EXHIBIT 13(D)
HARLEYSVILLE GROUP
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31,
------------------------
2002 2001
--------- ---------
ASSETS
- ---------
Investments:
Fixed maturities:
Held to maturity, at amortized
cost (fair value $411,235
and $459,588) $ 379,940 $ 439,499
Available for sale, at fair value
(cost $932,889 and $956,047) 995,032 984,264
Equity securities, at fair value
(cost $96,849 and $110,803) 107,177 150,686
Short-term investments, at cost,
which approximates fair value 89,692 36,695
Fixed maturity securities on loan:
Held to maturity, at amortized
cost (fair value $5,707) 5,222
Available for sale, at fair value
(amortized cost $118,991) 129,837
---------- ----------
Total investments 1,706,900 1,611,144
Cash 2,944 1,839
Receivables:
Premiums 138,905 122,508
Reinsurance 75,488 81,640
Accrued investment income 21,552 21,862
---------- ----------
Total receivables 235,945 226,010
Deferred policy acquisition costs 94,896 86,076
Prepaid reinsurance premiums 19,421 20,096
Property and equipment, net 27,556 28,873
Deferred income taxes 25,784 29,435
Security lending collateral 139,215
Due from affiliate 10,709
Other assets 48,154 41,817
---------- ----------
Total assets $2,311,524 $2,045,290
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Liabilities:
Unpaid losses and loss
settlement expenses $ 928,335 $ 879,056
Unearned premiums 406,277 373,737
Accounts payable and accrued
expenses 109,965 96,440
Security lending obligation 139,215
Debt 95,620 96,055
Due to affiliate 9,704
---------- ----------
Total liabilities 1,679,412 1,454,992
---------- ----------
Shareholders' equity:
Preferred stock, $1 par value,
authorized 1,000,000 shares;
none issued
Common stock, $1 par value,
authorized 80,000,000 shares;
issued 2002, 30,917,575 and
2001, 30,444,678 shares;
outstanding 2002, 29,917,575
and 2001, 29,444,678 shares 30,918 30,445
Additional paid-in capital 149,091 140,065
Accumulated other comprehensive
income 49,086 44,265
Retained earnings 418,582 391,088
Treasury stock, at cost,
1,000,000 shares (15,565) (15,565)
---------- ----------
Total shareholders' equity 632,112 590,298
---------- ----------
Total liabilities and
shareholders' equity $2,311,524 $2,045,290
========== ==========
See accompanying notes to consolidated financial statements.
Page 31
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
YEAR ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000
-------- -------- --------
Revenues:
Premiums earned $764,636 $729,889 $688,330
Investment income, net
of investment expense 86,265 85,518 86,791
Realized investment gains (losses) (18,448) (3,071) 9,780
Other income 15,283 15,415 17,670
-------- -------- --------
Total revenues 847,736 827,751 802,571
-------- -------- --------
Expenses:
Losses and loss settlement
expenses 521,617 519,822 492,801
Amortization of deferred
policy acquisition costs 185,547 180,283 177,217
Other underwriting expenses 74,105 64,267 60,916
Interest expense 5,698 6,207 6,612
Other expenses 4,287 5,372 7,320
-------- -------- --------
Total expenses 791,254 775,951 744,866
-------- -------- --------
Income before income taxes 56,482 51,800 57,705
Income taxes 10,227 8,307 9,013
-------- -------- --------
Net income $ 46,255 $ 43,493 $ 48,692
======== ======== ========
Per common share:
Basic earnings $ 1.56 $ 1.49 $ 1.69
======== ======== ========
Diluted earnings $ 1.53 $ 1.46 $ 1.67
======== ======== ========
Cash dividends $ .63 $ .58 $ .55
======== ======== ========
See accompanying notes to consolidated financial statements.
Page 32
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(dollars in thousands)
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL INCOME (LOSS) EARNINGS STOCK TOTAL
---------- ------- --------- ------------- -------- -------- --------
Balance at
December 31,
1999 29,498,651 $29,499 $124,798 $ 51,682 $331,769 $ (10,854) $526,894
Net income 48,692 48,692
Other compre-
hensive
income,
net of tax:
Unrealized
investment
gains,
net of
reclassify-
cation
adjustment 4,328 4,328
--------
Comprehensive
income 53,020
--------
Issuance of
common stock:
Incentive
plans 466,068 466 5,279 5,745
Dividend
Reinvestment
Plan 37,133 37 637 674
Tax benefit from
stock options
exercised 823 823
Cash dividends
paid (15,864) (15,864)
Purchase of
treasury
stock,
313,435 shares (4,711) (4,711)
---------- ------- -------- -------- -------- -------- --------
Balance at
December 31,
2000 30,001,852 30,002 131,537 56,010 364,597 (15,565) 566,581
Net income 43,493 43,493
Other compre-
hensive income,
net of tax:
Unrealized
investment
losses,
net of
reclassify-
cation
adjustment (11,745) (11,745)
--------
Comprehensive
income 31,748
--------
Issuance of
common stock:
Incentive
plans 413,528 414 6,708 7,122
Dividend
Reinvestment
Plan 29,298 29 656 685
Tax benefit
from stock
options
exercised 1,164 1,164
Cash
dividends
paid (17,002) (17,002)
---------- ------- -------- -------- -------- -------- --------
Balance at
December 31,
2001 30,444,678 30,445 140,065 44,265 391,088 (15,565) 590,298
(Continued)
Page 33
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Continued)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(dollars in thousands)
ACCUMULATED
ADDITIONAL OTHER
COMMON STOCK PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL INCOME (LOSS) EARNINGS STOCK TOTAL
---------- ------- --------- ------------- -------- -------- --------
Balance at
Net income $ $ $ $ 46,255 $ $ 46,255
Other compre-
hensive
income,
net of tax:
Unrealized
investment
gains, net of
reclassifi-
cation
adjustment 9,891 9,891
Minimum
pension
liability
adjustment (5,070) (5,070)
--------
Other compre-
hensive income 4,821
--------
Comprehensive
income 51,076
--------
Issuance of
common stock:
Incentive
plans 446,982 447 6,920 7,367
Dividend
Reinvestment
Plan 25,915 26 658 684
Tax benefit
from stock
options
exercised 1,448 1,448
Cash
dividends
paid (18,761) (18,761)
---------- ------- -------- -------- -------- -------- --------
Balance at
December 31,
2002 30,917,575 $30,918 $149,091 $ 49,086 $418,582 $(15,565) $632,112
========== ======= ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 34
HARLEYSVILLE GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 46,255 $ 43,493 $ 48,692
Adjustments to reconcile net
income to net cash provided
(used) by operating activities:
Change in receivables, unearned
premiums, prepaid reinsurance
