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 SEPTEMBER 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 Exchange Act). Yes X No .
Indicate by check mark whether Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X.
At October 31, 2005, 30,512,001 shares of common stock of Harleysville
Group Inc. were outstanding.
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
INDEX
Page Number
-----------
Part I - Financial Information
Consolidated Balance Sheets -
September 30, 2005 and December 31, 2004 3
Consolidated Statements of Income - For the
three months ended September 30, 2005 and 2004 4
Consolidated Statements of Income - For the nine
months ended September 30, 2005 and 2004 5
Consolidated Statement of Shareholders' Equity -
For the nine months ended September 30, 2005 6
Consolidated Statements of Cash Flows - For the
nine months ended September 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 27
Controls and Procedures 28
Part II - Other Information 29
Page 2
ITEM 1. FINANCIAL STATEMENTS
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(fair value $481,054 and $517,434) $ 473,532 $ 499,487
Available for sale, at fair value (cost
$1,182,955 and $1,028,457) 1,200,140 1,067,504
Equity securities, at fair value (cost
$138,513 and $110,495) 177,085 150,249
Short-term investments, at cost, which
approximates fair value 64,945 113,822
Fixed maturity securities on loan:
Held to maturity, at amortized cost
(fair value $5,029 and $1,966) 4,958 1,835
Available for sale, at fair value
(amortized cost $110,329 and $128,183) 112,726 134,020
---------- ----------
Total investments 2,033,386 1,966,917
Cash 3,671 328
Receivables:
Premiums 143,476 141,601
Reinsurance (affiliate $314 and $390) 229,448 193,209
Accrued investment income 22,376 23,236
---------- ----------
Total receivables 395,300 358,046
Deferred policy acquisition costs 106,603 100,755
Prepaid reinsurance premiums 34,884 32,675
Property and equipment, net 17,981 20,891
Deferred income taxes 63,130 53,137
Securities lending collateral 121,393 139,486
Due from affiliate 15,885
Other assets 45,416 45,828
---------- ----------
Total assets $2,837,649 $2,718,063
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss settlement expenses
(affiliate $183,314 and $187,172) $1,448,538 $1,317,735
Unearned premiums (affiliate $50,239 and $47,038) 455,645 441,697
Accounts payable and accrued expenses 89,328 99,098
Securities lending obligation 121,393 139,486
Debt (affiliate $18,500 and $18,500) 119,060 119,625
Due to affiliate 12,498
---------- ----------
Total liabilities 2,233,964 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 31,909,360 and
31,589,474 shares; outstanding 30,511,451
and 30,191,565 shares 31,909 31,589
Additional paid-in capital 167,704 161,689
Accumulated other comprehensive income 24,837 42,051
Retained earnings 404,582 377,282
Deferred compensation (860) (200)
Treasury stock, at cost, 1,397,909 shares (24,487) (24,487)
---------- ----------
Total shareholders' equity 603,685 587,924
---------- ----------
Total liabilities and shareholders' equity $2,837,649 $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 SEPTEMBER 30, 2005 AND 2004
(dollars in thousands, except per share data)
2005 2004
-------- -------
Revenues:
Premiums earned from affiliate, (ceded to
affiliated, $188,750 and $188,868) $212,327 $212,641
Investment income, net of investment expense 23,064 21,499
Realized investment gains (losses), net (1) 104
Other income (affiliate $1,719 and $1,755) 3,811 4,024
-------- --------
Total revenues 239,201 238,268
-------- --------
Losses and expenses:
Losses and loss settlement expenses from affiliate
(ceded to affiliate, $120,513 and $129,248) 139,078 153,944
Amortization of deferred policy acquisition costs 53,163 52,150
Other underwriting expenses 22,851 18,154
Interest expense (affiliate $177 and $100) 1,660 1,587
Other expenses 1,036 2,764
-------- --------
Total expenses 217,788 228,599
-------- --------
Income before income taxes 21,413 9,669
Income taxes 4,972 789
-------- --------
Net income $ 16,441 $ 8,880
======== ========
Per common share:
Basic earnings $ .54 $ .30
========= ========
Diluted earnings $ .54 $ .29
========= ========
Cash dividend $ .175 $ .17
========= ========
See accompanying notes to consolidated financial statements.
