UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2005
---------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------- --------
Commission file number 0-14697
HARLEYSVILLE GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 51-0241172
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
355 MAPLE AVENUE, HARLEYSVILLE, PA 19438-2297
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 256-5000
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark whether the Registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act). Yes X No .
At July 28, 2005, 30,430,482 shares of common stock of Harleysville
Group Inc. were outstanding.
Page 1
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
INDEX
Page Number
- ------------
Part I - Financial Information
Consolidated Balance Sheets -
June 30, 2005 and December 31, 2004 3
Consolidated Statements of Income - For the
three months ended June 30, 2005 and 2004 4
Consolidated Statements of Income -
For the six months ended June 30, 2005 and 2004 5
Consolidated Statement of Shareholders' Equity -
For the six months ended June 30, 2005 6
Consolidated Statements of Cash Flows -
For the six months ended June 30, 2005 and 2004 7
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Quantitative and Qualitative Disclosure About Market Risk 26
Controls and Procedures 27
Part II - Other Information 28
Page 2
ITEM 1. FINANCIAL STATEMENTS
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
JUNE 30, DECEMBER 31,
2005 2004
----------- ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(fair value $497,802 and $517,434) $ 483,369 $ 499,487
Available for sale, at fair value
(cost $1,164,813 and $1,028,457) 1,198,607 1,067,504
Equity securities, at fair value
(cost $110,988 and $110,495) 147,275 150,249
Short-term investments, at cost,
which approximates fair value 53,347 113,822
Fixed maturity securities on loan:
Held to maturity, at amortized cost
(fair value $4,923 and $1,966) 4,852 1,835
Available for sale, at fair value
(amortized cost $116,591 and $128,183) 122,145 134,020
---------- ----------
Total investments 2,009,595 1,966,917
Cash 355 328
Receivables:
Premiums 151,642 141,601
Reinsurance (affiliate $349 and $390) 170,356 193,209
Accrued investment income 23,747 23,236
---------- ----------
Total receivables 345,745 358,046
Deferred policy acquisition costs 106,092 100,755
Prepaid reinsurance premiums 32,174 32,675
Property and equipment, net 18,283 20,891
Deferred income taxes 57,067 53,137
Securities lending collateral 130,634 139,486
Due from affiliate 4,351
Other assets 44,662 45,828
---------- ----------
Total assets $2,748,958 $2,718,063
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss settlement expenses
(affiliate $181,431 and $187,172) $1,355,763 $1,317,735
Unearned premiums (affiliate $46,899 and $47,038) 458,667 441,697
Accounts payable and accrued expenses 84,047 99,098
Securities lending obligation 130,634 139,486
Debt (affiliate $18,500 and $18,500) 119,060 119,625
Due to affiliate 12,498
---------- ----------
Total liabilities 2,148,171 2,130,139
---------- ----------
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 31,739,809
and 31,589,474 shares; outstanding
30,341,900 and 30,191,565 shares 31,740 31,589
Additional paid-in capital 164,395 161,689
Accumulated other comprehensive income 36,200 42,051
Retained earnings 393,480 377,282
Deferred compensation (541) (200)
Treasury stock, at cost, 1,397,909 shares (24,487) (24,487)
---------- ----------
Total shareholders' equity 600,787 587,924
---------- ----------
Total liabilities and shareholders' equity $2,748,958 $2,718,063
========== ==========
See accompanying notes to consolidated financial statements.
Page 3
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2004
(dollars in thousands, except per share data)
2005 2004
-------- --------
Revenues:
Premiums earned from affiliate, (ceded to affiliate, $186,991
and $183,619) $209,865 $207,652
Investment income, net of investment expense 22,578 21,437
Realized investment gains, net 68 59
Other income (affiliate $1,708 and $1,680) 4,158 3,671
-------- --------
Total revenues 236,669 232,819
-------- --------
Losses and expenses:
Losses and loss settlement expenses (ceded to affiliate,
$124,485 and $122,097) 143,997 148,711
Amortization of deferred policy acquisition costs 52,043 50,698
Other underwriting expenses 18,778 19,726
Interest expense (affiliate $177 and $84) 1,665 1,566
Other expenses 1,763 1,266
-------- --------
Total expenses 218,246 221,967
-------- --------
Income before income taxes 18,423 10,852
Income taxes 3,896 1,124
-------- --------
Net income $ 14,527 $ 9,728
======== ========
Per common share:
Basic earnings $ .48 $ .32
======== ========
Diluted earnings $ .48 $ .32
======== ========
Cash dividend $ .17 $ .17
======== ========
See accompanying notes to consolidated financial statements.
Page 4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(dollars in thousands, except per share data)
2005 2004
-------- --------
Revenues:
Premiums earned from affiliate, (ceded to affiliate, $370,441 and
$364,795) $416,545 $414,600
Investment income, net of investment expense 44,339 43,079
Realized investment gains, net 68 12,547
Other income (affiliate $3,501 and $3,455) 8,441 8,235
-------- --------
Total revenues 469,393 478,461
-------- --------
Losses and expenses:
Losses and loss settlement expenses (ceded to affiliate, $256,505
and $261,782) 291,865 299,821
Amortization of deferred policy acquisition costs 102,961 101,386
Other underwriting expenses 35,133 39,364
Interest expense (affiliate $308 and $168) 3,285 3,143
Other expenses 3,270 2,685
-------- --------
Total expenses 436,514 446,399
-------- --------
Income before income taxes 32,879 32,062
Income taxes 6,370 5,841
-------- --------
Net income $ 26,509 $ 26,221
======== ========
Per common share:
Basic earnings $ .88 $ .88
======== ========
Diluted earnings $ .87 $ .87
======== ========
Cash dividend $ .34 $ .34
======== ========
See accompanying notes to consolidated financial statements.