and due to affiliate 2,867 (16,621) (2,475)
Increase (decrease) in unpaid
losses and loss settlement
expenses 49,279 14,213 (36,509)
Deferred income taxes 1,055 (3,425) (1,397)
Increase in deferred policy
acquisition costs (8,820) (1,317) (1,218)
Amortization and depreciation 3,116 2,854 3,215
Realized investment (gains)
losses 18,448 3,071 (9,780)
Other, net 967 3,520 (3,710)
--------- --------- ---------
Net cash provided (used)
by operating activities 113,167 45,788 (3,182)
--------- --------- ---------
Cash flows from investing activities:
Held to maturity investments:
Purchases (1,038) (3,895)
Maturities 55,547 42,329 37,725
Available for sale investments:
Purchases (260,262) (303,610) (142,691)
Maturities 56,950 75,662 58,240
Sales 103,322 165,796 37,070
Net (purchases) sales or maturities
of short-term investments (52,997) (12,814) 35,342
Purchases of property and
equipment (2,439) (3,724) (3,612)
--------- --------- ---------
Net cash provided (used)
by investing activities (100,917) (36,361) 18,179
--------- --------- ---------
Cash flows from financing activities:
Issuance of common stock 8,051 7,807 6,419
Repayment of debt (435) (395) (360)
Dividends paid (18,761) (17,002) (15,864)
Purchase of treasury stock (4,711)
--------- --------- ---------
Net cash used by financing
activities (11,145) (9,590) (14,516)
--------- --------- ---------
Increase (decrease) in cash 1,105 (163) 481
Cash at beginning of year 1,839 2,002 1,521
--------- --------- ---------
Cash at end of year $ 2,944 $ 1,839 $ 2,002
========= ========= =========
See accompanying notes to consolidated financial statements.
Page 35
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Harleysville Group consists of Harleysville Group Inc. and its subsidiaries
(all wholly owned). Those subsidiaries are:
- Harleysville-Atlantic Insurance Company (Atlantic)
- Harleysville Insurance Company (HIC)
- Harleysville Insurance Company of New Jersey (HNJ)
- Harleysville Insurance Company of New York (HIC New York)
- Harleysville Insurance Company of Ohio (HIC Ohio)
- Harleysville Lake States Insurance Company (Lake States)
- Harleysville Preferred Insurance Company (Preferred)
- Harleysville Worcester Insurance Company (Worcester)
- Mid-America Insurance Company (Mid-America)
- Harleysville Ltd., a real estate partnership that owns the home
office
Harleysville Group is approximately 56% owned by Harleysville Mutual
Insurance Company (Mutual).
Harleysville Group underwrites property and casualty insurance in both the
personal and commercial lines of insurance. The personal lines of insurance
include both auto and homeowners, and the commercial lines include auto,
commercial multi-peril and workers compensation. The business is marketed
primarily in the eastern and midwestern United States through independent
agents.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying financial statements include the accounts of Harleysville
Group prepared in conformity with accounting principles generally accepted in
the United States of America, which differ in some respects from those followed
in reports to insurance regulatory authorities. All significant intercompany
balances and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, including loss and loss settlement expenses, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses, including the
determination of other-than-temporary declines in investments, during the
reporting period. Actual results could differ from these estimates.
Page 36
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
INVESTMENTS
Accounting for fixed maturities depends on their classification as held to
maturity, available for sale or trading. Fixed maturities classified as held to
maturity are carried at amortized cost. Fixed maturities classified as
available for sale are carried at fair value. There were no investments
classified as trading. Equity securities are carried at fair value. Short-term
investments are recorded at cost, which approximates fair value.
Realized gains and losses on sales of investments are recognized in net
income on the specific identification basis. A decline in the fair value of an
investment below its cost that is deemed other than temporary is charged to
earnings. Unrealized investment gains or losses on investments carried at fair
value, net of applicable income taxes, are reflected directly in shareholders'
equity as a component of comprehensive income and, accordingly, have no effect
on net income.
PREMIUMS
Premiums are recognized as revenue ratably over the terms of the respective
policies. Unearned premiums are calculated on a pro rata basis.
POLICY ACQUISITION COSTS
Policy acquisition costs, such as commissions, premium taxes and certain
other underwriting and agency expenses that vary with and are directly related
to the production of business, are deferred and amortized over the effective
period of the related insurance policies. The method followed in computing
deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable value, which gives effect to the premium to be
earned, related investment income, losses and loss settlement expenses, and
certain other costs expected to be incurred as the premium is earned.
Page 37
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
LOSSES AND LOSS SETTLEMENT EXPENSES
The liability for losses and loss settlement expenses represents estimates
of the ultimate unpaid cost of all losses incurred, which includes the gross
liabilities to Harleysville Group's policyholders plus the net liability to
Mutual under the pooling agreement. See Note 2(a). Such estimates may be more
or less than the amounts ultimately paid when the claims are settled. These
estimates are periodically reviewed and adjusted as necessary; such adjustments
are reflected in current operations.
STOCK-BASED COMPENSATION
Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. Accordingly, no compensation
expense is recognized for fixed stock option grants and an employee stock
purchase plan. Compensation expense would be recorded on the date of a stock
option grant only if the current market price of the underlying stock exceeded
the exercise price. The following table illustrates the effect on net income and
earnings per share as if the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123 (as amended by SFAS No. 148), "Accounting for
Stock-Based Compensation," had been applied to all periods presented.
