SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999.
--------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-14697
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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, PENNSYLVANIA 19438-2297
----------------------------------------------------------
(Address of principal executive offices, including zip code)
(215) 256-5000
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(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 .
----- ------
At November 9, 1999 29,070,408 shares of common stock of
Harleysville Group Inc. were outstanding.
1
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
INDEX
PAGE NUMBER
-----------
Part I - Financial Information
Consolidated Balance Sheets - September 30, 1999
and December 31, 1998 3
Consolidated Statements of Income - For the three
months ended September 30, 1999 and 1998 4
Consolidated Statements of Income - For the nine
months ended September 30, 1999 and 1998 5
Consolidated Statement of Shareholders' Equity -
For the nine months ended September 30, 1999 6
Consolidated Statements of Cash Flows - For the
nine months ended September 30, 1999 and 1998 7
Notes to Consolidated Financial Statements 8
Management's Discussion and Analysis of Results
of Operations and Financial Condition 14
Part II - Other Information 19
2
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Held to maturity, at amortized
cost (fair value $615,024
and $680,371) $ 606,058 $ 638,319
Available for sale, at fair value
(amortized cost $767,364
and $716,325) 765,926 751,293
Equity securities, at fair value
(cost $104,499 and $95,797) 181,520 174,932
Short-term investments, at cost,
which approximates fair value 33,180 15,022
---------- ----------
Total investments 1,586,684 1,579,566
Cash 14,828 3,799
Receivables:
Premiums 95,963 91,256
Reinsurance 79,634 84,179
Accrued investment income 21,171 22,134
---------- ----------
Total receivables 196,768 197,569
Deferred policy acquisition costs 89,433 78,984
Prepaid reinsurance premiums 13,789 12,108
Property and equipment, net 26,580 25,051
Deferred income taxes 21,876 3,604
Due from affiliate 4,090
Other assets 36,884 33,816
---------- ----------
Total assets $1,990,932 $1,934,497
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss settlement
expenses $ 903,873 $ 893,420
Unearned premiums 361,509 317,772
Accounts payable and accrued expenses 104,114 83,735
Debt 96,810 97,140
Due to affiliate 12,772
---------- ----------
Total liabilities 1,466,306 1,404,839
---------- ----------
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 29,480,943
and 29,150,518 shares; outstanding
29,409,618 and 29,150,518 shares 29,481 29,151
Additional paid-in capital 124,597 119,302
Accumulated other comprehensive income 49,129 74,167
Retained earnings 322,811 307,038
Treasury stock, at cost,
71,325 shares (1,392)
---------- ----------
Total shareholders' equity 524,626 529,658
---------- ----------
Total liabilities and
shareholders' equity $1,990,932 $1,934,497
========== ==========
See accompanying notes to consolidated financial statements.
3
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(dollars in thousands, except per share data)
1999 1998
-------- --------
Revenues:
Premiums earned $179,503 $165,735
Investment income, net of
investment expenses 21,517 21,546
Realized investment gains 2,263 2,162
Other income 4,170 3,202
-------- --------
Total revenues 207,453 192,645
-------- --------
Losses and expenses:
Losses and loss settlement expenses 147,681 116,075
Amortization of deferred policy
acquisition costs 46,383 42,377
Other underwriting expenses 15,344 13,987
Interest expense 1,624 1,624
Other expenses 1,361 1,138
-------- --------
Total expenses 212,393 175,201
-------- --------
Income (loss) before income
taxes (4,940) 17,444
Income taxes (benefit) (4,633) 3,291
-------- --------
Net income (loss) $ (307) $ 14,153
======== ========
Per common share:
Basic earnings (loss) $ (.01) $ .49
======== ========
Diluted earnings (loss) $ (.01) $ .48
======== ========
Cash dividend $ .135 $ .125
======== ========
See accompanying notes to consolidated financial statements.