Page 4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(dollars in thousands, except per share data)
2005 2004
-------- --------
Revenues:
Premiums earned from affiliate, (ceded to
affiliate, $559,191 and $553,663) $628,872 $627,241
Investment income, net of investment expense 67,403 64,578
Realized investment gains, net 67 12,651
Other income (affiliate $5,220 and $5,210) 12,252 12,259
-------- --------
Total revenues 708,594 716,729
-------- --------
Losses and expenses:
Losses and loss settlement expenses from affiliate
(ceded to affiliate, ($377,018 and $391,030) 430,943 453,765
Amortization of deferred policy acquisition costs 156,124 153,536
Other underwriting expenses 57,984 57,518
Interest expense (affiliate $485 and $268) 4,945 4,730
Other expenses 4,306 5,449
-------- --------
Total expenses 654,302 674,998
-------- --------
Income before income taxes 54,292 41,731
Income taxes 11,342 6,630
-------- --------
Net income $ 42,950 $ 35,101
======== ========
Per common share:
Basic earnings $ 1.42 $ 1.17
======== ========
Diluted earnings $ 1.41 $ 1.17
======== ========
Cash dividend $ .515 $ .51
======== ========
See accompanying notes to consolidated financial statements.
Page 5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 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 42,950 42,950
Other comprehensive
income, net of tax:
Unrealized
investment
losses, net of
reclassification
adjustment (17,214) (17,214)
--------
Comprehensive
income 25,736
Issuance of common
stock 319,886 320 5,715 6,035
Tax benefit from
stock options
exercised 300 300
Deferred compensation (660) (660)
Cash dividends (15,650) (15,650)
---------- ------- -------- -------- -------- ----- -------- --------
Balance at
September 30, 2005 31,909,360 $31,909 $167,704 $ 24,837 $404,582 $(860) $(24,487) $603,685
========== ======= ======== ======== ======== ===== ======== ========
See accompanying notes to consolidated financial statements.
Page 6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(in thousands)
2005 2004
-------- ---------
Cash flows from operating activities:
Net income $ 42,950 $ 35,101
Adjustments to reconcile net income
to net cash provided by operating activities:
Change in receivables, unearned premiums and
prepaid reinsurance balances (25,515) (266)
Change in affiliate balance (28,383) (23,017)
Increase in unpaid losses and loss settlement expenses 130,803 60,843
Deferred income taxes (724) (1,518)
Increase in deferred policy acquisition costs (5,848) (4,343)
Amortization and depreciation 3,955 4,017
Gain on sale of investments (67) (12,651)
Other, net (1,245) 12,029
--------- ---------
Net cash provided by operating activities 115,926 70,195
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (217,595) (157,879)
Sales or maturities 90,343 151,491
Equity securities:
Purchases (55,873) (25,447)
Sales 31,343 25,064
Net sales (purchases) of short-term investments 48,877 (62,801)
Sale (purchase) of property and equipment, net 1,357 (818)
--------- ---------
Net cash used by investing activities (101,548) (70,390)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 5,180 3,635
Repayment of debt obligations (565) (520)
Dividend paid (to affiliate, $8,756 and $8,671) (15,650) (15,313)
--------- ---------
Net cash used by financing activities (11,035) (12,198)
--------- ---------
Increase (decrease) in cash 3,343 (12,393)
Cash at beginning of period 328 3,430
--------- ---------
Cash at end of period $ 3,671 $ 1,037
========= =========
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 (consisting of
only normal recurring 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 nine months ended