2002 2001 2000
-------- -------- --------
(in thousands, except per share data)
Net income, as reported $46,255 $43,493 $48,692
Plus: Stock-based employee
compensation expense included
in reported net income, net
of related tax effects 2,631 687 1,258
Less: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects (5,212) (3,185) (3,103)
------- ------- -------
Pro forma net income $43,674 $40,995 $46,847
======= ======= =======
Basic earnings
per share:
As reported $ 1.56 $ 1.49 $ 1.69
Pro forma $ 1.47 $ 1.40 $ 1.62
Diluted earnings
per share:
As reported $ 1.53 $ 1.46 $ 1.67
Pro forma $ 1.44 $ 1.38 $ 1.61
Page 38
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less accumulated depreciation.
Depreciation is calculated primarily on the straight-line basis over the
estimated useful lives of the assets (40 years for buildings and three to 15
years for equipment).
INCOME TAXES
Deferred income tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing earnings by the
weighted-average number of common shares outstanding during the year. Diluted
earnings per share includes the dilutive effect of the stock incentive plans
described in Note 12.
2 - TRANSACTIONS WITH AFFILIATES
(A) UNDERWRITING
The insurance subsidiaries participate in a reinsurance pooling agreement
with Mutual whereby such subsidiaries cede to Mutual all of their insurance
business and assume from Mutual an amount equal to their participation in the
pooling agreement. All losses and loss settlement expenses and other
underwriting expenses are prorated among the parties on the basis of
participation in the pooling agreement. The agreement pertains to all insurance
business written or earned on or after January 1, 1986. Harleysville Group's
participation was 72% for 2002, 2001 and 2000.
Because this agreement does not relieve Harleysville Group of primary
liability as the originating insurer, there is a concentration of credit risk
arising from business ceded to Mutual. However, the reinsurance pooling
agreement provides for the right of offset, and the net pooling balance with
Mutual is not material at December 31, 2002 and 2001. Mutual has an A. M. Best
rating of "A" (Excellent).
Page 39
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2 - TRANSACTIONS WITH AFFILIATES (CONTINUED)
(A) UNDERWRITING (CONTINUED)
The following amounts represent reinsurance transactions between
Harleysville Group and Mutual under the pooling arrangement:
2002 2001 2000
-------- -------- --------
(in thousands)
Ceded:
Premiums written $689,597 $649,974 $606,766
======== ======== ========
Premiums earned $664,576 $633,298 $603,650
======== ======== ========
Losses incurred $451,105 $459,906 $440,973
======== ======== ========
Assumed:
Premiums written $805,641 $754,621 $708,289
======== ======== ========
Premiums earned $772,426 $736,924 $695,147
======== ======== ========
Losses incurred $521,948 $527,773 $497,198
======== ======== ========
Net assumed from Mutual:
Unearned premiums $ 54,035 $ 45,841 $ 44,820
======== ======== ========
Unpaid losses and loss
settlement expenses $166,188 $155,301 $145,578
======== ======== ========
Harleysville Group and Mutual are parties to a reinsurance agreement
whereby Mutual, in return for a reinsurance premium, reinsured accumulated
catastrophe losses in a quarter up to $14,400,000 for 2002, 2001 and 2000. This
reinsurance coverage was in excess of a retention of $3,600,000 for 2002, 2001
and 2000. The agreement excludes catastrophe losses resulting from earthquakes,
terrorism or hurricanes and supplements the existing external catastrophe
reinsurance program. Under this agreement, Harleysville Group ceded to Mutual
premiums earned of $7,791,000, $7,035,000 and $6,817,000, and losses incurred of
$334,000, $7,951,000 and $4,397,000 for 2002, 2001 and 2000, respectively.
(B) PROPERTY
Harleysville Ltd. leases the home office to Mutual, which shares the
facility with Harleysville Group. Rental income under the lease was $3,531,000,
$3,512,000 and $3,421,000 for 2002, 2001 and 2000, respectively, and is included
in other income after elimination of intercompany amounts of $2,161,000,
$2,149,000 and $2,094,000 in 2002, 2001 and 2000, respectively.
Page 40
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2 - TRANSACTIONS WITH AFFILIATES (CONTINUED)
(C) MANAGEMENT AGREEMENTS
Harleysville Group Inc. received $6,808,000, $7,316,000 and $7,425,000 of
management fee income in 2002, 2001 and 2000, respectively, under agreements
whereby Harleysville Group Inc. provides management services to Mutual and other
affiliates. Such amounts are included in other income.
(D) INTERCOMPANY BALANCES
Intercompany balances are created primarily from the pooling arrangement
(settled quarterly), allocation of common expenses, collection of premium
balances and payment of claims (settled monthly). No interest is charged or
received on intercompany balances due to the timely settlement terms and nature
of the items. Interest expense on the loan from Mutual described in Note 8 was
$483,000, $936,000 and $1,302,000 in 2002, 2001 and 2000, respectively.
Harleysville Group has off-balance-sheet credit risk related to
approximately $68,000,000 and $64,000,000 of premium balances due to Mutual from
agents and insureds at December 31, 2002 and 2001, respectively.
