UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
Commission File Number 0-14243
ALLIED Group, Inc.
(Exact name of registrant as specified in its charter)
Iowa
(State or other jurisdiction of incorporation or organization)
42-0958655
(I.R.S. Employer Identification No.)
701 Fifth Avenue, Des Moines, Iowa
(Address of principal executive offices)
50391-2000
(Zip Code)
515-280-4211
(Registrant's telephone number, including area code)
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, and (2) has been subject to such filing requirements
for the past 90 days. Yes [ x ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of July 31, 1998:
30,145,585 shares of Common Stock.
2
PART I
Item 1. Financial Statements
ALLIED Group, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, December 31,
1998 1997
-------------- -------------
(in thousands)
Assets
Investments
Fixed maturities at fair value (amortized cost
$806,644 in 1998 and $791,945 in 1997) $ 829,586 $ 818,216
Equity securities at fair value (cost
$72,094 in 1998 and $69,452 in 1997) 88,363 79,182
Short-term investments at cost (note 2) 8,784 10,846
-------------- -------------
Total investments 926,733 908,244
Cash 5,201 2,168
Accrued investment income 11,697 11,634
Indebtness from affiliates (note 2) 2,554 3,035
Accounts receivable 105,184 91,596
Current income taxes recoverable 3,535 3,005
Reinsurance receivables for
losses and loss adjusting expenses 35,842 23,906
Mortgage loans held for sale (note 4) 71,953 29,521
Deferred policy acquisition costs 54,937 50,695
Prepaid reinsurance premiums 4,642 8,866
Mortgage servicing rights 40,701 35,931
Other assets 36,658 32,632
-------------- -------------
Total assets $ 1,299,637 $ 1,201,233
============== =============
See accompanying Notes to Interim Consolidated Financial Statements.
3
ALLIED Group, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, December 31,
1998 1997
-------------- -------------
(in thousands)
Liabilities
Losses and loss adjusting expenses (note 3) $ 396,938 $ 378,026
Unearned premiums 252,551 239,763
Notes payable to nonaffiliates (note 4) 99,939 51,038
Notes payable to affiliates (note 2) 7,250 5,900
Guarantee of ESOP obligations 20,530 22,380
Deferred income taxes 5,979 5,515
Other liabilities 74,785 68,527
-------------- -------------
Total liabilities 857,972 771,149
-------------- -------------
Stockholders' equity
Preferred stock, no par value, issuable
in series, authorized 7,500 shares
6-3/4% Series, 1,827 shares issued and outstanding 37,812 37,812
Common stock, no par value, $1 stated value, authorized
80,000 shares, issued and outstanding 30,119 shares
in 1998 and 30,532 shares in 1997 30,119 30,532
Additional paid-in capital 101,754 112,490
Retained earnings 263,631 244,079
Accumulated other comprehensive income 25,357 23,314
Unearned compensation related to ESOP (17,008) (18,143)
-------------- -------------
Total stockholders' equity 441,665 430,084
-------------- -------------
Total liabilities and stockholders' equity $ 1,299,637 $ 1,201,233
============== =============
See accompanying Notes to Interim Consolidated Financial Statements.
4
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
Three Months ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(in thousands, except per share data)
Revenues
Earned premiums $ 147,541 $ 135,876 $ 290,600 $ 267,743
Investment income 13,606 12,874 26,869 25,526
Realized investment gains 269 7 328 ---
Income from affiliates (note 2) 1,278 876 2,644 2,017
Other income 16,584 14,074 32,562 27,165
----------- ----------- ----------- -----------
179,278 163,707 353,003 322,451
----------- ----------- ----------- -----------
Losses and expenses
Losses and loss adjusting expenses (note 3) 111,564 94,798 206,807 182,689
Amortization of deferred
policy acquisition costs 32,630 29,769 64,287 58,707
Other underwriting expenses 2,464 4,364 9,323 9,882
Other expenses (note 5) 16,716 12,522 31,139 25,948
Interest expense 434 368 1,073 763
----------- ----------- ----------- -----------
163,808 141,821 312,629 277,989
----------- ----------- ----------- -----------
Income before income taxes
and minority interest 15,470 21,886 40,374 44,462
----------- ----------- ----------- -----------
Income taxes
Current 5,297 6,995 12,066 14,609
Deferred (797) (890) (702) (1,971)
----------- ----------- ----------- -----------
4,500 6,105 11,364 12,638
----------- ----------- ----------- -----------
Income before minority interest 10,970 15,781 29,010 31,824
Minority interest in net income
of consolidated subsidiary 144 125 261 227
----------- ----------- ----------- -----------
Net income 10,826 15,656 28,749 31,597
Other comprehensive income (losses) [net
of income taxes] (555) 8,825 2,043 1,507
----------- ----------- ----------- -----------
Comprehensive Income $ 10,271 $ 24,481 $ 30,792 $ 33,104
=========== =========== =========== ===========
Net income applicable to common stock (note 6) $ 9,947 $ 14,777 $ 26,991 $ 29,840
=========== =========== =========== ===========
Earnings per share (note 6)
Basic $ 0.33 $ 0.49 $ 0.89 $ 0.98
=========== =========== =========== ===========
Diluted $ 0.32 $ 0.48 $ 0.88 $ 0.97
=========== =========== =========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
5
ALLIED Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended
June 30,
-----------------------------------
1998 1997
---------------- ---------------
(in thousands)
Cash flows from operating activities
Net income $ 28,749 $ 31,597
Adjustments to reconcile net income to net cash
provided by operating activities
Realized investment gains (328) ---