September 30, 2005 and 2004:
Page 8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------- ------ ------- -------
(in thousands, except per share data)
Net income, as reported $16,441 $8,880 $42,950 $35,101
Plus:
Stock-based employee compensation
expense included in reported net
income, net of related tax effects 354 199 27 253
Less:
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects (760) (764) (1,607) (2,216)
------- ------- ------- -------
Pro forma net income $16,035 $8,315 $41,370 $33,138
======= ====== ======= =======
Basic earnings per share:
As reported $ .54 $ .30 $ 1.42 $ 1.17
Pro forma $ .53 $ .28 $ 1.36 $ 1.10
Diluted earnings per share:
As reported $ .54 $ .29 $ 1.41 $ 1.17
Pro forma $ .52 $ .28 $ 1.36 $ 1.10
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------- ------ ------- -------
(in thousands, except per share data)
Numerator for basic and diluted earnings
per share:
Net income $16,441 $ 8,880 $42,950 $35,101
======= ======= ======= =======
Denominator for basic earnings per share --
weighted average shares outstanding 30,428 30,063 30,330 29,995
Effect of stock incentive plans 161 90 156 96
------- ------- ------- -------
Denominator for diluted earnings per share 30,589 30,153 30,486 30,091
======= ======= ======= =======
Basic earnings per share $ .54 $ .30 $ 1.42 $ 1.17
======= ======= ======= =======
Diluted earnings per share $ .54 $ .29 $ 1.41 $ 1.17
======= ======= ======= =======
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------ ----- ----- -----
(in thousands)
Number of options 1,184 1,608 1,184 1,608
===== ===== ===== =====
Page 10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - Reinsurance
Premiums earned are net of amounts ceded of $24,711,000 and $70,538,000 for
the three and nine months ended September 30, 2005, respectively, and
$22,051,000 and $66,108,000 for the three and nine months ended September 30,
2004, respectively. Losses and loss settlement expenses are net of amounts
ceded of $71,856,000 and $83,052,000 for the three and nine months ended
September 30, 2005, respectively, and $13,592,000 and $53,308,000 for the three
and nine months ended September 30, 2004, respectively. Losses and loss
settlement expenses ceded for the three and nine months ended September 30, 2005
include $67,566,000 and $74,866,000 of losses ceded to the federal government's
National Flood Insurance Program (NFIP), primarily related to flood losses from
Hurricane Katrina. Reinsurance receivables include $65,869,000 and $22,389,000
at September 30, 2005 and December 31, 2004, respectively, for flood losses
recoverable from the NFIP. Since such flood losses are entirely ceded to the
NFIP they did not impact results of operations. 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.
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 $2,196,000 and $2,164,000
and losses incurred of $(24,000) and $(440,000), for the three months ended
September 30, 2005 and 2004, respectively. Harleysville Group ceded to Mutual
premiums earned of $6,607,000 and $6,424,000 and losses incurred of $(114,000)
and $544,000 for the nine months ended September 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
Net cash tax payments (refunds) of $8,600,000 and $(13,709,000) were made
(received) in the first nine months of 2005 and 2004, respectively. Cash
interest payments of $6,245,000 and $6,043,000 were made in the first nine
months of 2005 and 2004, respectively.
Page 11
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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).