Page 41
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - INVESTMENTS
The amortized cost and estimated fair value of investments, including
amounts on loan under the securities lending agreement, in fixed maturity and
equity securities are as follows:
DECEMBER 31, 2002
-------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----------
(in thousands)
Held to maturity:
U.S. Treasury securities
and obligations of
U.S. government corpora-
tions and agencies $ 5,324 $ 354 $ $ 5,678
Obligations of states
and political
subdivisions 228,438 16,878 245,316
Corporate securities 151,400 14,554 (6) 165,948
---------- -------- ------- ----------
Total held to maturity 385,162 31,786 (6) 416,942
---------- -------- ------- ----------
Available for sale:
U.S. Treasury securities
and obligations of
U.S. government corpora-
tions and agencies 62,965 7,189 (33) 70,121
Obligations of states
and political
subdivisions 446,115 29,261 (256) 475,120
Corporate securities 328,347 26,932 (4,018) 351,261
Mortgage-backed
securities 214,453 14,063 (149) 228,367
---------- -------- ------- ----------
Total available for sale 1,051,880 77,445 (4,456) 1,124,869
---------- -------- ------- ----------
Total fixed maturities $1,437,042 $109,231 $(4,462) $1,541,811
========== ======== ======= ==========
Total equity securities $ 96,849 $ 20,199 $(9,871) $ 107,177
========== ======== ======= ==========
Page 42
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - INVESTMENTS (CONTINUED)
DECEMBER 31, 2001
------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- -----------
(in thousands)
Held to maturity:
U.S. Treasury securities
and obligations of
U.S. government corpora-
tions and agencies $ 6,407 $ 320 $ (48) $ 6,679
Obligations of states
and political
subdivisions 257,833 11,153 (19) 268,967
Corporate securities 175,259 8,826 (143) 183,942
---------- ------- ------- ----------
Total held to maturity 439,499 20,299 (210) 459,588
---------- ------- ------- ----------
Available for sale:
U.S. Treasury securities
and obligations of
U.S. government corpora-
tions and agencies 63,546 3,256 (156) 66,646
Obligations of states
and political
subdivisions 353,826 12,540 (794) 365,572
Corporate securities 374,232 12,751 (3,106) 383,877
Mortgage-backed
securities 164,443 5,121 (1,395) 168,169
---------- ------- ------- ----------
Total available for sale 956,047 33,668 (5,451) 984,264
========== ======= ======= ==========
Total fixed maturities $1,395,546 $53,967 $(5,661) $1,443,852
========== ======= ======= ==========
Total equity securities $ 110,803 $47,968 $(8,085) $ 150,686
========== ======= ======= ==========
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 2002 by contractual maturity are shown below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Page 43
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - INVESTMENTS (CONTINUED)
ESTIMATED
AMORTIZED FAIR
COST VALUE
---------- ------------
(in thousands)
Held to maturity:
Due in one year or less $ 56,446 $ 57,432
Due after one year
through five years 189,633 205,841
Due after five years
through ten years 128,086 141,707
Due after ten years 10,997 11,962
---------- ----------
385,162 416,942
---------- ----------
Available for sale:
Due in one year or less 66,963 68,243
Due after one year
through five years 227,052 245,800
Due after five years
through ten years 442,297 473,614
Due after ten years 101,115 108,845
---------- ----------
837,427 896,502
Mortgage-backed
securities 214,453 228,367
---------- ----------
1,051,880 1,124,869
---------- ----------
Total fixed maturities $1,437,042 $1,541,811
========== ==========
The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 2002 and 2001 amounted to $25,555,000 and
$25,261,000, respectively.
Page 44
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - INVESTMENTS (CONTINUED)
A summary of net investment income is as follows:
2002 2001 2000
------- -------- --------
(in thousands)
Interest on fixed maturities $84,438 $83,191 $83,958
Dividends on equity securities 1,787 1,768 2,007
Interest on short-term
investments 1,078 1,712 1,846
------- ------- -------
Total investment income 87,303 86,671 87,811
Investment expense 1,038 1,153 1,020
------- ------- -------
Net investment income $86,265 $85,518 $86,791
======= ======= =======
Realized gross gains (losses) from investments and the change in difference
between fair value and cost of investments, before applicable income taxes, are
as follows:
2002 2001 2000
--------- --------- ---------
(in thousands)
Fixed maturity securities:
Held to maturity:
Gross gains $ 410 $ 183 $ 48
Gross losses (226) (1) (988)
Available for sale:
Gross gains 2,944 5,717 52
Gross losses (2,470) (1,394) (916)
Equity securities:
Gross gains 9,479 11,217 15,898
Gross losses (28,585) (18,793) (4,314)
-------- -------- --------
Net realized investment
gains (losses) $(18,448) $ (3,071) $ 9,780
======== ======== ========
Change in difference between
fair value and cost of
investments(1):
Fixed maturity securities $ 56,463 $ 14,310 $ 46,321
Equity securities (29,555) (28,350) (23,739)
-------- -------- --------
Total $ 26,908 $(14,040) $ 22,582
======== ======== ========
(1) Parentheses indicate a net unrealized decline in fair value.
Page 45
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - INVESTMENTS (CONTINUED)
Income taxes (benefit) on realized investment gains (losses) were
$(6,441,000), $(1,075,000) and $3,423,000 for 2002, 2001 and 2000, respectively.
Deferred income taxes applicable to net unrealized investment gains
included in shareholders' equity were $29,161,000 and $23,835,000 at December
31, 2002 and 2001, respectively.
At December 31, 2002, Harleysville Group held cash collateral of
$139,215,000 related to securities on loan with a market value of $135,544,000.
Harleysville Group's policy is to require initial collateral of 102% of the
market value of loaned securities plus accrued interest, which is required to be
maintained daily by the borrower at no less than 100% of such market value plus
accrued interest over the life of the loan. Acceptable collateral includes cash
and money market instruments, government securities, "A" rated corporate
obligations, "AAA" rated asset-backed securities or GICs and Funding Agreements
from issuers rated "A" or better.
Under provisions of SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of SFAS No. 133," fixed
maturity investments classified as held to maturity with an amortized cost of
$81,021,000 and unrealized gains of $1,547,000 were transferred to the available
for sale classification on January 1, 2001.
Harleysville Group has not held or issued derivative financial instruments.