4
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(dollars in thousands, except per share data)
1999 1998
-------- --------
Revenues:
Premiums earned $524,429 $494,201
Investment income, net of
investment expenses 64,274 64,124
Realized investment gains 8,283 9,512
Other income 11,453 9,335
-------- --------
Total revenues 608,439 577,172
-------- --------
Losses and expenses:
Losses and loss settlement expenses 387,326 346,791
Amortization of deferred policy
acquisition costs 135,198 125,522
Other underwriting expenses 44,818 40,925
Interest expense 4,741 4,889
Other expenses 3,703 3,110
-------- --------
Total expenses 575,786 521,237
-------- --------
Income before income taxes
and cumulative effect of
accounting change 32,653 55,935
Income taxes 2,684 11,328
-------- --------
Income before cumulative
effect of accounting
change 29,969 44,607
Cumulative effect of accounting
change, net of income tax (2,904)
-------- --------
Net income $ 27,065 $ 44,607
======== ========
Per common share:
Basic:
Income before cumulative effect
of accounting change $ 1.02 $ 1.54
Cumulative effect of accounting
change, net of income tax (.10)
-------- --------
Net income $ .92 $ 1.54
======== ========
Diluted:
Income before cumulative effect
of accounting change $ 1.01 $ 1.51
Cumulative effect of accounting
change, net of income tax (.10)
--------- --------
Net income $ .91 $ 1.51
========= ========
Cash dividend $ .385 $ .355
========= ========
See accompanying notes to consolidated financial statements.
5
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(dollars in thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL INCOME EARNINGS STOCK TOTAL
---------- ------- ----------- ------------- -------- -------- --------
Balance,
Dec. 31,
1998 29,150,518 $29,151 $119,302 $ 74,167 $307,038 $ $529,658
--------
Net income 27,065 27,065
Other compre-
hensive
income,
net of tax:
Unrealized
investment
losses, net
of reclassi-
fication
adjustment (25,038) (25,038)
--------
Comprehensive
income 2,027
--------
Issuance of
common
stock 330,425 330 5,295 5,625
Cash
dividend
paid (11,292) (11,292)
Purchase of
treasury
stock,
71,325
shares (1,392) (1,392)
---------- ------- -------- -------- -------- ------- --------
Balance,
Sept. 30,
1999 29,480,943 $29,481 $124,597 $ 49,129 $322,811 $(1,392) $524,626
========== ======= ======== ======== ======== ======= ========
See accompanying notes to consolidated financial statements.
6
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(in thousands)
1999 1998
---------- ----------
Cash flows from operating activities:
Net income $ 27,065 $ 44,607
Adjustments to reconcile net income
to net cash provided by operating
activities:
Cumulative effect of accounting
change, net of income tax 2,904
Change in receivables, unearned
premiums, prepaid reinsurance
and due to affiliate 25,995 (7,860)
Increase in unpaid losses and
loss settlement expenses 10,453 24,503
Deferred income taxes (2,607) (780)
Increase in deferred policy
acquisition costs (10,449) (8,266)
Amortization and depreciation 2,375 1,826
Gain on sale of investments (8,283) (9,512)
Other, net 11,546 28,066
Cash from change in intercompany
pooling agreement 14,962
--------- ---------
Net cash provided by operating
activities 58,999 87,546
--------- ---------
Cash flows from investing activities:
Fixed maturity investments:
Purchases (155,911) (156,658)
Sales or maturities 138,854 89,748
Equity securities:
Purchases (20,669) (19,344)
Sales 19,017 19,076
Net (purchases) sales of short-term
investments (18,158) 8,334
Purchase of property and equipment (3,714) (1,339)
--------- ---------
Net cash used by investing
activities (40,581) (60,183)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 5,625 5,362
Payment of debt obligations (330) (300)
Dividends paid (11,292) (10,301)
Purchase of treasury stock (1,392)
--------- ---------
Net cash used by
financing activities (7,389) (5,239)
--------- ---------
Increase in cash 11,029 22,124
Cash at beginning of period 3,799 1,460
--------- ---------
Cash at end of period $ 14,828 $ 23,584
========= =========
See accompanying notes to consolidated financial statements.
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 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, 1998 included in the Company's 1998 Annual Report
filed with the Securities and Exchange Commission on Form 10-K.
2 - Changes in Accounting Principles
(a) Guaranty-Fund and Other Insurance-Related Assessments
In 1997, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-
Related Assessments," which provides guidance for determining
when to recognize, and how to determine, a liability for guaranty-
fund and other insurance-related assessments. Effective January
1, 1999, the Company adopted SOP 97-3 and recorded a charge of
$2,904,000, net of a tax benefit of $1,564,000, as the cumulative
effect of the accounting change. Prior period financial
statements have not been restated and pro forma effects of
retroactive application are not material.