Financial data by segment is as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------- ------ ------- -------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $173,948 $169,680 $512,119 $495,791
Personal lines 38,379 42,961 116,753 131,450
-------- -------- -------- --------
Total premiums earned 212,327 212,641 628,872 627,241
Net investment income 23,064 21,499 67,403 64,578
Realized investment gains (losses) (1) 104 67 12,651
Other 3,811 4,024 12,252 12,259
-------- -------- -------- --------
Total revenues $239,201 $238,268 $708,594 $716,729
======== ======== ======== ========
Income before income taxes:
Underwriting gain (loss):
Commercial lines $ (5,742) $(13,517) $(25,740) $(39,523
Personal lines 2,497 344 4,028 (4,506)
-------- -------- -------- --------
SAP underwriting loss (3,245) (13,173) (21,712) (44,029)
GAAP adjustments 480 1,566 5,533 6,451
-------- -------- -------- --------
GAAP underwriting loss (2,765) 11,607) (16,179) (37,578)
Net investment income 23,064 21,499 67,403 64,578
Realized investment gains (losses) (1) 104 67 12,651
Other 1,115 (327) 3,001 2,080
-------- -------- -------- --------
Income before income taxes $ 21,413 $ 9,669 $ 54,292 $ 41,731
======== ======== ======== ========
Page 12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6 - Comprehensive Income
Comprehensive income for the three and nine months ended September 30, 2005
and 2004 consisted of the following (all amounts are net of taxes):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------- ------- -------- --------
(in thousands)
Net income $ 16,441 $ 8,880 $ 42,950 $ 35,101
Other comprehensive income (loss):
Unrealized investment holding gains
(losses) arising during period (11,363) 8,152 (17,170) (6,449)
Less:
Reclassification adjustment for gains
included in net income (65) (44) (8,196)
-------- ------- -------- --------
Net unrealized investment gains (losses) (11,363) 8,087 (17,214) (14,645)
-------- ------- -------- --------
Comprehensive income $ 5,078 $16,967 $ 25,736 $ 20,456
======== ======= ======== ========
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------- ------ ------- -------
(in thousands)
Components of net periodic pension cost:
Service cost $ 2,315 $ 2,007 $ 6,733 $ 5,992
Interest cost 2,986 2,821 8,962 8,361
Expected return on plan assets (3,018) (3,101) (8,598) (9,141)
Recognized net actuarial loss 1,134 600 3,358 1,635
Amortization of prior service cost 52 52 156 157
Net transition amortization 13 14 40 39
------- ------- ------- -------
Net periodic pension cost:
Entire plan $ 3,482 $ 2,393 $10,651 $ 7,043
======= ======= ======= =======
Harleysville Group portion $ 2,308 $ 1,589 $ 7,057 $ 4,658
======= ======= ======= =======
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 $5,963,000 were made in the nine
months ended September 30, 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
including the expenses related to these 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
- 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
- cash available for investing activities
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. 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.
Page 17
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
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.
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 September 30, 2005 and 2004 is discussed in greater detail below.
Results of Operations
Premiums earned decreased $0.3 million during the three months ended
September 30, 2005, and increased $1.6 million during the nine months ended
September 30, 2005, compared to the same prior year periods. The changes are
primarily due to increases in premiums earned for commercial lines of $4.3
million and $16.3 million partially offset by decreases of $4.6 million and
$14.7 million in personal lines premiums earned for the three and nine months
ended September 30, 2005, respectively. The increases in premiums earned for
commercial lines were 2.5% and 3.3% for the three and nine months ended
September 30, 2005, respectively, primarily due to higher average premiums. The
declines in premiums earned for personal lines were 10.7% and 11.2% for the
three and nine months ended September 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.
Page 18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Investment income increased $1.6 million and $2.8 million for the three and
nine months ended September 30, 2005, respectively, compared to the same prior
year periods, resulting from an increase in invested assets partially offset by
a lower yield on the fixed maturity investment portfolio.
Realized investment gains decreased $12.6 million for the nine months ended
September 30, 2005, as compared to the same period in the prior year, and were
essentially unchanged for the three months ended September 30, 2005. The
nine-month decrease primarily resulted from gains on the sale of two equity
securities in the first quarter of 2004.
Harleysville Group holds securities with unrealized losses at September 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 $151,823 $ 1,708 $1,050 $ 658
Obligations of states and
political subdivisions 161,013 2,976 1,373 1,603
Corporate securities 238,094 5,850 3,078 2,772
Mortgage-backed securities 83,496 846 754 92
-------- ------- ------ ------
Total fixed maturities $634,426 $11,380 $6,255 $5,125
======== ======= ====== ======
Equity securities $ 20,627 $ 756 $ 756 $ -
======== ======= ====== ======
There are 20 positions that comprise the unrealized loss in equity
investments at September 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 September
30, 2005, securities with a fair value of $498.4 million and an unrealized loss
of $8.6 million are classified as available for sale and are carried at fair
value on the balance sheet while securities with a fair value of $136.0 million
and an unrealized loss of $2.8 million are classified as held to maturity on the
balance sheet and are carried at amortized cost.