Depreciation and amortization 6,093 4,829
Indebtedness with affiliates 481 (3,884)
Accounts receivable, net (25,525) (19,695)
Accrued investment income (63) 185
Deferred policy acquisition costs (4,242) (2,573)
Mortgage loans held for sale, net 2,969 (27)
Other assets (5,217) 2,542
Losses and loss adjusting expenses 18,912 14,253
Unearned premiums, net 17,012 11,912
Cost of ESOP shares allocated 1,135 1,294
Current income taxes (530) (627)
Deferred income taxes (702) (1,971)
Other, net (103) 418
---------------- ---------------
Net cash provided by operating activities 38,641 38,253
---------------- ---------------
Cash flows from investing activities
Purchase of fixed maturities (81,743) (62,579)
Purchase of equity securities (11,889) (24,353)
Purchase of equipment (5,191) (4,241)
Sale of fixed maturities 24,911 18,660
Maturities, calls, and principal reductions of fixed maturities 42,070 38,858
Sale of equity securities 9,377 185
Short-term investments, net 2,062 (491)
Sale of equipment 290 278
---------------- ---------------
Net cash used in investing activities (20,113) (33,683)
---------------- ---------------
Cash flows from financing activities
Notes payable to nonaffiliates, net 3,500 6,560
Notes payable to affiliates, net 1,350 1,300
Issuance of common stock 3,749 3,648
Repurchase of common stock (14,898) (7,354)
Dividends paid to stockholders, net of income tax benefit (9,196) (8,214)
---------------- ---------------
Net cash used in financing activities (15,495) (4,060)
---------------- ---------------
Net increase in cash 3,033 510
Cash at beginning of year 2,168 1,067
---------------- ---------------
Cash at end of quarter $ 5,201 $ 1,577
================ ===============
See accompanying Notes to Interim Consolidated Financial Statements.
6
ALLIED Group, Inc. and Subsidiaries
Notes to Interim Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The accompanying interim consolidated financial statements include the accounts
of ALLIED Group, Inc. (the Company) and its subsidiaries. The interim
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) and include all adjustments
which are, in the opinion of management, necessary for fair presentation of the
results for the interim periods. All such adjustments are of a normal and
recurring nature. All significant intercompany balances and transactions have
been eliminated. The accompanying interim consolidated financial statements
should be read in conjunction with the following notes and with the Notes to
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
At June 30, 1998, The ALLIED Group Employee Stock Ownership Trust (ESOP Trust)
owned 24.6% and ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated
property-casualty insurance company, controlled 18.4% of the outstanding voting
stock of the Company.
(2) Transactions with Affiliates
Pursuant to the terms of the Intercompany Operating Agreement, the Company
leases employees to ALLIED Mutual and certain of its subsidiaries. Each company
that leases employees is charged a fee based upon costs incurred for salaries,
related benefits, taxes, and expenses associated with the employees it leases.
For the six months ended June 30, 1998 and 1997, the Company received revenues
of $1.5 million and $1.3 million for employees leased to affiliates,
respectively, which are included in income from affiliates.
Certain subsidiaries of the Company provide data processing and other services
for ALLIED Mutual and its subsidiaries. Included in income from affiliates are
revenues of $1.2 million and $741,000 relating to services performed for ALLIED
Mutual and its subsidiaries for the first six months of 1998 and 1997,
respectively.
The Company and its affiliates deposit their excess cash into a short-term
investment fund. The fund was established to concentrate short-term cash in a
single account to maximize yield. AID Finance Services, Inc., a wholly-owned
subsidiary of ALLIED Mutual, is the fund administrator. At June 30, 1998, the
Company and its subsidiaries had $5.5 million invested in the fund and had one
short-term unsecured note payable to the fund totaling $7.3 million. The
interest rate on the borrowing was 8.8%.
The Company and its subsidiaries had interest income from affiliates of $381,000
and $246,000 in the first six months of 1998 and 1997, respectively. Interest
paid to affiliates was $320,000 and $172,000 in the first six months of 1998 and
1997, respectively.
(3) Reinsurance
The Company's property-casualty subsidiaries purchase property catastrophe
reinsurance from a large number of reinsurers each of which provides a
relatively small percentage of the total cover. For 1998, the pool liability of
the cover is 90% of $120 million with a retention of $11 million. A
reinstatement agreement exists allowing purchases of reinsurance for an
additional catastrophe occurring in the same year. In the second quarter of
1998, the property-casualty segment exceeded the retention level and recovered
$7 million under the property catastrophe reinsurance. Additional reinsurance
was purchased in the second quarter under the reinstatement agreement.
Effective January 1, 1998, the Company's property-casualty subsidiaries and
ALLIED Mutual entered into a property catastrophe reinsurance agreement with a
nonaffiliated reinsurer. The agreement is an aggregate catastrophe excess of
loss reinsurance program that covers the property-casualty segment's share of
pooled losses up to $25 million in excess of $25 million in the aggregate for
any one quarter or in excess of $60 million in the aggregate for any one year.
