1999
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
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INDEX TO 1999 ANNUAL REPORT
Page
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 5
Common Stock Price and Dividend Information..................... 30
Report of Management............................................ 31
Report of Independent Auditors.................................. 32
Consolidated Balance Sheets at December 31, 1999 and 1998....... 33
Consolidated Statements of Earnings for the Years Ended
December 31, 1999, 1998 and 1997............................... 34
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1999, 1998 and 1997......................... 35
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997............................... 36
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash Provided by Operating Activities for the
Years Ended December 31, 1999, 1998 and 1997................... 37
Notes to Consolidated Financial Statements...................... 38
Selected Consolidated Financial Data............................ 65
Management's Discussion of the Supplemental Information on
Insurance Operations........................................... 66
Directors....................................................... 71
Officers........................................................ 75
Stockholder Information......................................... 77
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FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share and Share Amounts)
1999 1998 1997
Net premiums written............................ $ 911,993 $ 745,048 $ 741,501
Earned premiums................................. $ 871,830 $ 745,620 $ 730,497
Net investment income........................... 89,787 86,501 80,972
Premium finance and service fees................ 14,774 13,440 7,074
Amortization of excess of book value of
subsidiary interest over cost................. 3,019 - -
Net realized investment gains................... 8,130 6,769 22,770
Total revenues............................ $ 987,540 $ 852,330 $ 841,313
Earnings before income taxes and minority
interest...................................... $ 128,790 $ 124,467 $ 127,695
Income taxes.................................... 27,154 27,975 31,480
Net earnings before minority interest........... 101,636 96,492 96,215
Minority interest............................... 952 - -
Net earnings.............................. $ 102,588 $ 96,492 $ 96,215
Comprehensive income............................ $ 24,426 $ 94,555 $ 100,368
Basic and diluted net earnings per common share. $ 2.94 $ 2.68 $ 2.67
Net earnings excluding the after-tax impact of
net realized investment gains (1).............. $ 97,304 $ 92,092 $ 81,415
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (1).................. $ 2.79 $ 2.56 $ 2.26
Cash dividends paid per share................... $ 1.11 $ 1.07 $ 1.03
Weighted average number of common shares
outstanding................................... 34,940,074 36,042,652 36,044,679
Total investments at market value............... $ 1,268,979 $1,257,900 $1,242,695
Total assets.................................... 1,871,472 1,755,983 1,754,753
Total liabilities............................... 1,223,650 1,050,198 1,104,957
Minority interest............................... 1,188 - -
Total stockholders' equity...................... 646,634 705,785 649,796
Total stockholders' equity per share............ 18.82 19.58 18.03
Certain statutory financial ratios (unaudited):
Loss and LAE ratio............................ 72.0% 71.6% 71.4%
Underwriting expense ratio.................... 26.5 26.5 25.1
Combined ratio............................ 98.5% 98.1% 96.5%
Net premiums written to policyholders'
surplus..................................... 175.7% 132.2% 143.3%
(1) The above figures are presented to provide information to the reader due
to the amount of, and fluctuations in, net realized gains and losses. The
amounts noted, commonly known as Operating Income, are important measures of
corporate performance.
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THE COMMERCE GROUP, INC.
March 24, 2000
To Our Stockholders:
In 1999, your Company experienced satisfactory financial results for
the 24th consecutive year. From the very first day the funding of The
Commerce Insurance Company was accomplished (April 3, 1972) through December
31, 1999, we have achieved underwriting profit of $252.2 million on total
premiums written of $7.7 billion. This underwriting profit represents 3.3%
of total premiums written.
In November 1999, the 2000 personal automobile insurance rates were
announced by the Massachusetts Insurance Commissioner. Despite the
industry's request for a 7.8% increase, 2000 rates increased only 0.7% which
was identical to the 1999 rate increase announced in January 1999. The
slight increases announced for 1999 and 2000 follow four consecutive years of
state mandated rate decreases from 1995 through 1998. Although most
companies, including ours, continued to modify safe driver deviations and
affinity group discount programs in response to the 2000 rates, the
Massachusetts marketplace remains highly competitive. Through these ongoing
competitive conditions, your Company's share of the Massachusetts personal
automobile market has remained relatively stable, and at year-end, our market
share was 21.3%.
With the current industry trends and market forces changing the
insurance industry, insurers are seeking competitive advantages to maintain
peak operating performance. As we enter the new millennium, it is important
for your Company to focus on strategies that enable it to utilize core
competencies to their fullest. As mentioned last year, your Company
continued to build on one of these core competencies, the AAA group marketing
strategy, as we made a significant acquisition which will strengthen our goal
to grow and expand our business beyond Massachusetts. Your Company,
including Commerce West Insurance Company and American Commerce Insurance
Company, the newest member of our corporate family whose eleven month results
are included in this report, is well positioned to pursue our goals of
growing and expanding geographically beyond the borders of Massachusetts.
Through it all, your Company has continued to grow and prosper. The
Commerce Insurance Company continues to be the largest writer of
Massachusetts private passenger automobile insurance, as well as the second
largest writer of Massachusetts homeowners insurance. Additionally, I am
very pleased to report that A.M. Best Co. recently upgraded your Company's
group rating to A+ (Superior). Written premiums, earned premiums, investment
income, total assets, total stockholders' equity per share including
cumulative cash dividends paid per share, as illustrated in the bar graph on
the facing page, are all at new highs. For those of you who are interested
in the details, I draw your attention to the pages in this report labeled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". Behind these numbers are an extremely dedicated group of
people: Our Policyholders (represented by over 900,000 policies in force);
Agents(891); Employees (1,668); Officers (43); Directors (19); and, of
course, our Stockholders (over 4,000, not including our Employee Stock
Ownership Plan participants who now number 1,691).
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Property-liability insurance remains a good business to be in--and The
Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to believe
that owners' interests are its primary constituency.
Our sincere thanks to those who have helped in this building process--
especially our Agents, Employees, Officers and Board of Directors. This
diverse force of committed, ethical and hard working people will continue to
build on our past successes and look to the future with excitement and
opportunity. Their individual creativity, energy and professionalism will
continue to serve our stockholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J. Remillard, Jr.
President, Chief Executive Officer
and Chairman of the Board
Caring in everything we do.
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The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders'
equity per share value including cumulative cash dividends paid per
share through each December 31, year-end, over the most recent fifteen
year period. The X axis lists the years beginning with 1985 through
1999. The Y axis lists the dollar values starting at $0.00 and
increasing in one dollar increments to $24.00. The graph depicts a
total stockholders' equity per share value in 1985 of $0.81, 1986 of
$0.95, 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991
of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of $14.96,
1996 of $16.28, 1997 of $18.03, 1998 of $19.58 and 1999 of $18.82. The
graph also depicts the total stockholders' equity per share value
adjusted for cumulative dividends paid per share in 1985 of $0.81, 1986
of $0.95, 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36,
1991 of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $11.03, 1995 of
$15.34, 1996 of $17.47, 1997 of $20.25, 1998 of $22.87 and 1999 of
$23.22.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty insurance industry continues to remain
highly competitive and inherently volatile in nature. Property and
casualty insurance company results have traditionally been impacted by
the typical forces unique to the market such as competition, frequency
and severity of losses, the overall economy and the general regulatory
environment in those states in which the insurer operates. As the
industry crosses over into a new millennium, additional forces are
impacting the industry in the form of deregulation, on-line commerce,
price competition, empowered customers and technological advancement.
As a whole, the industry continued to experience slightly deteriorating
underwriting results during 1999, and, according to A.M. Best Co.,
"Personal auto margins will further erode as market leaders further
reduce prices and begin to use the Internet as a low-cost delivery
system.". Although price competition is quite heavy in many areas of
the country, it has improved in 1999, and to date in 2000, among
independent agency companies in Massachusetts. Beyond Massachusetts,
industry underwriting results are expected to continue to deteriorate in
the near future which further emphasizes the competitive advantages
gained by affinity marketing and operating efficiently. With these
issues on the forefront, The Commerce Group, Inc. ("Company") continues
to position itself to respond to the prevailing forces and conditions in
the market. The Company has utilized it's strong agency relationships,
a low-cost structure, affinity group alliances and a recent joint-
venture acquisition all aimed at keeping the Company responsive in
today's competitive environment.
The Company, incorporated in 1976, is a holding company for
several property and casualty insurers which, through these insurance
subsidiaries, offers predominantly private passenger motor vehicle
insurance along with a broad range of other property and casualty
insurance products. These products are marketed to affinity groups,
individuals, families and businesses through the Company's strong
relationships with professional independent insurance agencies. The
Company writes insurance primarily in the State of Massachusetts through
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation"), both wholly-owned subsidiaries of Commerce
Holdings, Inc. ("CHI").
Additionally, the Company writes insurance in the State of
California through Commerce West Insurance Company ("Commerce West"), a
wholly-owned subsidiary of Commerce, located in Pleasanton, California.
The Company also writes insurance through American Commerce Insurance
Company ("American Commerce"), which it acquired in January 1999.
Located in Columbus, Ohio, American Commerce, is a wholly-owned
subsidiary of ACIC Holding Co., Inc., with policies in 26 states and
licenses in several others.
In November of 1998, Commerce formed ACIC Holding Co., Inc., in a
joint venture with AAA Southern New England ("AAA SNE") and invested
$90,800 to fund the January 29, 1999 acquisition of the Automobile Club
Insurance Company whose name was changed to American Commerce upon
completion of the acquisition. Commerce invested $90,000 in the form of
preferred stock and an additional $800 representing an 80% common stock
ownership. AAA SNE invested $200 representing a 20% common stock
ownership. The terms of the preferred stock call for Commerce to
receive quarterly cash dividends at the rate of 10% per annum from ACIC
Holding, Co., Inc. In the event cash dividends cannot be paid,
additional preferred stock will be issued. Commencing with the January
29, 1999 acquisition date, ACIC Holding Co., Inc. and American
Commerce's results were consolidated into the Company's financial
statements found herein. Since 1995, Commerce has maintained an
affinity group marketing relationship with AAA Insurance Agency, Inc., a
subsidiary of AAA SNE. AAA Insurance Agency, Inc. has been a licensed
insurance agent of Commerce since 1985.
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The Company's business strategy remains focused on activities
primarily related to personal automobile insurance. The Company has
been the largest writer of personal property and casualty insurance in
the State of Massachusetts in terms of market share of direct premiums
written since 1990. The Company's share of the Massachusetts personal
automobile market remained fairly stable in 1999, as exhibited in the
table below, exceeding our nearest competitor which maintains an 11.4%
market share.
Growth of Massachusetts Personal Automobile Insured Vehicles
versus Commerce Massachusetts Market Share
Commerce
Year Industry Commerce Market Share
1999 2.0% 0.9% 21.3%
1998 2.7% 1.9% 21.6%
1997 2.1% 8.3% 21.8%
1996 3.3% 29.8% 20.8%
1995 1.7% 2.6% 16.4%
As mentioned, the Company predominantly writes private passenger
automobile insurance. The following tables indicate that direct
premiums written for private passenger automobile, commercial automobile
and homeowners represented 86.9%, 3.9% and 7.8%, respectively, of the
Company's total direct premiums written in 1999, as compared to 86.2%,
4.6% and 7.5%, respectively, in 1998. Total direct premiums written
increased $151,291 or 19.0% in 1999 over 1998. The 1999 increase was
primarily attributable to two factors: (1) a $67,409, or 10.2% increase
in Massachusetts private passenger automobile direct premiums written
which was the result of a 9.1% increase in average premiums per
exposure; and, (2) an $83,301 or 358.2% increase in direct premiums
written for all other states, which was directly attributable to
business written by American Commerce for the eleven months since the
acquisition.
Direct Premiums Written, Year Ended December 31, 1999
Massachusetts All Other States Total % of Total
Personal Automobile...... $731,329 $ 92,297 $823,626 86.9%
Commercial Automobile.... 36,616 - 36,616 3.9
Homeowners............... 59,981 14,378 74,359 7.8
Other Lines.............. 13,027 521 13,548 1.4
Total........... $840,953 $107,196 $948,149 100.0%
Direct Premiums Written, Year Ended December 31, 1998
Massachusetts All Other States Total % of Total
Personal Automobile...... $663,920 $ 23,312 $687,232 86.2%
Commercial Automobile.... 36,299 - 36,299 4.6
Homeowners............... 59,761 - 59,761 7.5
Other Lines.............. 13,483 83 13,566 1.7
Total........... $773,463 $ 23,395 $796,858 100.0%
Massachusetts Automobile Business
In Massachusetts, private passenger automobile insurance is
subject to extensive regulation. Owners of registered automobiles are
generally required to maintain certain minimum automobile insurance
coverages. With very limited exceptions, automobile insurers are
required by law to issue a policy to any applicant seeking to obtain
such coverages. Companies in Massachusetts are also assigned agents,
known as Exclusive Representative Producers ("ERPs") based on market
share, that have been unable to obtain a voluntary contract with an
insurance carrier. Marketing and underwriting strategies for companies
operating in Massachusetts are limited by maximum premium rates and
minimum agency commission levels for personal automobile insurance which
are mandated by the Massachusetts Commissioner of Insurance
("Commissioner"). In Massachusetts, accident rates, bodily injury
claims, and medical care costs continue to be among the highest in the
nation.
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During the three-year period from 1997 to 1999, average mandated
Massachusetts personal automobile insurance premium rates decreased an
average of 3.2% per year. The Commissioner again approved an average
0.7% increase in personal automobile premiums for 2000, the same average
rate increase as in 1999, following four consecutive years of average
rate decreases as depicted in the following table. Coinciding with the
2000 rate increase, the Commissioner also approved a decrease in the
commission rate agents receive for selling private passenger automobile
insurance from 12.4% in 1999 to 11.8% in 2000.
Average Annual Premium Rate Percentage Change for Massachusetts
Private Passenger Automobile Business
Year Industry Commerce
2000 0.7% 5.0% (Estimated)
1999 0.7% 9.1%
1998 (4.0%) 2.6%
1997 (6.2%) (1.8%)
1996 (4.5%) (9.2%)
1995 (6.1%) (3.6%)
Although average mandated personal automobile premium rates
increased only 0.7% in 1999, the Company's average rate increased 9.1%
per exposure. The 9.1% increase for 1999 was primarily the result of
decreases in the Safe Driver Insurance Plan ("SDIP") deviations for Step
9 and Step 10 drivers, the two best driver SDIP classifications in
Massachusetts. The increase was also due to the facts that the rate
decision did not anticipate purchases of new automobiles in the year to
which the rate decision applied and, secondly, the Company's mix of
personal automobile business differs from that of the industry.
The 1997, 1998 and 1999 average rate decisions were partially
driven by corrections for an industry error that had impacted prior year
rate decisions. The industry error resulted from a miscalculation of
industry expense allowances that had the effect of overstating rates for
1991 through 1996. Mandated rates for 1997, 1998 and 1999 included an
adjustment to recoup $176 million from the industry. The adjustment
included in the rate decision to recoup the error was phased in at 40%,
40% and 20% in 1997, 1998 and 1999, respectively. The earned premium
impact of this, coupled with the impact of a previous year imbalance in
the SDIP, was approximately $15.3 million for 1997, $23.9 million for
1998 and $14.0 million for 1999. The earnings per share after-tax
impact resulting from lower earned premiums has been estimated at $0.28
for 1997, $0.43 for 1998 and $0.26 for 1999.
Also factored into the 1999 rate decision were two sanctions
levied by the Commissioner against the Massachusetts personal automobile
insurance industry. One fine, amounting to $6 million, was imposed as a
result of the industry's failure to show that it adhered to adequate
cost containment efforts as identified by the Commissioner. A second
fine of $3 million was the result of what the Commissioner termed
"incomplete compliance" on the part of the Automobile Insurers Bureau of
Massachusetts ("AIB") with a discovery order concerning disclosure of
certain information as identified by the Commissioner.
The Company's performance in its personal and commercial
automobile insurance lines is integrally tied to its participation in
the Commonwealth Automobile Reinsurers ("C.A.R."). All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines.
Since its inception, C.A.R. has annually generated multi-million dollar
underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or
commercial deficit (its participation ratio) is based upon its market
share of the automobile risks for the particular pool, adjusted by a
utilization formula such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
exceeds that of the industry, and favorably affected if its relative use
of C.A.R. is less than that of the industry. Automobile insurers
attempt to develop and implement underwriting strategies that will
minimize their relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not insured through C.A.R.
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Significant changes in the utilization of the C.A.R. private
passenger pooling mechanism are not expected for 2000. Various C.A.R.
participation formula changes have been fully implemented since 1993
with only minor changes since then. The Company's strategy has been to
voluntarily retain more of the types of private passenger automobile
business that are factored as credits favorably impacting the
utilization formula. As a result of increased voluntary retention, the
credits impacting the utilization formula have favorably affected the
Company's participation ratio. As indicated in the accompanying table,
this ratio is several percentage points below the Company's estimated
21.3% share of the Massachusetts personal automobile market. The
Company continues to expect the marketplace to make minor annual
adjustments to find the optimum balance between voluntary and ceded
writings.
Company Estimated C.A.R. Private Passenger Participation Ratio
versus Market Share
Company Estimated Company Estimated
Year Participation Ratio Market Share
1999 16.5% 21.3%
1998 16.7% 21.6%
1997 18.0% 21.8%
1996 19.0% 20.8%
1995 16.2% 16.4%
The percentage of commercial automobile premiums ceded to C.A.R.
by the industry has decreased to a Company estimate of 19% in 1999. The
percentage of commercial automobile business ceded to C.A.R. by the
Company, is approximately 19%. C.A.R. depopulation, coupled with C.A.R.
rate increases for ceded commercial business, have led to a reduction in
the size of the annual commercial automobile deficits. The Company
intends to continue to respond to the incentives and disincentives
provided by C.A.R. rules as deemed necessary and appropriate.
The Company provides a separate rating tier for preferred
commercial automobile business through Citation. Approximately 23% of
the commercial automobile premiums produced by its voluntary agents in
1999 were written by Citation. The Company expects that this secondary
rating tier will continue to assist the Company in retaining its better
commercial automobile accounts, while also further increasing the
percentage of commercial automobile business that can be retained
voluntarily by the Company in 1999 and beyond.
The Company has actively pursued affinity group marketing programs
since 1995. The primary purpose of affinity group marketing programs is
to provide participating groups with a convenient means of purchasing
private passenger automobile insurance through associations and employer
groups. Emphasis is placed on writing larger affinity groups, although
accounts with as few as 25 participants are considered. Affinity groups
are eligible for rate discounts which must be filed annually with the
Division of Insurance. In general, the Company looks for affinity
groups with mature/stable membership, favorable driving records and
below average turnover ratios. Participants who leave the sponsoring
group during the term of the policy are allowed to maintain the policy
until expiration. At expiration, a regular Commerce policy may be
issued at the insured's option.
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Since the latter part of 1995, Commerce has been a leader in
affinity group marketing through agreements with the four American
Automobile Association Clubs of Massachusetts ("AAA clubs") offering
discounts on private passenger automobile insurance to the clubs'
members who reside in Massachusetts. A 6% discount was approved for
policies effective January 1, 2000. The AAA clubs discount can be
combined with safe driver deviations for up to an 11.6% reduction from
the 2000 state mandated rates. Membership in these clubs is estimated
to represent approximately one-third of the Massachusetts motoring
public, and has been the primary reason for a 44.5% increase in the
number of personal automobile exposures written by Commerce since year-
end 1995. As expected, this increase leveled off in 1999 and 1998 as
evidenced by the 0.9% and 1.9% increase in personal automobile
exposures, respectively, as compared to increases of 8.3% in 1997 and
29.8% in 1996. In 1999, total direct premiums written attributable to
the AAA group business were $495,962 or 52.3% of the Company's total
direct premiums written (67.8% of the Company's total Massachusetts
personal automobile premium), an increase of 8.5% over 1998. Total
exposures attributable to the AAA clubs group business were 547,009 or
67.1% of total Massachusetts personal automobile exposures in 1999, as
compared to 547,100 or 67.6% in 1998. Of the total Massachusetts
automobile exposures written by the Company, approximately 11% were
written through insurance agencies owned by the AAA clubs. The
remaining 89% were written through the Company's network of independent
agents. For additional details, refer to the table found on page 11
entitled "AAA Affinity Group Discount and SDIP Deviations".
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members must participate in a
group marketing program within one year. Accordingly, Commerce, in
coordination with the AAA clubs, aggressively pursued AAA members for
the AAA Affinity Group Marketing Program. At December 31, 1996,
Commerce had achieved the objective of writing more than 35% of the AAA
members within the first year, as over 300,000 AAA members joined the
program. Commerce has continued to maintain AAA member participation in
excess of 35% through December 31, 1999, where it is currently estimated
at 44.1% participation. The particular portion of the statute, dealing
with achieving the 35% penetration level (participation) in one year,
was amended by the Massachusetts Legislature in early 1997 to allow two
years to reach the required penetration level. This requirement has
subsequently been annually waived by the Massachusetts Legislature for
1998 and 1999. Waiving the penetration requirements allows insurance
companies to continue offering group discounts without reaching the 35%
level. The waiver of penetration requirements cannot be predicted for
years beyond 1999.
