- ----- ----- ----- Total revenues 0.5 0.0 1.8 0.0 Other operating expenses 4.5 0.0 14.0 0.0 ----- ----- ------ ----- Loss before taxes $(4.0) $0.0 $(12.2) $0.0 ===== ===== ====== =====
This segment consists primarily of $43.6 million of cash, investments, and other assets remaining from the $52.9 million in net proceeds retained by the holding company in the Company's initial public offering. These investments earned $2.2 million in net investment income in the first nine months of 1996. The segment incurred $14.0 million of other operating expenses in 1996 primarily including $11.4 million in interest expense on the Company's 7 5/8% Senior Debentures issued in October 1995. Investment Portfolio The Company had investment assets diversified across several asset classes, as follows:
September 30, 1996 December 31, 1995 Carrying % of Total Carrying % of Total Value Carrying Value Value Carrying Value (Dollars in millions) Fixed maturities $8,181.6 80.4% $8,197.3 78.1% Equity securities 438.0 4.3 517.2 4.9 Mortgages 768.3 7.5 856.5 8.2 Policy loans 364.2 3.6 365.7 3.5 Real estate 145.4 1.4 179.6 1.7 Cash and cash equivalents 170.6 1.7 307.1 2.9 Other invested assets 111.4 1.1 71.9 0.7 ---------- -------- ---------- -------- Total $10,179.5 100.0% $10,495.3 100.0% =========== ======== ========== ========= Includes Closed Block invested assets with a carrying value of $768.1 million and $775.1 million at September 30, 1996 and December 31, 1995, respectively. The Company carries the fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets decreased $315.8 million, or 3.0%, to $10.2 billion during the first nine months of 1996. This decrease is primarily attributable to a decline in invested assets related to GIC contracts, and to market value depreciation in the fixed maturities portfolio, partially offset by increased investments financed with repurchase agreements. Equity securities decreased $79.2 million, or 15.3%, to $438.0 million, as a result of the Regional Property and Casualty segment's shift in portfolio holdings from equity securities to tax-exempt fixed maturity securities. Despite this portfolio shift and an increase in fixed maturities financed with repurchase agreements in 1996, fixed maturities decreased $15.7 million, or 0.2%, due primarily to market value depreciation of $185.7 million and to financing of net GIC withdrawals. Additionally, mortgage loans decreased $88.2 million, or 10.3%, to $768.3 million caused primarily by loan repayments. The real estate portfolio decreased $34.2 million, or 19.0%, to $145.4 million during the first nine months of 1996 due to sales of these properties. The increase in other invested assets of $39.5 million, or 54.9% to $111.4 million primarily relates to the third quarter purchase of limited partnerships by FAFLIC. Cash and cash equivalents decreased $136.5 million, or 44.4%, to $170.6 million. The Company's fixed maturity portfolio is comprised of primarily investment grade corporate securities, tax-exempt issues of state and local governments, U.S. government and agency securities and other issues. Investment grade securities comprised 85.4% and 88.7% of the Company's total fixed maturity portfolio at September 30, 1996 and December 31, 1995, respectively. Although management expects that a substantial portion of new funds will be invested in investment grade fixed maturities, the Company may invest a portion of new funds in below investment grade fixed maturities or equity interests, which management anticipates will not become a significant portion of its total investment portfolio. Page 28 The following table illustrates asset valuation allowances and additions to or deductions from such allowances for the periods indicated.
Other Invested (Dollars in millions) Mortgages Real Estate Assets Total Year Ended December 31, 1995 Beginning balance $47.2 $22.9 $3.7 $73.8 Provision (benefits) 1.5 (0.6) 0.0 0.9 Write-offs (14.9) (2.7) 0.0 (17.6) -------- -------- -------- -------- Ending balance $33.8 $19.6 $3.7 $57.1 Valuation allowance as a percentage of carrying value before reserves 3.8 % 9.8 % 4.9 % 4.9 % Nine months ended September 30, 1996 Provision (benefits) 2.4 (1.2) 0.0 1.2 Write-offs (4.9) 0.0 0.0 (4.9) -------- -------- -------- -------- Ending balance $31.3 $18.4 $3.7 $53.4 Valuation allowance as a percentage of carrying value before reserves 3.9 % 11.2 % 3.2 % 5.0 % Write-offs reflect asset sales, foreclosures and forgiveness of debt upon restructuring.