In the second quarter of 1998, the property-casualty segment received the
maximum recovery of $16 million under the excess of loss reinsurance program.
7
(4) Notes Payable to Nonaffiliates
At June 30, 1998, the mortgage banking subsidiary had borrowed $84.4 million
under the terms of three separate mortgage loan warehousing agreements with
different commercial banks. These notes payable are not guaranteed by the
Company. Under the terms of the agreements, the subsidiary can borrow up to the
lesser of $95 million or 98% of the mortgage credit borrowing base. The
outstanding borrowings were secured by $72 million of pledged mortgage loans
held for sale, mortgage servicing rights on loans with a principal balance of $3
billion, and foreclosure loans. Interest rates applicable to the mortgage loan
warehousing agreements vary with the level of investable deposits maintained at
the respective commercial banks.
The mortgage banking subsidiary also had $10.5 million of 8.4% senior secured
notes outstanding as of June 30, 1998. The notes are payable to a nonaffiliated
life insurance company and are secured by pledged mortgage servicing rights. The
notes are payable in equal annual installments of $1.5 million each September 1,
with interest payable semi-annually. The final installment and interest is due
September 1, 2004.
The Federal Home Loan Bank of Des Moines provides a $5 million committed credit
facility through a line of credit agreement with AMCO Insurance Company (AMCO)
that expires February 26, 1999. Interest on any outstanding borrowings is
payable at an annual rate equal to the federal funds unsecured rate for Federal
Reserve member banks, which was 6.4% at June 30, 1998. The Company had an
outstanding balance under this line of credit of $5 million at June 30, 1998.
The borrowings were secured by United States Government securities with a
carrying value of $16.3 million.
(5) Merger Agreement with Nationwide
On June 3, 1998, the Company entered into a Merger Agreement with Nationwide
Mutual Insurance Company that provides for the acquisition of all of the
outstanding common stock of the Company pursuant to a tender offer price of
$48.25 in cash per share. For the six months ended June 30, 1998, the Company
incurred $2.6 million in expenses associated with the merger, which are included
in Other expenses.
(6) Earnings per Share
The following table presents a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computation for the three and six
months ended June 30, 1998 and 1997:
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------- -------------- ------------- --------------
(in thousands, except per share data)
Numerator
Net income $ 10,826 $ 15,656 $ 28,749 $ 31,597
Preferred stock dividends (879) (879) (1,758) (1,757)
------------- -------------- ------------- --------------
Net income applicable to common stock $ 9,947 $ 14,777 $ 26,991 $ 29,840
============= ============== ============= ==============
Denominator (weighted average shares)
Basic shares outstanding 30,328 30,412 30,434 30,476
Dilutive potential common shares 360 309 338 291
------------- -------------- ------------- --------------
Diluted shares outstanding 30,688 30,721 30,772 30,767
============= ============== ============= ==============
Basic earnings per share $ 0.33 $ 0.49 $ 0.89 $ 0.98
============= ============== ============= ==============
Diluted earnings per share $ 0.32 $ 0.48 $ 0.88 $ 0.97
============= ============== ============= ==============
All outstanding options were included in the dilutive computation per share. The
exercise prices on the outstanding options were less than the average market
price per share for the three and six months ended June 30, 1998.
8
(7) Segment Information
The Company has two reportable operating segments: property-casualty and excess
& surplus lines. For the six months ended June 30, 1998 and 1997, the
property-casualty and excess & surplus lines accounted for 85.4% and 5.8% of
consolidated revenues, respectively. Included in all other are mortgage banking,
data processing operations, and employee leasing services to affiliated
companies. All segments operated exclusively in the United States. The following
table presents a summary of the Company's operating segments for the six months
ended June 30, 1998 and 1997:
Revenues
---------------------------------------------------------------- Income before
Revenues Revenues Realized income taxes
from from investment Total and minority
nonaffiliates affiliates gains (losses) revenues interest *
------------- ------------ -------------- ------------- -------------
(in thousands)
Six months ended
June 30, 1998
Property-casualty $ 300,713 $ 598 $ 312 $ 301,623 $ 36,863
Excess & surplus lines 20,402 --- 12 20,414 4,756
All other 28,916 61,876 4 90,796 (1,245)
Eliminations --- (59,830) --- (59,830) ---
------------- ------------ -------------- ------------- -------------
Total $ 350,031 $ 2,644 $ 328 $ 353,003 $ 40,374
============= ============ ============== ============= =============
Six months ended
June 30, 1997
Property-casualty $ 275,344 $ 494 $ (2) $ 275,836 $ 39,542
Excess & surplus lines 19,726 --- (2) 19,724 4,740
All other 25,364 53,940 4 79,308 180
Eliminations --- (52,417) --- (52,417) ---
------------- ------------ -------------- ------------- -------------
Total $ 320,434 $ 2,017 $ --- $ 322,451 $ 44,462
============= ============ ============== ============= =============
Assets
--------------------------------------------
June 30, December 31,
1998 1997
---------------- ---------------
Property-casualty $ 1,070,790 $ 1,012,926
Excess & surplus lines 149,172 141,814
All other 631,379 560,270
Eliminations (551,704) (513,777)
---------------- ---------------
Total $ 1,299,637 $ 1,201,233
================ ===============
* includes realized investment gains or losses.