Commerce and the AAA clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
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Other States Business
Direct premiums written in states other than Massachusetts by
Commerce West and the Company's newest acquisition, American Commerce,
increased $83,801 or 358.2%. Commerce West writes 100% of its insurance
business in the state of California. American Commerce, who writes
business in 26 states, wrote approximately 71% of that business in seven
states. The seven states with the highest percentages of premiums
written by American Commerce are shown in the following table:
% of Direct Premiums
Company State Written by State
Commerce West California.............. 100.0%
American Commerce Arizona................. 21.5%
Oregon.................. 9.9%
Ohio.................... 9.8%
Rhode Island............ 9.0%
Washington.............. 8.7%
Oklahoma................ 6.3%
Kentucky................ 5.6%
Other states............ 29.2%
Total.............. 100.0%
Insurance Ratios
Underwriting profit margins are reflected by the extent to which
the combined ratio is less than 100%. This ratio is considered the best
simple index of current underwriting performance of an insurer. During
the five-year period ended December 31, 1999, the property and casualty
insurance industry's combined ratio, as reported by A.M. Best and
weighted to reflect the Company's product mix ("weighted industry
average"), has ranged from a low of 100.1% in 1997 to a high of 103.7%
in 1999 on a statutory accounting principles basis. During this same
period of time, the Company's combined ratio has consistently remained
below the weighted industry average, ranging from as low as 91.0% in
1995 to a high of 98.5% in 1999. On an average basis, the Company's
combined ratio was 96.4% for the five year period ended December 31,
1999 compared to a weighted industry average of 102.3%.
Year Ended December 31,
Company Statutory Ratios 1999 1998 1997 1996 1995
(unaudited)
Loss and LAE Ratio................. 72.0% 71.6% 71.4% 70.9% 62.0%
Underwriting Expense Ratio......... 26.5 26.5 25.1 27.1 29.0
Combined Ratio..................... 98.5% 98.1% 96.5% 98.0% 91.0%
Industry Combined Ratio
(all writers)(1)................... 103.7% 102.2% 100.1% 102.9% 102.8%
(1) Source: Best's Review (January, 2000), as reported by A.M. Best for
all property and casualty insurance companies and weighted to reflect
the Company's product mix. The 1999 industry information is estimated
by A.M. Best.
Investment Income and Realized Investment Gains
The Company's total revenues were supplemented in fiscal 1999,
1998 and 1997 by net investment income of $89,787, $86,501 and $80,972,
respectively. Additionally, the Company had realized investment gains
of $8,130, $6,769 and $22,770 in 1999, 1998 and 1997, respectively.
10
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Regulatory Matters
General
Although the U.S. federal government does not directly regulate
the insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies continue to investigate
the current condition of the insurance industry (encompassing both life
and health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Congress conducts hearings
relating, in general, to the solvency of insurers and has proposed
federal legislation from time to time on this and other subjects.
In November, 1999, the Gramm-Leach-Bliley Act (Financial Services
Modernization Act - S.900) was signed into law: (1) repealing the Glass-
Steagall Act of 1933, which had prohibited the merger of banks and
securities firms; and, (2) substantially modifying the Bank Holding
Company Act of 1956, had the effect of separating banking and insurance
underwriting business. The law contains provisions that governs
competition, creates safe-harbor protections for specific state laws and
establishes consumer protections that will govern bank-insurance sales.
Given the recent reform, the Company is unable to predict whether or in
what form initiatives will be implemented and what the possible effects
on the Company might be.
At the state level, various forms of automobile insurance reform
are continuously debated in the Massachusetts Legislature. New
regulations and legislation are often proposed with the goal of reducing
the need for premium increases. For further details, please refer to
the general discussion on insurance regulation and premium rates
beginning on page 5.
Personal Automobile Insurance
As previously mentioned, since 1995, the Company has been a leader
in affinity group marketing through discounts to members of the AAA
clubs. Membership in these clubs is estimated to represent
approximately one-third of the Massachusetts motoring public. The
Company increased its Massachusetts private passenger automobile
insurance exposures by 0.9%, ending the year with approximately 21.3% of
the Massachusetts private passenger automobile market.
Since 1996, the Company has offered its Massachusetts customers
safe driver deviations to drivers with SDIP classifications of either
Steps 9 or 10. Safe driver deviations are rate discounts based on the
customers driving record and resulting SDIP classification and must be
approved annually by the Commissioner. Steps 9 and 10 are the two best
driver SDIP classifications in Massachusetts, representing drivers with
no at fault accidents and not more than one minor moving vehicle
violation in the last six years. The accompanying table depicts the AAA
Affinity Group Discount, SDIP Deviations and their combined reduction
from Massachusetts average mandated rates:
AAA Affinity Group Discount and SDIP Deviations 2000* 1999 1998 1997 1996
AAA Affinity Group Discount................... 6% 6% 6% 10% 10%
SDIP Step 9 Deviation......................... 6% 8% 15% 10% 10%
SDIP Step 10 Deviation........................ 2% 3% 4% 10% 10%
Combined AAA Affinity Group Discount and
Step 9 Deviation............................ 11.6% 13.5% 20.1% 19.0% 19.0%
Combined AAA Affinity Group Discount and
Step 10 Deviation........................... 7.9% 9.8% 9.8% 19.0% 19.0%
*For policies with effective dates as of January 1, 2000.
11
<PAGE
In November 1999, in response to the average personal automobile
rate decisions over the last several years, the Company filed for and
ultimately received approval to offer SDIP deviations of 6% for Step 9
and 2% for Step 10 for policies incepting in the 2000 calendar year. At
December 31, 1999, 69.0% of the Company's exposures were eligible for
either Step 9 or Step 10 deviations versus 68.7% at December 31, 1998.
The Company received state regulatory approval to implement an
installment fee of $3.00 on each invoice, following the down payment,
for all personal lines policies with effective dates of January 1, 1998
and beyond. At December 31, 1999, this program completed its second
full year since implementation and, as a result, premium finance and
service fees increased $1,334 or 9.9% in 1999. In 1998, service fees
had increased $6,366 or 90.0%, which was the result of the installment
fee program replacing a "late fee" system that had been utilized for
1997 and 1996.
Risk-Based Capital
In order to enhance the regulation of insurer insolvency, the
National Association of Insurance Commissioners ("NAIC") developed a
formula and model law to implement Risk-Based Capital ("RBC")
requirements for property and casualty insurance companies which are
designed to assess capital adequacy and to raise the level of protection
that statutory surplus provides for policyholder obligations. The RBC
model for property and casualty insurance companies measures three major
areas of risk facing property and casualty insurers: (i) underwriting,
which encompasses the risk of adverse loss development and inadequate
pricing; (ii) declines in asset values arising from credit risk; and,
(iii) other business risks from investments. Insurers having less
statutory surplus than required by the RBC calculation will be subject
to varying degrees of regulatory action, depending on the level of
capital inadequacy.
The RBC model formula proposes four levels of regulatory action.
The extent of regulatory intervention and action increases as the level
of surplus to RBC falls. The first level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the
regulator if surplus falls below 200% of the RBC amount. The Regulatory
Action Level (as defined by the NAIC) requires an insurer to submit a
plan containing corrective actions and permits the Commissioner to
perform an examination or other analysis and issue a corrective order if
surplus falls below 150% of the RBC amount. The Authorized Control
Level (as defined by the NAIC) allows the regulator to rehabilitate or
liquidate an insurer in addition to the aforementioned actions if
surplus falls below 100% of the RBC amount. The fourth action level is
the Mandatory Control Level (as defined by the NAIC) which requires the
regulator to rehabilitate or liquidate the insurer if surplus falls
below 70% of the RBC amount. The Company's insurance subsidiaries,
Commerce, Citation, Commerce West, and American Commerce are listed in
the accompanying table which provides the key RBC information:
Commerce American
(Dollars in millions) Commerce Citation West Commerce
At December 31, 1999
Statutory surplus............. $ 411 $ 108 $ 23 $ 85
RBC Company action level...... 164 3 6 23
Statutory surplus in excess
of RBC Company action level. $ 247 $ 105 $ 17 $ 62
RBC amounts................... $ 82 $ 2 $ 3 $ 12
% of Surplus to RBC amounts... 501.5% 5,400.0% 766.7% 708.3%
12
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Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the years ending December 31, 1999 and
1998:
(Dollars in thousands)
Years Ended December 31,
1999 1998 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts........ $731,329 $663,920 $ 67,409 10.2%
Personal Automobile in All Other States..... 92,297 23,312 68,985 295.9%
Commercial Automobile....................... 36,616 36,299 317 0.9%
Homeowners in Massachusetts................. 59,981 59,761 220 0.4%
Homeowners in All Other States.............. 14,378 - 14,378 N/A
Other Lines in Massachusetts................ 13,027 13,483 (456) (3.4%)
Other Lines in All Other States............. 521 83 438 527.7%
Total Direct Premiums Written............ $948,149 $796,858 $151,291 19.0%
Net Premiums Written:
Direct Premiums............................. $948,149 $796,858 $151,291 19.0%
Assumed Premiums from C.A.R................. 87,241 74,644 12,597 16.9%
Ceded Premiums to C.A.R..................... (68,740) (70,435) 1,695 (2.4%)
Ceded Premiums to Other than C.A.R.......... (54,657) (56,019) 1,362 (2.4%)
Total Net Premiums Written............... $911,993 $745,048 $166,945 22.4%
Earned Premiums:
Personal Automobile in Massachusetts........ $633,746 $587,072 $ 46,674 8.0%
Personal Automobile in All Other States..... 91,357 24,681 66,676 270.2%
Commercial Automobile....................... 29,219 28,858 361 1.3%
Homeowners in Massachusetts................. 16,830 23,235 (6,405) (27.6%)
Homeowners in All Other States.............. 12,032 - 12,032 N/A
Other Lines in Massachusetts................ 3,190 5,717 (2,527) (44.2%)
Other Lines in All Other States............. 755 - 755 N/A
Assumed Premiums from C.A.R................. 84,356 75,718 8,638 11.4%
Assumed Premiums from Other than C.A.R...... 345 339 6 1.8%
Total Earned Premiums.................... $871,830 $745,620 $126,210 16.9%
Earned Premiums in Massachusetts............ $682,985 $644,882 $ 38,103 5.9%
Earned Premiums-Assumed..................... 84,701 76,057 8,644 11.4%
Earned Premiums in All Other States......... 104,144 24,681 79,463 322.0%
Total Earned Premiums.................... $871,830 $745,620 $126,210 16.9%
13
<PAGE
The $67,409 or 10.2% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 0.9% and
2.5%, in the number of Massachusetts personal automobile exposures for
liability and physical damage coverage, respectively, coupled with
increases of 2.5% and 20.4% in the average premium rate per exposure for
Massachusetts personal automobile liability and physical damage
exposures, respectively. The components of these 1999 changes were as
follows:
% of Direct
Coverage Type Premiums Written (1) Rate Change (2)
Liability:
Bodily Injury................. 37.0% (1.9%)
Personal Injury Protection.... 6.8 11.0
Property Damage to Others..... 18.6 9.1
Total Liability........... 62.4 2.5
Physical Damage:
Collision..................... 25.0 25.2
Comprehensive................. 12.6 11.7
Total Physical Damage..... 37.6 20.4
Total..................... 100.0% 9.1%
(1) Represents the Company's percentage of total direct private
passenger automobile premiums written in Massachusetts.
(2) Represents change in the 1999 average rate per exposure from
the 1998 average rate charged by the Company for Massachusetts
private passenger automobile premiums.
The above percentage changes were primarily the result of rate
modifications in the individual coverage components in the 1999 state
mandated average rate increase, combined with changes in the Company's
safe driver rate deviations. The combination of these factors resulted
in a 9.1% increase in the average personal automobile premium per
exposure in 1999. Despite the 1999 state mandated average rate
increase of only 0.7%, the Company's increase in the average personal
automobile premium per exposure was primarily due to the above noted
changes coupled with the fact that the rate decision does not
anticipate purchases of new automobiles in the year in which the rate
decision applies and the Company's mix of personal automobile business
differs from that of the industry. In 1999, the Company offered its
customers safe driver deviations of 8.0% to drivers with SDIP
classifications of Step 9 and 3.0% for Step 10 (15.0% for Step 9 and
4.0% for Step 10 in 1998).
As shown in the table found on page 11, the AAA affinity group
discount for 1999 was established at 6.0% which was unchanged from
1998. In 1999, for drivers who qualified, the Company's AAA affinity
group discount and safe driver deviations could be combined for up to a
13.5% reduction (20.1% in 1998) from state mandated rates.
The increases in other states personal automobile direct premiums
written resulted primarily from the joint-venture acquisition of
American Commerce, whose eleven month results were reflected in the
above table. American Commerce contributed $85,676 in direct premiums
written in 26 states.
Direct premiums written for commercial automobile insurance
increased by $317 or 0.9%, due primarily to a decrease of approximately
2.6% in the number of policies written, offset by a 3.7% increase in
the average commercial automobile premium per policy. Direct premiums
written for homeowners insurance (excluding the Massachusetts FAIR
Plan) increased by $220, or 0.4% due primarily to a 0.9% increase in
the number of policies written offset by a 1.2% decrease in the average
premium per policy.
14
<PAGE
The $166,945 or 22.4% increase in net premiums written was due to
the growth in direct premiums written as described above and by
premiums assumed from C.A.R. The increase in premiums assumed from
C.A.R. was the result of more premiums ceded to C.A.R. by the servicing
carriers in 1999 as compared to 1998. Premiums ceded to reinsurers
other than C.A.R. decreased $1,362, or 2.4% as compared to 1998 as a
result of changes to non-automobile reinsurance.
The $126,210 or 16.9% increase in earned premiums during 1999 as
compared to 1998 was primarily due to the joint-venture acquisition of
American Commerce. Earned premiums for American Commerce were $82,582
for the eleven months of 1999. The remaining amounts were primarily
attributable to increases to the average rates per exposure for
Massachusetts personal automobile liability and physical damage,
mentioned previously. This resulted in a $38,103 or 5.9%, increase for
Massachusetts earned premiums. The remaining increases were
attributable to a $8,638 or 11.4% increase in earned premiums assumed
from C.A.R. and a $6 or 1.8% increase in earned premiums assumed from
ANI and Fair Plan. The increases were offset by a decrease of $3,119
or 9.0% in earned premiums from Commerce West.
Investment Income
Net investment income is affected primarily from the composition
of the Company's investment portfolio. The following table summarizes
the composition of the Company's investment portfolio, at cost, at
December 31, 1999 and 1998:
Investments, at cost December 31,
(Dollars in thousands) % of % of
1999 Invest. 1998 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 82,349 6.1% $ 109,624 9.0%
Corporate bonds........................ 45,147 3.3 - -
U.S.Treasury bonds and notes........... 3,616 0.3 - -
Tax exempt state and municipal bonds... 530,333 39.2 490,858 40.4
Total fixed maturities............. 661,445 48.9 600,482 49.4
Preferred stocks....................... 230,934 17.1 200,270 16.4
Investments in closed-end
preferred stock mutual funds......... 267,956 19.8 169,394 13.9
Other equity securities................ 83,984 6.2 91,966 7.5
Total common stocks................ 351,940 26.0 261,360 21.4
Total equities..................... 582,874 43.1 461,630 37.8
Mortgages and collateral loans (net of
allowance for possible loan losses).. 72,451 5.4 73,510 6.0
Cash and cash equivalents.............. 22,535 1.7 72,243 5.9
Short-term investments................. - - 3,669 0.3
Other investments...................... 13,130 0.9 7,450 0.6
Total investments.................. $1,352,435 100.0% $1,218,984 100.0%
The Company's investment strategy is to maximize after-tax
investment income through high quality securities coupled with acquiring
equity investments which may forgo current investment yield in favor of
potential higher yielding capital appreciation in the future.
15
<PAGE
As depicted in the accompanying table, net investment income
increased $3,286 or 3.8%, compared to 1998, principally as a result of
an increase in average invested assets (at cost). Net investment income
as a percentage of total average investments was 6.8% in 1999 compared
to 7.0% in 1998. Net investment income after tax as a percentage of
total average investments was 5.7% in 1999 and 1998.
Investment Return Year Ended December 31,
(Dollars in thousands) 1999 1998
Average month-end investments (at cost)... $1,326,098 $1,242,633
Net investment income..................... 89,787 86,501
Net investment income after-tax........... 74,970 71,094
Net investment income as a percentage
of average net investments (at cost).... 6.8% 7.0%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.7% 5.7%
Premium Finance and Service Fees
Premium finance and service fees increased $1,334, or 9.9% during
1999. The increase was significantly less than the 90.0% increase
experienced in 1998. This reduction resulted from the completion of the
second full year of implementing a $3.00 installment on each invoice.
The Company had previously received state regulatory approval to charge
a $3.00 installment on each invoice following the down payment for all
personal lines policies with effective dates beginning January 1, 1998
and beyond. Previously, in 1997, the Company had utilized a "late fee"
system.
Amortization of Excess of Book Value of Subsidiary Interest over Cost
As a result of the acquisition of American Commerce (see
Management's Discussion and Analysis of Financial Condition and Results
of Operations - General and Notes to Consolidated Financial Statements -
NOTES A13 and A18), the amount representing the excess of the fair value
of the net assets acquired over the purchase price at January 29, 1999
was $16,465. The amount is being amortized into revenues on a straight-
line basis over a five-year period. The amount amortized into revenues
in 1999 was $3,019.
Investment Gains and Losses
Gross realized gains and losses on fixed maturity investments
totaled $458 and $6,449, respectively, for the year ended December 31,
1999 compared to gross realized gains and losses on fixed maturity
investments of $99 and $2,903, respectively, for the year ended December
31, 1998. Gross realized gains and losses on preferred stocks totaled
$207 and $451, respectively, for the year ended December 31, 1999
compared to gross realized gains and losses on preferred stocks of $369
and $1,096, respectively, for the year ended December 31, 1998. Gross
realized gains and losses on common stocks amounted to $18,187 and
$5,057, respectively, for the year ended December 31, 1999 compared to
gross realized gains on common stocks of $9,313 for the year ended
December 31, 1998. Gross realized gains on other investments amounted
to $1,235 for the year ended December 31, 1999 compared to gross
realized gains on other investments of $987 for the year ended December
31, 1998.
Net realized investment gains totalled $8,130 during 1999 as
compared to net realized investment gains of $6,769 for 1998. A
significant portion of the net realized gains in 1999 were the result of
sales of common stocks, partially offset by net realized losses in the
sales of non-taxable bonds, preferred stocks and in the maturity of
GNMAs. Also included were realized gains on mortgage activity of $196
in 1999 compared to realized losses of $321 in 1998 and realized
investment gains in other investments, specifically the Conning
Insurance Limited Partnership, of $888 in 1999 compared with $666 in
1998.
16
<PAGE
Gross unrealized gains and losses on fixed maturity investments
totaled $5,221 and $19,328, respectively, at December 31, 1999 compared
to $21,381 and $2,596, respectively, at December 31, 1998. The
unrealized gains on fixed maturities decreased significantly despite
increased fixed maturity holdings, as a result of the poor performance
in the bond market due to rising interest rates in 1999. Gross
unrealized gains and losses on preferred stocks totaled $782 and
$20,667, respectively, at December 31, 1999 compared to $2,706 and
$5,551, respectively, at December 31, 1998. Gross unrealized gains and
losses on common stocks totaled $1,446 and $51,919, respectively, at
December 31, 1999 compared to $24,721 and $2,120, respectively, at
December 31, 1998. The unrealized losses on preferred and common stocks
were primarily attributable to rising interest rates in 1999. Long-term
interest rates (30-year Treasury Bond) increased to 6.48% at December
31, 1999 from 5.08% at December 31, 1998. The Company also had gross
unrealized gains in other investments, specifically the Conning
Insurance Limited Partnership, of $1,009 in 1999 compared with $375 in
1998.
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased
$93,661 or 17.6% in 1999, compared to an increase of $5,302 or 1.0% in
1998. The increase in losses and LAE was primarily attributable to the
acquisition of American Commerce, which accounted for $62,731 of the
increase. The remaining increase was attributable to higher incurred
losses on Massachusetts business, which was the direct result of the
increased personal automobile direct premiums written discussed earlier,
and losses and LAE assumed from C.A.R. offset by lower computer services
expenses and higher reinsurance recoveries. Losses and LAE incurred (on
a statutory basis) as a percentage of insurance premiums earned ("loss
ratio") was 72.0% in 1999 as compared to 71.6% in 1998. The ratio of
net incurred losses, excluding LAE, to premiums earned ("pure loss
ratio") on personal automobile was 65.1% in 1999 compared to 61.4% in
1998. The increase to the personal automobile pure loss ratio was
primarily due to a continued decrease in redundancies arising from prior
accident years, and increases in the cost of adjusting losses. The
commercial automobile pure loss ratio increased to 60.3% in 1999
compared to 52.3% in 1998. This increase was primarily the result of
fewer prior year liability redundancies in the 1999 figure. For
homeowners, the pure loss ratio was 35.9% in 1999 compared to 31.8% in
1998. Offsetting the overall increase in pure loss ratio, total expenses
related to the Company's management incentive compensation plan and the
American Commerce agency stock option plan included in losses and loss
adjustment expenses were $397 lower in 1999 as compared to 1998. The
decrease was primarily driven by decreases, during 1999, in the market
price of the Company's common stock and offset by the 1999
implementation of the American Commerce agency stock option plan which
resulted in an additional $954 in expenses during 1999. These
management incentive and agency stock option expenses are directly
impacted by the market price of the Company's common stock. The loss
ratio was favorably impacted by 0.4% due to a reduction in expenses
related to the termination of a contract for software development with
an outside vendor during the second quarter of 1999. The loss ratio was
also favorably impacted by additional reductions in computer services
expenses paid to this vendor as compared to last year. The loss ratio
(on a statutory basis) for Commerce West was 71.2% for 1999 as compared
to 58.8% in 1998. The eleven month loss ratio (on a statutory basis)
for the Company's new acquisition, American Commerce, was 75.8% for
1999.