The decrease in write-offs of mortgages during 1996 as compared to 1995 reflects a decrease in foreclosures, debt restructuring agreements and discounted payoffs, as well as the improved real estate market. Income Taxes AFC and its life insurance subsidiaries (including certain noninsurance 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 nonlife insurance company subgroup. The consolidation of these subgroups is subject to certain statutory restrictions on the percentage of eligible nonlife tax losses that can be applied to offset life company taxable income. Allmerica P&C and its subsidiaries file a separate United States federal income tax return. For the nine months ended September 30, 1995, FAFLIC, as a mutual insurance company until October 1995, was required to adjust its deduction for policyholder dividends by the differential earnings amount under Section 809 of the Internal Revenue Code. This amount was computed, for each tax year, by multiplying the average equity base of the FAFLIC/AFLIAC consolidated group, as determined for tax purposes, by the estimate of an excess of an imputed earnings rate over the average mutual life insurance companies' earnings rate. The differential earnings amount for each tax year was subsequently recomputed when actual earnings rates were published by the IRS. As a stock company, AFC, including its life insurance subsidiaries, is no longer required to reduce its policyholder dividend deduction by the differential earnings amount. The differential earnings amount in the current period related to an adjustment for the 1994 tax year based on the actual average mutual life insurance companies' earnings estimated rate issued by the IRS in 1996. Provision for federal income taxes before minority interest was $21.2 million during the third quarter of 1996 compared to $32.8 million during the same period in 1995. These provisions resulted in consolidated effective federal tax rates of 23.8% and 36.6%, respectively. The effective tax rates for AFLIAC and FAFLIC and its non-insurance subsidiaries were 28.4% and 63.4% during the third quarter of 1996 and 1995, respectively. The effective tax rates for the Regional Property and Casualty subsidiaries were 21.3% and 25.3% during the third quarter of 1996 and 1995, respectively. The reduction in the rate for FAFLIC resulted primarily from a differential earnings benefit of $2.4 million during the third quarter of 1996 compared to a differential earnings charge of $6.4 million for the same period in 1995. The slight decrease in the rate for the Regional Property and Casualty subsidiaries reflects a higher underwriting loss and a greater proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves provided for revisions in estimated prior tax liabilities in the third quarter of 1995. Provision for federal income taxes before minority interest was $58.0 million during the first nine months of 1996 compared to $75.2 million during the same period in 1995. These provisions resulted in consolidated effective federal tax rates of 22.8% and 31.8%, respectively. The effective tax rates for AFLIAC and FAFLIC and its non-insurance subsidiaries were 27.9% and 50.8% during the first nine months of 1996 and 1995, respectively. The effective tax rates for the Regional Property and Casualty subsidiaries were 20.0% and 22.2% during the first nine months of 1996 and 1995, respectively. The reduction in the rate for FAFLIC resulted primarily from a differential earnings benefit of $8.3 million in the first nine months of 1996 Page 29 compared to a differential earnings charge of $7.7 million in the first nine months of 1995. The slight decrease in the rate for the Regional Property and Casualty subsidiaries reflects a higher underwriting loss and a greater proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves provided for revision in estimated prior tax liabilities in the first nine months of 1995. 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. Sources of cash for the Company's insurance subsidiaries are from premiums and fees collected, investment income and maturing investments. Primary cash outflows are paid benefits, claims losses and loss adjustment expenses, policy acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to benefits, claim 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 $145.2 million and $179.7 million for the first nine months of 1996 and 1995, respectively. This decrease is primarily attributable to the increase in underwriting losses in the Regional Property and Casualty lines of business during the first nine months of 1996 which resulted in an increase in claims payments. Net cash provided by investing activities was $24.6 million and $11.9 million during the first nine months of 1996 and 1995, respectively. The increase is primarily attributable to increased sales of investments used to finance net withdrawals from GICs and increased investments from maintaining a smaller balance of cash and cash equivalents. These changes were offset by delayed sales of investments financed instead with repurchase agreements and a decline in investable cash generated by operations. Net cash used for financing activities was $306.3 million during the nine months ended September 30, 1996 compared to $430.3 used during the comparable prior year