9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Forward-looking Information
The Private Securities Litigation Reform Act of 1995 provides a safe harbor to
encourage companies to provide prospective information so long as it is
identified as forward-looking and accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed. Forward-looking statements are related
to the plans and objectives of management for the future operations, economic
performance, or projections of revenues, income, earnings per share, capital
expenditures, dividends, capital structure, or other financial items. In the
following discussion and elsewhere in this report, statements containing words
such as expect, anticipate, believe, estimates, goal, objective, or similar
words are intended to identify forward-looking statements. ALLIED Group, Inc.
(the Company) undertakes no obligation to update such forward-looking
statements, and it wishes to identify important factors that could cause actual
results to differ materially from those projected in the forward-looking
statements contained in the following discussion and elsewhere in this report.
The risks and uncertainties that may affect the operations, performance,
development, and results of the Company's business include but are not limited
to the following: (1) risks and uncertainties relating to the pending tender
offer by Nationwide Mutual Insurance Company (Nationwide) for shares of the
Company's common stock and the pending merger of a subsidiary of Nationwide into
and with the Company, including the risks that the tender offer and merger are
not consummated; (2) heightened competition, particularly intensified price
competition; (3) adverse state and federal legislation and regulations; (4)
changes in interest rates causing a reduction of investment income; (5) general
economic and business conditions which are less favorable than expected; (6)
unanticipated changes in industry trends; (7) adequacy of loss reserves; (8)
catastrophic events or the occurrence of a significant number of storms and wind
and hail losses; and (9) other risks detailed herein and from time to time in
the Company's other reports.
Overview
The following analysis of the consolidated results of operations and financial
condition of the Company should be read in conjunction with the Interim
Consolidated Financial Statements and related footnotes included elsewhere
herein, and with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
The Company, a regional insurance holding company, and its subsidiaries operate
exclusively in the United States and primarily in the central and western
states. The largest segment includes three property-casualty insurance companies
that write personal lines (primarily automobile and homeowners) and small
commercial lines of insurance. The other reportable segment is excess & surplus
lines insurance. The property-casualty insurance segment accounted for 85.4% and
85.5% of consolidated revenues for each of the six months ended June 30, 1998
and 1997, respectively.
The property-casualty segment participates in a reinsurance pooling agreement
with ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated
property-casualty insurance company. The agreement generally provides that the
property-casualty insurance business is combined and then prorated among the
participants according to predetermined percentages. Participation percentages
are based on certain factors such as capitalization and business produced by the
respective companies. The segment's participation in the reinsurance pool has
been 64% since January 1, 1993.
Proposed Merger with Nationwide Mutual Insurance Company
On May 18, 1998, Nationwide Mutual Insurance Company (Nationwide) commenced an
unsolicited cash tender offer of $47.00 per share for all of the outstanding
common stock of the Company. On June 3, 1998, the Company entered into a Merger
Agreement with Nationwide that provides for the acquisition of all of the
outstanding stock of the Company by Nationwide pursuant to a revised tender
offer price of $48.25 in cash per share (the "Offer") to be followed by the
merger of an acquisition subsidiary of Nationwide with and into the Company, in
which shareholders (other than Nationwide, its acquisition subsidiary and
shareholders validly exercising dissenters' rights of appraisal) would receive
$48.25 in cash per share (the "Merger"). The Board of Directors (Board)
unanimously approved the Offer and determined that the terms of the Offer and
the Merger are fair to and in the best interests of the Company's stockholders.
The Board unanimously recommended that the Company's stockholders accept the
Offer and tender their shares.
10
Nationwide's obligations to consummate the Offer and the Merger and to purchase
and pay for the shares are subject to a number of conditions, including, without
limitation, the condition that all insurance regulatory approvals necessary for
Nationwide's acquisition of control of the Company and its insurance
subsidiaries are obtained on terms and conditions reasonably satisfactory to
Nationwide.
Results of Operations
Consolidated revenues for the first six months of 1998 were $353 million, up
9.5% over the $322.5 million reported for the same period of 1997. For the
second quarter only, consolidated revenues increased 9.5% to $179.3 million over
the same period in 1997. The increase occurred primarily because of the growth
in earned premiums for the six and three months ended June 30, 1998.
Income before income taxes and minority interest for the first six months of
1998 was down 9.2% to $40.4 million from $44.5 million for the same period in
1997. For the three months ended June 30, 1998, income before income taxes and
minority interest was down 29.3% from the same period in 1997. The decrease was
due to higher wind and hail losses experienced in the second quarter and from
increased expenses associated with the Nationwide merger agreement. For a
further discussion on the Nationwide merger agreement see Liquidity and Capital
Resources --Costs Associated with the Merger. Wind and hail losses increased
109% to $32.6 million for the six months ended June 30, 1998 compared to $15.6
million for the same period in 1997.
The Company's year-to-date effective income tax rate was 28.1% and 28.4% at June
30, 1998 and 1997, respectively. The decrease is due to lower operating income
and to the tax benefit attributed to the larger percentage of investment income
generated from tax-exempt securities and equity securities. The income tax
expense for the first six months of 1998 decreased slightly to $11.4 million
from $12.6 million for the same period in 1997.