17
<page
Policy Acquisition Costs
Policy acquisition costs expensed increased by $37,226, or 19.0%
in 1999, compared to an increase of $8,943, or 4.8% in 1998. The
increase in policy acquisition costs was primarily attributable to the
acquisition of American Commerce, which accounted for $26,659 of the
increase. The remaining increase was attributable to higher contingent
commission accruals and higher underwriting expenses assumed from C.A.R.
offset by lower computer services expenses. As a percentage of net
premiums written, underwriting expenses for the insurance companies (on
statutory basis) remained constant at 26.5% for both 1999 and 1998. As
mentioned, a portion of the computer services expense decrease resulted
from the termination, during the second quarter, of a contract for
software development with an outside vendor which favorably impacted the
underwriting expense ratio by 0.3% and through reduced computer services
expenses paid to this vendor as compared to last year. Total expenses
related to the Company's management incentive compensation plan and the
American Commerce agency stock option plan included in policy
acquisition costs were $219 lower in 1999 as compared to 1998. The
decrease was primarily driven by decreases, during 1999, in the market
price of the Company's common stock and offset by the 1999
implementation of the American Commerce agency stock option plan which
resulted in an additional $954 in expense during 1999. The underwriting
expense ratio (on a statutory basis) for Commerce West was 40.9% for
1999 as compared to 38.6% for 1998. The eleven month underwriting
expense ratio (on a statutory basis) for the Company's new acquisition,
American Commerce, was 31.4% for 1999.
Income Taxes
The Company's effective tax rate was 21.1% and 22.5% for the years
ended December 31, 1999 and 1998, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends received
deduction. The lower effective tax rate for 1999 was the result of the
tax exempt interest and the dividends received deduction comprising a
greater portion of earnings before taxes.
Minority Interest
As a result of the joint venture with AAA SNE and acquisition of
American Commerce (see Management's Discussion and Analysis of Financial
Condition and Results of Operations - General and Notes to Consolidated
Financial Statements - NOTES A13 and A18), the Company's interest in
ACIC Holding Co., Inc., through Commerce, a wholly-owned subsidiary of
CHI, is represented by ownership of 80% of the outstanding shares of
common stock at December 31, 1999. AAA SNE maintains a 20% common stock
ownership. The minority interest of $952 included in these consolidated
financial statements for 1999 represents 20% of the net loss for ACIC
Holding Co., Inc. which is calculated after the $8,300 preferred stock
dividend paid to Commerce.
Net Earnings
Net earnings increased $6,096, or 6.3% to $102,588, during 1999 as
compared to $96,492 in 1998 and operating earnings, which exclude the
after-tax impact of net realized investment gains, increased $5,212, or
5.7% to $97,304 during 1999 as compared to $92,092 in 1998, both as a
result of the factors previously mentioned.
18
<PAGE
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Premiums
The following table compares direct premiums, net premiums written and
earned premiums for the years ending December 31, 1998 and 1997:
(Dollars in thousands)
Years Ended December 31,
1998 1997 Change % Change
Direct Premiums Written:
Personal Automobile in Massachusetts........ $663,920 $633,681 $ 30,239 4.8%
Personal Automobile in All Other States..... 23,312 27,312 (4,082) (14.9)
Commercial Automobile....................... 36,299 37,071 (772) (2.1)
Homeowners in Massachusetts................. 59,761 56,681 3,080 5.4
Other Lines in Massachusetts................ 13,483 13,730 (247) (1.8)
Other Lines in All Other States............. 83 92 (9) (9.8)
Total Direct Premiums Written............ $796,858 $768,649 $ 28,209 3.7%
Net Premiums Written:
Direct Premiums............................. $796,858 $768,649 $ 28,209 3.7%
Assumed Premiums from C.A.R................. 74,644 76,531 (1,887) (2.5)
Ceded Premiums to C.A.R..................... (70,435) (71,816) 1,381 (1.9)
Ceded Premiums from Other than C.A.R........ (56,019) (31,863) (24,156) 75.8
Total Net Premiums Written............... $745,048 $741,501 $ 3,547 0.5%
Earned Premiums:
Personal Automobile in Massachusetts........ $587,072 $552,190 $ 34,882 6.3%
Personal Automobile in All Other States..... 24,681 28,159 (3,478) (12.4)
Commercial Automobile....................... 28,858 27,988 870 3.1
Homeowners in Massachusetts................. 23,235 30,598 (7,363) (24.1)
Other Lines in Massachusetts................ 5,717 8,425 (2,708) (32.1)
Assumed Premiums from C.A.R................. 75,718 82,867 (7,149) (8.7)
Assumed Premiums from Other than C.A.R...... 339 270 69 25.6
Total Earned Premiums.................... $745,620 $730,497 $ 15,123 2.1%
Earned Premiums in Massachusetts............ $644,882 $619,201 $ 25,681 4.1%
Earned Premiums-Assumed..................... 76,057 83,137 (7,080) (8.5)
Earned Premiums in All Other States......... 24,681 28,159 (3,478) (12.4)
Total Earned Premiums.................... $745,620 $730,497 $ 15,123 2.1%
The $30,239 or 4.6% increase in Massachusetts personal automobile
direct premiums written resulted primarily from increases of 1.9% and
4.5% in the number of Massachusetts personal automobile exposures for
liability and physical damage coverage, respectively, coupled with a
3.2% decrease and a 13.3% increase in average rates for personal
automobile physical liability and physical damage exposures,
respectively.
19
<PAGE
The components of these 1998 changes were as follows:
% of Direct
Coverage Type Premiums Written (1) Rate Change (2)
Liability:
Bodily Injury................. 41.2% (8.4%)
Personal Injury Protection.... 6.7 0.0
Property Damage to Others..... 18.6 9.1
Total Liability........... 66.5 (3.2)
Physical Damage:
Collision..................... 21.4 13.6
Comprehensive................. 12.1 12.7
Total Physical Damage..... 33.5 13.3
Total..................... 100.0% 2.6%
(1) Represents the Company's percentage of total direct private passenger
automobile premiums written in Massachusetts.
(2) Represents change in 1998 average rate per exposure from the 1997
average rate charged by the Company for Massachusetts private
passenger automobile premiums.
The above percentage changes were primarily the result of the
changes in the Company's affinity group marketing programs, safe driver
rate deviations and the effect of the 1998 state mandated average rate
decrease of 4.0%. The combination of these factors resulted in a 2.6%
increase in the average personal automobile premium (each vehicle
insured). Despite the 1998 state mandated average rate decrease of
4.0%, the Company's increase in the average personal automobile premium
per exposure was primarily due to the above noted changes coupled with
the fact that the rate decision does not anticipate purchases of new
automobiles in the year in which the rate decision applies and the
Company's mix of personal automobile business differs from that of the
industry. In 1998, the Company offered its customers safe driver
deviations of 15% to drivers with SDIP classifications of Step 9 and
4.0% for Step 10 (10% for both Steps 9 and 10 in 1997). The decrease in
California personal automobile direct premiums written resulted
primarily from the increasingly competitive personal automobile market
that has witnessed several new entrants since 1997.
As shown in the table found on page 11, the AAA affinity group
discount for 1998 was established at 6.0% (10% in 1997). In 1998, for
drivers who qualified, the Company's AAA affinity group discount and
safe driver deviations could be combined for up to a 20.1% reduction
from state mandated rates.
Direct premiums written for commercial automobile insurance
decreased by $772 or 2.1%, due primarily to a decrease of approximately
0.2% in the number of policies written, and a 1.9% decrease in the
average commercial automobile premium per policy. Direct premiums
written for homeowners insurance (excluding the Massachusetts FAIR Plan)
increased by $2,862, or 5.2% due primarily to a 1.6% increase in the
number of policies written and a 3.6% increase in the average premium
per policy.
The increase in net premiums written was due to the growth in
direct premiums written as described above, offset by increased levels
of coverage provided by non-automobile reinsurance treaties resulting in
an increase of ceded premiums. Written premiums assumed from C.A.R.
decreased $1,887, or 2.5% and written premiums ceded to C.A.R. decreased
$1,381 or 1.9% as compared to 1997, both as a result of changes in the
industry's and the Company's utilization of C.A.R. reinsurance.
Premiums ceded to reinsurers other than C.A.R. increased $24,156 or
75.8% as compared to 1997 as a result of changes to non-automobile
reinsurance discussed on page 51.
20
<page
The increase in earned premiums was primarily attributable to a
$34,882 or 6.3% increase in earned premiums for Massachusetts personal
automobile insurance, an increase of $870, or 3.1% in earned premiums
for commercial automobile insurance offset by a $7,363 decrease in
earned premiums for homeowners insurance, a $3,478 or 12.4% decrease in
earned premiums for California personal automobile insurance and a
$2,708 or 32.1% decrease in earned premiums for all other than
automobile lines. Earned premiums were impacted by increased levels of
coverage provided by non-automobile reinsurance treaties which commenced
during the 2nd half of 1998. Earned premiums assumed from C.A.R.
decreased $7,149 or 8.7% during 1998 compared to 1997. Earned premiums
ceded to C.A.R. decreased $3,594 or 5.0%.
Investment Income
Net investment income is derived primarily from the composition of
the Company's investment portfolio. The following table summarizes the
composition of the Company's investment portfolio, at cost, at December
31, 1998 and 1997:
Investments, at cost December 31,
(Dollars in thousands) % of % of
1998 Invest. 1997 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 109,624 9.0% $ 175,788 14.6%
Corporate bonds........................ - - - -
U.S.Treasury bonds and notes........... - - - -
Tax exempt state and municipal bonds... 490,858 40.4 390,996 32.6
Total fixed maturities............. 600,482 49.4 566,784 47.2
Preferred stocks....................... 200,270 16.4 148,135 12.3
Investments in closed-end
preferred stock mutual funds......... 169,394 13.9 115,943 9.7
Other equity securities................ 91,966 7.5 44,428 3.7
Total common stocks................ 261,360 21.4 160,371 13.4
Total equities..................... 461,630 37.8 308,506 25.7
Mortgages and collateral loans (net of
allowance for possible loan losses).. 73,510 6.0 82,839 6.9
Cash and cash equivalents.............. 72,243 5.9 106,188 8.8
Short term investments................. 3,669 0.3 132,700 11.1
Other investments...................... 7,450 0.6 3,783 0.3
Total investments.................. $1,218,984 100.0% $1,200,800 100.0%
Net investment income increased $5,529 or 6.8%, compared to 1997,
principally as a result of an increase in average invested assets (at
cost). Net investment income as a percentage of total average
investments was 7.0% in 1998 compared to 6.9% in 1997. Net investment
income after tax as a percentage of total average investments was 5.7%
in 1998 compared to 5.5% in 1997. The increase was primarily the result
of the after-tax benefits of increased dividends received on common and
preferred stocks.
Investment Return Year Ended December 31,
(Dollars in thousands) 1998 1997
Average month-end net investments (at cost)... $1,242,633 $1,181,181
Net investment income......................... 86,501 80,972
Net investment income after-tax of average.... 71,094 65,286
Net investment income as a percentage
net investments (at cost)................... 7.0% 6.9%
Net investment income after-tax as a
percentage of average net investments
(at cost).................................... 5.7% 5.5%
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Premium Finance and Service Fees
Premium finance and service fees increased $6,366 or 90.0% during
1998. The increase was primarily attributable to the Company receiving
state regulatory approval to charge a $3.00 installment on each invoice
following the down payment for all personal lines policies with
effective dates of January 1, 1998 and beyond. Previously, in 1996 and
1997, the Company had utilized a "late fee" system.
Investment Gains and Losses
Gross realized gains and losses on fixed maturity investments
totaled $99 and $2,903, respectively, for the year ended December 31,
1998 compared to gross realized gains and losses on fixed maturity
investments of $4,306 and $2,887, respectively, for the year ended
December 31, 1997. Gross realized gains and losses on preferred stocks
totaled $369 and $1,096, respectively, for the year ended December 31,
1998 compared to gross realized gains and losses on preferred stocks of
$2,688 and $2,682, respectively, for the year ended December 31, 1997.
Gross realized gains on common stocks amounted to $9,313 for the year
ended December 31, 1998 compared to gross realized gains on common
stocks of $21,440 for the year ended December 31, 1997.
Net realized investment gains totalled $6,769 during 1998 as
compared to net realized investment gains of $22,770 for 1997. A
significant portion of the net realized gains in 1998 were the result of
sales of common stocks, partially offset by net realized losses in the
sales of non-taxable bonds, preferred stocks and in the maturity of
GNMAs. A significant portion of the realized gains in 1997 were
primarily the result of a merger of a major New England financial
corporation and its property and casualty subsidiary. The merger
election and exchange of stock coupled with subsequent post merger sales
of this corporation's common stock resulted in realized investment gains
of $18,968. Also included were realized gains on mortgage activity of
$321 in 1998 compared to realized losses of $95 in 1997 and realized
investment gains in the Conning Insurance Limited Partnership of $666 in
1998 compared with none in 1997.
Gross unrealized gains and losses on fixed maturity investments
totaled $21,381 and $2,596, respectively, at December 31, 1998 compared
to $24,190 and $377, respectively, at December 31, 1997. The unrealized
gains on fixed maturities decreased despite increased fixed maturity
holdings and declining interest rates in 1998. Gross unrealized gains
and losses on preferred stocks totaled $2,706 and $5,551, respectively,
at December 31, 1998 compared to $1,599 and $1,235, respectively at
December 31, 1997. Gross unrealized gains and losses on common stocks
totaled $24,721 and $2,120, respectively, at December 31, 1998 compared
to $17,888 and $170, respectively, at December 31, 1997. The Company
also recognized gross unrealized gains in the Conning Insurance Limited
Partnership of $375 in 1998 compared with none in 1997.
22
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Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred (on a
statutory basis) as a percentage of insurance premiums earned ("loss
ratio") was 71.6% in 1998 as compared to 71.4% in 1997. The ratio of
net incurred losses, excluding LAE, to premiums earned ("pure loss
ratio") on personal automobile was 61.4% in 1998 compared to 61.3% in
1997. Although the personal automobile pure loss ratio remained stable,
various components impacted the ratio, primarily in the bodily injury
area. Redundancies from prior year losses realized in the current year,
relating to bodily injury claims, were approximately $18.0 million less
in 1998, as compared to 1997. Approximately $11.0 million of this
amount was attributable to voluntary personal automobile bodily injury
loss reserves and $7.0 million to fewer redundancies from C.A.R. assumed
reserves. The decreased redundancies, however, were offset by better
current year experience, also primarily in the personal automobile
bodily injury area. This improvement was primarily the result of
improved severity of bodily injury claims coupled with slightly improved
claim frequency. The commercial automobile pure loss ratio increased to
52.3% in 1998 compared to 45.4% in 1997. For homeowners, the pure loss
ratio was 31.8% in 1998 compared to 48.2% in 1997. This decrease was
due to favorable weather conditions during 1998 as compared to normal
weather conditions experienced during 1997, coupled with favorable
development in the homeowners liability area. The LAE component of the
loss ratio was primarily impacted by an increase of approximately $3.2
million in computer service expenses, relating to the Year 2000 and PMSC
projects, offset by a decrease of management incentive plan expenses.
On a consolidated financial statement basis, total expenses related to
the Company's management incentive plan included in losses and loss
adjustment expenses were $10,093 lower in 1998 as compared to 1997. Of
this decrease, $3,112 benefited the loss ratio for insurance companies
directly with the remainder benefiting corporate expenses. Corporate
expenses are not included in the calculation of the Company's statutory
loss ratio. The decrease in the Company's management incentive plan
expenses was primarily driven by the decrease in the market price of the
Company's common stock which directly impacts plan expenses.
Policy Acquisition Costs
Policy acquisition costs expensed increased by $8,943, or 4.8% in
1998, compared to an increase of $6,478, or 3.6% in 1997. The increase
in policy acquisition costs was primarily due to higher contingent
commission accruals, and higher computer service expenses relating to
the Year 2000 and PMSC projects, both offset by lower expenses relating
to the Company's management incentive plan. Specifically, total
expenses related to the Company's management incentive plan included in
policy acquisition costs were $8,764 lower in 1998 as compared to 1997.
Of this decrease, $3,052 benefited the underwriting ratio for insurance
companies directly with the remainder benefiting corporate expenses.
Corporate expenses are not included in the calculation of the statutory
underwriting expense ratio. The decrease in the Company's management
incentive plan expenses was primarily driven by the decrease in the
market price of the Company's common stock which directly impacts plan
expenses. As a percentage of net premiums written, underwriting
expenses for the insurance companies (on a statutory basis) were 26.5%
during 1998 as compared to 25.1% for 1997.
Income Taxes
The Company's effective tax rate was 22.5% and 24.7% for the years
ended December 31, 1998 and 1997, respectively. The decrease was
primarily attributable to higher dividends on preferred and common stock
coupled with less realized capital gains during 1998 as compared to
1997. In both years the effective rate was lower than the statutory
rate of 35% primarily due to tax-exempt interest income and the
corporate dividends received deduction comprising a greater portion of
net earnings before taxes.
Net Earnings
Net earnings increased to $96,492, during 1998 as compared to
$96,215 in 1997 and operating earnings, which exclude the after-tax
impact of net realized investment gains, increased $10,677, or 13.1% to
$92,092 during 1998 as compared to $81,415 in 1997, both as a result of
the factors previously mentioned.
23
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Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is
on the Consolidated Balance Sheets on page 33 and the Consolidated
Statements of Cash Flows on pages 36 and 37. Stockholders' equity
decreased by $59,151, or 8.4%, in 1999 as compared to 1998. The
decrease resulted from $102,588 in net earnings offset by changes in
other comprehensive loss, net of income tax benefits, on fixed
maturities and preferred and common stocks of $78,162, dividends paid to
stockholders of $38,656 and Treasury Stock purchased of $44,921. Total
assets at December 31, 1999 increased $115,489, or 6.6% to $1,871,472 as
compared to total assets of $1,755,983 at December 31, 1998, most of
which resulted from the acquisition of American Commerce. Invested
assets, at market value, increased $11,079 or 0.9% primarily as a result
of the addition of $150,664, of invested assets from American Commerce,
offset by the initial $90,800 investment in the joint venture, treasury
stock purchases impacting cash and short-term investments and the
interest rate impact on investments resulting in a net accumulated other
comprehensive loss during 1999 (see next paragraph). Premiums
receivable increased $32,282 or 19.8%, $9,727 attributable to American
Commerce. The increase in premiums receivable from December 31, 1998,
was primarily attributable to the seasonality of the policy effective
dates of the Company's business, higher average premiums per exposure
for Massachusetts auto business and the acquisition of American
Commerce. Deferred policy acquisition costs increased $9,741 or 11.0%,
$6,563 attributable to American Commerce. Receivable from reinsurers
increased $11,678 or 31.8%, $5,496 attributable to American Commerce
with the remainder primarily attributable to the sliding-scale
commission on the quota-share reinsurance program. The deferred income
tax asset increased $43,051, $7,808 attributable to American Commerce
with the remainder primarily the result of the decrease of the market
value of the investment portfolio. All other remaining assets increased
$7,658 or 3.7%, $6,034 attributable to American Commerce.
The Company's investment portfolio, at market, is shown on the following table
as of December 31, 1999 and 1998 (for investments, at cost, refer to the table found on page
15):
December 31,
Investments, at market % of % of
(Dollars in thousands) 1999 Invest. 1998 Invest.
GNMA & FNMA mortgage-backed bonds...... $ 82,613 6.5% $ 112,588 9.0%
Corporate bonds........................ 42,532 3.4 - -
U.S.Treasury bonds and notes........... 3,315 0.2 - -
Tax exempt state and municipal bonds... 518,878 40.9 506,679 40.3
Total fixed maturities............. 647,338 51.0 619,267 49.3
Preferred stocks....................... 211,049 16.6 197,425 15.7
Investment in closed-end
preferred stock mutual funds......... 224,120 17.7 172,455 13.7
Other equity securities................ 77,347 6.1 111,506 8.9
Total common stocks................ 301,467 23.8 283,961 22.6
Total equities..................... 512,516 40.4 481,386 38.3
Mortgages and collateral loans (net of
allowance for possible loan losses).. 72,451 5.7 73,510 5.8
Cash and cash equivalents.............. 22,535 1.8 72,243 5.7
Short-term investments................. - - 3,669 0.3
Other investments...................... 14,139 1.1 7,825 0.6
Total investments.................. $1,268,979 100.0% $1,257,900 100.0%
24
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The Company's fixed maturity portfolio is comprised of GNMAs and
FNMA mortgage backed bonds (12.8%), municipal bonds (80.1%), corporate
bonds (6.6%) and U.S. Treasury bonds (0.5%). Of the Company's bonds,
96.8% are rated in either of the two highest quality categories provided
by the NAIC. As of December 31, 1999, the book value of the Company's
fixed maturity portfolio exceeded its market value by $14,107 ($9,170
after taxes, or $0.27 per share). As of December 31, 1998, the market
value of the Company's fixed maturity portfolio exceeded its book value
by $18,785 ($12,210 after taxes, or $0.34 per share). At December 31,
1999, the cost of the Company's preferred stocks exceeded market value
by $19,885 ($12,925 after taxes, or $0.38 per share). At December 31,
1998, the cost of the Company's preferred stocks exceeded market value
by $2,845 ($1,849 after taxes, or $0.05 per share). At December 31,
1999, the cost of the Company's common stocks exceeded market value by
$50,473 ($32,807 after taxes, or $0.95 per share). At December 31,
1998, the market value of the Company's common stocks exceeded cost by
$22,601 ($14,691 after taxes, or $0.41 per share).