period. This change is due to increases in short-term debt partially offset by the continued negative financing cash flows from GIC withdrawals. During 1996, the Company increased its short-term debt in order to finance additions to the investment portfolio and maximize investment earnings. These inflows were partially offset by cash payments on withdrawals from GICs that exceeded cash received from deposits on these contracts by $548.8 million and $407.7 million in the first nine months of 1996 and 1995, respectively. Although the Company expects this trend in negative financing cash flows from GIC withdrawals to continue, particularly in 1996, the Company does not expect GIC withdrawals to have a material impact on liquidity. Also, cash used to purchase subsidiary common stock increased $28.9 million, to $42.0 million during the first nine months of 1996. On October 16, 1995, FAFLIC converted from a policyholder owned to stockholder owned insurance company and AFC became the holding company for FAFLIC. AFC also raised net proceeds of $248.0 million from the sale of Common Stock and issued $200.0 million principal amount 7 5/8% Senior Debentures due 2025 with net proceeds to the Company of $197.2 million. The Company will also pay approximately $15.3 million per year in interest payments on the Senior Debentures. AFC has sufficient funds at the holding company or available through dividends from FAFLIC to meet its obligations to pay interest on the Senior Debentures 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 costs of administering a dividend program as compared to the benefits conferred, and upon the earnings and financial condition of AFC. Based on current trends, the Company expects to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements. The Company maintains a high degree of liquidity within the investment portfolio in fixed maturity investments, common stock and short-term investments. FAFLIC and Allmerica P&C have $100.0 million and $40.0 million available, respectively, under various committed short-term lines of credit, with no amounts outstanding at September 30, 1996. FAFLIC and Allmerica P&C had $55.0 million and $21.7 million, respectively, of commercial paper borrowings outstanding at September 30, 1996. In addition, FAFLIC and AFLIAC had $186.2 million and $63.2 million, respectively, of repurchase agreements outstanding at September 30, 1996 down from $235.6 million and $171.4 million, respectively, at June 30, 1996. The repurchase agreements were used to finance the purchase of investments and are expected to be substantially repaid by the end of the year. The Company, at its option, could liquidate these investments at any time and settle the repurchase agreements. Page 30 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 1996 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. When used in the MD&A discussion, the words "believes," "anticipated," "expects" and similar expressions are intended to identify forward looking statements. See "Important Factors Regarding Forward-Looking Statements" filed herewith as Exhibit 99-1 and incorporated herein by reference. Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward looking statements include among others, the following possibilities: (i) adverse catastrophe experience and severe weather; (ii) adverse loss development for events the Company insured in prior years or adverse trends in mortality and morbidity; (iii) heightened competition, including the intensification of price competition, the entry of new competitors, and the introduction of new products by new and existing competitors; (iv) adverse state and federal legislation, including decreases in rates, limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates, and limitations on the ability to manage care and utilization; (v) changes in interest rates causing a reduction of investment income and in the market value of interest rate sensitive investments; (vi) failure to obtain new customers, retain existing customers or reductions in policies in force by existing customers; (vii) higher service, administrative, or general expense due to the need for additional advertising, marketing, administrative or management information systems expenditures; (viii) loss or retirement of key executives; (ix) increases in medical costs, including increases in utilization, costs of medical services, pharmaceuticals, durable medical equipment and other covered items; (x) termination of provider contracts or renegotiation at less cost-effective rates or terms of payment; (xi) changes in the Company's liquidity due to changes in asset and liability matching; (xii) adverse changes in the ratings obtained by independent rating agencies, such as Moody's, Standard and Poors and A.M. Best; (xiii) lower appreciation on managed investments, resulting in reduced variable products' and investment management fees. Page 31 PART II - OTHER INFORMATION ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K (a) Exhibits EX-11 Statement regarding computation of per share earnings EX-27 Financial Data Schedule EX-99-1 Important Factors Regarding Forward-Looking Statements (b) Reports on Form 8K None. Page 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Allmerica Financial Corporation Registrant Dated November 13, 1996 /s/ John F. O'Brien John F. O'Brien President and Chief Executive Officer Dated November 13, 1996 /s/ Edward J. Parry III Edward J. Parry III Vice President, Treasurer and Principal Accounting Officer Page 33 EX-11 2 Exhibit 11 ALLMERICA FINANCIAL CORPORATION STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS For the Period Ended September 30, 1996 (Unaudited)