Page 5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2005
(dollars in thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------ PAID-IN COMPREHENSIVE RETAINED DEFERRED TREASURY
SHARES AMOUNT CAPITAL INCOME EARNINGS COMPENSATION STOCK TOTAL
---------- -------- ---------- ------------- -------- ------------ -------- -----
Balance at
December 31, 2004 31,589,474 $31,589 $161,689 $42,051 $377,282 $(200) $(24,487) $587,924
--------
Net income 26,509
Other comprehensive
income, net of tax:
Unrealized investment
losses, net of
reclassification
adjustment (5,851) (5,851)
--------
Comprehensive income 20,658
Issuance of common stock 150,335 151 2,549 2,700
Tax benefit from stock
options exercised 157 157
Deferred compensation (341) (341)
Cash dividends (10,311) (10,311)
---------- ------- -------- ------- -------- ----- -------- --------
Balance at
June 30, 2005 31,739,809 $31,740 $164,395 $36,200 $393,480 $(541) $(24,487) $600,787
========== ======= ======== ======= ======== ===== ======== ========
See accompanying notes to consolidated financial statements.
Page 6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(in thousands)
2005 2004
-------- ---------
Cash flows from operating activities:
Net income $ 26,509 $ 26,221
Adjustments to reconcile net income
to net cash provided by operating activities:
Change in receivables, unearned premiums and
prepaid reinsurance balances 29,772 (5,813)
Change in affiliate balance (16,849) (10,831)
Increase in unpaid losses and loss settlement expenses 38,028 33,306
Deferred income taxes (779) (32)
Increase in deferred policy acquisition costs (5,337) (4,891)
Amortization and depreciation 2,737 2,727
Gain on sale of investments (68) (12,547)
Other, net (2,494) (4,286)
--------- ---------
Net cash provided by operating activities 71,519 23,854
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (180,736) (113,176)
Sales or maturities 56,322 102,754
Equity securities:
Purchases (3,878) (16,106)
Sales 3,401 16,491
Net sales (purchases) of short-term investments 60,475 (16,569)
Sale (purchase) of property and equipment, net 1,507 (379)
--------- ---------
Net cash used by investing activities (62,909) (26,985)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 2,293 1,466
Repayment of debt obligations (565) (520)
Dividends paid (to affiliate, $5,781 and $5,781) (10,311) (10,195)
--------- ---------
Net cash used by financing activities (8,583) (9,249)
--------- ---------
Increase (decrease) in cash 27 (12,380)
Cash at beginning of period 328 13,430
--------- ---------
Cash at end of period $ 355 $ 1,050
========= =========
See accompanying notes to consolidated financial statements.
Page 7
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 - Basis of Presentation
The financial information for the interim periods included herein is
unaudited; however, such information reflects all adjustments which are, in the
opinion of management, necessary to a fair presentation of the financial
position, results of operations, and cash flows for the interim periods. The
results of operations for interim periods are not necessarily indicative of
results to be expected for the full year.
These financial statements should be read in conjunction with the
financial statements and notes for the year ended December 31, 2004 included in
the Company's 2004 Annual Report filed with the Securities and Exchange
Commission on Form 10-K.
The affiliate transaction disclosures on the face of the financial
statements are in regards to transactions with Harleysville Mutual Insurance
Company (Mutual). Mutual owns approximately 56% of the outstanding common stock
of Harleysville Group Inc. As used herein, "Harleysville Group" refers to
Harleysville Group Inc. and its subsidiaries.
Policy Acquisition Costs
Policy acquisition costs, such as commissions, premium taxes and
certain other underwriting and agency expenses that vary with and are primarily
related to the production of business, are deferred and amortized over the
effective period of the related insurance policies and in proportion to the
premiums earned. The method followed in computing deferred policy acquisition
costs limits the amount of such deferred costs to their estimated realizable
value. The estimation of net realizable value takes into account the premium to
be earned, related investment income over the claim paying period, losses and
loss settlement expenses, and certain other costs expected to be incurred as the
premium is earned. Future changes in estimates, the most significant of which
is expected losses and loss settlement expenses, may require adjustments to
deferred policy acquisition costs. If the estimation of net realizable value
indicates that the acquisition costs are unrecoverable, further analyses are
completed to determine if a reserve is required to provide for losses that may
exceed the related unearned premiums.
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 for the three and six months
ended June 30, 2005 and 2004:
Page 8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------ ------ ------ ------
(in thousands, except per share data)
Net income, as reported $14,527 $9,728 $26,509 $26,221
Plus:
Stock-based employee compensation
expense (benefit) included in reported
net income, net of related tax effects (57) 11 (327) 54
Less:
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects (635) (703) (847) (1,452)
------- ------ ------- -------
Pro forma net income $13,835 $9,036 $25,335 $24,823
======= ====== ======= =======
Basic earnings per share:
As reported $ .48 $ .32 $ .88 $ .88
Pro forma $ .46 $ .30 $ .84 $ .83
Diluted earnings per share:
As reported $ .48 $ .32 $ .87 $ .87
Pro forma $ .46 $ .30 $ .83 $ .83
In December 2004, the Financial Accounting Standards Board issued
SFAS No. 123(R), "Shared-Based Payment," which is a revision of SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS 123(R) requires that the
compensation cost related to share-based payment transactions be recognized in
financial statements. The compensation cost will be measured based on the fair
value of the equity or liability instruments issued. The Statement is effective
as of the beginning of the first fiscal year beginning after June 15, 2005. The
impact of adopting SFAS No. 123(R) is currently being evaluated. The impact
that any future share-based payment transactions will have on our financial
position or results of operations is not yet known.