Preferred stocks increased $13,624, or 6.9% and common stocks
(primarily composed of closed-end preferred stock mutual funds)
increased $17,506, or 6.2%, during 1999 primarily as a result of the
Company's previously announced change in investment strategy which
included the joint-venture acquisition of American Commerce. The
Company's strategy is to maximize after-tax investment income through
high quality securities coupled with acquiring equity investments which
may forego current investment yield in favor of potential higher
yielding capital appreciation in the future. As a result of the
American Commerce acquisition, the Company's cash position has decreased
$53,377, or 70.3% as compared to December 31, 1998.
The Company's liabilities totalled $1,223,650 at December 31, 1999
as compared to $1,050,198 at December 31, 1998. The $173,452 or 16.5%
increase resulted partially from the acquisition of American Commerce.
Loss and loss adjustment expense reserves comprised 55.2% of the
Company's liabilities at December 31, 1999 compared with 56.8% at
December 31, 1998. Unearned premiums comprised 37.4% of the Company's
liabilities at December 31, 1999 compared with 37.3% at December 31,
1998. All other liabilities comprised 7.4% of the Company's liabilities
at December 31, 1999 compared with 5.9% at December 31, 1998. Losses
and loss adjustment expenses increased $78,912 or 13.1%, $56,508
attributable to American Commerce. The increase in liability for loss
and loss adjustment expenses is attributed primarily to the acquisition
of American Commerce, as mentioned, coupled with increased reported
losses and higher assumed losses from C.A.R., as described below for
Massachusetts business, during 1999. Unearned premiums increased
$65,671 or 16.8%, $27,615 attributable to American Commerce, as a result
of the seasonality of the policy effective dates of the Company's
business coupled with higher average premiums per exposure for
Massachusetts auto business. Contingent commissions accrued increased
$11,401 or 51.7% due to better experience in the agency profit sharing
program. Excess of book value of subsidiary interest over cost
(formerly referred to as Negative Goodwill) associated with the January
29, 1999 acquisition of American Commerce was $10,758. The net effect
of all other liabilities increased $7,430 or 18.7%.
The primary sources of the Company's liquidity are funds generated
from insurance premiums, net investment income, premium finance and
service fees and the maturing and sale of investments as reflected in
the Consolidated Statements of Cash Flows on pages 36 and 37. The
discussion of these items can be found under "Year Ended December 31,
1999 Compared to Year Ended December 31, 1998", herein.
25
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The Company's operating activities provided cash of $124,674 in
1999, as compared to $65,324 in 1998. These cash flows were primarily
impacted by the fact that while premiums collected increased $119,933,
or 15.7% in 1999 as compared to an increase of $34,009, or 4.7% in 1998,
losses and LAE paid increased only $38,226, or 6.7% in 1999, as compared
to an increase of $56,531, or 11.0% in 1998, and policy acquisition
costs paid increased $38,814, or 20.8% in 1999 as compared to a decrease
of $11,142, or 5.6% in 1998. The increase in premiums was primarily the
result of the American Commerce acquisition, coupled with higher
physical damage exposures written, and an average overall rate increase
in premium per exposure of 9.1%. Federal income tax payments decreased
$9,643, or 27.4% in 1999 as compared to an increase of $13,368, or 61.2%
in 1998 due to additional payments made in 1998 applicable to prior
years.
The increase in net losses and LAE paid, which includes the change
in the losses and LAE liability, resulted primarily from the acquisition
of American Commerce.
The net cash flows used in investing activities were primarily the
result of purchases of fixed maturities, equity securities and the
acquisition of American Commerce offset by proceeds from the sale and
maturity of fixed maturities and equity securities. Investing
activities were funded by accumulated cash and cash provided by
operating activities during 1999 and 1998.
Cash flows used in financing activities totaled $83,577 during
1999 compared to $38,566 during 1998. The 1999 cash flows used in
financing activities consisted of $38,656 in dividends paid to
stockholders and $44,921 used to purchase 1,683,100 shares of Treasury
Stock. The 1998 cash flows used in financing activities consisted
exclusively of dividends paid to stockholders.
The Company's funds are generally invested in securities with
maturities intended to provide adequate funds to pay claims without the
forced sale of investments. The carrying value (at market) of total
investments at December 31, 1999 was $1,268,979. At December 31, 1999,
the Company held cash and short-term investments of $22,535. These
funds provide sufficient liquidity for the payment of claims and other
short-term cash needs. The Company also relies upon dividends from its
subsidiaries for its cash requirements. Every Massachusetts insurance
company seeking to make any dividend or other distributions to its
stockholders may, within certain limitations, pay such dividends and
then file a report with the Commissioner. Dividends in excess of these
limitations are called extraordinary dividends. An extraordinary
dividend is any dividend or other property, whose fair value together
with other dividends or distributions made within the preceding twelve
months exceeds the greater of ten percent of the insurer's surplus as
regards to policyholders as of the end of the preceding year, or the net
income of a non-life insurance company for the preceding year. No pro-
rata distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has
not objected. No extraordinary dividends were paid in 1999, 1998 and
1997.
Periodically, sales have been made from the Company's fixed
maturity investment portfolio to actively manage portfolio risks,
including credit-related concerns, to optimize tax planning and to
realize gains. This practice will continue in the future.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.76 to 1.00, 1.32 to 1.00, and
1.43 to 1.00 for the years ended December 31, 1999, 1998 and 1997,
respectively.
In keeping with the Company's long-term growth objective to expand
outside Massachusetts, in 1995 the Company acquired Commerce West, a
personal automobile insurer, located in Pleasanton, California. Most
recently, the Company formed a joint venture (ACIC Holding Co., Inc.) in
November 1998, and acquired, American Commerce located in Columbus,
Ohio, in January 1999. American Commerce writes automobile and
homeowners insurance solely through 34 AAA independent insurance
agencies in 26 states.
26
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In early 1999, Commerce, a subsidiary of the Company, invested
$90,800 in the joint venture (ACIC Holding Co., Inc.) to fund the
American Commerce acquisition and to capitalize the joint venture that
is owned together with AAA SNE. Of this $90,800, Commerce invested
$90,000 in the form of preferred stock and an additional $800
representing its 80% common stock ownership. The terms of the preferred
stock call for quarterly cash dividends at the rate of 10% per annum.
In the event cash dividends cannot be paid, additional preferred stock
will be issued. AAA SNE invested $200 representing its 20% common stock
ownership. Commerce consolidates ACIC Holding Co., Inc. and it's
wholly-owned subsidiary, American Commerce, for financial reporting and
tax purposes. Since 1995, Commerce has maintained an affinity group
marketing relationship with AAA Insurance Agency, Inc., a subsidiary of
AAA SNE. AAA Insurance Agency, Inc. has been an agent of Commerce since
1985.
Year 2000 Compliance
The Year 2000 issue existed primarily because most computer
programs were originally coded to recognize only the last two digits in
the date field. If not addressed and corrected, many systems could have
failed and produced erroneous results. The impact of this could have
lead to a material adverse impact upon the Company's business including
policy and claims processing. As a result, considerable effort took
place to assess the impact and determine whether to replace and/or
reprogram the systems in order for the systems to distinguish the
intended year. The Company initiated the Century Change project to
address all internal/external systems, software, agents, third parties
and vendors in dealing with year 2000 compliance.
The Century Change project, enlisted both a redeployment of
internal resources and additional external consultant resources,
involved the development of a formal plan to address the Year 2000
problem and progressed in accordance with that plan. The Company's
plan, which was designed to avoid any material adverse business
production issues, organized corporate systems into four sub-categories:
Data Exchange, AS400 Systems/Programs, PC Applications and PC Based
Vendor Purchased Application Software. Different sub-plans were
established for each category with the same Year 2000 objective in mind.
As a result of this effort, the majority of the programming changes
dealing with policy issuance, claims processing and maintenance were
completed as of October 1998. Other internal changes were completed in
accordance with specified delivery dates as outlined in the plan.
System testing for Year 2000 modifications successfully concluded as of
the end of the third quarter of 1999. No processing problems have been
encountered to date during the year 2000, regarding these computer
programs.
As part of the Century Change project, the Company reviewed the
status of vendors who performed outside processing, those whose software
the Company used for internal processing and those third parties with
whom the Company did significant business. Accordingly, the Company
recognized that year 2000 non-compliance could materially adversely
affect the financial position, results of operations and cash flows of
the Company. As a result, the Company contacted all significant related
third parties in an effort to determine year 2000 compliance. This
program included sending out questionnaires to our major business
partners, including our agents, regarding their year 2000 readiness.
Based on the responses received the Company did not anticipate any
material impact on its operations or financial condition. If there were
instances where the Company ascertained a potential non-compliance, the
Company sought alternative year 2000 compliant third parties. While the
Company took what it believed to be the appropriate safeguards, there
could be no assurances that the failure of such third parties to be year
2000 compliant would not have had a material adverse impact on the
Company. During 2000, no processing problems have been encountered to-
date with the services or products provided by third parties.
The Company's Executive Committee, as well as all departments in
the Company, reviewed issues dealing with identifying possible year 2000
worst case scenarios and developed contingency plans to respond to the
likelihood of these scenarios. Contingency plans were developed, where
deemed appropriate, for all material systems and relationships during
1999. Previously, contingency plans had been developed for the
continuation of policy and claim processing in the event that the
Company's computer systems were not available due to a year 2000 related
failure. No problems (worst case or otherwise) have been encountered
during the year 2000, and it has not been necessary to activate any
contingency plans.
27
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The project, through December 31, 1999, involved internal staff
costs as well as consulting expenses to prepare the systems for the year
2000. Total costs through December 31, 1999, for the Century Change
project were approximately $7.4 million ($2.5 million of which related
to 1999). Total costs applicable to internal staff, and external
consulting and network hardware/software were approximately $2.4
million, $4.7 million, and $0.3 million, respectively ($0.8 million,
$1.4 million, and $0.3 million, respectively, related to 1999).
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield
while maintaining investment quality. The Company's investment
objective is to maintain high quality diversified investments structured
to maximize after-tax investment income while minimizing risk. The
Company's funds are generally invested in securities with maturities
intended to provide adequate funds to pay claims and meet other
operating needs without the forced sale of investments. Periodically,
sales have been made from the Company's fixed maturity portfolio to
actively manage portfolio risks, including credit-related concerns, to
optimize tax planning and to realize gains. This practice will continue
in the future.
In conducting investing activities, the Company is subject to, and
assumes, market risk. Market risk is the risk of an adverse financial
impact from changes in interest rates and market prices. The level of
risk assumed by the Company is a function of the Company's overall
objectives, liquidity needs and market volatility.
The Company manages its market risk by focusing on higher quality
equity and fixed income investments, by periodically monitoring the
credit strength of companies in which investments are made, by limiting
exposure in any one investment and by monitoring the quality of the
investment portfolio by taking into account credit ratings assigned by
recognized rating organizations.
As part of its investing activities, the Company assumes positions
in fixed maturity, equity, short-term and cash equivalents markets. The
Company is, therefore, exposed to the impacts of interest rate changes
in the market value of investments. For 1999, the Company's exposure to
interest rate changes and equity price risk has been estimated using
sensitivity analysis. The interest rate impact is defined as the effect
of a hypothetical interest rate change of plus-or-minus 200 basis points
on the market value of fixed maturities and preferred stocks. The
equity price risk is defined as a hypothetical change of plus-or-minus
10% in the fair value of common stocks. Changes in interest rates would
result in unrealized gains or losses in the market value of the fixed
maturity and preferred stock portfolio due to differences between
current market rates and the stated rates for these investments. Based
on the results of the sensitivity analysis at December 31, 1999, the
Company's estimated market exposure for a 200 basis point increase
(decrease) in interest rates was calculated. A 200 basis point increase
results in an $87,972 decrease in the market value of the fixed
maturities and preferred stocks. A 200 basis point decrease results in
a $49,136 increase in the market value of the same securities. The
equity price risk impact at December 31, 1999, based upon a 10% increase
in the fair value of common stocks, would be an increase of $30,147.
Based upon a 10% decrease, common stocks would decrease $30,147. This
analysis was further exemplified during 1999 as the Company experienced
a decline in the market value of investments, net of taxes, of $78,162
primarily as evidenced by an increase in long-term interest rates during
this period. Long-term interest rates (30-year Treasury Bond) increased
to 6.48% at December 31, 1999 from 5.08% at December 31, 1998.
28
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Recent Accounting Developments
During 1997, the Accounting Standards Executive Committee
("AcSEC") issued Statement of Position 97-3 Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments ("SOP 97-3")
effective for financial statements issued for periods ending after
December 31, 1998. This statement provides guidance on accounting by
insurance companies on the timing of recognition, the methods of
measurement, and the required disclosures for guaranty fund and other
related assessments. The adoption of this statement did not have a
material impact on the Consolidated Financial Statements. Guaranty fund
and insolvency fund assessments have not been material in recent years.
During 1998, the AcSEC issued Statement of Position 98-1,
Accounting for Costs of Computer Software Developed or Obtained for
Internal Use ("SOP 98-1") effective for financial statements issued for
periods beginning after December 15, 1998. This statement establishes
guidance on accounting for the costs incurred related to internal use
software. Prior to adoption, the Company expensed all software costs as
incurred. The adoption of this statement did not have a material impact
on the Consolidated Financial Statements, since the Company incurred no
software costs during 1999 required to be capitalized under this
statement.
During 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("FAS 133") effective
for financial statements issued for fiscal years beginning after June
15, 1999. Subsequently, during 1999, FASB issued Financial Accounting
Standards No. 137 "Deferral of the Effective Date of FASB Statement 133"
("FAS 137"). The adoption date was delayed to fiscal years beginning
after June 15, 2000. The Company had no derivative or hedging activity
in 1999, 1998 or 1997.
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation
in its personal automobile insurance line since the premiums it charges
are subject to state regulation. The premium rates charged by the
Company for personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in
premium rates may lag behind related cost increases. Economic
recessions will also have an impact upon the Company, primarily through
the policyholder's election to decrease non-compulsory coverages
afforded by the policy and decreased driving, each of which tends to
decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these
environments affect current market rates of return, previously committed
investments may rise or decline in value depending on the type and
maturity of investment.
Inflation and recession must also be considered by the Company in
the creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of
continually adjusting reserves is even more pronounced in periods of
changing economic circumstances.
29
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COMMON STOCK PRICE AND DIVIDEND INFORMATION
The Company's common stock trades on the NYSE under the symbol
"CGI". The high, low and close prices for shares as quoted in the Wall
Street Journal, of the Company's Common Stock for 1999 and 1998 were as
follows:
1999 1998
High Low Close High Low Close
First Quarter...... $35-1/16 $23-7/16 $24-9/16 $37-3/8 $31-3/4 $35-1/4
Second Quarter..... 25-1/8 21-9/16 24-3/8 39-5/8 34-3/8 38-3/4
Third Quarter...... 26-7/8 21-1/2 23 39 24-7/8 27-5/8
Fourth Quarter..... 28-1/8 20-3/4 26-1/8 36-1/2 22-11/16 35-7/16
As of March 1, 2000, there were 1,188 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name" or
held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.11 per share
and $1.07 per share in 1999 and 1998, respectively. On May 21, 1999,
the Board voted to increase the quarterly stockholder dividend from
$0.27 to $0.28 per share to stockholders of record as of June 4, 1999.
Prior to that declaration, the Company had paid quarterly dividends of
$0.27 per share dating back to May 15, 1998 when the Board voted to
increase the dividend from $0.26 to $0.27 per share.
The Company purchased 1,683,100 shares of Treasury Stock under the
stock buyback program during 1999 increasing the total shares of
Treasury Stock to 3,640,448 at December 31, 1999. The Company began a
stock buyback program during the second quarter of 1995. That program,
which was approved by the Board of Directors on May 19, 1995, authorized
the Company to purchase up to 3 million shares of Treasury Stock.
Through March 31, 1999, the Company completed its share purchases under
that program. In May 1999, the Board of Directors approved an
additional stock buy back program of up to 2 million shares. At
December 31, 1999, the Company has authority to purchase approximately
1.5 million additional shares.
30
<page
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
generally accepted accounting principles determined by management to be
appropriate in the circumstances and include amounts based on
management's informed estimates and judgments. Financial information
presented elsewhere in this Annual Report is consistent with the
financial statements. The appropriateness of data underlying such
financial information is monitored through internal accounting controls,
an internal audit department, independent auditors and the Board of
Directors through its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are executed
in accordance with management's authorization and recorded properly.
The system of internal accounting controls is supported by the selection
and training of qualified personnel combined with the appropriate
division of responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to
the highest standards of personal and corporate conduct. Management
encourages open communication within the Company and requires the
confidential treatment of proprietary information and compliance with
all domestic laws, including those relating to financial disclosure.
The 1999 consolidated financial statements were audited by the
Company's independent auditors, Ernst & Young LLP, in accordance with
generally accepted auditing standards. In addition, Ernst & Young LLP
performs reviews of the unaudited quarterly financial statements.
Management has made available to Ernst & Young LLP all the Company's
financial records and related data, as well as the minutes of
stockholders' and directors' meetings. Furthermore, management believes
that all representations made to Ernst & Young LLP were valid and
appropriate.
31
<page
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheets
of The Commerce Group, Inc. and Subsidiaries as of December 31,
1999 and 1998, and the related consolidated statements of
earnings, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of The Commerce Group, Inc. and Subsidiaries at
December 31, 1999 and 1998, and the consolidated results of their
operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
February 18, 2000
32
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars)
1999 1998
ASSETS
Investments (notes A2, A3, A4 and B)
Fixed maturities, at market (cost: $661,445 in 1999 and $600,482
in 1998).......................................................... $ 647,338 $ 619,267
Preferred stocks, at market (cost: $230,934 in 1999 and $200,270
in 1998).......................................................... 211,049 197,425
Common stocks, at market (cost: $351,940 in 1999 and $261,360 in
1998)............................................................. 301,467 283,961
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $2,127 in 1999
and $2,301 in 1998)............................................... 72,451 73,510
Cash and cash equivalents.......................................... 22,535 72,243
Short-term investments............................................. - 3,669
Other investments (cost: $13,130 in 1999 and $7,450 in 1998)....... 14,139 7,825
Total investments.............................................. 1,268,979 1,257,900
Accrued investment income............................................ 14,697 13,662
Premiums receivable (less allowance for doubtful receivables of
$1,452 in 1999 and $1,450 in 1998)................................. 195,160 162,878
Deferred policy acquisition costs (notes A5 and C)................... 98,500 88,759
Property and equipment, net of accumulated depreciation
(notes A6 and D)................................................... 34,802 35,854
Residual market receivable (note F)
Losses and loss adjustment expenses................................ 106,576 111,784
Unearned premiums.................................................. 50,084 41,436
Due from reinsurers (note F)......................................... 48,365 36,687
Deferred income taxes (notes A10 and G).............................. 43,051 -
Non-compete agreement net of accumulated amortization (note A7)...... 3,179 -
Other assets......................................................... 8,079 7,023
Total assets................................................... $1,871,472 $1,755,983
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses (notes A8, E and F)............ $ 675,188 $ 596,996
Unearned premiums (note A9)........................................ 457,095 391,424
Current income taxes (notes A10 and G)............................. 10,839 4,061
Deferred income taxes (notes A10 and G)............................ - 3,769
Deferred income (notes A11 and F).................................. 7,464 6,948
Contingent commissions accrued (note A12).......................... 33,468 22,067
Payable for securities purchased................................... 1,953 62
Excess of book value of subsidiary interest over cost (note A13)... 10,758 -
Other liabilities and accrued expenses............................. 26,885 24,871
Total liabilities.............................................. 1,223,650 1,050,198
Minority interest (note A14)......................................... 1,188 -
Stockholders' Equity (notes B, K, L and M)
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 1999 and 1998...................................... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,000,000 shares issued in 1999 and 1998......................... 19,000 19,000
Paid-in capital.................................................... 29,621 29,621
Net accumulated other comprehensive income (loss), net of income
taxes (benefits) of ($28,467) in 1999 and $13,621 in 1998......... (52,867) 25,295
Retained earnings.................................................. 734,488 670,556
730,242 744,472
Treasury stock, 3,640,448 shares in 1999 and 1,957,348 shares in
1998, at cost (note A15).......................................... (83,608) (38,687)
Total stockholders' equity..................................... 646,634 705,785
Total liabilities, minority interest and stockholders' equity.. $1,871,472 $1,755,983
The accompanying notes are an integral part of these consolidated financial statements.
33
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Per Share Data)
1999 1998 1997
Revenues
Earned premiums (notes A9 and F)..................... $ 871,830 $ 745,620 $ 730,497
Net investment income (note B)....................... 89,787 86,501 80,972
Premium finance and service fees..................... 14,774 13,440 7,074
Amortization of excess of book value of subsidiary
interest over cost (note A13)...................... 3,019 - -
Net realized investment gains (note B)............... 8,130 6,769 22,770
Total revenues.................................. 987,540 852,330 841,313
Expenses
Losses and loss adjustment expenses
(notes A8, E and F)................................. 625,090 531,429 526,127
Policy acquisition costs (notes A5 and C)............ 233,660 196,434 187,491
Total expenses.................................. 858,750 727,863 713,618
Earnings before income taxes and minority
interest...................................... 128,790 124,467 127,695
Income taxes (notes A10 and G)......................... 27,154 27,975 31,480
Net earnings before minority interest........... 101,636 96,492 96,215
Minority interest in net loss of subsidiary (note A14). 952 - -
NET EARNINGS.................................... $ 102,588 $ 96,492 $ 96,215
COMPREHENSIVE INCOME............................ $ 24,426 $ 94,555 $ 100,368
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE
(note A16)..................................... $ 2.94 $ 2.68 $ 2.67
CASH DIVIDENDS PAID PER SHARE................... $ 1.11 $ 1.07 $ 1.03
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING............................. 34,940,074 36,042,652 36,044,679
The accompanying notes are an integral part of these consolidated financial statements.