Net income was down 9% to $28.7 million, bringing diluted earnings per share to
$0.88 for the six months ended June 30, 1998, from $31.6 million ($0.97 per
share) for the corresponding period in 1997. Diluted earnings per share before
realized investment gains and losses were $0.87 for the first six months of 1998
compared with $0.97 for the same period of 1997. For the three months ended June
30, 1998 and 1997, diluted earnings per share before realized gains were $0.32
and $0.48, respectively. The impact of the wind and hail losses on diluted
earnings per share was $0.69 and $0.33 for the six months ended June 30, 1998
and 1997, respectively. For the second quarter of 1998 and 1997 the impact per
share was $0.57 and $0.27, respectively.
Book value per share at June 30, 1998 increased to $13.97 compared to $13.44 at
December 31, 1997 and remained unchanged when compared to the book value per
share on March 31, 1998. Growth in the book value per share was slowed by higher
dividends paid to common stockholders, by the stock repurchase program
authorized on May 5, 1998, and from lower net income in the first half of 1998.
The fair value of investments in fixed maturities was $22.9 million above cost
at June 30, 1998 compared to $26.3 million above cost at December 31, 1997. If
the investments in fixed maturities were reported at amortized cost, the book
value would have been $13.48 at June 30, 1998 compared to $12.88 at December 31,
1997.
Investments and Investment Income
The investment policy for the Company's insurance segments require that the
fixed maturity portfolio be invested primarily in debt obligations rated "BBB"
or higher by Standard & Poor's Corporation or a recognized equivalent at the
time of acquisition. The policy also states that equity securities are to be of
United States and Canadian corporations listed on established exchanges or
publicly traded in the over-the-counter market. Preferred stocks are to be
comprised primarily of issues rated at least A3/A- by Standard and Poor's
Corporation or Moody's. The Company's investment portfolio consisted primarily
of fixed income securities and equity securities; 89.5% and 9.5%, respectively.
The ratings on 99.3% of the fixed income securities at June 30, 1998 were
investment grade or higher. The investment portfolio contained no real estate or
mortgage loans at June 30, 1998.
Invested assets were up 2% to $926.7 million from $908.2 million at year-end
1997. Six-month consolidated investment income increased 5.3% to $26.9 million
from $25.5 million through June 30, 1997. Investment income for the quarter
ended June 30, 1998, was up 5.7% to $13.6 million over the second quarter of
1997. The increase was due to a larger average balance of invested assets. The
Company's pretax rate of return on invested assets was down to 5.8% from last
year's 6.0%. The pretax yield was down as a result of the low interest rate
environment and a higher proportional share of investment income from tax-exempt
securities.
11
Property-casualty
Net written premiums for the pool (including ALLIED Mutual) totaled $448.6
million, an 8.9% increase over production in the first six months of 1997.
Growth was constrained by commercial lines that grew 3.3%, reflecting the highly
competitive environment in which the commercial lines are operating. The average
premium per policy for personal lines was up 3.4% from the first six months of
1997 to $631 while the policy count grew 5.8%. The average premium per policy
for commercial lines excluding crop-hail increased slightly from the first six
months of 1997 to $1,155 and the policy count was up 2.1%. Earned premiums for
the property-casualty segment were 69.2% personal lines and 30.8% commercial
lines in the first six months of 1998. The business mix for the first six months
of 1997 was 67.8% personal lines and 32.2% commercial lines.
Revenues for the property-casualty segment increased 9.3% to $301.6 million from
$275.8 million for the six months ended June 30, 1998 and 1997, respectively.
Revenues for the quarter ended June 30, 1998, increased 9.5% to $153.3 million.
Direct earned premiums for the segment were $307.1 million for the first half of
1998 compared with $275.6 million one year earlier. Earned premiums increased
8.9% for the first six months of 1998 to $273.7 million from $251.4 million; for
the second quarter only, earned premiums increase 9.1% to $139.1 million from
$127.5 million for the same period in 1997. The increase resulted from growth in
insurance exposure and increase in average premium per policy.
Investment income for the first six months of 1998 was $23.4 million compared to
$22.1 million for the same period in 1997. For the three months ended June 30,
1998, investment income increased 6.1% to $11.8 million compared to $11.2
million for the same quarter in 1997. The increase was the result of a larger
average balance in invested assets. The pretax yield on invested assets was 5.8%
and 6.1% for the six months ended June 30, 1998 and 1997, respectively. The
segment had realized investment gains of $312,000 in the first six months of
1998 compared with realized losses of $2,000 in the same period of 1997. Other
income for the first six months of 1998 and 1997 was $4.2 million and $2.3
million, respectively.
Income before income taxes decreased 6.8% to $36.9 million from $39.5 million in
the first six months of 1997. Growth was adversely effected by a 13.6% increase
in losses and loss adjusting expenses.
The statutory combined ratio (after policyholder dividends) for the first six
months of 1998 was 97.6 compared to 93.8 reported in the first six months of
1997. The higher combined ratio was primarily the result of a 3-point increase
in the loss and loss adjusting expense ratio, due to high wind and hail losses.
The impact of wind and hail losses on the combined ratio was 11.9 points and 6.2
points for the six months ended June 30, 1998 and 1997, respectively. The
underwriting expense ratio also increased , 0.9-point. The 1998 ratio was
unfavorably impacted by an under accrual of contingency commissions for 1997,
one-time costs associated with setting up the new Central States Office, and
legal expenses. The generally accepted accounting principles (GAAP) underwriting
gain was $9 million compared with a gain of $15.1 million for the first six
months of 1997.