4 - REINSURANCE
In the ordinary course of business, Harleysville Group cedes insurance to,
and assumes insurance from, insurers to limit its maximum loss exposure through
diversification of its risks. See Note 2(a) for discussion of reinsurance with
Mutual. Reinsurance contracts do not relieve Harleysville Group of primary
liability as the originating insurer. After excluding reinsurance transactions
with Mutual under the pooling arrangement, the effect of Harleysville Group's
share of other reinsurance on premiums written and earned is as follows:
Page 46
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4 - REINSURANCE (CONTINUED)
2002 2001 2000
-------- -------- --------
(in thousands)
Premiums written:
Direct $842,897 $781,190 $740,425
Assumed 22,189 29,683 26,415
Ceded (67,236) (63,286) (65,368)
-------- -------- --------
Net premiums written $797,850 $747,587 $701,472
======== ======== ========
Premiums earned:
Direct $807,332 $761,792 $738,797
Assumed 25,215 29,442 25,653
Ceded (67,911) (61,345) (76,120)
-------- -------- --------
Net premiums earned $764,636 $729,889 $688,330
======== ======== ========
Losses and loss settlement expenses are net of reinsurance recoveries of
$38,172,000, $68,852,000 and $55,638,000 for 2002, 2001 and 2000, respectively.
5 - CONTINGENCY
GE Reinsurance Corporation (GE Re) had sought rescission of a reinsurance
agreement between Mutual and GE Re relating to certain automobile insurance
policies written in California through a managing general agent beginning in
1999.
On December 13, 2002, Mutual and GE Re settled this matter by agreeing to a
commutation and termination of the reinsurance agreement effective December 31,
2002. The settlement agreement did not materially impact Harleysville Group's
financial statements.
6 - PROPERTY AND EQUIPMENT
Property and equipment consisted of land and buildings with a cost of
$30,511,000 and $29,867,000, and equipment, including software, with a cost of
$15,569,000 and $14,782,000 at December 31, 2002 and 2001, respectively.
Accumulated depreciation related to such assets was $18,524,000 and $15,776,000
at December 31, 2002 and 2001, respectively.
Page 47
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6 - PROPERTY AND EQUIPMENT (CONTINUED)
Rental expense under leases with non-affiliates amounted to $1,960,000,
$2,832,000 and $3,519,000 for 2002, 2001 and 2000, respectively. Operating
lease commitments were not material at December 31, 2002.
7 - LIABILITY FOR UNPAID LOSSES AND LOSS SETTLEMENT EXPENSES
Activity in the liability for unpaid losses and loss settlement expenses is
summarized as follows:
2002 2001 2000
-------- -------- --------
(in thousands)
Liability at January 1 $879,056 $864,843 $901,352
Less reinsurance recoverables 78,195 72,259 77,438
-------- -------- --------
Net liability at January 1 800,861 792,584 823,914
-------- -------- --------
Incurred related to:
Current year 526,265 537,172 541,738
Prior years (4,648) (17,350) (48,937)
-------- -------- --------
Total incurred 521,617 519,822 492,801
-------- -------- --------
Paid related to:
Current year 199,874 229,435 244,978
Prior years 265,422 282,110 279,153
-------- -------- --------
Total paid 465,296 511,545 524,131
-------- -------- --------
Net liability at December 31 857,182 800,861 792,584
Plus reinsurance recoverables 71,153 78,195 72,259
-------- -------- --------
Liability at December 31 $928,335 $879,056 $864,843
======== ======== ========
Harleysville Group recognized favorable development in the provision for
insured events of prior years of $4,648,000, $17,350,000 and $48,937,000 in
2002, 2001 and 2000, respectively. The favorable development for 2002 primarily
relates to lower-than-expected claim severity in the commercial and personal
lines of business. The favorable development for 2001 primarily relates to
lower-than-expected loss settlement expenses and, for 2000, lower-than-expected
loss settlement expenses and lower-than-expected claim severity in the
commercial and personal lines of business. The 2001 and 2000 favorable
development includes
Page 49
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7 - Liability for Unpaid Losses and Loss Settlement Expenses
(Continued)
$14,772,000 and $20,186,000 of reductions in loss settlement expenses. In both
years, such reductions are related to benefits from initiatives to reduce costs
of adjusting claims and to the favorable development on losses.
In establishing the liability for unpaid losses and loss settlement
expenses, management considers facts currently known and the current state of
the law and coverage litigation. Liabilities are recognized for known losses
(including the cost of related litigation) when sufficient information has been
developed to indicate the involvement of a specific insurance policy, and
management can reasonably estimate its liability. In addition, liabilities have
been established to cover additional exposures on both known and unasserted
losses. Estimates of the liabilities are reviewed and updated continually.
The property and casualty insurance industry has received significant
publicity about environmental-related losses from exposures insured many years
ago. Since the intercompany pooling agreement pertains to insurance business
written or earned on or after January 1, 1986, Harleysville Group has not
incurred significant environmental-related losses.
8 - DEBT
Debt is as follows:
DECEMBER 31,
--------------------
2002 2001
------- -------
(in thousands)
Notes, 6.75%, due 2003 $75,000 $75,000
Demand term-loan payable
to Mutual, LIBOR plus
0.65%, due 2005 18,500 18,500
Economic Development
Corporation (EDC)
Revenue Bond obligation 2,120 2,555
------- -------
Total debt $95,620 $96,055
======= =======
Page 49
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8 - DEBT (CONTINUED)
The fair value of the notes was $76,069,000 and $76,388,000 at December 31,
2002 and 2001, respectively, based on quoted market prices for the same or
similar debt. The carrying value of the remaining debt approximates fair value.
The EDC obligation is secured by Lake States' building. Interest is payable
semiannually at a variable rate (1.7% at December 31, 2002) equal to the market
interest rate that would allow the bonds to be remarketed at par value. The
bonds are subject to redemption prior to maturity in 2006 at levels dependent
upon the occurrence of certain events.
Interest paid was $5,599,000, $6,134,000 and $6,507,000 in 2002, 2001 and
2000, respectively.
9 - RESTRUCTURING CHARGES
In 1999 and 2000, Harleysville Group recorded restructuring charges in
connection with the consolidation of its claims offices and field operations.
There is no remaining liability for these restructurings at December 31, 2002.
The charge (benefit) to earnings for these restructuring charges was $15,000,
$(118,000) and $949,000 for 2002, 2001 and 2000, respectively. The 2002 and
2001 amounts primarily are from changes in the estimate of occupancy costs.