Page 9
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2 - Earnings Per Share
The computation of basic and diluted earnings per share is as
follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------ ------ ----- -----
(in thousands, except per share data)
Numerator for basic and diluted earnings per share:
Net income $14,527 $ 9,728 $26,509 $26,221
======= ======= ======= =======
Denominator for basic earnings per share --
weighted average shares outstanding 30,305 29,960 30,279 29,960
Effect of stock incentive plans 89 68 131 85
------- ------- ------- -------
Denominator for diluted earnings per share 30,394 30,028 30,414 30,045
======= ======= ======= =======
Basic earnings per share $ .48 $ .32 $ .88 $ .88
======= ======= ======= =======
Diluted earnings per share $ .48 $ .32 $ .87 $ .87
======= ======= ======= =======
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:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
----- ----- ----- -----
(in thousands)
Number of options 1,747 2,127 1,747 1,635
===== ===== ===== =====
3 - Reinsurance
Premiums earned are net of amounts ceded of $23,918,000 and
$45,827,000 for the three and six months ended June 30, 2005, respectively, and
$22,479,000 and $44,057,000 for the three and six months ended June 30, 2004,
respectively. Losses and loss settlement expenses are net of amounts ceded of
$3,522,000 and $11,196,000 for the three and six months ended June 30, 2005,
respectively, and $5,562,000 and $39,716,000 for the three and six months ended
June 30, 2004, respectively. Such amounts ceded do not include the reinsurance
transactions with Mutual under the pooling arrangement (described below) which
are reflected on the face of the income statements, but do include reinsurance
with unaffiliated reinsurers and the reinsurance described in the following
paragraph.
Page 10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Harleysville Group has a reinsurance agreement with Mutual whereby
Mutual reinsures accumulated catastrophe losses in a quarter up to $14,400,000
in excess of $3,600,000 in return for a reinsurance premium. The agreement
excludes catastrophe losses resulting from earthquakes, terrorism or hurricanes,
and supplements the existing external catastrophe reinsurance program.
Harleysville Group ceded to Mutual premiums earned of $2,336,000 and $2,263,000
and losses incurred of $(151,000) and $(816,000), for the three months ended
June 30, 2005 and 2004, respectively. Harleysville Group ceded to Mutual
premiums earned of $4,411,000 and $4,260,000 and losses incurred of $(90,000)
and $984,000 for the six months ended June 30, 2005 and 2004, respectively.
Harleysville Group and Mutual have agreed to terminate this agreement on
December 31, 2005.
Pursuant to the terms of a reinsurance pooling agreement with
Mutual, each of the insurance subsidiaries of Harleysville Group Inc. cedes
premiums, losses and expenses on all of their respective business to Mutual
which, in turn, retrocedes to such subsidiaries a specified portion of premiums,
losses and expenses of Mutual and such subsidiaries. Because this agreement
does not relieve Harleysville Group Inc.'s insurance subsidiaries of primary
liability as originating insurers, there is a concentration of credit risk
arising from business ceded to Mutual. However, the reinsurance pooling
agreement provides for the right of offset. Mutual has an A. M. Best rating of
"A-" (Excellent).
4 - Cash Flows
There were net cash tax payments of $4,100,000 and $4,282,000 and
cash interest payments of $3,195,000 and $3,071,000 in the first six months of
2005 and 2004, respectively.
5 - Segment Information
The performance of the personal lines and commercial lines is
evaluated based upon underwriting results as determined under statutory
accounting practices (SAP).
Page 11
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Financial data by segment is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------ ------ ------ ------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $170,858 $163,791 $338,171 $326,111
Personal lines 39,007 43,861 78,374 88,489
-------- -------- -------- --------
Total premiums earned 209,865 207,652 416,545 414,600
Net investment income 22,578 21,437 44,339 43,079
Realized investment gains 68 59 68 12,547
Other 4,158 3,671 8,441 8,235
-------- -------- -------- --------
Total revenues $236,669 $232,819 $469,393 $478,461
======== ======== ======== ========
Income before income taxes:
Underwriting gain (loss):
Commercial lines $ (9,760) $(16,358) $(19,998) $(26,006)
Personal lines 1,114 10 1,531 4,850
-------- -------- -------- --------
SAP underwriting loss (8,646) (16,348) (18,467) (30,856)
GAAP adjustments 3,693 4,865 5,053 4,885
-------- -------- -------- --------
GAAP underwriting loss (4,953) (11,483) (13,414) (25,971)
Net investment income 22,578 21,437 44,339 43,079
Realized investment gains 68 59 68 12,547
Other 730 839 1,886 2,407
-------- -------- -------- --------
Income before income taxes $ 18,423 $ 10,852 $ 32,879 $ 32,062
======== ======== ======== ========
Page 12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6 - Comprehensive Income
Comprehensive income for the three and six months ended June 30,
2005 and 2004 consisted of the following (all amounts are net of taxes):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------ ------ ------ ------
(in thousands)
Net income $14,527 $ 9,728 $26,509 $ 26,221
Other comprehensive income (loss):
Unrealized investment holding gains
(losses) arising during period 9,603 (25,322) (5,807) (14,601)
Less:
Reclassification adjustment for gains
included in net income (44) (38) (44) (8,131)
------- -------- ------- --------
Net unrealized investment gains (losses) 9,559 (25,360) (5,851) (22,732)
------- -------- ------- --------
Comprehensive income (loss) $24,086 $(15,632) $20,658 $ 3,489
======= ======== ======= ========
7 - Pension
Harleysville Group Inc. has a pension plan that covers substantially
all full-time employees. The net periodic pension cost for the plan including
Mutual consists of the following components:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------- ------ ------ -------
(in thousands)
Components of net periodic pension cost:
Service cost $ 2,209 $ 1,992 $ 4,418 $ 3,985
Interest cost 2,988 2,770 5,976 5,540
Expected return on plan assets (2,790) (3,020) (5,580) (6,040)
Recognized net actuarial loss 1,112 517 2,224 1,035
Amortization of prior service cost 52 53 104 105
Net transition amortization 14 13 27 25
------- ------- ------- -------
Net periodic pension cost:
Entire plan $ 3,585 $ 2,325 $ 7,169 $ 4,650
======= ======= ======= =======
Harleysville Group portion $ 2,374 $ 1,536 $ 4,749 $ 3,069
======= ======= ======= =======
Page 13
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Harleysville Group's expected portion of the 2005 contribution to
the pension plan is $8,015,000. Contributions of $4,001,000 were made in the
first six months of 2005.