(b) Costs of Internal Use Software
In March 1998, the AICPA issued SOP 98-1, "Accounting for
Costs of Computer Software Developed or Obtained for Internal
Use." The SOP requires that certain costs related to the
development or purchase of internal-use software be capitalized
and amortized over the estimated useful life of the software.
This SOP also requires that costs related to the preliminary
project stage and the post implementation/operations stage in an
internal-use computer software development project be expensed as
incurred. Effective January 1, 1999, the Company adopted SOP 98-1
and accordingly has capitalized costs of $1,317,000 in 1999.
Prior period financial statements have not been restated.
8
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3 - Earnings Per Share
The computation of basic and diluted earnings (loss) per
share is as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
-------- -------- -------- --------
(in thousands, except per share data)
Numerator for basic
and diluted earnings
(loss) per share:
Net income (loss) $ (307) $14,153 $27,065 $44,607
======= ======= ======= =======
Denominator for basic
earnings (loss) per
share -- weighted
average shares
outstanding 29,395 29,086 29,311 28,995
Effect of stock
incentive plans 392 356 494
------- ------- ------- -------
Denominator for
diluted earnings
(loss) per share 29,395 29,478 29,667 29,489
======= ======= ======= =======
Basic earnings
(loss) per share $ (.01) $ .49 $ .92 $ 1.54
======= ======= ======= =======
Diluted earnings
(loss) per share $ (.01) $ .48 $ .91 $ 1.51
======= ======= ======= =======
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:
9
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,
1999 1998 1999 1998
------- ------ ------- ------
(in thousands)
Number of options 662 331 318 162
=== === === ===
For the three months ended September 30, 1999, an additional
1,465,175 options to purchase shares of common stock were not
included in the computation of diluted earnings per share because
their inclusion would have had an antidilutive effect.
4- Reinsurance
Premiums earned are net of amounts ceded of $11,980,000 and
$34,997,000 for the three and nine months ended September 30,
1999, respectively, and $9,876,000 and $21,646,000 for the three
and nine months ended September 30, 1998, respectively. The
ceded earned premiums for the nine months ended September 30,
1998 are net of a $8,217,000 refund of premiums previously ceded
to the Michigan Catastrophic Claims Association. Such premiums
were refunded to Harleysville Group which were then immediately
refunded to policyholders and thus had no effect on net premiums.
Losses and loss settlement expenses are net of amounts ceded of
$5,044,000 and $20,691,000 for the three and nine months ended
September 30, 1999, respectively, and $17,945,000 and $49,494,000
for the three and nine months ended September 30, 1998,
respectively. Such amounts do not include the reinsurance
transactions with Mutual under the pooling arrangement, but do
include the reinsurance described in the following paragraph.
Harleysville Group has a reinsurance agreement with
Harleysville Mutual Insurance Company (Mutual) whereby Mutual
reinsures accumulated catastrophe losses in a quarter up to
$14,400,000 ($16,200,000 in 1998) in excess of $3,600,000
($1,800,000 in 1998) in return for a reinsurance premium. The
agreement excludes catastrophe losses resulting from earthquakes
or hurricanes, and supplements the existing external catastrophe
reinsurance program. Harleysville Group ceded to Mutual premiums
earned of $1,775,000 and $789,000 and losses incurred of
$(447,000) and $7,506,000 for the three months ended September
30, 1999 and 1998, respectively. Harleysville Group ceded to
Mutual premiums earned of $5,330,000 and $2,271,000 and losses
incurred of $5,001,000 and $27,431,000 for the nine months ended
September 30, 1999 and 1998, respectively.
10
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Harleysville Group cedes business to and assumes business
from Mutual under a reinsurance pooling agreement. Because this
agreement does not relieve Harleysville Group of primary
liability as the originating insurer, there is a concentration of
credit risk arising from business ceded to Mutual. However, the
reinsurance pooling agreement provides for the right of offset
and the net balance with Mutual is a liability at September 30,
1999 and December 31, 1998. Mutual has an A. M. Best rating of
"A" (Excellent) and, in accordance with certain state regulatory
requirements, maintained $321.1 million (fair value) of
investments in a trust account to secure liabilities under the
reinsurance pooling agreement at September 30, 1999.