Page 50
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10 - SHAREHOLDERS' EQUITY
Comprehensive income consisted of the following:
2002 2001 2000
------- -------- -------
(in thousands)
Net income $46,255 $ 43,493 $48,692
------- -------- -------
Other comprehensive
income:
Unrealized investment
holding gains (losses)
arising during period,
net of taxes (benefits)
of $(1,195), $(7,463)
and $6,082 (2,220) (13,859) 11,296
Less:
Reclassification
adjustment for (gains)
losses included in net
income, net of taxes
(benefits) of $(6,521),
$(1,139) and $3,752 12,111 2,114 (6,968)
------- -------- -------
Net unrealized
investment gains (losses) 9,891 (11,745) 4,328
------- -------- -------
Minimum pension liability
net of taxes (benefits)
of $(2,730) (5,070)
------- -------- -------
Other comprehensive income 4,821 (11,745) 4,328
------- -------- -------
Comprehensive income $51,076 $ 31,748 $53,020
======= ======== =======
A source of cash for the payment of dividends is dividends from
subsidiaries. Harleysville Group Inc.'s insurance subsidiaries are required by
law to maintain certain minimum surplus on a statutory basis, and are subject to
risk-based capital requirements and to regulations under which payment of a
dividend from statutory surplus is restricted and may require prior approval of
regulatory authorities. Applying the current regulatory restrictions as of
December 31, 2002, $10,960,000 would be available for distribution to
Harleysville Group Inc. without prior approval until October 1, 2003, after
which $52,860,000 would be available for distribution to Harleysville Group Inc.
without prior approval.
Page 51
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10 - SHAREHOLDERS' EQUITY (CONTINUED)
The National Association of Insurance Commissioners (NAIC) has adopted the
Codification of Statutory Accounting Principles, which were effective January 1,
2001. The codified principles are intended to provide a basis of accounting
recognized and adhered to in the absence of, conflict with, or silence of, state
statutes and regulations. The impact of the codified principles on the January
1, 2001 statutory capital and surplus of the Company's insurance subsidiaries
ranged from a decrease of $442,000 to an increase of $6,397,000 and was an
increase of $21,003,000 on a consolidated basis.
The following table contains selected information for Harleysville Group
Inc.'s property and casualty insurance subsidiaries, as determined in accordance
with prescribed statutory accounting practices:
DECEMBER 31,
-------------------------------
2002 2001 2000
-------- -------- --------
(in thousands)
Statutory capital and surplus $509,344 $538,878 $515,679
======== ======== ========
Statutory unassigned surplus $375,075 $404,609 $381,410
======== ======== ========
Statutory net income $ 42,338 $ 41,095 $ 48,412
======== ======== ========
11 - INCOME TAXES
The components of income tax expense (benefit) are as follows:
2002 2001 2000
------- ------- -------
Current $ 9,172 $11,732 $10,410
Deferred 1,055 (3,425) (1,397)
------- ------- -------
$10,227 $ 8,307 $ 9,013
======= ======= =======
Cash paid for federal income taxes in 2002, 2001 and 2000 was $13,250,000,
$13,158,000 and $6,499,000, respectively.
Page 52
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
11 - INCOME TAXES (CONTINUED)
The actual income tax rate differed from the statutory federal income tax
rate applicable to income before income taxes as follows:
2002 2001 2000
------ ------ ------
Statutory federal income
tax rate 35.0% 35.0% 35.0%
Tax-exempt interest (16.8) (19.3) (19.7)
Other, net (0.1) 0.3 0.3
----- ----- -----
18.1% 16.0% 15.6%
===== ===== =====
The tax effects of the significant temporary differences that give rise to
deferred tax liabilities and assets are as follows:
DECEMBER 31,
--------------------------
2002 2001
-------- --------
(in thousands)
Deferred tax liabilities:
Deferred policy acquisition
costs $33,214 $30,127
Unrealized investment 29,161 23,835
Other 9,373 6,169
------- -------
Total deferred tax
liabilities 71,748 60,131
------- -------
Deferred tax assets:
Unearned premiums 27,080 24,755
Losses incurred 42,494 41,811
Pension plan 8,077 4,842
AMT credit carryforward 6,141 4,811
Other 13,740 13,347
------- -------
Total deferred tax
assets 97,532 89,566
------- -------
Net deferred tax asset $25,784 $29,435
======= =======
A valuation allowance is required to be established for any portion of the
deferred tax asset that management believes will not be realized. In the
opinion of management, it is more likely than not that the benefit of the
deferred tax asset will be realized and, therefore, no such valuation allowance
has been established.
Page 53
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - INCENTIVE PLANS
Fixed Stock Option Plans
- ------------------------
Harleysville Group has an Equity Incentive Plan (EIP) for key employees.
Awards may be made in the form of stock options, stock appreciation rights
(SARs), restricted stock or any combination of the above. The EIP was amended
in 1997 and limited future awards to an aggregate of 4,260,946 shares of
Harleysville Group Inc.'s common stock. The plan provides that stock options may
become exercisable from six months to 10 years from the date of grant with an
option price not less than fair market value on the date of grant. The options
normally vest 50% at the end of one year and 50% at the end of two years from
the date of grant. SARs have not been material.
The income tax benefit related to the difference between the market price
at the date of exercise and the option price for non-qualified stock options was
credited to additional paid-in capital.
The Harleysville Group Inc. Year 2000 Directors' Stock Option Program
provides for the granting of options to eligible directors to purchase a maximum
of 123,500 shares of common stock. Options are granted at exercise prices equal
to fair market value on the date of grant. The options vest immediately,
although no option is exercisable until six months after the date of grant. The
options have a term of 10 years.
Harleysville Group maintains stock option plans for substantially all
employees and certain designated agents. The plans provide for the granting of
options to purchase a maximum of 850,000 shares of common stock. The plans
provide that the options become exercisable from three to 10 years from the date
of grant with an option price not less than fair market value on the date of
grant.