8 - Shareholders' Equity
Various states have adopted the National Association of Insurance
Commissioners (NAIC) risk-based capital (RBC) standards that require insurance
companies to calculate and report statutory capital and surplus needs based on a
formula measuring underwriting, investment and other business risks inherent in
an individual company's operations. These RBC standards have not affected the
operations of Harleysville Group since each of the Company's insurance
subsidiaries has statutory capital and surplus in excess of RBC requirements.
These RBC standards require the calculation of a ratio of total
adjusted capital to Authorized Control Level. Insurers with a ratio below 200%
are subject to different levels of regulatory intervention and action. Based
upon their 2004 statutory financial statements, the ratio of total adjusted
capital to the Authorized Control Level for the Company's nine insurance
subsidiaries at December 31, 2004 ranged from 498% to 609%.
Page 14
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain of the statements contained herein (other than statements of
historical facts) are forward looking statements. Such forward looking
statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and include estimates and assumptions
related to economic, competitive and legislative developments. These forward
looking statements are subject to change and uncertainty which are, in many
instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect on Harleysville Group. There can be no assurance that future
developments will be in accordance with management's expectations so that the
effect of future developments on Harleysville Group will be those anticipated by
management. Actual financial results including premium growth and underwriting
results could differ materially from those anticipated by Harleysville Group
depending on the outcome of certain factors, which may include changes in
property and casualty loss trends and reserves; catastrophe losses; competition
in insurance product pricing; government regulation and changes therein which
may impede the ability to charge adequate rates; performance of the financial
markets; fluctuations in interest rates; availability and price of reinsurance;
the Best's rating of Harleysville Group; and the status of labor markets in
which the Company operates.
Overview
The Company's net income is primarily determined by three elements:
- net premium income
- investment income
- amounts paid or reserved to settle insured claims
A number of factors may affect the level of premium income,
including:
- limitations on rates arising from the competitive market place or
regulation
- limitation on available business arising from a need to maintain the
quality of underwritten risks
- the Company's ability to maintain its A- ("excellent") rating by A.M. Best
- the ability of the Company to maintain a reputation for efficiency and
fairness in claims administration
Page 15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
A number of factors may affect the level of investment income,
including:
- general interest rate levels and amounts of cash flow
- specific adverse events affecting the issuers of debt obligations held by
the Company
- changes in the prices of equity securities generally and those held by the
Company specifically
Loss and loss settlement expenses are affected by a number of
factors, including:
- the quality of the risks underwritten by the Company
- the nature and severity of catastrophe losses
- the availability, cost and terms of reinsurance
- underlying settlement costs, including medical and legal costs
The Company seeks to manage each of the foregoing to the extent
within its control. Many of the foregoing factors are partially, or entirely,
outside of the control of the Company.
Critical Accounting Policies and Estimates
The consolidated financial statements are prepared in conformity
with U.S. generally accepted accounting principles, which require Harleysville
Group to make estimates and assumptions (see Note 1 of the Notes to Consolidated
Financial Statements for the year ended December 31, 2004 included in the
Company's 2004 Annual Report filed with the Securities and Exchange Commission
on Form 10-K). Harleysville Group believes that of its significant accounting
policies, the following may involve a higher degree of judgment and estimation.
The judgments, or the methodology on which the judgments are made, are reviewed
quarterly with the Audit Committee.
Liability for Losses and Loss Settlement Expenses. The liability
for losses and loss settlement expenses represents estimates of the ultimate
unpaid cost of all losses incurred, including losses for claims which have not
yet been reported to Harleysville Group. The amount of loss reserves for
reported claims is based primarily upon a case-by-case evaluation of the type of
risk involved, knowledge of the circumstances surrounding each claim and the
insurance policy provisions relating to the type of loss. The amounts of loss
reserves for unreported claims and loss
Page 16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
settlement expense reserves are determined utilizing historical information by
line of insurance as adjusted to current conditions. Inflation is implicitly
provided for in the reserving function through analysis of costs, trends and
reviews of historical reserving results. Reserves are closely monitored and are
recomputed periodically using the most recent information on reported claims and
a variety of statistical techniques. It is expected that such estimates will be
more or less than the amounts ultimately paid when the claims are settled.
Changes in these estimates are reflected in current operations.
Investments. Generally, 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. However, if the fair value of an
investment declines below its cost and that decline is deemed other than
temporary, the amount of the decline below cost is charged to earnings.
Harleysville Group monitors its investment portfolio and quarterly reviews
investments that have experienced a decline in fair value below cost to evaluate
whether the decline is other than temporary. Such evaluations consider, among
other things, the magnitude and reasons for a decline and the prospects for the
fair value to recover in the near term. Future adverse investment market
conditions, or poor operating results of underlying investments, could result in
an impairment charge in the future.