The following table presents the property-casualty's statutory combined ratio by
line of business for the three and six months ended June 30, 1998 and 1997:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
------- ------- ------- -------
Personal automobile 94.9 90.9 94.8 93.1
Homeowners 127.6 110.8 111.2 100.5
Personal lines 103.9 96.3 99.3 95.1
Commercial automobile 90.1 79.2 95.4 92.1
Workers' compensation 95.0 90.2 96.9 88.1
Other property/liability 96.7 96.8 93.4 92.0
Other lines 60.6 59.7 65.1 60.5
Commercial lines 94.7 92.5 93.8 91.0
Total 101.0 95.1 97.6 93.8
12
The personal auto statutory combined ratio deteriorated to 94.8 for the first
half of 1998 from 93.1 for the same period in 1997. The deterioration was
largely due to a 1.1-point increase in the loss and loss adjusting expense
ratio; the underwriting expense ratio increased 0.6-points. The impact of wind
and hail losses on the combined ratio for personal auto was up to 4.6 from 2.3
for the first half of 1997. The statutory combined ratio for the homeowners line
was 111.2 for the first six months of 1998 compared with 100.5 for the same
period of 1997. The deterioration was primarily due to a 10.4-point increase in
the loss and loss adjusting expense ratio; the underwriting expense ratio also
increased 0.3 points. The impact of higher wind and hail losses on the combined
ratio for the homeowners line increased 35.7-points from 17.6-points for the
first six months of 1997. Overall, the personal lines statutory combined ratio
increased to 99.3 in the first six months of 1998 from 95.1 in the same period
of 1997. The statutory combined ratio for commercial lines increased to 93.8 in
the first six months of 1998 from 91.0 for the first half of 1997. The
deterioration of personal and commercial lines combined ratio was primarily
attributable to higher wind and hail losses in the first half of 1998.
Excess & Surplus Lines
Earned premiums increased to $16.9 million for the first six months of 1998 from
$16.3 million for the same period in 1997. Earned premiums for the quarter ended
June 30, 1998 and 1997 were $8.5 million and $8.4 million, respectively. Net
written premiums increased to $21 million for the six months ended June 30, 1998
from $17.4 million in the same period of 1997. The increase is due to a change
in reinsurance, effective January 1, 1998, from the ceding of premiums on an
written basis to an earned basis. For the six month period ended June 30, 1998,
the segment's book of business was comprised of 3.9% personal lines and 96.1%
commercial lines. The business mix for the first six months of 1997 was 2.9%
personal lines and 97.1% commercial lines.
Investment income for the first six months of 1998 increased 3.9% to $3.5
million from $3.4 million for the same period in 1997. For the quarter ended
June 30, 1998 and 1997, investment income was $1.8 million and $1.7 million,
respectively. Investment income increased due to a larger average balance in the
investment portfolio. The pretax yield on those assets was 6% in the first six
months of 1998 compared to 6.3% for the same period in 1997. The pretax yield on
invested assets for the year ended December 31, 1997 was 6.2%. Invested assets
increased 6.4% to $120.8 million at June 30, 1998 from $113.5 million at
year-end 1997.
The statutory combined ratio (after policyholder dividends) was 94.3, which
produced a GAAP underwriting gain of $1.2 million for the first half of 1998.
The combined ratio for the first six months of 1997 was 90.9 which resulted in a
GAAP underwriting gain of $1.4 million. The combined ratio deteriorated in part
because of a 2.1-point increase in the loss and loss adjusting expense ratio in
the first six months of 1998, due to losses and loss adjusting expenses
increasing more than twice as fast as earned premiums. The underwriting expense
ratio deteriorated 1.3-points in the first half of 1998 from the same period in
1997.
Income before income taxes for the six months ended June 30, 1998 increased
slightly to $4.8 million from $4.7 million; income before income taxes for the
second quarter of 1998 and 1997 were $2.3 million and $2.7 million,
respectively. The segment had realized gains of $12,000 in the first six months
of 1998 and had realized losses of $2,000 in the same period of 1997.
Noninsurance Operations
Revenues for the noninsurance operations (including mortgage banking, data
processing operations, and employee leasing to affiliates) after eliminations
increased 15.2% to $31 million for the first six months of 1998 from $26.9
million for the same period last year. The increase was primarily due to a $4
million increase in data processing revenues from outside consulting fees.
The segment reported a loss before income taxes of $1.2 million for the first
half of 1998 compared to income before income taxes of $180,000 for the same
period in 1997. The decrease was primarily due to $2.6 million in expenses
associated with the Nationwide merger agreement. The mortgage banking servicing
portfolio at June 30, 1998 increased slightly to $3 billion from $2.9 billion at
year-end 1997.
13
New Accounting Pronouncement
In February of 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," effective for years beginning
after December 31, 1997. SFAS 132 revises the disclosure requirements but does
not change the measurement or recognition of those plans. SFAS 132 superseded
SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions." The adoption of SFAS 132 will result in revised and additional
disclosures but will have no effect on the financial position, results of
operations, or liquidity of the Company.