Page 54
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - INCENTIVE PLANS (CONTINUED)
Information regarding activity in Harleysville Group's fixed stock option
plans is presented below:
WEIGHTED-AVERAGE
NUMBER EXERCISE PRICE
OF SHARES PER SHARE
---------- ----------------
Outstanding at
December 31, 1999 2,115,944 $16.30
Granted--2000 434,361 16.48
Exercised--2000 (254,567) 12.65
Forfeited--2000 (187,948) 18.09
--------- ------
Outstanding at
December 31, 2000 2,107,790 16.62
Granted--2001 475,850 26.36
Exercised--2001 (259,912) 14.26
Forfeited--2001 (84,180) 16.31
--------- ------
Outstanding at
December 31, 2001 2,239,548 18.97
Granted--2002 495,917 27.20
Exercised--2002 (323,611) 14.98
Forfeited--2002 (291,313) 15.93
--------- ------
Outstanding at
December 31, 2002 2,120,541 $21.92
========= ======
Exercisable at:
December 31, 2000 1,552,506 $16.37
========= ======
December 31, 2001 1,608,426 $17.21
========= ======
December 31, 2002 1,455,606 $19.64
========= ======
Page 55
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - INCENTIVE PLANS (CONTINUED)
The following table summarizes information about fixed stock options at
December 31, 2002:
RANGE OF EXERCISE PRICES
----------------------------------------
$11.13-16.69 $17.94-24.50 $26.36-27.20
------------ ------------ ------------
Options outstanding at
December 31, 2002:
Number of options 546,240 664,556 909,745
========== ========== ==========
Weighted-average
remaining contractual
life 5.3 years 5.5 years 8.9 years
========== ========== ==========
Weighted-average
exercise price $ 14.76 $ 21.12 $ 26.81
========== ========== ==========
Options exercisable at
December 31, 2002:
Number of options 546,240 662,556 246,810
========== ========== ==========
Weighted-average
exercise price $ 14.76 $ 21.13 $ 26.45
========== ========== ==========
The per share weighted-average fair value of options granted during 2002,
2001 and 2000 was $9.04, $8.45 and $4.80, respectively. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 2002, 2001 and 2000, respectively: dividend yield of 2.21%, 2.12% and
3.31%; expected volatility of 37.34%, 34.89% and 31.84%; risk-free interest rate
of 4.60%, 4.77% and 6.76%; and an expected life of 5.25 years.
Page 56
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12 - INCENTIVE PLANS (CONTINUED)
Other Stock Purchase and Incentive Plans
- ----------------------------------------
Harleysville Group Inc. is authorized to issue up to 1,000,000 shares of
common stock under the terms of the 1995 Employee Stock Purchase Plan.
Virtually all employees are eligible to participate in the plan, under which a
participant may elect to have up to 15% of base pay withheld to purchase shares.
The purchase price of the stock is 85% of the lower of the
beginning-of-the-subscription-period or end-of-the-subscription-period fair
market value. Each subscription period runs from January 15 through July 14, or
July 15 through January 14. Under the plan, Harleysville Group Inc. issued
92,175, 93,637 and 156,958 shares to employees in 2002, 2001 and 2000,
respectively.
Under Harleysville Group Inc.'s 1995 Agency Stock Purchase Plan, eligible
independent insurance agencies may invest up to $12,500 in shares of common
stock at 90% of the fair market value at the end of each six-month subscription
period. There are 1,000,000 shares of common stock available under the plan.
There were 43,174, 29,980 and 60,844 shares issued under the plan for which
$76,000, $180,000 and $66,000 of expense was recognized in 2002, 2001 and 2000,
respectively.
The 1996 Directors' Stock Purchase Plan provides for the issuance of up to
200,000 shares of Harleysville Group Inc. common stock to outside directors of
Harleysville Group Inc. and Mutual. The purchase price of the stock is 85% of
the lower of the beginning-of-the-subscription-period or
end-of-the-subscription-period fair market value. In 2002, 2001 and 2000
respectively, there were 9,647, 7,999 and 4,965 shares issued under the plan for
which $31,000, $75,000 and $20,000 of expense was recognized.
Harleysville Group has incentive bonus plans. Cash and common stock
bonuses are earned on a formula basis depending upon the performance of
Harleysville Group and Mutual in relation to certain targets. There are 600,000
shares of common stock available under the Long Term Incentive Plan and none of
these shares has been issued. Harleysville Group's expense for such plans was
$7,291,000, $1,808,000 and $2,963,000 for 2002, 2001 and 2000, respectively.
Page 57
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13 - PENSION AND OTHER BENEFIT PLANS
Harleysville Group Inc. has a pension plan that covers substantially all
full-time employees. Retirement benefits are a function of both the years of
service and level of compensation. Harleysville Group Inc.'s funding policy is
to contribute annually an amount equal to at least the minimum required
contribution in accordance with minimum funding standards established by ERISA.
Contributions are intended to provide not only for benefits attributed to
service to date, but also for those expected to be earned in the future.