Harleysville Group has written down to fair value, any equity
security that has declined below cost by more than 20% and maintained such
decline for six months, or by 50% or more, in the quarter in which either such
decline occurred. In some cases, securities that have declined by a lesser
amount or for a shorter period of time are written down if the evaluation
indicates the decline is other-than-temporary. Fair value of equity securities
is based on the closing market value as reported by a national stock exchange or
Nasdaq. The fair value of fixed maturities is based upon data supplied by an
independent pricing service. It can be difficult to determine the fair value of
non-traded securities but Harleysville Group does not own a material amount of
non-traded securities.
Policy Acquisition Costs. Policy acquisition costs, such as
commissions, premium taxes and certain other underwriting and agency expenses
that vary with and are primarily related to the production of business, are
deferred and amortized over the effective period of the related insurance
policies and in proportion to the premiums earned. The method followed in
computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value. The estimation of net realizable
value takes into account the premium to be earned, related investment income
over the claim paying period, losses and loss settlement expenses, and certain
other costs expected to be incurred as the premium is earned. Future changes in
estimates, the most significant of which is expected losses and loss settlement
expenses, may require adjustments to deferred policy acquisition costs. If the
estimation of net realizable value indicates that the acquisition costs are
unrecoverable, further analyses are completed to determine if a reserve is
required to provide for losses that may exceed the related unearned premiums.
Page 17
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Contingencies. Besides claims related to its insurance products,
Harleysville Group is subject to proceedings, lawsuits and claims in the normal
course of business. Harleysville Group assesses the likelihood of any adverse
outcomes to these matters as well as potential ranges of probable losses. There
can be no assurance that actual outcomes will not differ from those assessments.
The application of certain of these critical accounting policies to
the periods ended June 30, 2005 and 2004 is discussed in greater detail below.
Results of Operations
Premiums earned increased $2.2 million and $1.9 million during the
three and six months ended June 30, 2005, respectively. The increases are
primarily due to increases in premiums earned for commercial lines of $7.1
million and $12.0 million, respectively, partially offset by decreases of $4.9
million and $10.1 million in personal lines premiums earned for the three and
six months ended June 30, 2005, respectively. The increases in premiums earned
for commercial lines were 4.3% and 3.7% for the three and six months ended June
30, 2005, respectively, primarily due to higher average premiums. The declines
in premiums earned for personal lines were 11.1% and 11.4% for the three and six
months ended June 30, 2005, respectively, primarily due to fewer policy counts.
The reduction in personal lines volume was driven primarily by a reduction of
personal automobile business from the continued implementation of more stringent
underwriting processes.
Investment income increased $1.1 million and $1.3 million for the
three and six months ended June 30, 2005 as compared to the same periods in the
prior year, resulting from an increase in invested assets partially offset by a
lower yield on the fixed maturity investment portfolio.
Realized investment gains decreased $12.5 million for the six months
ended June 30, 2005 as compared to the same period in the prior year, and were
essentially unchanged for the three months ended June 30, 2005. The six-month
decrease primarily resulted from gains on the sale of two equity securities in
the first quarter of 2004.
Page 18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Harleysville Group holds securities with unrealized losses at June
30, 2005 as follows:
LENGTH OF UNREALIZED LOSS
-------------------------
UNREALIZED LESS THAN OVER 12
FAIR VALUE LOSS 12 MONTHS MONTHS
-------------- ---------- ------------- -----------
(in thousands)
Fixed maturities:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 78,644 $ 662 $ 240 $ 422
Obligations of states and
political subdivisions 96,414 1,403 409 994
Corporate securities 158,808 2,719 891 1,828
Mortgage-backed securities 18,334 103 94 9
-------- ------- ------ ------
Total fixed maturities $352,200 $ 4,887 $1,634 $3,253
======== ======= ====== ======
Equity securities $ 27,362 $ 2,184 $2,184 $ -
======== ======= ====== ======
There are 13 positions that comprise the unrealized loss in equity
investments at June 30, 2005. All have had volatile price movements and have
not been significantly below cost for significant continuous amounts of time.
Harleysville Group has been monitoring these securities and it is possible that
some may be written down in the income statement in the future.
Of the total fixed maturity securities with an unrealized loss at
June 30, 2005, securities with a fair value of $260.1 million and an unrealized
loss of $3.7 million are classified as available for sale and are carried at
fair value on the balance sheet while securities with a fair value of $92.1
million and an unrealized loss of $1.2 million are classified as held to
maturity on the balance sheet and are carried at amortized cost.
The fixed maturity investments with continuous unrealized losses for
less than twelve months were primarily due to the impact of higher market
interest rates rather than a decline in credit quality. There are $137.0
million in fixed maturity securities, at fair value, that at June 30, 2005, had
been below amortized cost for over twelve months. Of the $3.3 million of
unrealized losses on such securities, $2.0 million relates to securities which
carry investment grade ratings and have declined in fair value roughly in line
with market interest rate changes. The remaining $1.3 million of unrealized
losses are comprised of airline enhanced equipment trust certificates (EETC) as
follows:
FAIR MATURITY
COST VALUE DATES
--------- ------- ---------
(in thousands)
American Airlines $14,369 $13,712 2011
United Airlines 6,932 6,423 2010-2012
Other airlines 2,000 1,892 2011
------- -------
$23,301 $22,027
======= =======
Page 19
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
After the events of September 11, 2001, air travel and the value of
these airlines' EETC securities declined. The EETCs are all "A tranche"
holdings, which means they are in a senior credit position to the underlying
airplane collateral value as compared to B and C tranche holders. At the time
of issuance, the collateral was appraised at approximately twice the value of
the A tranche EETCs. Recent estimates indicate that in a distressed sale
scenario, the value of the collateral would be approximately the same as the
EETCs' cost. The EETCs' market value has improved over the past year.