34
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
Net
Accumulated
Other
Common Paid-in Comprehensive Retained Treasury
Stock Capital Income/(Loss) Earnings Stock Total
Balance January 1, 1997...... $19,000 $29,621 $ 23,079 $553,539 $(38,200) $587,039
Net earnings................ 96,215 96,215
Other comprehensive income:
Unrealized holding gains
arising during the period
net of taxes of $7,268... 13,498 13,498
Reclassification adjustment
net of tax benefits of
$5,032.................... (9,345) (9,345)
Other comprehensive loss... 4,153 4,153
Comprehensive income........ 100,368
Stockholder dividends....... (37,124) (37,124)
Treasury stock purchased.... (487) (487)
Balance December 31, 1997.... 19,000 29,621 27,232 612,630 (38,687) 649,796
Net earnings................ 96,492 96,492
Other comprehensive income
(loss):
Unrealized holding gains
arising during the period,
net of taxes of $1,455... 2,702 2,702
Reclassification adjustment
net of tax benefits of
$2,498.................... (4,639) (4,639)
Other comprehensive loss... (1,937) (1,937)
Comprehensive income........ 94,555
Stockholder dividends....... (38,566) (38,566)
Balance December 31, 1998.... 19,000 29,621 25,295 670,556 (38,687) 705,785
Net earnings............... 102,588 102,588
Other comprehensive income
(loss):
Unrealized holding losses
arising during the period,
net of tax benefits of
$35,103................... (65,192) (65,192)
Reclassification adjustment
net of tax benefits of
$6,984.................... (12,970) (12,970)
Other comprehensive loss... (78,162) (78,162)
Comprehensive income........ 24,426
Stockholder dividends....... (38,656) (38,656)
Treasury Stock purchased.... (44,921) (44,921)
Balance December 31, 1999.... $19,000 $29,621 $(52,867) $734,488 $(83,608) $646,634
The accompanying notes are an integral part of these consolidated financial statements.
35
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
1999 1998 1997
Cash flows from operating activities
Premiums collected.................................... $ 881,472 $ 761,539 $ 727,530
Net investment income received........................ 90,556 85,076 81,376
Premium finance and service fees received............. 14,774 13,440 7,074
Losses and loss adjustment expenses paid.............. (610,887) (572,661) (516,130)
Policy acquisition costs paid......................... (225,683) (186,869) (198,011)
Federal income tax payments........................... (25,558) (35,201) (21,833)
Net cash provided by operating activities........... 124,674 65,324 80,006
Cash flows from investing activities
Proceeds from maturity of fixed maturities............ 46,565 64,004 108,592
Proceeds from sale of fixed maturities................ 142,562 34,034 124,653
Proceeds from sale of equity securities............... 76,485 80,420 224,059
Purchase of fixed maturities.......................... (107,664) (134,540) (98,098)
Purchase of equity securities......................... (171,097) (224,896) (296,714)
Purchase of other investments......................... (4,875) (3,616) (1,752)
Purchase of subsidiary, net of cash acquired.......... (77,056) - -
Net (increase) decrease in short-term investments,
net of payable for securities purchased.............. 3,669 117,531 (121,200)
Payments received on mortgage loans and collateral
notes receivable..................................... 11,800 26,788 11,386
Mortgage loans and collateral notes originated........ (10,911) (16,450) (19,816)
Purchase of property and equipment.................... (2,910) (4,293) (8,133)
Other proceeds from investing activities.............. 2,627 315 281
Net cash used in investing activities............... (90,805) ( 60,703) (76,742)
Cash flows from financing activities
Dividends paid to stockholders........................ (38,656) (38,566) (37,124)
Purchase of treasury stock............................ (44,921) - (487)
Net cash used in financing activities............... (83,577) (38,566) (37,611)
Decrease in cash and cash equivalents................... (49,708) (33,945) (34,347)
Cash and cash equivalents at beginning of year.......... 72,243 106,188 140,535
Cash and cash equivalents at end of year................ $ 22,535 $ 72,243 $ 106,188
The accompanying notes are an integral part of these consolidated financial statements.
36
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities
For the years ended December 31,
(Thousands of Dollars)
1999 1998 1997
Cash flows from operating activities
Net earnings........................................... $ 102,588 $ 96,492 $ 96,215
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable.................................. (22,399) 6,591 (11,634)
Deferred policy acquisition costs.................... (3,374) (3,495) (2,296)
Residual market receivable........................... (3,440) 27,579 14,414
Due from reinsurers.................................. (4,116) (18,517) 1,489
Losses and loss adjustment expenses.................. 15,080 (52,477) (13,359)
Unearned premiums.................................... 38,796 11,825 11,608
Current income taxes................................. 6,909 1,405 2,485
Deferred income taxes................................ (5,314) (8,632) 6,984
Deferred income...................................... 516 (323) (703)
Contingent commissions............................... 11,401 8,206 (11,851)
Other assets, liabilities and accrued expenses....... (8,795) 533 4,992
Net realized investment gains........................ (8,130) (6,769) (22,770)
Other - net.......................................... 4,952 2,906 4,432
Net cash provided by operating activities......... $ 124,674 $ 65,324 $ 80,006
The accompanying notes are an integral part of these consolidated financial statements.
37
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc.
(the "Company") have been prepared in accordance with generally accepted
accounting principles ("GAAP").
The consolidated financial statements include The Commerce Group,
Inc. and its wholly-owned subsidiaries, Bay Finance Company, Inc.,
Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI").
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation") are wholly-owned subsidiaries of CHI. Commerce
West Insurance Company ("Commerce West") is a wholly-owned subsidiary of
Commerce. American Commerce Insurance Company ("American Commerce") is
a wholly-owned subsidiary of ACIC Holding Co., Inc. ACIC Holding Co.,
Inc. is owned jointly with AAA Southern New England ("AAA SNE") with
Commerce maintaining an 80% common stock interest and AAA SNE
maintaining a 20% common stock interest (see note A18). All
intercompany transactions and balances have been eliminated in
consolidation. Certain prior year account balances have been
reclassified to conform to the 1999 presentation.
The insurance subsidiaries, Commerce, Citation, Commerce West and
American Commerce, prepare statutory financial statements in accordance
with accounting practices prescribed by the National Association of
Insurance Commissioners ("NAIC"), the Commonwealth of Massachusetts, the
State of California, and the State of Ohio.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Investments
All investment transactions have credit exposure to the extent
that a counterparty may default on an obligation to the Company. Credit
risk is a consequence of carrying investment positions. To manage
credit risk, the Company focuses on higher quality fixed-income
securities and preferred stocks, reviews the credit strength of all
companies which it invests in, limits its exposure in any one investment
category and monitors the portfolio quality, taking into account credit
ratings assigned by recognized statistical rating organizations.
Investments in fixed maturities, which include taxable and non-
taxable bonds, and investments in common and preferred stocks, are
carried at fair market value and are classified as available for sale.
Unrealized investment gains and losses on common and preferred stocks
and fixed maturities, to the extent that there is no permanent
impairment of value, are credited or charged to a separate component of
stockholders' equity, known as "net accumulated other comprehensive
income (loss)", until realized, net of any tax effect. When investment
securities are sold, the realized gain or loss is determined based upon
specific identification. Fair market value of fixed maturities and
common and preferred stocks is based on quoted market prices. For other
securities held as investments, fair market value equals quoted market
price, if available. If a quoted market price is not available, fair
market value is estimated using quoted market prices for similar
securities. The Company has not invested more than 5% of fixed
maturities in any one state or political subdivision.
38
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
The Company originates and holds mortgage loans on real estate on
properties located in the Commonwealth of Massachusetts and the State of
Connecticut. The Company controls credit risk through credit approvals,
credit limits and monitoring procedures. The Company performs in-depth
credit evaluations on all new mortgage customers. Bad debt expenses
have not been material in recent years.
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by Management. Factors considered in
evaluating the adequacy of the allowance include previous loss
experience, current economic conditions and their effect on borrowers
and the performance of individual loans in relation to contract terms.
The provision for possible loan losses charged to operating expenses is
based upon Management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses
are charged against the allowance when Management believes the
collectibility of the principal is unlikely and recoveries are credited
to the allowance when received.
Interest on mortgage loans is included in income as earned based
upon rates applied to principal amounts outstanding. Accrual of
interest on mortgage loans is discontinued either when reasonable doubt
exists as to the full, timely collection of interest or principal, or
when a loan becomes contractually past due more than ninety days. When
a loan is placed on nonaccrual status, all unpaid interest previously
accrued is reversed against current period earnings.
3. Cash and Cash Equivalents
Cash and cash equivalents includes cash currently on hand to cover
operating expenses. The Company held $18,655 and $13,572 in U.S.
Government Repurchase Agreements at various financial institutions in
1999 and 1998, respectively. The amount of collateral, maintained by
the seller, at the time of purchase and each subsequent business day, is
required to have a market value that is equal to 102% of the resale
price.
4. Short-Term Investments
In 1998, the Company held short-term investments consisting of
Commercial Paper, Auction Rate Preferred Stocks and Variable Rate
Municipal Bonds, carried at cost, which approximates market value.
5. Deferred Policy Acquisition Costs
Policy acquisition costs relating to unearned premiums, consisting
of commissions, premium taxes and other underwriting expenses incurred
at the policy issuance, are deferred and amortized over the period in
which the related premiums are earned, the amount being reduced by any
potential premium deficiency. If any potential premium deficiency
exists, it represents future estimated losses, loss adjustment expenses
and amortization of deferred acquisition costs in excess of the related
unearned premiums. There was no premium deficiency in 1999, 1998 and
1997. In determining whether a premium deficiency exists, the Company
considers anticipated investment income on unearned premiums.
39
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
6. Property and Equipment
Property and equipment are stated at cost and are depreciated on
the straight line method over the estimated useful lives of the assets
using the following rates:
Percent
Asset Classification Per Annum
Buildings....................................... 2.5
Building improvements (prior to 1992)........... 2.5
Building improvements (1992 and subsequent)..... 5.0
Equipment and office furniture.................. 10.0
EDP equipment and copiers....................... 20.0
Automobiles..................................... 33.3
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon are eliminated from the related
property and accumulated depreciation accounts and any resulting gain or
loss is credited or charged to income.
7. Non-Compete Agreement
The non-compete agreement of $3,179 represents the portion of the
purchase price associated with the acquisition of American Commerce
allocated to the arrangement whereby principals of AAA National agreed
not to compete with American Commerce for a period of ten years. The
cost of $3,500 is being amortized on a straight-line basis over the term
of the arrangement. The amount of accumulated amortization at December
31, 1999 was $321.
8. Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses
("LAE") represents the accumulation of individual case estimates for
reported losses and estimates for incurred but not reported ("IBNR")
losses and LAE. Assumed losses and LAE are recorded as reported by the
ceding organization with additional adjustments for IBNR. The liability
for losses and LAE is intended to cover the ultimate net cost of all
losses and loss adjustment expenses incurred through the balance sheet
date. Liability estimates are continually reviewed and updated, and
therefore, the ultimate liability may be more or less than the current
estimate. The effects of changes in the estimates are included in the
results of operations in the period in which the estimates are revised.
9. Premiums
Insurance premiums are recognized as income ratably over the terms
of the policies. Unearned premiums are determined by prorating policy
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's Massachusetts premiums written is derived
through the American Automobile Association Clubs of Massachusetts ("AAA
clubs") affinity group marketing program. Of the Company's total direct
premiums written, the portion attributable to the AAA affinity group
marketing program was $495,962 or 52.3% in 1999, $457,430 or 57.3% in
1998 and $423,243 or 55.1% in 1997. Of these amounts, 11% were written
through insurance agencies owned by the AAA clubs and 89% were written
through the Company's network of independent agents in 1999, 1998 and
1997, respectively.
40
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
10. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized. No valuation allowance was
established in 1999 and 1998.
11. Deferred Income
Income consisting of expense reimbursements, which include
servicing carrier fees from Commonwealth Automobile Reinsurers
("C.A.R."), a state-mandated reinsurance mechanism, on policies written
for C.A.R., are deferred and amortized over the term of the related
insurance policies (see note F).
12. Contingent Commissions
In addition to state mandated minimum and other commissions on
policies written, the Company pays certain of its agencies compensation
in the form of profit sharing. This is based, in part, on the
underwriting profits of an individual agent's business written with the
Company. This arrangement utilizes a three year rolling plan, with one
third of each of the current and the two prior years profit or loss
calculations, summed to a single amount. This amount, if positive, is
multiplied by the profit sharing commission rate and paid to the agent.
13. Excess of Book Value of Subsidiary Interest Over Cost
As a result of the acquisition of American Commerce, the amount
representing the excess of the fair value of the net assets acquired
over the purchase price at the January 29, 1999 acquisition date was
$16,465. The amount is being amortized into revenue on the straight
line basis over a five year period. The amount amortized into income in
1999 was $3,019. The amount shown on the Balance Sheet represents the
Company's 80% share of the net excess of book value of subsidiary
interest over cost less accumulated amortization.
14. Minority Interest
The Company's interest in ACIC Holding Co., Inc. through Commerce,
a wholly owned subsidiary of CHI, is represented by 80% ownership of the
outstanding shares of common stock at December 31, 1999. AAA SNE
maintains a 20% common stock ownership. The minority interest of $952
for 1999 represents 20% of the net loss of ACIC Holding Co., Inc., after
the preferred stock dividends, which is included in these consolidated
financial statements.
15. Treasury Stock
On May 19, 1995, the Board of Directors of the Company announced
the approval of a stock buyback program of up to 3,000,000 shares.
Through March 31, 1999, the Company completed its share purchase under
that program. Under prior Board of Directors authorizations, the
Company purchased an additional 143,248 shares of Treasury Stock during
the first quarter of 1999, bringing total purchases of Treasury Stock to
3,143,248 as of March 31, 1999. In May 1999, the Board of Directors
approved an additional stock buy back program of up to 2 million shares.
Since that announcement, the Company has purchased 497,200 shares of
Treasury Stock bringing the total number of shares to 3,640,448 as of
December 31, 1999.
41
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
16. Net Earnings Per Common Share
Net earnings per common share is computed by dividing net earnings
by the weighted average number of common shares outstanding. The
weighted average number of common shares outstanding for the years ended
December 31, 1999, 1998 and 1997 were 34,940,074, 36,042,652 and
36,044,679, respectively. Weighted average number of common shares
outstanding is determined by taking the average of the following
calculation for a specified period of time: The daily amount of (1) the
total issued outstanding common shares minus (2) the total Treasury
Stock purchased.
17. New Accounting Pronouncements
During 1997, the Accounting Standards Executive Committee
("AcSEC") issued Statement of Position 97-3 Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments ("SOP 97-3")
effective for financial statements issued for periods ending after
December 31, 1998. This statement provides guidance on accounting by
insurance companies on the timing of recognition, the methods of
measurement, and the required disclosures for guaranty fund and other
related assessments. The adoption of this statement did not have a
material impact on the Consolidated Financial Statements. Guaranty fund
and insolvency fund assessments have not been material in recent years.
During 1998, the AcSEC issued Statement of Position 98-1,
Accounting for Costs of Computer Software Developed or Obtained for
Internal Use ("SOP 98-1") effective for financial statements issued for
periods beginning after December 15, 1998. This statement establishes
guidance on accounting for the costs incurred related to internal use
software. Prior to adoption, the Company expensed all software costs as
incurred. The adoption of this statement did not have a material impact
on the Consolidated Financial Statements, since the Company incurred no
software costs during 1999 required to be capitalized under this
statement.
During 1998, the Financial Accounting Standards Board ("FASB")
issued statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("FAS 133") effective
for financial statements issued for fiscal years beginning after June
15, 1999. Subsequently, during 1999, FASB issued Financial Accounting
Standards No. 137 "Deferral of the Effective Date of FASB Statement 133"
("FAS 137"). The adoption date was delayed to fiscal years beginning
after June 15, 2000. The Company had no derivative or hedging activity
in 1999, 1998 or 1997.
18. Acquisition
In November of 1998, Commerce formed ACIC Holding Co., Inc., in a
joint venture with AAA SNE and invested $90,800 to fund the January 29,
1999 acquisition of the Automobile Club Insurance Company, whose name
was changed to American Commerce upon completion of the acquisition.
Commerce invested $90,000 in the form of preferred stock and an
additional $800 representing an 80% common stock ownership. AAA SNE
invested $200 representing a 20% common stock ownership. The terms of
the preferred stock call for Commerce to receive quarterly cash
dividends at the rate of 10% per annum from ACIC Holding, Co., Inc. In
the event cash dividends cannot be paid, additional preferred stock will
be issued. The acquisition was accounted for as a purchase. Commencing
with the January 29, 1999 acquisition date, ACIC Holding Co., Inc. and
American Commerce's results were consolidated into the Company's
financial statements found herein. Since 1995, Commerce has maintained
an affinity group marketing relationship with AAA Insurance Agency,
Inc., a subsidiary of AAA SNE. AAA Insurance Agency, Inc. has been a
licensed insurance agent of Commerce since 1985.
42
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE B-Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market value of investments
in fixed maturities are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair Market
Cost Gains Losses Value
At December 31, 1999:
Corporate bonds..................... $ 45,147 $ 87 $ (2,702) $ 42,532
U.S. Treasury bonds and notes....... 3,616 19 (320) 3,315
GNMA & FNMA mortgage-backed bonds... 82,349 753 (489) 82,613
Obligations of states and
political subdivisions............. 530,333 4,362 (15,817) 518,878
Totals......................... $661,445 $ 5,221 $(19,328) $647,338
At December 31, 1998:
GNMA mortgage-backed bonds.......... $109,624 $ 2,965 $ (1) $112,588
Obligations of states and
political subdivisions............. 490,858 18,416 (2,595) 506,679
Totals......................... $600,482 $ 21,381 $ (2,596) $619,267
Proceeds from sales of investments in fixed maturities, gross gains and
gross losses realized on those sales were as follows:
Proceeds Gross Gross
From Realized Realized
Sales Gains Losses
For the year ended December 31, 1999:
Corporate bonds.................................... $ 17,516 $ 102 $ (941)
U.S. Treasury bonds and notes...................... 27 096 8 (842)
GNMA mortgage-backed bonds......................... - - -
Obligations of states and political subdivisions... 97,950 298 (2,606)
Totals........................................ $142,562 $ 408 $ (4,389)
For the year ended December 31, 1998:
GNMA mortgage-backed bonds......................... $ - $ - $ -
Obligations of states and political subdivisions... 34,034 25 (435)
Totals........................................ $ 34,034 $ 25 $ (435)
For the year ended December 31, 1997:
GNMA mortgage-backed bonds......................... $ - $ - $ -
Obligations of states and political subdivisions... 124,653 3,994 (390)
Totals........................................ $124,653 $ 3,994 $ (390)
43
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
The amortized cost and approximate fair market value of fixed
maturities at December 31, 1999 and 1998, by contractual maturity, are
as follows:
1999 1998
Fair Fair
Amortized Market Amortized Market
Cost Value Cost Value
Obligations of states, political subdivisions,
corporate bonds and U.S. Treasury bonds and
notes:
Due in one year or less.......................... $ 2,780 $ 2,793 $ - $ -
Due after one year through five years............ 1,738 4,980 2,096 2,177
Due after five years through ten years........... 18,201 13,446 1,748 1,740
Due after ten years.............................. 556,377 543,506 487,014 502,762
579,096 564,725 490,858 506,679
GNMA & FMNA mortgage-backed bonds................ 82,349 82,613 109,624 112,588
Total fixed maturities.................... $661,445 $647,338 $600,482 $619,267
Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations.
2. Common Stocks
The cost and approximate fair market value of common stocks at
December 31, 1999 and 1998, are as follows:
1999 1998
Fair Fair
Market Market
Cost Value Cost Value
Investments in closed-end preferred stock
mutual funds.............................. $267,956 $224,120 $169,394 $ 172,455
Investments in other equities............... 83,984 77,347 91,966 111,506
Total common stocks............. $351,940 $301,467 $261,360 $ 283,961
The Company holds a greater than 20%, but less than 50%, equity
position in seven closed-end preferred stock mutual funds at December
31, 1999. These holdings are accounted for and represent investments in
the ordinary course of business. The Company has determined that the
equity method of accounting should be utilized for holdings when they
exceed a 50% equity position.
44
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 1999 and 1998, mortgage loans on real estate and
collateral notes receivable consisted of the following:
December 31,
1999 1998
Residential (1st Mortgages)............ $58,506 $59,377
Residential (2nd Mortgages)............ 227 261
Commercial (1st Mortgages)............. 13,881 13,762
Commercial (2nd Mortgages)............. 67 104
72,681 73,504
Collateral notes receivable............ 1,897 2,307
74,578 75,811
Allowance for possible loan losses..... (2,127) (2,301)
Mortgage loans on real estate and
collateral notes receivable....... $72,451 $73,510
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities.
The future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work
out arrangements or the disposition of collateral. The fair value of
mortgage loans on real estate and collateral notes receivable at
December 31, 1999 and 1998, prior to the allowance for possible loan
losses, was $75,221 and $78,382, respectively, which was estimated by
discounting the future cash flows.
At December 31, 1999 and 1998 mortgage loans which were on
nonaccrual status amounted to $1,259 and $1,638, respectively. The
reduction in interest income associated with nonaccrual loans was $129,
$205 and $207 for the years ended December 31, 1999, 1998 and 1997,
respectively.