5 - Cash Flows
Net cash tax payments of $9,820,000 and $12,175,000 were
made in the first nine months of 1999 and 1998, respectively.
Cash interest payments of $3,371,000 and $3,516,000 were made in
the first nine months of 1999 and 1998, respectively.
6 - Segment Information
The performance of the personal lines and commercial lines
is evaluated based upon underwriting results as determined under
statutory accounting practices (SAP) for the total pooled
business of Harleysville Group and Mutual. The following tables
reflect the total pooled business. The eliminations reflect the
share of the total pooled business not retained by Harleysville
Group and the effect of the catastrophe reinsurance agreement
between Harleysville Group and Mutual.
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
-------- --------- --------- ---------
(in thousands)
Revenues:
Premiums earned:
Commercial lines $155,870 $139,518 $ 457,388 $ 414,583
Personal lines 95,904 91,766 278,388 274,962
Eliminations (72,271) (65,549) (211,347) (195,344)
-------- -------- --------- ---------
Total premiums
earned 179,503 165,735 524,429 494,201
Net investment
income 21,517 21,546 64,274 64,124
Realized investment
gains 2,263 2,162 8,283 9,512
Other 4,170 3,202 11,453 9,335
-------- -------- --------- ---------
Total revenues $207,453 $192,645 $ 608,439 $ 577,172
======== ======== ========= =========
Income (loss) before
income taxes and
cumulative effect of
accounting change:
Underwriting loss:
Commercial lines $(25,273) $(13,451) $(51,551) $(50,641)
Personal lines (17,099) (8,846) (22,312) (21,334)
Eliminations 9,985 13,465 21,362 45,846
-------- -------- --------- --------
SAP underwriting
loss (32,387) (8,832) (52,501) (26,129)
GAAP adjustments 2,482 2,128 9,588 7,092
-------- -------- --------- --------
GAAP underwriting
loss (29,905) (6,704) (42,913) (19,037)
Net investment income 21,517 21,546 64,274 64,124
Realized investment
gains 2,263 2,162 8,283 9,512
Other 1,185 440 3,009 1,336
-------- -------- --------- --------
Income (loss) before
income taxes and
cumulative effect of
accounting change $ (4,940) $ 17,444 $ 32,653 $ 55,935
======== ======== ======== ========
12
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7 - Comprehensive Income
Comprehensive income (loss) consisted of the following (all
amounts are net of taxes):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
--------- -------- -------- --------
Net income (loss) $ (307) $14,153 $ 27,065 $44,607
Other comprehensive
income (loss):
Unrealized investment
holding gains
(losses) arising
during period (12,843) 3,910 (19,868) 21,960
Less:
Reclassification
adjustment for
gains included
in net income (1,466) (1,402) (5,170) (6,125)
-------- ------- -------- -------
Net unrealized
investment gains
(losses) (14,309) 2,508 (25,038) 15,835
-------- ------- -------- -------
Comprehensive income
(loss) $(14,616) $16,661 $ 2,027 $60,442
======== ======= ======== =======
13
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Premiums earned increased $13.8 million and $30.2 million
during the three and nine months ended September 30, 1999. The
increases are primarily due to an increase in premiums earned for
commercial lines of $11.8 million and $30.8 million partially
offset by increases of $1.0 million and $3.1 million in premiums
ceded under the catastrophe reinsurance agreement with Mutual for
the three and nine months ended September 30, 1999, respectively.
Premiums earned for personal lines increased by $3.0 million for
the three months ended September 30, 1999 after having been
essentially unchanged for the six months ended June 30, 1999.
This increase is primarily due to personal automobile business
written through a managing general agent. Such business is
expected to increase for the fourth quarter of 1999 but increases
therefrom may not continue as termination of the arrangement with
the managing general agent is being negotiated.
Investment income was essentially unchanged for the three
and nine months ended September 30, 1999 as an increase in
invested assets was offset by a lower yield on the investment
portfolio.
Realized investment gains were essentially unchanged for the
three months ended September 30, 1999. Realized investment gains
decreased $1.2 million for the nine months ended September 30,
1999 primarily resulting from sales of equity securities at
lesser gains.