Harleysville Group is participating in certain EETC creditor committees and is
monitoring developments. It is possible that these EETCs may be written down in
the income statement in the future, depending upon developments involving both
the issuers and world events which impact the level of air travel.
Income before income taxes increased $7.6 million for the three
months ended June 30, 2005 compared to the same prior year period. The increase
was primarily due to the increase in investment income and a lower underwriting
loss. Income before income taxes increased $0.8 million for the six months
ended June 30, 2005 compared to the same prior year period. The increase was
primarily due to the increase in investment income and a lower underwriting
loss, partially offset by lower realized investment gains. The lower
underwriting losses were primarily due to lower catastrophe losses, lesser loss
severity and lower expenses. Catastrophe losses were $0.6 million and $1.6
million for the three and six months ended June 30, 2005, respectively, as
compared to $1.3 million and $3.9 million for the three and six months ended
June 30, 2004, respectively.
An insurance company's statutory combined ratio is a standard
measure of underwriting profitability. This ratio is the sum of (1) the ratio
of incurred losses and loss settlement expenses to net earned premium; (2) the
ratio of expenses incurred for commissions, premium taxes, administrative and
other underwriting expenses to net written premium; and (3) the ratio of
dividends to policyholders to net earned premium. The combined ratio does not
reflect investment income, federal income taxes or other non-operating income or
expense. A ratio of less than 100 percent generally indicates underwriting
profitability. Harleysville Group's statutory combined ratio decreased to
101.9% for the three months ended June 30, 2005 from 105.4% for the three months
ended June 30, 2004 and decreased to 103.1% for the six months ended June 30,
2005 from 106.3% for the six months ended June 30, 2004. Such decreases were
due to better underwriting results in both commercial lines and personal lines.
Page 20
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
The statutory combined ratios by line of business for the three and
six months ended June 30, 2005, as compared to the three and six months ended
June 30, 2004, were as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2005 2004 2005 2004
------ ------ ------ ------
Commercial:
Automobile 97.9% 104.7% 99.0% 103.9%
Workers compensation 124.2% 122.2% 124.8% 122.5%
Commercial multi-peril 100.4% 105.5% 102.7% 105.3%
Other commercial 100.9% 95.4% 92.9% 88.5%
Total commercial 103.0% 106.7% 103.7% 105.7%
Personal:
Automobile 104.1% 110.9% 105.1% 114.6%
Homeowners 92.3% 86.0% 97.4% 97.6%
Other personal 63.7% 83.6% 75.8% 112.3%
Total personal 97.2% 100.6% 100.4% 108.4%
Total personal and commercial 101.9% 105.4% 103.1% 106.3%
The following table presents the liability for unpaid losses and
loss settlement expenses by major line of business:
JUNE 30, DECEMBER 31,
2005 2004
----------- ------------
(in thousands)
Commercial:
Automobile $ 264,564 $ 249,044
Workers compensation 305,045 298,994
Commercial multi-peril 406,389 371,247
Other commercial 78,063 70,535
---------- ----------
Total commercial 1,054,061 989,820
---------- ----------
Personal:
Automobile 99,465 103,050
Homeowners 38,301 37,026
Other personal 1,314 1,713
---------- ----------
Total personal 139,080 141,789
---------- ----------
Total personal and commercial 1,193,141 1,131,609
Plus reinsurance recoverables 162,622 186,126
---------- ----------
Total liability $1,355,763 $1,317,735
========== ==========
Page 21
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
The commercial lines statutory combined ratio decreased to 103.0%
for the three months ended June 30, 2005 from 106.7% for the three months ended
June 30, 2004 and decreased to 103.7% for the six months ended June 30, 2005
from 105.7% for the six months ended June 30, 2004. The decreases were
primarily due to declines in the combined ratio for commercial automobile and
commercial multi-peril primarily due to lower loss severity and lower property
losses.
There was $8.8 million of net favorable development in the provision
for insured events in prior years for the six months ended June 30, 2005 ($2.8
million in the second quarter of 2005) of which $4.3 million was in commercial
lines and $4.5 million was in personal lines. Approximately $4.0 million of the
$8.8 million of favorable development related to the liability for loss
adjusting expenses. The remaining favorable development primarily related to
the 2004 and 2003 accident years partially offset by adverse development in the
prior accident years. There was $3.0 million of net adverse development in the
provision for insured events in prior years for the six months ended June 30,
2004.
The following table presents workers compensation claim count
information for the total pooled business in which Harleysville Group
participates and payment amounts which are Harleysville Group's pooling share of
the total pooled amounts.
FOR THE SIX MONTHS FOR THE YEAR ENDED
ENDED JUNE 30, 2005 DECEMBER 31, 2004
------------------- ------------------
(dollars in thousands)
Number of claims pending, beginning of period 6,832 8,005
Number of claims reported 4,523 10,632
Number of claims settled or dismissed (4,915) (11,805)
Number of claims pending, end of period 6,440 6,832
-------- --------
Losses paid $ 32,831 $ 73,548
======== ========
Loss settlement expenses paid $ 7,306 $ 15,831
======== ========
Workers compensation losses primarily consist of indemnity and
medical costs for injured workers. The reduction in claim counts reflects the
impact of a reduction in workers compensation exposure as policy counts have
declined.