The Company originates and services residential and commercial
mortgages in Massachusetts and Connecticut. The Company's exposure is
80% or less of the appraised value of any collateralized real property
at the time of the loan origination. The ability and willingness of
residential and commercial borrowers to honor their repayment
commitments is generally dependent upon the level of overall economic
activity and real estate values.
A summary of the changes in the allowance for possible loan losses follows:
Year ended December 31,
1999 1998
Balance, beginning of year........................ $ 2,301 $ 2,812
Decrease in provision for possible loan losses.. (174) (511)
Balance, end of year.............................. $ 2,127 $ 2,301
45
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
The following table describes mortgage principal balances by
maturity, total mortgages over 90 days past due and total mortgages in
foreclosure:
1999 1998
Fixed rate mortgages maturing:
One year or less................................ $ 82 $ -
More than one year to five years................ 1,388 1,886
More than five years to ten years............... 8,286 7,121
Over ten years.................................. 49,629 48,204
Total fixed mortgages...................... $ 59,385 $ 57,211
Adjustable rate mortgages maturing:
One year or less................................ $ - $ -
More than one year to five years................ 123 67
More than five years to ten years............... 275 395
Over ten years.................................. 12,898 15,831
Total adjustable mortgages................. $ 13,296 $ 16,293
Past due over 90 days............................. $ 1,259 $ 1,638
Mortgages in foreclosure, included in past due
over 90 days.................................... $ 737 $ 979
4. Net Investment Income
The components of net investment income were as follows:
Year ended December 31,
1999 1998 1997
Interest on fixed maturities.................. $ 45,957 $ 41,368 $ 46,449
Dividends on common and preferred stocks...... 38,631 32,145 19,799
Interest on cash and short-term investments... 2,596 8,683 10,544
Interest on mortgage loans.................... 5,908 6,604 6,578
Other......................................... 116 119 122
Total investment income.............. 93,208 88,919 83,492
Investment expenses........................... 3,421 2,418 2,520
Net investment income................ $ 89,787 $ 86,501 $ 80,972
5. Net Realized and Unrealized Investment Gains (Losses)
Net realized investment gains (losses) were as follows:
Year ended December 31,
1999 1998 1997
Net realized investment gains (losses):
Fixed maturities.................................. $ (5,991) $ (2,804) $ 1,419
Preferred stocks.................................. (244) (727) 6
Common stocks..................................... 13,130 9,313 21,440
Other............................................. 1,235 987 (95)
Total......................................... $ 8,130 $ 6,769 $ 22,770
46
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
6. Other Comprehensive Income (Loss)
Net increases (decreases) in other comprehensive income (loss)
less applicable income tax (expense) benefit were as follows:
Year ended December 31,
1999 1998 1997
Other comprehensive income (loss):
Fixed maturities.................................. $(32,892) $ (5,028) $ 7,622
Preferred stocks.................................. (17,040) (3,209) 1,165
Common stocks..................................... (73,074) 4,883 (2,398)
Other............................................. 634 375 -
Impact of minority interest....................... 2,122 - -
Total......................................... (120,250) (2,979) 6,389
Tax benefit (expense)............................. 42,831 1,042 (2,236)
Impact of minority interest....................... (743) - -
Total tax benefit (expense)................... 42,088 1,042 (2,236)
Total other comprehensive income (loss)....... $(78,162) $ (1,937) $ 4,153
A summary of net accumulated other comprehensive income (loss) on
stocks and fixed maturity investments in 1999, 1998 and 1997 follows:
Year ended December 31,
1999 1998 1997
Unrealized gains................................. $ 8,458 $ 49,184 $ 43,675
Unrealized losses................................ (91,914) (10,268) (1,780)
Impact of minority interest...................... 2,122 - -
Total unrealized gains (losses)............. (81,334) 38,916 41,895
Tax benefit (expense)............................ 29,210 (13,621) (14,663)
Impact of minority interest...................... (743) - -
Total benefit (expense)..................... 28,467 (13,621) (14,663)
Total....................................... $ (52,867) $ 25,295 $ 27,232
NOTE C-Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
Year ended December 31,
1999 1998 1997
Balance, beginning of year.............. $ 88,759 $ 85,264 $ 82,968
Costs deferred during the year.......... 243,401 199,929 189,787
Amortization charged to expense......... (233,660) (196,434) (187,491)
Balance, end of year.................... $ 98,500 $ 88,759 $ 85,264
47
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE D-Property and Equipment
A summary of property and equipment at December 31, is as follows:
1999 1998
Buildings................................. $ 31,017 $ 30,719
Equipment and office furniture............ 33,128 33,230
Building improvements..................... 791 838
64,936 64,787
Less accumulated depreciation....... (32,246) (29,907)
32,690 34,880
Land...................................... 1,251 939
Construction in progress.................. 861 35
$ 34,802 $ 35,854
Depreciation expense was $4,243, $4,706 and $4,213 for the years
ended December 31, 1999, 1998 and 1997, respectively. Depreciation
expense is allocated evenly between losses and loss adjustment expenses
and policy acquisition costs.
NOTE E-Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at
December 31, consist of:
1999 1998
Unpaid loss and LAE reserves.............. $756,593 $666,177
Salvage and subrogation recoverable....... (81,405) (69,181)
$675,188 $596,996
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to annually obtain a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
When a claim is reported to the Company, claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon an
evaluation of the type of claim involved, the circumstances surrounding
the claim and the policy provisions relating to the loss. The estimate
reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims person. During the loss adjustment period, these estimates are
revised as deemed necessary by the Company's claims department based on
subsequent developments and periodic reviews of the cases.
48
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses (continued)
In accordance with industry practice, the Company also
maintains reserves for estimated IBNR. IBNR reserves are determined
on the basis of historical information and the experience of the
Company. Adjustments to IBNR are made periodically to take into
account changes in the volume of business written, claims frequency
and severity, the mix of business, claims processing and other items
that can be expected to affect the Company's liability for losses and
LAE over time.
When reviewing reserves, the Company analyzes historical data
and estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in
general economic conditions, including the effects of inflation.
This process assumes that past experience, adjusted for the effects
of current developments and anticipated trends, is an appropriate
basis for predicting future events. There is no precise method,
however, for subsequently evaluating the impact of any specific
factor on the adequacy of reserves, because the eventual development
of reserves is affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company
estimates the ultimate net liability for losses and LAE. After
taking into account all relevant factors, management believes that
the provision for losses and LAE at December 31, 1999 is adequate to
cover the ultimate net cost of losses and claims incurred as of that
date. The ultimate liability, however, may be greater or lower than
reserves. Establishment of appropriate reserves is an inherently
uncertain process, and there can be no certainty that currently
established reserves will prove adequate in light of subsequent
actual experience. The Company does not discount to present value
that portion of its loss reserves expected to be paid in future
periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known
and unknown losses. Because of the Company's limited exposure to
these types of claims, management believes they will not have a
material impact on the consolidated financial position of the Company
in the future. Loss reserves on environmental related claims
amounted to $4,185 and $5,687 in 1999 and 1998, respectively.
49
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expense, net of
reinsurance deductions from all reinsurers including C.A.R., as shown in
the Company's consolidated financial statements for the periods
indicated.
Year ended December 31,
1999 1998 1997
Loss and loss adjustment expense reserves,
beginning of year, prior to effect of ceded
reinsurance recoverable............................. $498,829 $530,077 $533,980
January 29, 1999 American Commerce loss and
loss adjustment expense reserves.................. 63,112 - -
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 664,978 592,796 609,930
Decrease in provision for insured events of
prior years...................................... (39,888) (61,367) (83,803)
Total incurred losses and loss adjustment
expenses....................................... 625,090 531,429 526,127
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 383,707 335,047 322,882
Losses and loss adjustment expenses attributable
to insured events of prior years................. 243,496 227,630 207,148
Total payments.................................. 627,203 562,677 530,030
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 559,828 498,829 530,077
Ceded reinsurance recoverable..................... 115,360 98,167 119,396
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $675,188 $596,996 $649,473
The provision for insured events of the current year is higher for
1999 compared to 1998 primarily due to the acquisition of American
Commerce. The line labeled decrease in provision for insured events of
prior years is less in 1999 due primarily to fewer redundancies from
prior year losses realized in the current year. Redundancies relating
to automobile bodily injury claims, were approximately $32.2 million
less in 1999, as compared to 1998. These were offset primarily by
increased redundancies in other lines of business. The increase in
payments is primarily due to the American Commerce acquisition.
The Company's loss and LAE reserves reflect its share of the
aggregate loss and LAE reserves of all Servicing Carriers. The Company
is a defendant in various legal actions arising from the normal course
of its business. These proceedings are considered to be ordinary to
operations or without foundation in fact. Management is of the opinion
that these actions will not have a material adverse effect on the
consolidated financial statements of the Company.
50
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE F-Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses
from a single occurrence or event. The Company also has a quota share
reinsurance contract on its other than automobile business.
Property, Catastrophe and Quota Share Reinsurance
From September 30, 1995 through June 30, 1998, the Company had a
combined property quota share and excess loss reinsurance contract which
was written with six reinsurance companies. Under the quota share
portion of the arrangement, the reinsurers indemnified the Company for
45% of the loss and LAE, and paid a commission allowance based on the
ratio of losses incurred to premiums earned. In exchange, the Company
paid to the reinsurers 49% of the net premium pertaining to the related
business. The maximum per occurrence loss reimbursement was $50.0
million and the maximum annual aggregate occurrence loss reimbursement
was $75.0 million. Under the excess loss reinsurance portion of the
arrangement, the Company reinsured each risk, retaining $125 and
reinsuring 100% of the next $875.
Various catastrophe only reinsurance programs were utilized from
1996 through May, 1998 in conjunction with the quota share and excess
loss program noted above.
Effective July 1, 1998, the Company expanded the quota share
portion of the program. A 75% quota-share reinsurance program was
incepted, covering all non-automobile property and liability business,
except umbrella policies. The excess loss portion of the program was
reduced on July 1, 1998 and completely eliminated on September 30, 1998.
The expanded program is split between American Re-Insurance Company,
Employers Reinsurance Corporation, Hartford Fire Insurance Company and
Swiss Reinsurance America Corporation. The maximum per occurrence loss
reimbursement is the higher of 350% of premium ceded under the program
or $175.9 million. The maximum annual aggregate occurrence loss
reimbursement is the higher of 450% of premium ceded under the program
or $226.1 million. A sliding scale commission, based on loss ratio, is
utilized under this program. This program provides the Company with
sufficient protection for catastrophe coverage so as to enable the
Company to forego pure catastrophe reinsurance coverage, which was
previously tailored in conjunction with the former quota share
arrangement.
Through December 31, 1999, American Commerce utilized a separate
catastrophe reinsurance program. Effective January 1, 2000, this
program expired and American Commerce joined the quota-share reinsurance
program described above.
51
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
The table below provides information depicting the approximate
recovery under the expanded quota share contract at various loss
scenarios, if a single catastrophe were to strike:
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
$ 50,000 $ 37,500 $12,500
100,000 75,000 25,000
150,000 112,500 37,500
200,000 150,000 50,000
250,000 187,500 62,500
Under the above scenario and based on the business subject to the
quota-share reinsurance contract for 2000, the Company has no
reinsurance recoveries for a single event catastrophe in excess of a
total loss of approximately $297.5 million. The Company's estimated
total loss on its other than automobile business for 100 and 250 year
storms (including American Commerce) is approximately $117.0 million and
$198.1 million, respectively. The Company estimates were derived
through the services of Swiss Reinsurance America Corporation who
utilized the CLASIC model provided by Applied Insurance Research.
Written premiums ceded in 1999, 1998 and 1997 under the above
referenced programs were $51.5 million, $54.0 million and $27.5 million,
respectively. Ceding commission income is calculated on a ceded earned
premium basis.
Casualty Reinsurance
Since January 1, 1997, casualty reinsurance has been on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$9.0 million over a net retention of $1.0 million. This coverage is
placed with Swiss Reinsurance America Corporation (rated A+ by A.M.
Best).
Personal and commercial liability umbrella policies are reinsured
on a 95% quota share basis in regard to limits up to $1.0 million and
100% quota share basis for limits in excess of $1.0 million but not
exceeding $5.0 million for policies with underlying automobile coverage
of $250/$500 or more. The Company also has personal liability umbrella
reinsurance coverage for policies with underlying automobile coverage of
$100/$300, on a 65% quota share basis in regard to limits up to $1.0
million and 100% quota share basis for limits in excess of $1.0 million
but not exceeding $3.0 million. These coverages are placed with
American Re-Insurance Company (rated A+ by A.M. Best).
Earned premiums and losses and loss adjustment expenses are stated
in the accompanying consolidated financial statements after deductions
for ceded reinsurance. Those deductions for reinsurance other than
C.A.R. are as follows:
Year ended December 31,
1999 1998 1997
Written premiums ceded............................ $54,657 $56,019 $ 31,863
Earned premiums ceded............................. 55,557 43,518 33,847
Losses and loss adjustment expenses ceded......... 24,240 16,568 10,754
The Company, as primary insurer, would be required to pay losses
in their entirety in the event that the reinsurers were unable to
discharge their obligations under the reinsurance agreements.
52
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999 1998 and 1997
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the
Company and 45 other writers of automobile insurance in Massachusetts
("Servicing Carriers") to reinsure any automobile risk that the insurer
perceives to be underpriced at the premium level permitted by the
Massachusetts Insurance Commissioner (the "Commissioner"). Servicing
Carriers, who are responsible for over 99.0% of total direct premiums
written for personal automobile insurance in Massachusetts, are required
to offer automobile insurance coverage to all eligible applicants
pursuant to "take-all-comers" regulations, but may reinsure undesirable
business with C.A.R.
The Company pays to C.A.R. all of the premiums generated by the
policies it has ceded and C.A.R. reimburses the Company for all losses
incurred on account of ceded policies. In addition, the Company
receives a fee for servicing ceded policies based on the expense
structure established by C.A.R. For the years ended December 31, 1999,
1998 and 1997, these servicing fees amounted to $17,235, $15,574 and
$17,133, respectively.
Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both the personal and commercial pools.
The Company is required to share in the underwriting results of C.A.R.
business for its respective product lines. Under current regulations,
the Company's share of the C.A.R. personal or commercial deficit is
based upon its market share for retained automobile risks for the
particular pool, adjusted by a "utilization" concept, such that, in
general, the Company is disproportionately and adversely affected if its
relative use of C.A.R. reinsurance exceeds that of the industry, and
favorably affected if its relative use of C.A.R. reinsurance is less
than that of the industry. The Company's strategy has been to
voluntarily retain more types of private passenger automobile business
that are factored as credits, thereby favorably impacting the
utilization formula. As a result of increased voluntary retention, the
credits impacting the utilization formula have favorably affected the
Company's participation ratio compared to its market share. During
1999, 1998 and 1997, the Company's net participation in the C.A.R.
personal automobile pool approximated 17.0%, 16.7% and 18.0%,
respectively, as reported by C.A.R.
Written premiums, earned premiums, losses incurred and the
liabilities for unearned premiums, unpaid losses ceded to and assumed
from C.A.R. were as follows:
Year ended December 31,
1999 1998 1997
Ceded Assumed Ceded Assumed Ceded Assumed
Income Statement
Written premiums... $ 68,740 $ 87,241 $ 70,435 $ 74,644 $ 71,816 $ 76,530
Earned premiums.... 68,902 84,356 68,383 75,718 71,977 82,866
Losses incurred.... 81,853 104,273 64,784 95,937 83,240 89,081
Balance Sheet
Unearned premiums.. $ 50,084 $ 42,156 $ 41,436 $ 39,271 $ 51,662 $ 40,345
Unpaid losses...... 106,576 100,680 111,784 99,427 129,137 102,819
The Company presents assets and liabilities gross of reinsurance.
The Residual Market Receivable represents the gross amount of
reinsurance recoverable from C.A.R. including unpaid losses, unearned
premiums, paid losses recoverable and unpaid ceded and assumed premiums.
53
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
The current C.A.R. utilization-based participation ratio has been
in place for the personal automobile market since 1993. During 1999,
1998 and 1997 the Company's amount of personal automobile exposures it
reinsured through C.A.R. approximated 5.6%, 6.4% and 6.6%, respectively,
as compared to industry averages of 9.6%, 10.0% and 10.1%, respectively.
NOTE G-Income Taxes
The Company and its subsidiaries file a consolidated federal
income tax return.
The federal income tax expense consisted of the following:
Year ended December 31,
1999 1998 1997
Current............................ $ 26,481 $ 36,607 $ 24,496
Deferred........................... 673 (8,632) 6,984
$ 27,154 $ 27,975 $ 31,480
Deferred taxes arise from temporary differences in the basis of
assets and liabilities for tax and financial statement purposes. The
sources of these differences and the related tax effects consisted of
the following:
Year ended December 31,
1999 1998 1997
Unearned premiums.................................. $ (2,785) $ 39 $ (769)
Discounting of loss reserves....................... (928) 2,782 2,421
Bad debt expense................................... (99) (17) 129
Deferred policy acquisition costs.................. 1,251 (782) 1,297
Salvage and subrogation recoverable................ 272 (233) (406)
Tax depreciation in excess of book depreciation.... 639 109 151
Book value rights/book value awards/stock
appreciation rights............................... 2,825 (11,056) 4,912
Pension liability.................................. (320) - -
Deferred items not included above.................. (182) 526 (751)
Deferred income tax.......................... 673 (8,632) 6,984
Other comprehensive income (loss).................. (42,831) (1,042) 2,236
Deferred taxes at acquisition of American Commerce. (4,662) - -
Change in deferred tax liability............. $(46,820) $ (9,674) $ 9,220
54
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE G-Income Taxes (continued)
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, Management believes it is more likely than not that all of the
deferred tax assets will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term
if estimates of future taxable income or unrealized gains are reduced.
Deferred tax liabilities (assets) were comprised of the following at
December 31, 1999 and 1998:
1999 1998
Unearned premiums............................................... $(25,214) $(20,569)
Discounting of loss reserves.................................... (21,278) (18,597)
Net accumulated comprehensive loss.............................. (29,210) -
Book value awards/stock appreciation rights..................... (32) (2,857)
Pension liability of American Commerce.......................... (1,742) -
Bad debt allowances............................................. (888) (789)
Deferred tax assets....................................... (78,364) (42,812)
Deferred policy acquisition costs............................... 28,529 25,050
Salvage and subrogation recoverable............................. 2,144 1,768
Tax depreciation in excess of book depreciation................. 1,738 2,965
Net accumulated comprehensive income............................ - 13,621
Deferred items not included above............................... 2,902 3,177
Deferred tax liabilities.................................. 35,313 46,581
Net deferred tax (asset) liability........................ $(43,051) $ 3,769
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 1999, 1998 and
1997 for the following reasons:
Year ended December 31,
1999 1998 1997
Tax at statutory rate.. $ 45,077 35.0% $ 43,563 35.0% $ 44,693 35.0%
Tax exempt interest.... (9,157) (7.1) (8,429) (6.8) (8,036) (6.3)
Dividends paid to ESOP
participants......... (785) (0.6) (762) (0.6) (782) (0.6)
Dividends received
deduction............ (7,560) (5.9) (6,152) (4.9) (4,567) (3.6)
Other.................. (421) (0.3) (245) (0.2) 172 0.2
Tax at effective rate.. $ 27,154 21.1% $27,975 22.5% $31,480 24.7%
NOTE H-Related-Party Transactions
The Company has made loans to insurance agencies with which
Commerce transacts business on a regular basis. At December 31, 1999,
six of these loans with an aggregate outstanding principal balance of
$2,297, were collateralized by the assets of the agencies, one of these
loans with an outstanding balance of $341 was collateralized by real
estate as the primary collateral and the assets of the agency as
secondary collateral. There were no loans to insurance agencies
collateralized solely by real estate. At December 31, 1998, eight of
these loans with an aggregate outstanding balance of $2,738 were
collateralized by the assets of the agencies and none of these loans
were collateralized by real estate.
55
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE H-Related-Party Transactions (continued)
One Director of the Company is the Chairman Emeritus and Assistant
Clerk of an insurance agency which is one of the Company's independent
insurance agencies. This Director sold his ownership interest in that
agency in 1994, although he remains associated with it in the above
stated capacity. This Director also continued to receive payments under
non-competition and loan agreements through 1998. This Director
receives no direct or indirect compensation based on the commissions
paid to the agency by the Company. During the years ended December 31,
1998 and 1997, the agency received from the Company commissions of $940
and $834, respectively, in the aggregate, for policies written. The
Company also purchased certain insurance coverages through the agency
and paid premiums for these policies of $520 and $367 in 1998 and 1997,
respectively.
The immediate family of one Director of the Company owns more than
a 10% equity interest in a construction company. This construction
company provided construction and construction management services in
connection with the construction of a new addition to an office building
beginning in 1999. Terms of the contract provide for a guaranteed
maximum payment to the construction company of $448, including a
management fee of $111. Payments to the general contractor in
connection with this contract in 1999 were $245.
NOTE I-Employee Stock Ownership Plan and 401(k) Plan
The Company offers an Employee Stock Ownership Plan ("E.S.O.P.")
and 401(k) Plan for the benefit of substantially all employees,
including those of the Company's subsidiaries, with the exception of
American Commerce as discussed in Note J. The E.S.O.P. is
noncontributory on the part of participants and contributions are made
at the discretion of the Board of Directors. The Company is under no
obligation to make contributions or maintain the E.S.O.P. for any length
of time, and may completely discontinue or terminate the E.S.O.P. at any
time without liability. Contributions by the Company and subsidiaries
to the E.S.O.P. for the years ending December 31, 1999, 1998 and 1997
were $5,744, $5,412 and $4,841, respectively. The E.S.O.P. owned
3,447,486 and 3,186,968 shares of the Company's common stock at December
31, 1999 and 1998, respectively.