In June of 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for fiscal quarters beginning
after June 30, 1999. SFAS 133 establishes accounting and reporting standards for
derivative instruments and hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure the instruments at fair value. Early application
is encouraged, but is permitted only as of the beginning of any fiscal quarter
that begins after issuance of this statement. SFAS 133 shall not be applied
retroactively. Management has not determined the impact of SFAS 133 on the
financial position, results of operations, or liquidity of the Company at this
time.
Liquidity and Capital Resources
Substantial cash inflows are generated from premiums, pool administration fees,
investment income, and proceeds from sales and maturities of investments. The
principal outflows of cash are payment of claims, commissions, premium taxes,
operating expenses, and income taxes and the purchase of fixed income and equity
securities. In developing its investment strategy, the Company establishes a
level of cash and highly liquid short- and intermediate-term securities that,
combined with expected cash flow, is believed adequate to meet anticipated
short-term and long-term payment obligations.
In the first six months of 1998 and 1997, operating activities generated cash
flows of $38.6 million and $38.3 million, respectively. For both periods, the
primary source of funds was premium growth in the Company's property-casualty
insurance operations. The funds were used primarily to purchase fixed income and
equity securities and to repurchase Company common stock.
Operating cash flows were also used to pay $9.6 million of dividends to
stockholders in the first six months of 1998. For the same period in 1997, the
Company paid dividends of $8.7 million to stockholders. Dividend payments to
common stockholders totaled $7.9 million for the six months ended June 30, 1998,
up from $6.9 million for the same period in 1997. The increase in dividends to
common stock shareholders is primarily due to a higher dividend per share, 14.7%
increase from June 30, 1997. In the first half of 1998 and 1997, the Company
paid dividends of $1.8 million on the 6-3/4% Series preferred stock.
The Company relies primarily on dividend payments from its property-casualty
subsidiaries to pay preferred and common stock dividends to stockholders. During
the first six months of 1998, the Company received dividend payments of $8.6
million from the property-casualty subsidiaries and $38,000 from noninsurance
subsidiaries. During the same period of 1997, the Company received dividend
payments of $8.1 million from the property-casualty subsidiaries and $38,000
from noninsurance subsidiaries.
During the second quarter of 1998, the Company canceled 557,600 shares of its
common stock purchased on the open market at an average price per share of
$26.72. The program was approved by the Board of Directors on May 5, 1998, to
repurchase up to 2 million shares of Company common stock over the next twelve
months. The program can be terminate at any time and is pursuant to Rule 10b-18
of the Securities Exchange Act of 1934. As of June 30, 1998, 1.4 million shares
remain available under the program for repurchase.
On May 5, 1998, the Company announced an amendment to the reinsurance pooling
agreement between the Company's property-casualty segment and ALLIED Mutual.
Beginning July 1, 1998, the amended pooling agreement phases out the provisions
which provide that the pool administrator is reimbursed for such expenses by the
other pool participants on a set percentage-of-premiums basis. Once the
phase-out is completed by the year 2001, all underwriting expenses, loss
adjusting expense and premium collection expenses will be allocated based on
each participant's pool participation percentage in the same manner premiums and
losses are allocated. The Company's management assumed third and fourth quarter
earnings will be the same as first quarter's and calculated the effect of the
amended agreement to be $0.01 per share per quarter reduction.
14
The mortgage banking subsidiary has separate credit arrangements to support its
operations. Short-term and long-term notes payable to nonaffiliated companies
are used to finance its mortgage loans held for sale and to purchase mortgage
servicing rights. The level of short-term borrowings fluctuates daily depending
on the level of inventory being financed. At June 30, 1998, short-term
borrowings amounted to $84.4 million to be repaid through the subsequent sale of
mortgage loans held for sale and long-term borrowings amounted to $10.5 million
to be repaid over the next seven years. These notes payable are not guaranteed
by the Company. In the normal course of its business, the subsidiary also makes
commitments to buy and sell securities that may result in credit and market risk
in the event the counterparty is unable to fulfill its obligation.
Management anticipates that short-term and long-term capital expenditures, cash
dividends, and operating cash needs will be met from existing capital and
internally generated funds. As of June 30, 1998, the Company and its
subsidiaries had no material commitments for capital expenditures. Future debt
and stock issuance will be considered as additional capital needs arise. The
method of funding will depend upon financial market conditions.
Costs associated with the Merger
The Company will incurr additional merger-related costs until the transaction is
completed, but at this time the Company can not estimate what the amount of
those costs will be. The Company will expense such costs as they are incurred.
In the first half of 1998, earnings were lower $0.09 per share by expenses
associated with the second-quarter Merger Agreement with Nationwide.
Contingencies
California has been the source of approximately 25% of the pool's direct written
premiums for the past ten years. Proposition 103, approved by California voters
in 1988, provides for a rollback of rates on premiums collected in calendar year
1989 to the extent that the insurer's return on equity for each Proposition 103
line of business exceeded 10%. The rollback liability, if any, has not been
determined. Management of the Company continues to believe that the insurance
subsidiaries will not be liable for any material rollback of premiums.