Harleysville Group records the actuarial best estimate of the
ultimate unpaid losses and loss settlement expenses incurred and does not
determine an estimated possible range of loss. Actuarial loss reserving
techniques and assumptions, which rely on historical information as adjusted to
reflect current conditions, have been consistently applied during the periods
presented. Changes in the estimate of the liability for unpaid losses and loss
settlement expenses reflect actual payments and evaluations of new information
and data since the last reporting date. These changes correlate with actuarial
trends.
Page 22
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Because of the nature of insurance claims, there are uncertainties
inherent in the estimates of ultimate losses. Reorganization of the claims
operation in recent years has resulted in new people and processes involved in
settling claims. As a result, more recent statistical data reflects different
patterns than in the past and give rise to uncertainty as to the pattern of
future loss settlements. Litigation on bodily injury liability cases is higher
for the past three years while the rate of settlement is slower. These changed
patterns give rise to greater uncertainty as to the pattern of future loss
settlements on bodily injury liability claims. There are uncertainties
regarding future loss cost trends particularly related to medical treatments and
automobile repair. Court decisions, regulatory changes and economic conditions
can affect the ultimate cost of claims that occurred in the past. Accordingly,
the ultimate liability for unpaid losses and loss settlement expenses will
likely differ from the amount recorded at June 30, 2005. For every 1% change in
the estimate, the effect on pre-tax income would be $11.9 million.
The property and casualty industry has had substantial aggregate
loss experience from claims related to asbestos-related illnesses, environmental
remediation, product liability, mold, and other uncertain exposures.
Harleysville Group has not experienced significant losses from such claims.
The personal lines statutory combined ratio decreased to 97.2% and
100.4% for the three and six months ended June 30, 2005 from 100.6% and 108.4%
for the three and six months ended June 30, 2004. The decreases primarily were
due to generally lower loss severity, lesser catastrophe losses which affected
the homeowners line and the aforementioned favorable development.
Net catastrophe losses decreased $0.7 million and $2.3 million and
losses ceded under the aggregate catastrophe reinsurance agreement with Mutual
decreased $0.7 million and $1.1 million for the three and six months ended June
30, 2005, respectively, due to fewer and less severe catastrophes in the 2005
periods.
Page 23
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Severance charges of $1.1 million and $0.7 million were incurred
during the three months ended June 30, 2005 and 2004, respectively, related to
ongoing expense-reduction initiatives. An estimated $1.5 million severance
charge is expected to be recorded in the third quarter of 2005 related to a
further expense-reduction initiative begun in the third quarter.
The income tax expense for the three and six months ended June 30,
2005 includes a tax benefit of $2.5 million and $5.1 million associated with
tax-exempt interest compared to $2.7 million and $5.4 million in the same prior
year periods.
Effective for one year from July 1, 2005, the Company's subsidiaries
and Mutual and its wholly-owned subsidiaries renewed its catastrophe reinsurance
which provides coverage ranging from 85.0% to 100% of up to $205 million in
excess of a retention of $30 million for any given catastrophe excluding
terrorism for commercial lines. Harleysville Group's 2005 pooling share of this
coverage would range from 85.0% to 100% of up to $147.6 million in excess of a
retention of $21.6 million for any given catastrophe. Pursuant to the terms of
the treaty, the maximum recovery would be $196.5 million for any catastrophe
involving an insured loss equal to or greater than $235 million. Harleysville
Group's 2005 pooling share of this maximum recovery would be $141.5 million for
any catastrophe involving an insured loss of $169.2 million or greater. The
treaty includes reinstatement provisions providing for coverage for a second
catastrophe and requiring payment of an additional premium in the event of a
first catastrophe occurring. Harleysville Group and Mutual have purchased
property per risk excess of loss reinsurance which covers certain terrorism
losses and provides for recovery of up to $8.5 million in excess of $1.5 million
of terrorism losses for any one risk under certain circumstances. The maximum
recovery by Harleysville Group on a terrorism loss occurrence is $8.6 million.
Harleysville Group and Mutual agreed on August 2, 2005 to terminate
the reinsurance agreement whereby Mutual reinsures certain accumulated
catastrophe losses as described in Note 3 of Notes to Consolidated Financial
Statements. The agreement will terminate on December 31, 2005. The coverage
will not be replaced as it is no longer needed based on our current catastrophe
risk profile. Harleysville Group ceded to Mutual premiums earned of $4,411,000
and $4,260,000 and losses incurred of $(90,000) and $984,000 for the six months
ended June 30, 2005 and 2004, respectively.
Liquidity and Capital Resources
Operating activities provided $71.5 million and $23.9 million of net
cash for the six months ended June 30, 2005 and 2004, respectively. The change
primarily is from an increase in net cash provided by underwriting activities.
Page 24
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Investing activities used $62.9 million and $27.0 million of net
cash for the six months ended June 30, 2005 and 2004, respectively. The
increase is primarily due to an increase in net purchases of fixed maturity
investments, partially offset by a decrease in the purchase of short-term
investments.
Net cash used by financing activities was $8.6 million and $9.2
million for the six months ended June 30, 2005 and 2004, respectively. The
change is primarily due to an increase in the issuance of common stock.
Harleysville Group participates in a securities lending program
whereby certain fixed maturity securities from the investment portfolio are
loaned to other institutions for a short period of time in return for a fee. At
June 30, 2005, Harleysville Group held cash collateral of $130.6 million related
to securities on loan with a market value of $127.1 million. 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 GIC's and Funding Agreements from issuers
rated A or better. The securities on loan to others have been segregated from
the other invested assets on the balance sheet. In addition, the assets and
liabilities have been grossed up to reflect the collateral held under the
securities lending program and the obligation to return this collateral upon the
return of the loaned securities.