The 401(k) Plan, implemented in September, 1998, enables eligible
employees to contribute up to 15% of eligible compensation on a pre-tax
basis up to the annual maximum limits under federal tax law. The
Company incurs no expenses in the form of matching contributions but
does pay for administration of the Plan.
NOTE J-American Commerce Pension and Post-Retirement Benefits
American Commerce maintains a noncontributory defined benefit
pension plan (the "pension plan") covering substantially all of their
employees. All participants of the pension plan are eligible to retire
with full retirement benefits upon attainment of age 65 with 5 years of
participation. Retirement benefits are payable for the life of the
participant with guaranteed payments for 10 years. To-date, all
retirees have taken lump-sum payments.
American Commerce makes contributions to a deposit administration
contract, which provides the pension plan with assets sufficient to fund
pension benefits to pension plan participants. The deposit
administration contract is carried at contract value, which represents
the cost of contributions plus interest and experience refunds. The
pension plan is subject to and exceeds the minimum funding requirements
of ERISA. Subsequent to year-end December 31, 1999, the Directors of
American Commerce voted to terminate the pension plan and will be
transitioning in 2000 to the E.S.O.P. American Commerce maintains a
separate 401(k) Plan for the benefit of substantially all of its
employees. American Commerce matches 50% of all employee contributions
up to 6% of pay. Both American Commerce and it's employees share in
administration expenses of the plan. Subsequent to December 31, 1999,
the Directors of American Commerce voted to merge the 401(k) plan with
the Company's Plan on January 1, 2001.
56
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE J-American Commerce Pension and Post-Retirement Benefits
(continued)
American Commerce also maintains a noncontributory post-retirement
benefit plan (the "post-retirement plan") for retirees that includes
medical, dental and life insurance coverages. All participants of the
post-retirement plan are eligible upon attainment of age 55 with 10
years of service or age 65 with 5 years of service. Dental coverage
ceases at age 65 and life insurance coverage decreases based upon the
age of the retiree until the attainment of age 70, at which time they
are provided a nominal amount of coverage from age 70 and thereafter.
Participant's spouses are also covered under the post-retirement plan.
The cost of post-retirement medical, dental and life insurance benefits
is accrued over the active service periods of employees to the date they
attain full eligibility for such benefits. It is the policy of American
Commerce to pay for post-retirement benefits as incurred.
The following table shows, as of December 31, 1999, the American
Commerce plans' funded status reconciled with amounts reported in the
consolidated balance sheet and the assumptions used in determining the
actuarial present value of the benefit obligation:
Post-
Pension Retirement
Plan Plan
Plan assets at fair value.............................. $ 3,048 $ 0
Accumulated benefit obligation:
Vested............................................... 3,438 -
Non-vested........................................... 135 -
Retirees............................................. - 1,219
Active participants, fully eligible.................. - 889
Active participants, not eligible.................... - 1,844
Accumulated benefit obligation......................... 3,573 3,952
Additional benefits based on future salary levels.... 2,337 -
Projected benefit obligation....................... 5,910 3,952
Unfunded status of plan................................ (2,862) (3,952)
Unrecognized prior service costs....................... 324 (23)
Unrecognized net transition obligation................. 161 1,285
Unrecognized net loss.................................. 1,569 143
Accrued benefit cost............................. $ (808) $ (2,547)
Assumptions:
Weighted average discount rate....................... 7.1% 7.0%
Weighted average rate of compensation increase....... 5.0% -
57
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE J-American Commerce Pension and Post-Retirement Benefits
(continued)
Net periodic cost of the American Commerce pension and post-
retirement plans for the period ended December 31, 1999 includes the
following components:
Post-
Pension Retirement
Plan Plan
Service cost-benefits earned........................... $ 497 $ 238
Interest cost on projected benefit obligation.......... 453 246
Actual return on plan assets........................... (168) -
Amortization of unrecognized net transition
obligation........................................... 41 99
Amortization of unrecognized prior service cost........ 83 (3)
Amortization of unrecognized loss...................... 74 -
Net asset loss deferred for later recognition.......... (109) -
Net periodic cost.................................... $ 871 $ 580
The assumed health care cost trend rate for 1999 was 9.5% and
7.75% for medical and dental, respectively. These rates grade down
until the final trend rates of 6.0% and 5.0% for medical and dental,
respectively, are reached in 2010. A one percentage point increase in
the assumed health and dental cost trend rates increases the sum of the
service and interest costs components of the 1999 periodic post-
retirement benefit cost by 13.0% and the accumulated post-retirement
benefit obligation as of December 31, 1999 by 14.0%
NOTE K-Stockholders' Equity
Book Value Rights, Book Value Awards, Stock Appreciation Rights and
Stock Options Program
The Management Incentive Plan approved by the Company's
stockholders in May, 1994 provides for the award of incentive stock
options, non-qualified stock options, book value awards, stock
appreciation rights, restricted stock and performance stock units. Up
to 2,500,000 shares of common stock (subject to increase for anti-
dilution adjustments) may be issued under the Plan, including shares
that may be issued pursuant to awards of restricted stock or upon the
exercise of common stock equivalent awards such as stock options and
stock appreciation rights payable in the form of common stock (not in
the form of cash). All directors, officers and other senior management
employees of the Company or any of its subsidiaries are eligible to
participate in this Management Incentive Plan.
Book value awards issued relating to this Plan totaled 478,248,
482,215 and 453,488 in 1999, 1998 and 1997, respectively. Expenses
relating to book value awards were $438, $470 and $3,068 in 1999, 1998
and 1997, respectively. Stock appreciation rights issued also relating
to this Plan totalled 509,872 and 493,992 in 1998 and 1997,
respectively. Expenses (income) relating to stock appreciation rights
were ($3,159), ($656) and $15,657 in 1999, 1998 and 1997, respectively.
The outstanding book value awards and stock appreciation rights entitle
the holders to cash payments based upon the extent to which, if at all,
the per share book value or market value, as applicable, of the common
stock exceeds certain thresholds set at the time the award was granted.
During 1999, for the first time under the Plan, the Company
granted stock options ("options") totaling 700,179. There were no
expenses related to these options in 1999. The outstanding options
entitle the recipient to purchase the Company's common stock based upon
the extent to which, if at all, the per share market value of the common
stock exceeds certain thresholds set at the time the option was granted.
Unexercised options terminate not later than eight years after the date
of grant (not later than ten years after the date of grant for those
options granted to officers of American Commerce).
58
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars Except for Per Share Data)
NOTE K-Stockholders' Equity (continued)
Aggregate liabilities for the combined programs were $986 and
$9,609 at December 31, 1999 and 1998, respectively.
The following is a summary of the changes in options outstanding
under the Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding, beginning of year.... - -
Granted January 29, 1999................. 50,000 $36.32
Granted April 30, 1999................... 650,179 32.81
Exercised................................ - -
Terminated............................... - -
Options outstanding, end of year.......... 700,179 $32.83
Options exercisable, end of year.......... - -
The estimated weighted average fair value per share of the options
was $3.78 in 1999.
Additionally, during 1999, the Company granted options totaling
1,872,380 to certain agents of American Commerce (the "American Commerce
Agents' Plan"). The right of the recipient to exercise these options is
contingent upon the average volume of other-than-Massachusetts private
passenger automobile and homeowners direct written premiums placed and
maintained with American Commerce for the five year period ending
December 31, 2003. If qualified, the recipient may purchase the
Company's common stock at a price of $36.32, the exercise price, on or
after January 29, 2004, the confirmation date, up to and until January
29, 2009, the expiration date. Expenses related to these options,
determined in accordance with the fair value accounting provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation", amounted to
$1,909 in 1999.
The following is a summary of the changes in options outstanding
under the American Commerce Agents' Plan:
Weighted
Average
Exercise
Shares Price
Options outstanding, beginning of year.. - -
Granted................................ 1,872,380 $36.32
Exercised.............................. - -
Terminated............................. - -
Options outstanding, end of year........ 1,872,380 $36.32
Options exercisable, end of year........ - -
59
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars Except for Per Share Data)
NOTE K-Stockholders' Equity (continued)
The fair value of each option granted in 1999, under the American
Commerce Agents' Plan, was estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted average
assumptions:
Dividend yield.................................... 4.43%
Volatility........................................ 28.20%
Risk-free interest rate........................... 6.25%
Expected option life in years..................... 7
The estimated weighted average fair value per share of the options
under the American Commerce Agents' Plan was $5.28 at December 31, 1999.
NOTE L-Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established
by their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders may, within certain limitations, pay such dividends and
then file a report with the Commissioner. Dividends in excess of these
limitations are called extraordinary dividends. An extraordinary
dividend is any dividend or other property, whose fair value together
with other dividends or distributions made within the preceding twelve
months exceeds the greater of ten percent of the insurer's surplus as
regards policyholders as of the end of the preceding year, or the net
income of a non-life insurance company for the preceding year. No pro-
rata distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has
not objected. No extraordinary dividends were paid in 1999, 1998 and
1997.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to
its stockholders is limited. During 1999 Commerce and Citation paid
$47,000 and $9,306 in dividends, respectively to CHI; CHI then paid
$56,070 to the Company in March 1999. During 1998 Commerce and Citation
paid $43,300 and $8,338 in dividends, respectively, to CHI; CHI then
paid $51,345 to the Company in March 1998.
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.11 per share
and $1.07 per share in 1999 and 1998, respectively. On May 21, 1999,
the Board voted to increase the quarterly stockholder dividend from
$0.27 to $0.28 per share to stockholders of record as of June 4, 1999.
Prior to that declaration, the Company had paid quarterly dividends of
$0.27 per share dating back to May 15, 1998 when the Board voted to
increase the dividend from $0.26 to $0.27 per share.
60
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE M-Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings
and policyholders surplus for the combined operations of Commerce,
Citation, Commerce West and American Commerce:
1999 1998 1997
Earnings Equity Earnings Equity Earnings Equity
GAAP............................. $ 99,155 $614,416 $ 93,888 $649,751 $101,528 $609,416
Deferred income taxes (benefits). (944) (40,634) (1,971) 5,423 4,039 8,352
Deferred acquisition costs....... (3,373) (98,499) (3,495) (88,759) (2,296) (85,264)
Bonds-book versus market......... - 11,400 - (18,786) - (23,812)
Preferred stock-market versus
book............................ - (528) - (1,307) - (429)
Deferred income.................. 518 7,380 (326) 6,744 (697) 7,071
Deferred service fee income
(expense)...................... (804) 2,611 91 3,411 1,784 3,139
Deferred reinsurance
commissions..................... (201) 10,054 5,728 10,253 (1,267) 4,424
Statutory reserve over statement
reserves........................ - (3,053) - (4,072) - (8,567)
Goodwill in subsidiary........... (291) 1,645 (291) 1,936 (291) 2,226
Pension and post-retirement
benefit......................... - 3,408 - - - -
Adjustment for non-insurance
company subsidiary............... 8,651 11,727 - - - -
Difference in GAAP to statutory
net income in subsidiary........ 329 - 80 - 57 -
Other............................ - (953) - (1,091) - 42
Total adjustments........... 3,885 (95,442) (184) (86,248) 1,329 (92,818)
Statutory........................ $103,040 $518,974 $ 93,704 $563,503 $102,857 $516,598
NOTE N-Segment Information
The Company has four reportable segments: (1) property and
casualty insurance - Massachusetts; (2) property and casualty insurance
- - other than Massachusetts; (3) real estate and commercial lending; and,
(4) corporate and other. The Company's property and casualty insurance
operations are written through Commerce, Citation, Commerce West, and
American Commerce and are marketed to affinity groups, individuals,
families and businesses through the Company's relationships with
professional independent insurance agencies. The Company's real estate
and commercial lending operations are a result of insurance companies
having the authorization to invest in mortgages. The Company's wholly-
owned subsidiary, Bay Finance Company, Inc., originates and services
residential and commercial mortgages in Massachusetts and Connecticut.
The corporate and other segment represents the remainder of the
Company's activities, including those of the parent company.
The Company evaluates performance and allocates resources based
primarily on the property and casualty insurance segment which
represents 99.0% of the Company's total revenue for the past three
years. The accounting policies of the reportable segments are the same
as those described in Note A - Summary of Significant Accounting
Polices.
61
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE N-Segment Information (continued)
Selected information by industry segment for 1999, 1998 and 1997 is
summarized as follows:
Earnings Before Identifiable
Revenue Income Taxes Assets
1999
Property and casualty insurance
Massachusetts............................. $864,508 $118,636 $1,574,734
Other than Massachusetts.................. 115,630 2,431 223,444
Real estate and commercial lending......... 4,355 4,355 72,937
Corporate and other........................ 3,047 3,368 357
Consolidated........................... $987,540 $128,790 $1,871,472
1998
Property and casualty insurance
Massachusetts............................. $816,201 $113,593 $1,627,633
Other than Massachusetts.................. 27,597 3,666 45,366
Real estate and commercial lending......... 5,049 5,049 74,070
Corporate and other........................ 3,483 2,159 8,914
Consolidated........................... $852,330 $124,467 $1,755,983
1997
Property and casualty insurance
Massachusetts............................. $802,587 $128,006 $1,613,746
Other than Massachusetts.................. 30,895 4,716 45,628
Real estate and commercial lending......... 4,448 4,448 83,420
Corporate and other........................ 3,383 (9,475) 11,959
Consolidated........................... $841,313 $127,695 $1,754,753
NOTE O-Supplement to Consolidated Statements of Cash Flows
During the years ended December 31, 1999 and 1998, the Company did
not acquire any property through foreclosure of mortgages.
NOTE P-Insolvency Fund Assessments
As provided in the statutes, insurance companies which write
business in Massachusetts are assessed for losses attributable to the
insolvency of other insurance companies by the Massachusetts Insurers
Insolvency Fund ("M.I.I.F."). From its inception, on August 2, 1972
through December 31, 1999, the M.I.I.F. has approved assessments
totaling $126,822, of which the Company's share was approximately
$7,269. It is anticipated that there will be additional assessments
from time to time relating to various insolvencies. By statute, no
insurer may be assessed in any year an amount greater than two percent
of that insurer's net direct written premiums for the calendar year
preceding the assessment. Although the timing and amounts of any such
assessments are not known, Management is of the opinion that such
assessments will not have a material effect on the consolidated
financial position of the Company. According to statute, the assessed
insurance companies have the right to recoup amounts paid to the
M.I.I.F., over a reasonable length of time, through premium rates
approved by the Commissioner. The Company's policy has been to
recognize the recovery of the assessed amounts as received. M.I.I.F.
had no activity during 1999. Refunds of assessments from the M.I.I.F.
for the year ended December 31, 1998 were $271 and assessments by the
M.I.I.F. for the year ended December 31, 1997 were $283.
62
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars Except for Per Share Data)
NOTE P-Insolvency Fund Assessments (continued)
In 1997, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position 97-3 Accounting by Insurance and Other
Enterprise for Insurance-Related Assessments ("SOP 97-3") effective for
financial statements issued for periods ending after December 31, 1998.
This statement provides guidance on accounting by insurance companies on
the timing of recognition, the methods of measurement, and the required
disclosures for guaranty fund and other related assessments. The
adoption of this statement has not had a material impact on the
Consolidated Financial Statements.
NOTE Q-Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 1999 and 1998 quarterly
performance is as follows:
1999 First Second Third Fourth
Quarter Quarter Quarter Quarter
Total revenues................................. $227,746 $250,762 $251,316 $257,716
Net earnings................................... 14,681 22,792 27,021 38,094
Comprehensive income (loss).................... (5,030) 14,633 9,680 5,143
Net earnings excluding the after-tax impact
of net realized investment gains (losses)(1).. 14,954 18,525 25,925 37,609
Net earnings per weighted average common
share (basic and diluted).................... 0.41 0.65 0.78 1.10
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (losses)(1)........ 0.42 0.53 0.74 1.10
Cash dividends paid per share.................. 0.27 0.28 0.28 0.28
1998 First Second Third Fourth
Quarter Quarter Quarter Quarter
Total revenues................................. $214,380 $217,610 $206,060 $214,280
Net earnings................................... 25,235 19,585 29,861 21,811
Comprehensive income........................... 23,953 16,473 32,417 21,712
Net earnings excluding the after-tax impact
of net realized investment gains (losses)(1).. 22,764 18,752 29,862 20,714
Net earnings per weighted average common
share (basic and diluted).................... 0.70 0.54 0.83 0.61
Basic and diluted net earnings per common
share excluding the after-tax impact of net
realized investment gains (losses)(1)........ 0.63 0.52 0.83 0.58
Cash dividends paid per share.................. 0.26 0.27 0.27 0.27
(1) The above figures are presented to provide information to the reader
due to the amount of, and fluctuations in, net realized gains and
losses. The amounts noted, commonly known as Operating Income, are
important measures of corporate performance.
63
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
(Thousands of Dollars)
NOTE R-Subsequent Events
In 2000, the Company entered into a Limited Partnership Agreement
with Conning Partners V, L.P., a Delaware limited partnership. This
partnership agreement required a commitment by the Company to invest
$50,000 into the partnership throughout the next five years as
determined by the General Partner. To date the Company has not yet
invested into the partnership leaving a balance for funds still
committed but not paid into the partnership of $50,000. The Partnership
was formed to operate as an investment fund principally for the purpose
of making investments primarily in equity, equity-related and other
securities issued in expansion financing, start-ups, buy-outs and
recapitalization transactions relating to companies in the areas of
insurance, financial services, e-commerce, healthcare and related
businesses, including, without limitation, service and technology
enterprises supporting such businesses, in order to realize long-term
capital returns, all as determined and managed by the General Partner
for the benefit of the Partners.
On February 10, 2000 the Massachusetts Division of Insurance
placed Trust Insurance Company ("Trust") in rehabilitation. At December
31, 1999, Trust was the ninth largest writer of private passenger
automobile insurance in Massachusetts, with an approximate 5% market
share. Although expected to have minimal adverse impact, if any, the
Company is unable to determine the overall effect that this event may
have on the consolidated operating and financial position of the
Company.
64
SELECTED CONSOLIDATED FINANCIAL DATA
The data should be read in conjunction with the consolidated
financial statements, related footnotes, and other financial information
included herein. The financial statements for the three years ended
December 31, 1999 have been audited by Ernst & Young LLP. The financial
statements for the two years ended December 31, 1996 have been audited
by other independent auditors. All dollar amounts set forth in the
following tables are in thousands, except per share data:
Year ended December 31,
1999 1998 1997 1996 1995
Statement of Earnings Data:
Net premiums written.......... $ 911,993 $ 745,048 $ 741,501 $ 711,570 $ 603,421
(Increase) decrease in
unearned premiums............ (40,163) 572 (11,004) (42,854) (10,831)
Earned premiums............... 871,830 745,620 730,497 668,716 592,590
Net investment income......... 89,787 86,501 80,972 77,402 71,313
Premium finance and service
fees......................... 14,774 13,440 7,074 9,713 19,420
Amortization of excess of
book value of subsidiary
interest over cost........... 3,019 - - - -
Net realized investment gains
(losses)...................... 8,130 6,769 22,770 (7,574) 712
Total revenues........... 987,540 852,330 841,313 748,257 684,035
Losses and loss adjustment
expenses..................... 625,090 531,429 526,127 475,231 367,552
Policy acquisition costs...... 233,660 196,434 187,491 181,013 166,741
Total expenses........... 858,750 727,863 713,618 656,244 534,293
Earnings before income taxes
and minority interest........ 128,790 124,467 127,695 92,013 149,742
Income taxes.................. 27,154 27,975 31,480 18,049 39,541
Net earnings before minority
interest..................... 101,636 96,492 96,215 73,964 110,201
Minority interest............. 952 - - - -
Net earnings............. $ 102,588 $ 96,492 $ 96,215 $ 73,964 $ 110,201
Comprehensive income..... $ 24,426 $ 94,555 $ 100,368 $ 80,539 $ 169,119
Per Share Data:
Basic and diluted net
earnings per share...... $ 2.94 $ 2.68 $ 2.67 $ 2.04 $ 2.93
Cash dividends paid per
share................... $ 1.11 $ 1.07 $ 1.03 $ 0.81 $ 0.23
Weighted average number of
shares outstanding............. 34,940,074 36,042,652 36,044,679 36,311,887 37,632,236
December 31,
1999 1998 1997 1996 1995
Balance Sheet Data:
Total investments............. $1,268,979 $1,257,900 $1,242,695 $1,167,671 $1,096,778
Premiums receivable........... 195,160 162,878 169,469 157,835 127,047
Total assets.................. 1,871,472 1,755,983 1,754,753 1,676,799 1,564,175
Unpaid losses and loss
adjustment expenses.......... 675,188 596,996 649,473 662,832 626,029
Unearned premiums............. 457,095 391,424 379,599 367,991 330,454
Stockholders' equity.......... 646,634 705,785 649,796 587,039 549,714
Stockholders' equity
per share ................... 18.82 19.58 18.03 16.28 14.96
65
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following exhibits depict the progress of the insurance
operations of the Company over the past fifteen years. For these years
of operation, net premiums written amounted to $6,380,394. During this
period, the aggregate statutory financial ratios were 68.8% for losses
and loss expenses and 26.8% for underwriting expenses resulting in an
aggregate combined ratio of 95.6%. Total net investment income amounted
to $682,827 or 10.7% of net premiums written. Net realized gains were
$102,475. Stockholders' equity was $24,588 at the beginning of 1985 and
$614,416, at the end of 1999, resulting in an average annual increase in
excess of 23.9%. The progress of the insurance operations during the
most recent five year period, compared to the two previous five year
periods, can best be illustrated by the following comparison:
5-Year Period
1995-99 1990-94 1985-89
Direct premiums written.......................... $3,872,145 $2,582,664 $1,095,999
Net premiums written............................. 3,713,533 2,192,395 474,466
Net investment income............................ 405,976 214,311 62,540
Net realized gains............................... 30,579 65,036 6,860
Stockholders' equity at end of period............ 614,416 378,301 95,288
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned.... 70.0% 65.6% 73.9%
Underwriting expenses to net premiums written.. 26.7 27.3 24.3
Combined ratio............................. 96.7% 92.9% 98.2%
Increase in Stockholders' Equity................. 62.4% 297.0% 287.5%
The insurance operations of the Company include the operating results of
Commerce and Citation, along with Commerce's subsidiary company's,
Commerce West and American Commerce. Citation commenced business in
1981 as a wholly-owned subsidiary of Commerce. On December 31, 1989,
the ownership of Citation was transferred to The Commerce Group, Inc.