Page 19
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
The fixed maturity investments with continuous unrealized losses for less
than twelve months were primarily due to the impact of the higher market
interest rates rather than a decline in credit quality. There are $139.5
million in fixed maturity securities, at fair value, that at September 30, 2005,
had been below amortized cost for over twelve months. Of the $5.1 million of
unrealized losses on such securities, $3.5 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 $1.6 million of unrealized
losses are comprised of airline enhanced equipment trust certificates (EETC) as
follows:
FAIR MATURITY
COST VALUE DATES
------- ----- ---------
(in thousands)
American Airlines $14,370 $13,214 2011
United Airlines 6,925 6,578 2010-2012
Other airlines 2,000 1,935 2011
------- -------
$23,295 $21,727
======= =======
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.
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 $11.7 million for the three months
ended September 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 $12.6 million for the nine months
ended September 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 and lesser
loss severity. Catastrophe losses were $2.4 million and $4.0 million for the
three and nine months ended September 30, 2005, respectively, as compared to
$6.1 million and $10. 0 million for the three and nine months ended September
30, 2004, respectively.
Page 20
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
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
102.5% and 102.8% for the three and nine months ended September 30, 2005,
respectively from 106.6% and 106.4% for the three and nine months ended
September 30, 2004, respectively. Such decreases were due to improved
underwriting results in both commercial lines and personal lines, primarily
resulting from improved loss experience and lower catastrophe losses in the 2005
periods. The improved loss experience reflects lower claim severity in general
and lower claim frequency in property coverages.
The statutory combined ratios by line of business for the three and nine
months ended September 30, 2005, as compared to the three and nine months ended
September 30, 2004, were as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2005 2004 2005 2004
------ ------ ------ ------
Commercial:
Automobile 104.5% 103.8% 100.8% 103.8%
Workers compensation 118.6% 131.2% 122.6% 125.4%
Commercial multi-peril 101.0% 105.8% 102.0% 105.4%
Other commercial 102.5% 103.4% 95.9% 93.5%
Total commercial 104.7% 108.6% 103.9% 106.7%
Personal:
Automobile 98.1% 113.0% 102.8% 114.0%
Homeowners 88.8% 78.3% 94.5% 91.2%
Other personal 67.5% 88.0% 73.1% 103.8%
Total personal 92.8% 99.0% 97.9% 105.3%
Total personal and commercial 102.5% 106.6% 102.8% 106.4%
Page 21
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
The following table presents the liability for unpaid losses and loss
settlement expenses by major line of business:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------ ------------
(in thousands)
Commercial:
Automobile $ 274,547 $ 249,044
Workers compensation 306,137 298,994
Commercial multi-peril 423,390 371,247
Other commercial 82,584 70,535
---------- ----------
Total commercial 1,086,658 989,820
---------- ----------
Personal:
Automobile 96,782 103,050
Homeowners 39,351 37,026
Other personal 1,354 1,713
---------- ----------
Total personal 137,487 141,789
---------- ----------
Total personal and commercial 1,224,145 1,131,609
Plus reinsurance recoverables 224,393 186,126
---------- ----------
Total liability $1,448,538 $1,317,735
========== ==========
The commercial lines statutory combined ratio decreased to 104.7% and
103.9% for the three and nine months ended September 30, 2005, respectively,
from 108.6% and 106.7% for the three and nine months ended September 30, 2004,
respectively. The decreases were primarily due to lower loss severity and lower
property losses.
There was $11.7 million of net favorable development in the provision for
insured events in prior years for the nine months ended September 30, 2005 ($2.9
million in the third quarter of 2005) of which $5.6 million was in commercial
lines and $6.1 million was in personal lines. Approximately $4.4 million of the
$11.7 million of favorable development related to the liability for unpaid loss
settlement 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 $9.1 million of net adverse development in the
provision for insured events in prior years for the nine months ended September
30, 2004 ($6.1 million in the third quarter of 2004).