Three Months Ended Nine MonthsEnded September 30, September 30, 1996 1996 Primary: Average shares outstanding 50.1 50.1 Net effect of dilutive stock options based on the treasury stock method using average market price - - ----- ----- TOTALS 50.1 50.1 ===== ===== Net income $ 46.7 $ 136.6 Per share amount $ 0.93 $ 2.72 Fully diluted: Average shares outstanding 50.1 50.1 Net effect of dilutive stock options based on the treasury stock method using the higher of period end or average market price - - ----- ----- TOTALS 50.1 50.1 ===== ===== Net income $ 46.7 $ 136.6 Per share amount $ 0.93 $ 2.72 The weighted average incremental options used to calculate primary earnings per share were 251 and 13,817 for the quarter and nine months ended September 30, 1996. The weighted average incremental options used to calculate fully diluted earnings per share were 3,305 and 22,416 for the quarter and nine months ended September 30, 1996.
EX-27 3
7 This schedule contains summary financial information extracted from the interim consolidated balance sheet and income statement of Allmerica Financial Corporation as of September 30, 1996 and for the period then ended, and is qualified in its entirety by reference to such financial statements. 1,000,000 9-MOS DEC-31-1996 SEP-30-1996 7731 0 0 438 690 145 9247 164 969 816 18729 2628 848 3058 2142 528 0 0 1 1632 18729 1658 502 53 222 1461 358 362 254 58 196 0 0 0 137 2.72 2.72 2896 1101 (80) 516 505 2860 (36)
EX-99 4 Allmerica Financial Corporation Exhibit 99.1 IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS The Company wishes to caution readers that the following important factors, among others, in some cases have affected the Company's results and in the future could cause actual results and needs of the Company to vary materially from forward-looking statements made from time to time by the Company on the basis of management's then-current expectations. The businesses in which the Company is engaged are in rapidly changing and competitive markets and involve a high degree of risk, and accuracy with respect to forward-looking projections is difficult. Geographic Concentration in the Property and Casualty Insurance Business Substantially all of the Company's property and casualty insurance subsidiaries net premiums written and earnings are generated in Michigan and the Northeast (Connecticut, Massachusetts, New York, New Jersey, New Hampshire, Rhode Island, Vermont and Maine). The revenues and profitability of the Company's property and casualty insurance subsidiaries are therefore subject to prevailing economic, regulatory, demographic and other conditions, including adverse weather, in Michigan and the Northeast. Cyclicality in the Property and Casualty Insurance Industry Historically, the property and casualty insurance industry has been highly cyclical. The property and casualty industry's profitability can be affected significantly by price competition, volatile and unpredictable developments such as extreme weather conditions and natural disasters, legal developments affecting insurer liability and the size of jury awards, fluctuations in interest rates and other factors that affect investment returns and other general economic conditions and trends that may affect the adequacy of reserves. Over the past several years, the property and casualty insurance industry as a whole has been in a soft market. Competition for premiums in the property and casualty insurance markets may continue to have an adverse impact on the Company's rates and profitability. Catastrophe Losses in the Property and Casualty Insurance Industry Property and casualty insurers are subject to claims arising out of catastrophes, which may have a significant impact on their results of operations and financial condition. The Company may experience catastrophe losses in the future which could have a material adverse impact on the Company. Catastrophes can be caused by various events including hurricanes, earthquakes, tornadoes, wind, hail, fires, severe winter weather and explosions, and the frequency and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of two factors: the total amount of insured exposure in the area affected by the event and the severity of the event. Although catastrophes can cause losses in a variety of property and casualty lines, homeowners and commercial property insurance have in the past generated the vast majority of the Company's catastrophe-related claims. The Company purchases catastrophe reinsurance as protection against catastrophe losses. The Company believes, based upon its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, that the financial condition of its reinsurers is sound. However, there can be no assurance that reinsurance will be adequate to protect the Company against such losses or that such reinsurance will continue to be available to the Company in the future at commercially reasonable rates. Uncertainty Regarding Adequacy of