In September 1993, ownership of both Commerce and Citation was
transferred from The Commerce Group, Inc. to CHI, a subsidiary of The
Commerce Group, Inc. Results of Commerce West are included since its
acquisition by Commerce on August 31, 1995. Results of American
Commerce are included since its acquisition by Commerce on January 29,
1999. The combined balance sheets of these insurance subsidiaries
appear on pages 67 and 68. The combined statements of earnings of
insurance operations appear on pages 69 and 70.
66
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1999 1998 1997 1996 1995
ASSETS
Cash and short-term investments..... $ 22,411 $ 75,655 $ 238,685 $ 140,102 $ 52,308
Bonds, at market (at amortized cost
prior to 1993)..................... 647,338 619,267 590,597 716,702 815,277
Preferred stocks, at market (at
amortized cost prior to 1993)...... 211,049 197,425 148,499 147,680 111,220
Common stocks, at market............ 301,467 283,961 178,089 86,041 40,359
Mortgage loans on real estate....... 42,479 46,573 57,425 45,398 31,404
Other investments................... 14,139 7,825 3,783 127 -
Premium balances receivable......... 195,047 162,704 169,311 157,673 126,090
Investment income receivable........ 14,531 13,544 12,103 12,655 14,440
Residual market receivable.......... 156,660 153,220 180,799 195,213 200,124
Reinsurance receivable.............. 48,365 36,687 18,170 19,659 21,897
Deferred acquisition costs.......... 98,500 88,759 85,264 82,968 67,160
Current income taxes................ - 2,773 - - -
Deferred income taxes............... 43,081 - - - 2,100
Non-compete agreement............... 3,179 - - - -
Real estate, furniture and equipment 27,321 27,885 29,060 26,011 24,642
Total assets................ $1,825,567 $1,716,278 $1,711,785 $1,630,229 $1,507,021
LIABILITIES
Unpaid losses and loss expenses..... $ 674,666 $ 592,174 $ 637,094 $ 657,854 $ 618,791
Unearned premiums................... 457,095 391,424 379,599 367,991 330,454
Excess of book value of subsidiary
interest over cost................. 10,758 - - - -
Notes payable....................... - - - - -
Deferred income..................... 7,464 6,948 7,271 7,974 8,954
Accounts payable, accrued and other
liabilities........................ 48,158 70,558 60,332 41,368 34,351
Current income taxes................ 11,822 - 9,635 2,726 1,596
Deferred income taxes............... - 5,423 8,438 2,165 -
Total liabilities........... 1,209,963 1,066,527 1,102,369 1,080,078 994,146
Minority interest................... 1,188 - - - -
STOCKHOLDERS' EQUITY
Capital stock....................... 3,600 3,620 3,600 3,600 3,450
Paid-in capital..................... 45,050 45,050 45,050 45,050 23,700
Retained earnings
Balance, January 1................ 601,081 560,766 501,501 485,725 351,151
Net earnings...................... 99,155 93,888 101,528 74,432 110,450
Other comprehensive income (loss). (78,164) (1,935) 4,152 6,574 58,919
Dividends paid.................... (56,306) (51,638) (46,415) (65,230) (34,795)
Balance, December 31................ 565,766 601,081 560,766 501,501 485,725
Total stockholders' equity.. 614,416 649,751 609,416 550,151 512,875
Total liabilities and
stockholders' equity...... $1,825,567 $1,716,278 $1,711,785 $1,630,229 $1,507,021
67
<page
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
ASSETS
$ 4,560 $ 12,615 $ 25,809 $ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051 $ 10,048 $ 11,802
745,010 649,491 505,565 329,935 242,735 153,621 133,867 116,220 88,755 56,985
85,574 80,059 2,261 869 1,010 1,324 1,606 2,295 6,755 9,956
9,656 47,462 43,545 30,055 4,869 2,900 1,921 1,438 149 134
35,715 42,042 60,697 66,122 56,124 52,244 42,882 15,931 - -
- - 67,876 55,510 57,733 56,713 33,727 19,329 11,817 8,194
101,529 94,333 - - - - - - - -
13,285 10,205 9,710 6,063 4,235 3,093 2,889 2,370 2,485 1,722
214,818 220,312 274,426 277,196 290,440 268,951 198,177 132,725 87,178 50,327
16,892 12,868 365 - - - - - - -
59,066 53,647 55,442 33,981 27,273 22,702 15,699 10,898 7,129 5,417
- - - - - 341 266 - 2,209 1,294
38,180 - - 883 1,666 - - - - -
- - - - - - - - - -
25,246 22,371 23,183 24,163 25,046 23,118 9,684 8,356 7,370 5,648
$1,349,531 $1,245,405 $1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613 $223,895 $151,479
LIABILITIES
$ 592,373 $ 567,797 $ 495,800 $439,551 $403,752 $345,020 $270,628 $169,539 $113,513 $ 71,525
314,719 283,526 264,567 192,785 175,334 174,345 118,079 84,876 55,378 36,024
- - - - - - - - - -
- - - - 1,662 1,837 2,013 2,204 3,772 4,140
10,451 7,351 8,384 12,918 20,264 23,689 23,307 11,058 7,503 4,208
43,433 16,564 20,863 7,677 21,065 27,513 19,350 14,532 8,532 4,162
10,254 4,867 9,249 5,811 3,542 - - 470 - -
- 13,669 4,400 - - 1,623 1,021 1,853 3,736 3,623
971,230 893,774 803,263 658,742 625,619 574,027 434,398 284,532 192,434 123,682
- - - - - - - - - -
STOCKHOLDERS' EQUITY
3,450 3,450 3,450 3,450 3,450 3,450 2,350 2,350 2,350 2,350
23,700 8,700 8,700 8,700 8,700 8,700 6,500 6,500 6,500 6,500
339,481 253,466 165,075 112,016 83,138 62,877 37,231 22,611 18,947 15,738
113,892 79,837 91,980 55,214 32,414 21,966 21,837 15,614 4,362 4,025
(77,622) 21,928 9,811 2,545 (86) 645 321 (54) 7 (158)
(24,600) (15,750) (13,400) (4,700) (3,450) (2,350) (1,034) (940) (705) (658)
351,151 339,481 253,466 165,075 112,016 83,138 58,355 37,231 22,611 18,947
378,301 351,631 265,616 177,225 124,166 95,288 67,205 46,081 31,461 27,797
$1,349,531 $1,245,405 $1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613 $223,895 $151,479
68
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
1999 1998 1997 1996 1995
Underwriting
Direct premiums written................... $948,149 $796,858 $768,649 $731,823 $626,666
Net premiums written...................... $911,993 $745,048 $741,501 $711,570 $603,421
Increase (decrease) in unearned
premiums................................. 40,163 (572) 11,004 42,854 10,831
Earned premiums....................... 871,830 745,620 730,497 668,716 592,590
Expenses
Losses and loss expenses.................. 628,087 533,523 521,775 474,173 367,258
Underwriting expenses..................... 238,458 200,525 185,146 194,873 171,892
(Increase) decrease in deferred
acquisition costs........................ (3,374) (3,495) (2,296) (15,809) (5,723)
Total expenses........................ 863,171 730,553 704,625 653,237 533,427
Underwriting income (loss).................. 8,659 15,067 25,872 15,479 59,163
Net investment income....................... 90,042 86,664 81,396 76,867 71,007
Premium finance fees........................ 14,768 13,426 7,056 9,666 19,246
Amortization of excess of book value
of subsidiary interest over cost........... 3,019 - - - -
Net realized investment gains (losses)...... 8,168 6,645 22,909 (7,863) 720
Earnings before Federal income taxes,
withdrawing companies' settlements
and minority interest................. 124,656 121,802 137,233 94,149 150,136
Other income
Withdrawing companies' settlements........ - - - - -
Earnings before Federal income taxes
and minority interest...................... 124,656 121,802 137,233 94,149 150,136
Federal income taxes (benefits)............. 26,453 27,914 35,705 19,717 39,686
Earnings before cumulative effect of
change in accounting principle and
minority interest.......................... 98,203 93,888 101,528 74,432 110,450
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes............................... - - - - -
Minority interest........................... 952 - - - -
NET EARNINGS.......................... $ 99,155 $ 93,888 $101,528 $ 74,432 $110,450
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned.......................... 72.0% 71.6% 71.4% 70.9% 62.0%
Underwriting expenses to net
premiums written......................... 26.5 26.5 25.1 27.1 29.0
Combined ratio........................ 98.5% 98.1% 96.5% 98.0% 91.0%
Underwriting profit (loss)............ 1.5% 1.9% 3.5% 2.0% 9.0%
69
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
$625,023 $601,289 $ 525,495 $429,780 $401,077 $366,492 $306,469 $206,231 $131,807 $85,000
$589,197 $563,416 $ 508,847 $310,999 $219,936 $140,313 $124,923 $ 99,193 $ 60,808 $49,229
17,144 14,856 98,353 30,193 34,692 12,655 9,678 13,428 6,775 6,392
572,053 548,560 410,494 280,806 185,244 127,658 115,245 85,765 54,033 42,837
369,764 373,243 271,848 173,901 125,219 88,564 80,203 65,299 44,205 33,548
162,446 147,290 138,669 85,655 55,551 44,181 33,115 25,882 18,460 15,177
(5,420) 1,796 (21,462) (6,708) (4,571) (7,003) (4,801) (3,769) (1,712) (1,448)
526,790 522,329 389,055 252,848 176,199 125,742 108,517 87,412 60,953 47,277
45,263 26,231 21,439 27,958 9,045 1,916 6,728 (1,647) (6,920) (4,440)
63,119 52,868 39,685 32,661 25,978 21,256 15,999 10,896 7,554 6,835
18,315 16,486 13,734 11,165 10,074 8,095 4,592 3,021 1,436 531
- - - - - - - - - -
32,025 13,040 12,368 7,529 74 618 2,298 3,423 185 336
158,722 108,625 87,226 79,313 45,171 31,885 29,617 15,693 2,255 3,262
- - 43,168 - - - - - - -
158,722 108,625 130,394 79,313 45,171 31,885 29,617 15,693 2,255 3,262
44,830 28,788 38,414 24,099 12,757 9,919 7,780 2,987 (2,107) (763)
113,892 79,837 91,980 55,214 32,414 21,966 21,837 12,706 4,362 4,025
- - - - - - - 2,908 - -
- - - - - - - - - -
$113,892 $ 79,837 $ 91,980 $ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614 $ 4,362 $ 4,025
64.6% 68.0% 66.2% 61.9% 65.7% 68.0% 69.5% 79.4% 83.5% 79.7%
27.1 25.7 28.1 30.0 26.7 26.3 22.0 22.5 24.4 28.1
91.7% 93.7% 94.3% 91.9% 92.4% 94.3% 91.5% 101.9% 107.9% 107.8%
8.3% 6.3% 5.7% 8.1% 7.6% 5.7% 8.5% (1.9%) (7.9%) (7.8%)
70
THE COMMERCE GROUP, INC.
DIRECTORS
Herman F. Becker......................... President and owner, Sterling Realty and Huguenot
Development Corporation
Joseph A. Borski, Jr..................... Self-employed Certified Public Accountant
Eric G. Butler........................... Retired Vice President and General Claims Manager
of Commerce and Citation
Henry J. Camosse......................... Retired President, Henry Camosse & Sons Co., Inc.,
a building and masonry supplies company
Gerald Fels.............................. Executive Vice President and Chief Financial
Officer of the Company
David R. Grenon.......................... Chairman Emeritus and Assistant Clerk of The
Protector Group Insurance Agency, Inc.
Robert W. Harris......................... Retired Treasurer, H.C. Bartlett Insurance Agency,
Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett Insurance Agency,
Inc.
John J. Kunkel........................... President and Treasurer, Kunkel Buick and GMC
Truck, Treasurer, Kunkel Bus Company
Raymond J. Lauring....................... Retired President, Lauring Construction Company
Roger E. Lavoie.......................... Retired President and Treasurer, Lavoie Toyota-
Dodge, Inc.
Normand R. Marois........................ Retired Chairman of the Board, Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Retired physician who specialized in internal
medicine
Arthur J. Remillard, Jr.................. President, Chief Executive Officer and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and Assistant Clerk of
the Company; Senior Vice President of Commerce
and Citation in charge of Policyholder Benefits
Regan P. Remillard....................... Senior Vice President of the Company; President
and Secretary of Commerce West Insurance Company;
President of ACIC Holding Co., Inc.; Vice Chairman
of the Board and Chief Executive Officer of
American Commerce Insurance Company
Antranig Sahagian........................ Retired Owner, A. Sahagian Service Center
Gurbachan Singh.......................... Retired physician who specialized in general
surgery
John W. Spillane......................... Clerk of the Company and practicing attorney
71
DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Commerce West Insurance Company
Citation Insurance Company
Arthur J. Remillard, Jr........... President, Chief Executive Officer and
Chairman of the Board
Gerald Fels....................... Executive Vice President and Chief
Financial Officer; Treasurer,
Commerce Holdings, Inc.
Arthur J. Remillard, III (1)...... Senior Vice President and Clerk
Regan P. Remillard................ Senior Vice President; President and
Secretary of
Commerce West Insurance Company
David R. Grenon (1)............... Chairman Emeritus and Assistant Clerk
of The Protector Group Insurance Agency
John M. Nelson (1)................ Chairman of TJX Companies
Suryakant M. Patel (1)............ Retired physician who specialized in
internal medicine
William G. Pike (1)............... Executive Vice President and Chief
Financial Officer
of Granite State Bankshares, Inc.
H. Thomas Rowles (1).............. Chairman of the Board of ACIC Holding
Co., Inc.; Chairman of
the Board of American Commerce
Insurance Company; President,
Chief Executive Officer and Director of
AAA Southern New
England
Mark A. Shaw (1).................. Treasurer of ACIC Holding Co., Inc.;
Executive Vice
President and Chief Operating Officer
of AAA Southern New
England
(1) Commerce Holdings, Inc., The Commerce Insurance Company and
Citation Insurance Company only.
72
<page
DIRECTORS OF
ACIC HOLDING CO., INC.(1)
American Commerce Insurance Company
H. Thomas Rowles.................. Chairman of the Board of ACIC Holding Co., Inc.;
Chairman of the Board of American Commerce
Insurance Company; President, Chief Executive
Officer and Director of AAA Southern New England
Regan P. Remillard................ President of ACIC Holding Co., Inc.; Vice Chairman
of the Board and Chief Executive Officer of
American Commerce Insurance Company; Senior Vice
President of The Commerce Group, Inc.; President
and Secretary of Commerce West Insurance Company
Mark A. Shaw...................... Treasurer of ACIC Holding Co., Inc.; Executive Vice
President and Chief Operating Officer of AAA
Southern New England
Gerald Fels....................... Executive Vice President and Chief Financial Officer
of The Commerce Group, Inc.
Patrick W. Doherty (2)............ President and Chief Executive Officer of AAA
Oklahoma
Terry R. Farias (2)............... President and Chief Executive Officer of AAA Hoosier
Motor Club
Roger L. Graybeal (2)............. President and Secretary of AAA Oregon/Idaho
Richard S. Hamilton (2)........... President of AAA West Pennsylvania/West
Virginia/South Central Ohio
Gerald P. Hogan (2)............... President and Chief Operating Officer of American
Commerce Insurance Company
Charles B. Liekweg (2)............ President and Chief Executive Officer of AAA
Washington
D. James McDowell (2)............. President and Chief Executive Officer of AAA Arizona
Peter C. Ohlheiser (2)............ President of Ohio Motorists Association
(1) Incorporated in November, 1998. 80% owned by The Commerce
Insurance Company and 20% owned by AAA Southern New England.
(2) American Commerce Insurance Company only, which was acquired in
January 1999.
73
DIRECTORS OF
BAY FINANCE COMPANY, INC.
Arthur J. Remillard, Jr................ President and Chairman of the Board
Gerald Fels............................ Executive Vice President and Chief
Financial Officer
John W. Spillane....................... Clerk and Practicing Attorney
Arthur J. Remillard, III............... Senior Vice President and Assistant Clerk
Regan P. Remillard..................... Senior Vice President
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
Arthur J. Remillard, Jr................ President and Chairman of the Board
Gerald Fels............................ Executive Vice President and Chief
Financial
Officer
John W. Spillane....................... Clerk and Practicing Attorney
Arthur J. Remillard, III............... Senior Vice President and Assistant Clerk
Elizabeth M. Edwards................... Vice President
74
THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Commerce West Insurance Company
ACIC Holding Co., Inc. (1)
American Commerce Insurance
Company (2)
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF THE COMMERCE GROUP, INC.
President, Chief Executive Officer and Chairman of the Board.. Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer.......... Gerald Fels
Senior Vice President and Assistant Clerk..................... Arthur J. Remillard, III
Senior Vice President......................................... Regan P. Remillard
Senior Vice President......................................... Mary M. Fontaine
Vice President and General Counsel............................ James A. Ermilio
Clerk......................................................... John W. Spillane
Treasurer and Chief Accounting Officer........................ Randall V. Becker
Assistant Treasurer........................................... Thomas A. Gaylord
Assistant Vice President...................................... Robert E. McKenna
OFFICERS OF MASSACHUSETTS SUBSIDIARIES (3)
President, Chief Executive Officer and Chairman of the Board.. Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer.......... Gerald Fels
Senior Vice President and Secretary........................... Arthur J. Remillard, III
Senior Vice Presidents........................................ David H. Cochrane
Peter J. Dignan
Mary M. Fontaine
Regan P. Remillard
Joyce B. Virostek
Vice Presidents............................................... Elizabeth M. Edwards
Karen A. Lussier
Michael J. Richards
Angelos Spetseris
Henry R. Whittier, Jr.
Vice President and General Counsel............................ James A. Ermilio
Assistant Vice Presidents................... David P. Antocci Susan A. Horan
Robert M. Blackmer John V. Kelly
Stephen R. Clark Ronald J. Lareau
Raymond J. DeSantis Donald G. MacLean
Warren S. Ehrlich Robert E. McKenna
Richard W. Goodus Robert L. Mooney
James E. Gow Emile E. Riendeau
Treasurer and Chief Accounting Officer........................ Randall V. Becker
Assistant Treasurer........................................... Thomas A. Gaylord
(1) Incorporated in November, 1998. 80% owned by The Commerce Insurance
Company and 20% owned by AAA Southern New England.
(2) Acquired by ACIC Holding Co., Inc. in January, 1999.
(3) Massachusetts subsidiaries include The Commerce Insurance Company,
Citation Insurance Company, Bay Finance Company, Inc. and Clark-Prout
Insurance Agency. Officers often hold positions with several operating
subsidiaries. The titles listed represent their primary office as of
March 1, 2000.
75
<page
Officers of ACIC Holding Co., Inc.
Chairman of the Board........................................ H. Thomas Rowles
President.................................................... Regan P. Remillard
Treasurer.................................................... Mark A. Shaw
Secretary.................................................... James A. Ermilio
Officers of American Commerce Insurance Company
Chairman of the Board........................................ H. Thomas Rowles
Vice Chairman of the Board and Chief Executive Officer....... Regan P. Remillard
President and Chief Operating Officer........................ Gerald P. Hogan
Senior Vice President........................................ Carol R. Blaine
Treasurer.................................................... Richard B. O'Hara
Secretary and Chief Legal Officer............................ James A. Ermilio
Assistant Vice President..................................... Gregory S. Clark
Assistant Vice President and General Counsel................. Julie Deley-Shimer
Officers of Commerce West Insurance Company
Chairman of the Board........................................ Arthur J. Remillard, Jr.
President and Secretary...................................... Regan P. Remillard
Treasurer and Chief Financial Officer........................ Michael V. Vrban
Chief Reporting Officer...................................... Albert E. Peters
Investment Officer........................................... Gerald Fels
Vice Presidents.............................................. Michael J. Berryessa
Albert R. Harris
Tushar M. Kothare
76
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Stockholder Information
Annual Meeting
The Annual meeting of stockholders will be held at 9:00 a.m. on
Friday, May 19, 2000 at the Company's Underwriting Building, 11
Gore Road (Route 16), Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in
the Company's annual report on Form 10-K, as filed with the
Securities and Exchange Commission, may obtain a copy without
charge, by writing to the Assistant to the President at 211 Main
Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o BANKBOSTON, NA
EquiServe, L.P.
P.O. Box 8040
Boston, MA 02266-8040
(781) 575-3100 or (800) 733-5001
http://www.equiserve.com
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Company Websites
http://www.commerceinsurance.com
http://www.bayfinance.com
http://www.acilink.com
Trading of Common Stock
The Company's Common Stock trades on the NYSE under the symbol
"CGI".
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
(617) 266-2000
http://www.ey.com
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