Page 22
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
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 NINE MONTHS FOR THE YEAR ENDED
ENDED SEPTEMBER 30, 2005 DECEMBER 31, 2004
------------------------ ------------------
(dollars in thousands)
Number of claims pending, beginning of period 6,832 8,005
Number of claims reported 7,093 10,632
Number of claims settled or dismissed (7,531) (11,805)
------- --------
Number of claims pending, end of period 6,394 6,832
======= ========
Losses paid $49,718 $ 73,548
Loss settlement expenses paid $10,771 $ 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.
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 September 30, 2005. For every 1% change in the aggregate
estimate across all lines, the effect on pre-tax income would be $12.2 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.
Page 23
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
The personal lines statutory combined ratio decreased to 92.8% and 97.9%
for the three and nine months ended September 30, 2005 from 99.0% and 105.3% for
the three and nine months ended September 30, 2004. The decreases primarily
were due to generally lower loss severity.
Net catastrophe losses decreased $3.7 million and $5.9 million for the
three and nine months ended September 30, 2005, respectively, primarily due to
less severe catastrophes in the 2005 periods. The three months ended September
30, 2004 includes $6.1 million of losses from weather related catastrophes,
primarily four hurricanes.
The income tax expense for the three and nine months ended September 30,
2005 includes the tax benefit of $2.5 million and $7.7 million associated with
tax-exempt income compared to $2.6 million and $8.0 million in the same prior
year periods.
Other underwriting expenses increased $4.7 million for the three months
ended September 30, 2005 compared to the same prior year period. A severance
charge of $1.6 million was incurred during the three months ended September 30,
2005 related to ongoing expense-reduction initiatives. An estimated $0.6
million severance charge is expected to be recorded in the fourth quarter of
2005 related to a further expense-reduction initiative begun in the fourth
quarter. The remaining increase in other underwriting expenses related to
higher incentive costs, primarily for agents.
Other expense decreased $1.7 million for the three months ended September
30, 2005 primarily related to the write-off of capitalized costs for a software
project during the three months ended September 30, 2004.
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 $6.6 million and
$6.4 million and losses incurred of $(0.1) million and $0.5 million for the nine
months ended September 30, 2005 and 2004, respectively.
Page 24
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Liquidity and Capital Resources
Operating activities provided $115.9 million and $70.2 million of net cash
for the nine months ended September 30, 2005 and 2004, respectively. The change
primarily is from greater underwriting cash flow primarily due to lower paid
losses.
Investing activities used $101.5 million and $70.4 million of net cash for
the nine months ended September 30, 2005 and 2004, respectively. The increase
is primarily due to an increase in net purchases of fixed maturity and equity
investments partially offset by a decrease in the purchase of short-term
investments.
Financing activities used $11.0 million and $12.2 million of net cash for
the nine months ended September 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 September
30, 2005, Harleysville Group held cash collateral of $121.4 million related to
securities on loan with a market value of $117.8 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.
Page 25
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Continued)
Harleysville Group Inc. maintained $9.6 million of cash and marketable
securities at September 30, 2005 which is available for general corporate
purposes including dividends, debt service, capital contributions to
subsidiaries, acquisitions and the repurchase of stock.
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 26
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 September 30,
2005. In addition, the Company has maintained approximately the same investment
mix during this period.
Page 27
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 September 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 third quarter of 2005 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Page 28
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 6. a. Exhibits
10.1 Settlement, Non-solicitation and Release Agreement with
former executive officer.
31.1 Certification of Chief Executive Officer Pursuant to Rule
3a-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. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Page 29
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
(Continued)
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: November 2, 2005 By: /s/ ARTHUR E. CHANDLER
-----------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
(principal financial officer)
Page 30
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
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: November 2, 2005 /s/ MICHAEL L. BROWNE
--------------------------------------
Michael L. Browne
Chief Executive Officer and a Director
Page 31
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
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: November 2, 2005 /s/ ARTHUR E. CHANDLER
--------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
Page 32
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 September 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: November 2, 2005 /s/ MICHAEL L. BROWNE
--------------------------------------
Michael L. Browne
Chief Executive Officer and a Director
Page 33
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 September 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: November 2, 2005 /s/ ARTHUR E. CHANDLER
----------------------------
Arthur E. Chandler
Senior Vice President and
Chief Financial Officer
Page 34