Harleysville Group Inc. maintained $13.9 million of cash and
marketable securities at June 30, 2005 which is available for general corporate
purposes including dividends, debt service, capital contributions to
subsidiaries, acquisitions and the repurchase of stock. The Company has no
material commitments for capital expenditures as of June 30, 2005.
RISK FACTORS
The business, results of operations and financial condition, and
therefore the value of Harleysville Group's securities, are subject to a number
of risks. Some of those risks are set forth in the Company's annual report on
Form 10-K for fiscal year 2004, filed with the Securities and Exchange
Commission on March 14, 2005.
Page 25
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
Harleysville Group's market risk generally represents the risk of
gain or loss that may result from the potential change in the fair value of
Harleysville Group's investment portfolio as a result of fluctuations in prices
and interest rates. Harleysville Group attempts to manage its interest rate
risk by maintaining an appropriate relationship between the average duration of
the investment portfolio and the approximate duration of its liabilities.
Harleysville Group has maintained approximately the same duration of
its investment portfolio to its liabilities from December 31, 2004 to June 30,
2005. In addition, the Company has maintained approximately the same investment
mix during this period.
Page 26
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our management, under the
supervision and with the participation of the chief executive officer and
the chief financial officer, has evaluated the effectiveness of our
disclosure controls and procedures as of June 30, 2005, which is the
end of the period covered by this quarterly report on Form 10-Q. Based
on that evaluation, the chief executive officer and chief financial
officer have concluded that the Company's disclosure controls and
procedures are effective and as such provide for a mechanism whereby
(a) material information relating to us, including our consolidated
subsidiaries, is made known to these officers by other employees of us and
our consolidated subsidiaries, particularly material information related
to the period for which this periodic report is being prepared; and (b)
this information is recorded, processed, summarized, evaluated and reported,
as applicable, within the time periods specified in the rules and forms
of the Securities and Exchange Commission.
(b) Change in internal control over financial reporting. There was no
change in the Company's internal control over financial reporting that
occurred during the second quarter of 2005 that has materially affected, or
is reasonably likely to materially affect, the Company's internal control
over financial reporting.
Page 27
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of Harleysville Group Inc. was held on
April 27, 2005 (the "Annual Meeting" or "Meeting"), with the following
result:
The total number of shares represented at the Annual Meeting in person or
by proxy was 28,202,918 of the 30,293,759 shares of common stock outstanding
and entitled to vote at the Meeting.
On the resolution to elect W. Thacher Brown, Mirian M. Graddick and William
W. Scranton, III as class "C" Directors to serve until the expiration of
their respective terms and until their successors are duly elected, the
nominees for Director received the number of votes set forth opposite their
respective names:
Number of Votes
------------------------
For Withheld
---------- ---------
W. Thacher Brown 25,967,249 2,235,669
Mirian M. Graddick 25,964,937 2,237,981
William W. Scranton, III 25,963,138 2,239,780
There were no abstentions or broker non-votes recorded. On the basis of the
above vote, W. Thacher Brown, Mirian M. Graddick and William W. Scranton,
III were elected as class "C" Directors to serve until the expiration
of their respective terms and until their successors are duly elected.
The other directors who continued in office after the election were:
Lowell R. Beck, Michael L. Browne, G. Lawrence Buhl, Frank E. Reed and
Jerry S. Rosenbloom.
The resolution to approve the Directors' Deferred Stock Unit Plan was
adopted, 20,532,567 votes for the resolution, 6,600,098 votes against
the resolution and 31,413 abstentions. There were 1,038,840 broker
non-votes.
The resolution to approve the Amended and Restated Long Term Incentive Plan
was adopted, 24,901,685 votes for the resolution, 2,240,777 votes against
the resolution and 21,616 abstentions. There were 1,038,840 broker
non-votes.
Stockholders of Harleysville Group Inc. owning a majority of the Company's
outstanding voting stock approved the Harleysville Group Inc. 2005 Agency
Stock Purchase Plan by written consent dated June 16, 2005 i n lieu
of a special meeting of stockholders.
Page 28
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
(Continued)
ITEM 6. a. Exhibits
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. 1 350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
SIGNATURE
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.
HARLEYSVILLE GROUP INC.
Date: August 2, 2005 By: /s/ ARTHUR E. CHANDLER
----------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
(principal financial officer)
Page 29
EXHIBIT (31.1)
CERTIFICATION PURSUANT TO THE SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Michael L. Browne, certify that:
1. I have reviewed the quarterly report on Form 10-Q of Harleysville Group
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: August 2,2005 /s/ MICHAEL L. BROWNE
-------------- -------------------------------------------
Michael L. Browne
Chief Executive Officer and a Director
Page 30
EXHIBIT (31.2)
CERTIFICATION PURSUANT TO THE SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Arthur E. Chandler, certify that:
1. I have reviewed the quarterly report on Form 10-Q of Harleysville Group
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: August 2,2005 /s/ ARTHUR E. CHANDLER
-------------- ---------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
Page 31
EXHIBIT (32.1)
HARLEYSVILLE GROUP INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Harleysville Group Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2005, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Michael
L. Browne, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that based on my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
Date: August 2, 2005 /s/ MICHAEL L. BROWNE
---------------- --------------------------
Michael L. Browne
Chief Executive Officer
and a Director
Page 32
EXHIBIT (32.2)
HARLEYSVILLE GROUP INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Harleysville Group Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2005, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Arthur
E. Chandler, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that based on my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
Date: August 2, 2005 /s/ ARTHUR E. CHANDLER
----------------- ---------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
Page 33