Property and Casualty Loss Reserves The Company's property and casualty insurance subsidiaries maintain reserves to cover their estimated ultimate liability for losses and loss adjustment expenses ("LAE") with respect to reported and unreported claims incurred as of the end of each accounting period. These reserves are estimates, involving actuarial projections at a given time, of what the Company's property and casualty insurance subsidiaries expect the ultimate settlement and administration of claims will cost based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and judicial theories of liability, legislative activity and other factors. The inherent uncertainties of estimating reserves are greater for certain types of property and casualty insurance lines, particularly workers' compensation, where a longer period of time may elapse before a definitive determination of ultimate liability may be made, and environmental liability, where the technological, judicial and political climates involving these types of claims are changing. The company's property and casualty insurance subsidiaries regularly review reserving techniques, reinsurance and overall reserve adequacy. Based upon (i) review of historical data, legislative enactments, judicial decisions, legal developments in imposition of damages, changes in political attitudes and trends in general economic conditions; (ii) review of per claim information; (iii) historical loss experience of the property and casualty insurance subsidiaries and the industry; and (iv) the relatively short-term nature of most of its property and casualty insurance policies, management believes that adequate provision has been made for reserves. However, establishment of appropriate reserves is an inherently uncertain process involving estimates of future losses and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. The Company's property and casualty insurance subsidiaries' reserves are annually certified as required by insurance regulatory authorities. Sensitivity to Interest Rates Relative to Life Insurance Subsidiaries The Company's life insurance subsidiaries are exposed to risk of disintermediation and reduction in interest spread or profit margins when interest rates fluctuate. Bond calls, mortgage prepayments, contract surrenders and withdrawals of life insurance policies, annuities and guaranteed investment contracts are influenced by the interest rate environment. Since the Company's life insurance subsidiaries' investment portfolios consist primarily of fixed income assets, the investment portfolio market value and the yields on newly invested and reinvested assets vary depending on interest rates. Management attempts to mitigate any negative impact of interest rate changes through asset/liability management, product design (including an increased focus on variable insurance products), management of crediting rates, use of hedging techniques, relatively high surrender charges and management of mortality charges and dividend scales with respect to its in force life insurance policies. Regulatory, Surplus, Capital, Rating Agency and Related Matters Insurance companies are subject to supervision and regulation by the state insurance authority in each state in which they transact business. Such supervision and regulation relate to numerous aspects of an insurance company's business and financial condition, including limitations on the authorization of lines of business, underwriting limitations, the setting of premium rates, the establishment of standards of solvency, the licensing of insurers and agents, concentration of investments, levels of reserves, the payment of dividends, transactions with affiliates, changes of control and the approval of policy forms. Such regulation is concerned primarily with the protection of policyholders. State regulatory oversight and various proposals at the federal level (including the proposed adoption of a federal regulatory framework for insurance companies) may in the future adversely affect the Company's ability to sustain adequate returns in certain lines of business. In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems. Further, the National Association of Insurance Commissioner ("NAIC") and state insurance regulators are reexamining existing laws and regulations, and as a condition to accreditation have required the adoption of certain model laws which specifically focus on insurance company investments, issues relating to the solvency of insurance companies, risk-based capital ("RBC") guidelines, interpretations of existing laws, the development of new laws, and the definition of extraordinary dividends. The capacity for an insurance company's growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by state insurance regulators, is considered important by state insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by the private rating agencies. The NAIC has created a new system for assessing the adequacy of statutory capital for life and health insurers and property and casualty insurers. The new system, known as risk-based capital, is in addition to the states' fixed dollar minimum capital and other requirements. The new system is based on risk- based formulas (separately defined for life and health insurers and property and casualty insurers) that