Income (loss) before income taxes and cumulative effect of
accounting change decreased $22.4 million and $23.3 million for
the three and nine months ended September 30, 1999, respectively,
primarily due to greater losses incurred relative to premiums.
Harleysville Group's statutory combined ratio increased to 116.0%
for the three months ended September 30, 1999 from 104.1% for the
three months ended September 30, 1998 and to 107.4% for the nine
months ended September 30, 1999 from 103.5% for the nine months
ended September 30, 1998. Hurricane Floyd struck the east coast
of the United States during the third quarter of 1999 and caused
losses of $12.2 million ($.27 per basic share after taxes) and
adversely affected the statutory combined ratio by 6.8 points and
2.3 points for the three and nine months ended September 30,
1999, respectively. Hurricane Bonnie struck North and South
Carolina and Virginia during the third quarter of 1998 and caused
losses of $3.0 million ($.07 per basic share after taxes) and
adversely affected the statutory combined ratio by 1.9 points and
0.6 points for the three and nine months ended September 30,
1998, respectively. Hurricane losses are not covered under the
aggregate catastrophe reinsurance agreement with Mutual.
14
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
The third quarter of 1999 included a pre-tax charge of $2.6
million ($.06 per basic share after taxes) related to the
consolidation of 23 claims offices into a centralized direct
reporting center and four specialized regional claims service
centers. The restructuring is expected to result in a net
reduction in claims staff of approximately 125 people. The
consolidation is expected to be completed by the second quarter
of 2000 and result in annual after-tax savings of approximately
$2.3 million, or $.08 per share, based on a preliminary analysis
of achievable cost savings. This claims restructuring charge
adversely affected the statutory combined ratio by 1.4 points and
0.5 points for the three and nine months ended September 30,
1999, respectively. Excluding the impacts of the hurricanes and
claims restructuring charge, the statutory combined ratio
increased 5.6 points and 1.7 points for the three and nine months
ended September 30, 1999, respectively, primarily due to worse
results in the commercial automobile and commercial multi-peril
lines of business. Harleysville Group is effecting price
increases in these lines of business which could mitigate the
combined ratio trend in these lines or cause premium growth to
decline.
Losses ceded under the aggregate catastrophe reinsurance
agreement with Mutual decreased by $8.0 million and $22.4 million
for the three and nine months ended September 30, 1999,
respectively, due to fewer and less severe non-hurricane
catastrophes in 1999. In 1998, there were several severe spring
and summer storms and a first quarter ice storm in upstate New
York.
The income tax provision for the three and nine months ended
September 30, 1999 includes the tax benefit of $3.0 million and
$8.9 million associated with tax-exempt investment income,
compared to $2.9 million and $8.4 million in the same prior year
periods.
Liquidity and Capital Resources
Net cash provided by operating activities was $59.0 million
and $87.5 million for the nine months ended September 30, 1999
and 1998. The decrease primarily resulted from a decline of $7.4
million in cash held as collateral for security lending
transactions, and by the effect of the 1998 amendment to the
pooling agreement with Mutual. A cash transfer of $15.0 million
was received effective January 1, 1998, by Harleysville Group
related to the various liabilities assumed in connection with
such amendment.
15
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
Net cash used by investing activities was $40.6 million and
$60.2 million for the nine months ended September 30, 1999 and
1998. The decrease is primarily due to the decline in cash
provided by operating activities.
Net cash used by financing activities increased $2.2 million
for the nine months ended September 30, 1999 primarily due to an
increase in dividends paid and the purchase of treasury stock.
Harleysville Group Inc. maintained $7.9 million of cash and
marketable investments at the holding company level at September
30, 1999 which is available for general corporate business
purposes including dividends, debt service, capital contributions
to subsidiaries, acquisitions and the repurchase of stock. In
October 1999, the Board of Directors increased the number of
shares authorized to be purchased under the stock repurchase plan
adopted in June 1999. Under the increased authorization, the
Company and Mutual may each purchase up to 1.0 million shares of
Harleysville Group Inc. common stock, up to a total of 2.0
million shares. The Company had no other material commitments
for capital expenditures as of September 30, 1999.
Year 2000
Harleysville Group began assessing its information
technology (IT) systems in 1996 and developed plans to ensure
their functionality with respect to the year 2000 millennium
change. These plans contain four major phases: remediation,
certification testing, enterprise testing and street testing.