Page 58
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13 - PENSION AND OTHER BENEFIT PLANS (CONTINUED)
The following table sets forth the year-end status of the plan including
Mutual:
2002 2001
-------- --------
(in thousands)
Change in benefit obligation
Benefit obligation at January 1 $126,900 $110,066
Service cost 5,632 4,745
Interest cost 9,137 8,348
Amendments 28
Net actuarial loss 12,780 8,035
Benefits paid (4,645) (4,294)
------- --------
Benefit obligation at
December 31 $149,832 $126,900
======== ========
Change in plan assets
Fair value of plan assets at
January 1 $101,967 $118,727
Actual return on plan assets (17,549) (12,657)
Contributions 2,493
Benefits paid (4,448) (4,103)
-------- --------
Fair value of plan assets
at December 31 $ 82,463 $101,967
======== ========
Funded status $(67,369) $(24,933)
Unrecognized net actuarial loss
(gain) 39,559 (845)
Unrecognized prior service cost 1,229 1,608
Unrecognized transition obligation 213 266
-------- --------
Accrued pension cost:
Entire plan $(26,368) $(23,904)
======== ========
Harleysville Group portion $(18,159) $(16,364)
======== ========
Amounts recognized in the statement
of financial position consist of:
Accrued pension cost $(26,780) $(16,608)
Intangible asset 821 244
Accumulated other comprehensive
income 7,800
-------- --------
Net amount recognized $(18,159) $(16,364)
======== ========
Page 59
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13 - PENSION AND OTHER BENEFIT PLANS (CONTINUED)
The net periodic pension cost for the plan including Mutual consists of the
following components:
2002 2001 2000
-------- -------- --------
(in thousands)
Components of net periodic
pension cost:
Service cost $ 5,632 $ 4,745 $4,434
Interest cost 9,137 8,348 7,482
Expected return on
plan assets (10,076) (9,596) (8,580)
Recognized net actuarial
loss (gain) 1 (152) (478)
Amortization of prior
service cost 407 588 610
Net transition
amortization 53 19 (117)
Curtailment (1,962)
-------- ------- -------
Net periodic pension cost:
Entire plan $ 5,154 $ 3,952 $ 1,389
======== ======= =======
Harleysville Group
portion $ 3,477 $ 2,663 $ 788
======== ======= =======
2002 2001 2000
-------- -------- --------
Weighted-average assumptions
as of December 31:
Discount rate 6.75% 7.25% 7.50%
Expected long-term rate
of return on plan
assets 9.00% 9.50% 9.50%
Rate of compensation
increase 4.50% 4.50% 4.50%
Harleysville Group has profit-sharing plans covering qualified employees.
Harleysville Group's expense under the plans was $1,573,000, $1,601,000 and
$2,821,000 for 2002, 2001 and 2000, respectively.
Page 60
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
14 - SEGMENT INFORMATION
As an underwriter of property and casualty insurance, Harleysville Group
has three reportable segments, which consist of the investment function, the
personal lines of insurance and the commercial lines of insurance. Using
independent agents, Harleysville Group markets personal lines of insurance to
individuals, and commercial lines of insurance to small and medium-sized
businesses.
Harleysville Group evaluates the performance of the personal lines and
commercial lines primarily based upon underwriting results as determined under
statutory accounting practices (SAP). Assets are not allocated to the personal
and commercial lines, and are reviewed in total by management for purposes of
decision making. Harleysville Group operates only in the United States, and no
single customer or agent provides 10 percent or more of revenues.
Financial data by segment is as follows:
2002 2001 2000
-------- -------- --------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $553,194 $493,362 $437,873
Personal lines 211,442 236,527 250,457
-------- -------- --------
Total premiums
earned 764,636 729,889 688,330
Net investment income 86,265 85,518 86,791
Realized investment
gains (losses) (18,448) (3,071) 9,780
Other 15,283 15,415 17,670
-------- -------- --------
Total revenues $847,736 $827,751 $802,571
======== ======== ========
Income before income taxes:
Underwriting loss:
Commercial lines $(11,473) $ (7,128) $(22,925)
Personal lines (13,963) (29,372) (23,281)
-------- -------- --------
SAP underwriting
loss (25,436) (36,500) (46,206)
GAAP adjustments 8,803 2,017 3,602
-------- -------- --------
GAAP underwriting
loss (16,633) (34,483) (42,604)
Net investment income 86,265 85,518 86,791
Realized investment
gains (losses) (18,448) (3,071) 9,780
Other 5,298 3,836 3,738
-------- -------- --------
Income before income taxes $ 56,482 $ 51,800 $ 57,705
======== ======== ========
Page 61
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
15 - EARNINGS PER SHARE
The computation of basic and diluted earnings per share is as follows:
2002 2001 2000
--------- -------- --------
(dollars in thousands, except per share data)
Numerator for basic
and diluted earnings
per share:
Net income $46,255 $43,493 $48,692
======= ======= =======
Denominator for basic
earnings per share --
weighted-average
shares outstanding 29,699,201 29,267,587 28,838,824
Effect of stock
incentive plans 596,748 550,942 297,582
-------- -------- --------
Denominator for
diluted earnings
per share 30,295,949 29,818,529 29,136,406
========== ========== ==========
Basic earnings
per share $ 1.56 $ 1.49 $ 1.69
======= ======= =======
Diluted earnings
per share $ 1.53 $ 1.46 $ 1.67
======= ======= =======
The following options to purchase shares of common stock were not included
in the computation of diluted earnings per share because the exercise price of
the options was greater than the average market price:
2002 2001 2000
---- ---- ----
(in thousands)
Number of options 491 284 566
=== === ===
Page 62
HARLEYSVILLE GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
2002
-------------------------------------------------------
(in thousands, except per share data)
FIRST SECOND THIRD FOURTH TOTAL
--------- -------- -------- -------- ---------
Revenues $208,210 $192,149 $222,287 $225,090 $847,736
Losses and
expenses 191,287 195,353 202,562 202,052 791,254
Net income 13,340 296 15,216 17,403 46,255
Earnings per
common share:
Basic $ .45 $ .01 $ .51 $ .58 $ 1.56
Diluted $ .44 $ .01 $ .50 $ .57 $ 1.53
2001
-------------------------------------------------------
(in thousands, except per share data)
FIRST SECOND THIRD FOURTH TOTAL
--------- -------- -------- -------- ---------
Revenues $200,320 $203,442 $205,821 $218,168 $827,751
Losses and
expenses 189,523 190,309 197,396 198,723 775,951
Net income 9,718 10,978 7,855 14,942 43,493
Earnings per
common share:
Basic $ .33 $ .38 $ .27 $ .51 $ 1.49
Diluted $ .33 $ .37 $ .26 $ .50 $ 1.46
Page 63
Independent Auditors' Report
The Board of Directors
and Shareholders
Harleysville Group Inc.:
We have audited the accompanying consolidated balance sheets of Harleysville
Group as of December 31, 2002 and 2001, and the related consolidated statements
of income, shareholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Harleysville Group
as of December 31, 2002 and 2001, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
2002, in conformity with accounting principles generally accepted in the United
States of America.
/s/KPMG LLP
Philadelphia, Pennsylvania
February 14, 2003
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