On December 31, 1997, a complaint was filed by Mary M. Rieff, a policyholder of
ALLIED Mutual, in the Iowa District Court in and for Polk County Iowa, against
the Company and certain other individuals who are or were officers and/or
directors of ALLIED Mutual and the Company. The complaint, an alleged
policyholder derivative action brought on behalf of ALLIED Mutual, asserts,
among other things, (a) that the defendants were responsible for the
inappropriate transfer of ALLIED Mutual's corporate assets, the seizure of
certain corporate opportunities, and the implementation of an improper de facto
demutualization without informing or compensating policyholders or receiving the
appropriate approval from regulatory authorities; (b) that this allegedly
wrongful demutualization began on or about January 1, 1985 and was accomplished
through transfers of ALLIED Mutual's assets to the Company and to the individual
defendants for inadequate consideration; (c) that the individual defendants
breached fiduciary duties owed to ALLIED Mutual, wasted its corporate assets,
and intentionally interfered with its contracts, prospective business advantage,
and business relationships; and (d) that the defendants improperly transferred
substantial ownership of and control over the Company and ALLIED Mutual's
insurance business. The complaint further asserts that as a result of the
foregoing, ALLIED Mutual and its policyholders have suffered damages in excess
of $500 million. The complaint requests an accounting of the assets allegedly
wrongfully transferred to the Company and compensation to ALLIED Mutual for the
value of such assets, for the seizure of corporate opportunities, and for the de
facto demutualization of ALLIED Mutual. The complaint also asks for certain
other relief, including attorneys' fees and costs, equitable relief and
interest, and restitution for any assets wrongfully transferred or conveyed. On
June 1, 1998, the plaintiff filed a motion to enjoin the defendant directors of
ALLIED Mutual from considering, negotiating or approving any transaction on
behalf of ALLIED Mutual with Nationwide or any third party because of alleged
conflicts of interest of the members of the Board of Directors of ALLIED Mutual.
On June 4, 1998, the complaint was amended to include a class action component.
On July 17, 1998, the Iowa District Court in and for Polk County, Iowa, ordered
that the plaintiff's motion for temporary and permanent injunctive relief be
denied.
15
On May 21, 1998, a class action on behalf of all shareholders of the Company was
filed in Iowa District Court in and for Polk County, Iowa. Plaintiff seeks to
compel the company to consider Nationwide's Offer or, in the alternative, to
recover damages caused by an alleged breach of fiduciary duty owed by the Board
to its shareholders.
The Company believes these suits are without merit and intends to defend them
vigorously. As is the case in all pending actions, the ultimate outcome is
uncertain.
16
PART II
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders was held on May 5, 1998.
(b) James W. Callison, Richard O. Jacobson, and John P. Taylor were
elected to serve as directors of the Company for a term of three
years which expires in the year 2001. Current directors whose
terms expire in 1999 are John E. Evans, William E. Timmons, and
Donald S. Willis. Current directors whose terms expire in 2000 are
Douglas L. Andersen, Harold S. Carpenter, Charles I. Colby, and
Harold S. Evans.
(c) With respect to the voting on the election of the directors:
For Withheld
------------ ----------
James W. Callison 33,817,992 410,370
Richard O. Jacobson 33,848,716 379,645
John P. Taylor 33,841,561 386,800
Item 6. Exhibits and Reports on Form 8-K
(Note: See "Index to Exhibits on page number 18, which discloses the
specific page numbers for the exhibits included in this Form 10-Q)
(a) 2.4 Agreement and Plan Merger, dated June 3, 1998, among
Nationwide Mutual Insurance Company, Nationwide Group
Acquisition Corporation, and the Company Incorporated
by reference to Exhibit 35 to Amendment No.1 to the
Company's Schedule 14D-9 filed with the Commission on
June 4, 1998).
10.65 Second Amendment to The ALLIED Group Employee Stock
Ownership Plan, dated June 1, 1998. (Incorporated by
reference to Exhibit 30 to the Company's Schedule 14D-9
filed with the Commission on June 2, 1998).
10.66 Third Amendment to The ALLIED Group Employee Stock
Ownership Plan, dated July 27, 1998.
10.67 Severance Pay Plan, dated May 30, 1998 (Incorporated
by reference to Exhibit 28 to the Company's Schedule
14D-9 filed with the Commission on June 2, 1998).
10.68 Form of Severance Agreement (Incorporated by reference
to Exhibit 29 to the Company's Schedule 14D-9 filed
with the Commission on June 2, 1998).
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule for March 31, 1997,
June 30, 1997, September 30, 1997, and December 31,
1996.
27.3 Restated Financial Data Schedule for March 31, 1996,
June 30, 1996, September 30, 1996, and December 31,
1995.
(b) The Company filed one report on Form 8-K during the second
quarter ended June 30, 1998.
Items Financial Date
Reported Statements Filed
----------------- ----------------- ----------------
Item 5 -- Other None May 5, 1998
17
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.
ALLIED Group, Inc.
(Registrant)
Date: August 12, 1998 /s/ Jamie H. Shaffer
----------------------------------------
Jamie H. Shaffer, Senior Vice President,
Chief Financial Officer, and Treasurer
18
ALLIED Group, Inc. and Subsidiaries
INDEX TO EXHIBITS
EXHIBIT
NUMBER ITEM PAGE
10.66 Third Amendment to The ALLIED Group Employee Stock
Ownership Plan, dated July 27, 1998 19
27.1 Financial Data Schedule 21
27.2 Restated Financial Data Schedule for March 31, 1997,
June 30, 1997, September 30, 1997, and December 31, 1996. 22
27.3 Restated Financial Data Schedule for March 31, 1996,
June 30, 1996, September 30, 1996, and December 31, 1995. 23