apply prescribed factors to the various risk elements in an insurer's business to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. Because the investment of First Allmerica Financial Life Insurance Company ("FAFLIC"), a life insurance subsidiary of the Company, in Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C") represents a significant percentage of FAFLIC's surplus, the trading price of the common stock of Allmerica P&C will affect FAFLIC's RBC calculations and may affect the FAFLIC's claims-paying ability and financial strength ratings. There can be no assurance that capital requirements applicable to the FAFLIC's businesses will not increase or that the FAFLIC will be able to meet minimum RBC requirements in the future. In addition, in March 1995, S&P lowered its claims-paying ability ratings of FAFLIC and Allmerica Financial Life Insurance and Annuity Company to A+ (Good), and Moody's reduced FAFLIC's Financial Strength Rating From Aa3 (Excellent) to A1 (Good). Management believes that its strong ratings are important factors in marketing the products of its insurance companies to its agents and customers, since rating information is broadly disseminated and generally used throughout the industry. Insurance company ratings are assigned to an insurer based upon factors relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. Further downgrades may have a material adverse effect on the Company's business and prospects. State Guaranty Funds, Shared Markets Mechanisms and Pooling Arrangements All fifty states of the United States have insurance guaranty fund laws requiring all life and health and property and casualty insurance companies doing business within the state to participate in guaranty associations, which are organized to pay contractual obligations under insurance policies issued by impaired or insolvent insurance companies. These associations levy assessments (up to prescribed limits) on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired or insolvent insurer is engaged. Mandatory assessments by state guaranty funds are used to cover losses to policyholders of insolvent or rehabilitated companies and can be partially recovered through a reduction in future premium taxes in many states. These assessments may increase in the future depending upon the rate of insolvencies of insurance companies. In addition, as a condition to the ability to conduct business in various states, the Company's property and casualty insurance subsidiaries are required to participate in mandatory property and casualty shared market mechanisms or pooling arrangements, which provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage voluntarily provided by private insurers. The Company cannot predict whether its participation in these shared market mechanisms or pooling arrangements will provide underwriting profits or losses to the Company. Competition The Company's business is composed of four principal segments: Property and Casualty Insurance, Corporate Risk Management Services, Retail Financial Services, and Institutional Services. Each of these industry segments in general is highly competitive. The Company's products and services compete not only with those offered by insurance companies but also with products offered by other financial institutions and health maintenance organizations. In all of its segments, many of the Company's competitors are larger and have greater financial, technical and operating resources than those of the Company. In addition, the Company may face additional competition from banks and other financial institutions should current regulatory restrictions on the sale of insurance and securities by these institutions be repealed. Retention of Key Executives The future success of the Company will be affected by its continued ability to attract and retain qualified executives. The Company's success is dependent in large part on John F. O'Brien, the loss of whom could adversely affect the Company's business. The Company does not have an employment agreement with Mr. O'Brien. Federal Income Tax Legislation Currently, under the Code, holders of certain life insurance and annuity products are entitled to tax-favored treatment on these products. For example, income tax payable by policyholders on investment earnings under certain life insurance and annuity products is deferred during the product's accumulation period and is payable, if at all, only when the insurance or annuity benefits are actually paid or to be paid. Also, for example, interest on loans up to $50,000 secured by the cash value of certain insurance policies owned by businesses is eligible for deduction even though investment earnings during the accumulation period are tax-deferred. In the past, legislation has been proposed that would have curtailed the tax- favored treatment of the life insurance and annuity products offered by the Company. These proposals were not enacted, and no such proposals or similar proposals are currently under active consideration by the Congress. Nevertheless, if these or similar proposals directed at limiting the tax- favored treatment of life insurance policies and annuity contracts were enacted, market demand for such products offered by the Company would be adversely affected. -----END PRIVACY-ENHANCED MESSAGE-----