The major part of the remediation phase involved modifying
our basic transaction processing systems that include the policy
issuance, billing and claims systems. The remediation phase was
completed during the fourth quarter of 1998.
The certification testing phase began in the third quarter
of 1998 and was fully completed in the second quarter of 1999.
This phase involved testing each system using aged data and
critical future dates in a separate year 2000 compliant
environment and remediating any problems that arise.
Harleysville Group did not encounter any significant problems
during certification testing and all problems identified have
been remediated.
16
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
The enterprise testing phase began in the second quarter of
1999 and involved testing hardware and operating system software
running in concert with each other using critical future dates.
The enterprise testing was completed and no significant problems
were encountered.
The street testing phase involves testing Harleysville
Group's IT systems with third parties and began in the second
quarter of 1999. There have been no significant problems in the
testing and the testing has been completed.
Harleysville Group has non-IT systems that include embedded
technology such as office equipment and building systems.
Harleysville Group has inventoried the non-IT systems and has
either tested or communicated with vendors and landlords
regarding year 2000 readiness for essentially all of the non-IT
systems. Harleysville Group currently does not expect any
material impact to its business, results of operations or
financial condition from the failure of non-IT systems.
Harleysville Group's expenses since 1996 to address year
2000 issues were approximately $3.6 million as of September 30,
1999 and consisted primarily of costs of internal resources.
Estimated remaining costs to complete the year 2000 work are
currently less than $0.1 million.
Harleysville Group's year 2000 plans provide for time to
correct problems encountered in the testing phases. Harleysville
Group is continually assessing the most reasonably likely worst
case year 2000 scenario and the contingency alternatives. This
assessment is ongoing and contingency plans will be finalized in
the fourth quarter. Current contingency plans include backup
electricity generators and additional staffing over the three day
New Year holiday weekend.
Harleysville Group has risk that third parties will suffer
year 2000 problems. As most of Harleysville Group's computer
systems have been internally developed, Harleysville Group is not
significantly dependent on third party vendors for year 2000
compliance. Of the independent agents that interface
electronically with Harleysville Group, almost all either
utilize, or have access to, a system for which the remediation
and certification testing phases are complete. Some information
used
17
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
(Continued)
in underwriting policies and adjusting claims, such as motor
vehicle reports, rating information and crime data bases, is
generally obtained electronically. Investment portfolio pricing
information and bank statement information is obtained
electronically. Harleysville Group is communicating with and
monitoring the year 2000 progress of such third parties and will
conclude its contingency planning later in 1999. Harleysville
Group is also communicating with and monitoring the year 2000
readiness of other third parties it does business with but with
which it does not exchange data electronically. To the extent
that any of these third parties appear not to be year 2000 ready,
Harleysville Group will make appropriate contingency plans
dependent upon the facts and circumstances of each third party.
Harleysville Group has risk that claims related to year 2000
issues will be made under insurance policies that it underwrites.
Harleysville Group has concluded that its policies do not
generally provide coverage for losses relating to year 2000
issues and has issued endorsements further clarifying this
exclusion. However, due in part to the potential for judicial
decisions which expand policies to cover risks that were not
contemplated by the policy, which in turn may produce
unanticipated claims at that point in time, the amount of any
potential year 2000 coverage liabilities is not determinable.
This year 2000 disclosure contains statements which are
forward-looking statements that involve risks and uncertainties
and qualify for the statutory safe harbor under the Private
Securities Litigation Reform Act of 1995. Future year 2000
readiness activities may not adhere to the anticipated schedule
and cost estimations because: more problems may be encountered
than anticipated in the various stages of testing and trained
personnel may not be available to work on internal systems in the
time required; or there may be unexpected problems with the
readiness of third party business partners and vendors who cannot
produce services; or utility companies may not be able to provide
the vital services required to maintain operations.
18
HARLEYSVILLE GROUP INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders -
None
ITEM 5. Other Information - None
ITEM 6. a. Exhibits - None
b. Reports on Form 8-K - None
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 12 1999 /s/BRUCE J. MAGEE
------------------ ---------------------------------
Bruce J. Magee
Senior Vice President and
Chief Financial Officer
(principal financial officer and
principal accounting officer)
19