UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 2001 Commission File Number 0-16882
THE COMMERCE GROUP, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2599931
(State or other jurisdiction (IRS Employer
of Incorporation) Identification No.)
211 Main Street Webster, Massachusetts 01570
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 943-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No___
As of November 1, 2001, the number of shares outstanding of the
Registrant's common stock (excluding Treasury Shares) was
33,390,452
Page 1 of 33
<page>
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Consolidated Balance Sheets at
September 30, 2001 (Unaudited) and December 31, 2000............... 3
Consolidated Statements of Earnings for the
Three and Nine Months Ended September 30, 2001 and 2000 (Unaudited) 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000 (Unaudited).......... 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash Provided by Operating Activities for the Nine Months
Ended September 30, 2001 and 2000 (Unaudited)...................... 6
Notes to Unaudited Consolidated Financial Statements................... 7
Management's Discussion and Analysis................................... 15
Part II - Other Information
Item 6
Exhibits and Reports on Form 8-K................................... 33
Signature.............................................................. 33
- - 2 -
<page>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
<table>
<caption>
September 30, December 31,
2001 2000
(Unaudited)
ASSETS
<s> <c> <c>
Investments:
Fixed maturities, at market (cost: $585,211 in 2001 and $665,881 in 2000)............. $ 599,469 $ 669,935
Preferred stocks, at market (cost: $259,164 in 2001 and $215,823 in 2000)............. 251,905 200,083
Common stocks, at market (cost: $87,703 in 2001 and $87,704 in 2000).................. 104,242 115,827
Preferred stock mutual funds, at equity (cost: $287,942 in 2001 and $327,980 in 2000). 298,670 337,733
Mortgage loans on real estate and collateral notes receivable (less allowance for
possible loan losses of $740 in 2001 and $858 in 2000)............................... 42,507 51,661
Cash and cash equivalents.............................................................. 177,731 70,521
Other investments (cost: $24,286 in 2001 and $25,475 in 2000).......................... 17,185 26,802
Total investments.................................................................. 1,491,709 1,472,562
Accrued investment income................................................................ 16,499 18,218
Premiums receivable (less allowance for doubtful receivables of $1,526 in 2001 and
$1,487 in 2000)........................................................................ 285,204 230,580
Deferred policy acquisition costs........................................................ 120,758 111,305
Property and equipment, net of accumulated depreciation.................................. 39,937 34,823
Residual market receivable
Losses and loss adjustment expenses.................................................... 81,374 82,450
Unearned premiums...................................................................... 47,106 44,791
Due from reinsurers...................................................................... 71,156 61,554
Deferred income taxes.................................................................... 15,470 12,041
Receivable for investments sold.......................................................... 355 -
Non-compete agreement.................................................................... 2,567 2,829
Other assets............................................................................. 5,768 4,461
Total assets....................................................................... $2,177,903 $2,075,614
<caption>
LIABILITIES AND STOCKHOLDERS' EQUITY
<s> <c> <c>
Liabilities
Unpaid losses and loss adjustment expenses............................................. $ 688,180 $ 674,140
Unearned premiums...................................................................... 593,544 519,885
Current income taxes................................................................... 8,781 13,988
Deferred income........................................................................ 6,940 7,703
Contingent commissions accrued......................................................... 27,256 35,346
Payable for securities purchased....................................................... 581 524
Excess of book value of subsidiary interest over cost.................................. 6,398 8,431
Other liabilities and accrued expenses................................................. 39,566 32,648
Total liabilities.................................................................. 1,371,246 1,292,665
Minority interest........................................................................ - 1,068
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value; none issued in
2001 and 2000........................................................................ - -
Common stock, authorized 100,000,000 shares at $.50 par value;
38,000,000 shares issued in 2001 and 2000............................................ 19,000 19,000
Paid-in capital........................................................................ 29,621 29,621
Net accumulated other comprehensive income, net of income taxes of
$8,197 in 2001 and $6,371 in 2000.................................................... 15,222 11,833
Retained earnings...................................................................... 855,503 820,528
919,346 880,982
Treasury stock 4,609,548 shares in 2001 and 4,246,648 in 2000.......................... (112,689) (99,101)
Total stockholders' equity......................................................... 806,657 781,881
Total liabilities, minority interest and stockholders' equity...................... $2,177,903 $2,075,614
</table>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 3 -
<page>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three and Nine Months Ended September 30, 2001 and 2000
(Thousands of Dollars Except Per Share Data)
(Unaudited)
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
<s> <c> <c> <c> <c>
Revenues
Direct premiums written................................... $ 290,088 $ 268,415 $ 897,576 $ 840,595
Assumed premiums.......................................... 20,981 19,876 59,021 60,736
Ceded premiums............................................ (41,885) (37,677) (113,365) (111,058)
Net premiums written.................................. 269,184 250,614 843,232 790,273
Increase in unearned premiums............................. (1,374) (10,928) (67,126) (90,500)
Earned premiums........................................... 267,810 239,686 776,106 699,773
Net investment income..................................... 24,274 24,120 74,753 71,008
Premium finance and service fees.......................... 4,644 3,914 13,260 11,463
Amortization of excess of book value of subsidiary
interest over cost...................................... 848 847 2,542 2,542
Net realized investment gains (losses).................... (2,934) 27,213 (9,275) 24,166
Total revenues....................................... 294,642 295,780 857,386 808,952
Expenses
Losses and loss adjustment expenses....................... 199,445 185,143 582,749 537,796
Policy acquisition costs.................................. 70,322 63,118 196,920 178,707
Total expenses....................................... 269,767 248,261 779,669 716,503
Earnings before income taxes and minority interest... 24,875 47,519 77,717 92,449
Income taxes................................................ 3,362 11,570 13,619 16,112
Net earnings before minority interest................ 21,513 35,949 64,098 76,337
Minority interest in net loss of subsidiary................. 626 25 863 247
NET EARNINGS......................................... $ 22,139 $ 35,974 $ 64,961 $ 76,584
COMPREHENSIVE INCOME................................. $ 19,823 $ 44,921 $ 68,350 $ 93,630
NET EARNINGS PER COMMON SHARE:
BASIC.............................................. $ 0.66 $ 1.05 $ 1.93 $ 2.24
DILUTED............................................ $ 0.65 $ 1.05 $ 1.92 $ 2.24
NET EARNINGS PER SHARE EXCLUDING THE AFTER-TAX
IMPACT OF NET REALIZED INVESTMENTS GAINS (LOSSES):
BASIC.............................................. $ 0.70 $ 0.51 $ 2.09 $ 1.71
DILUTED............................................ $ 0.69 $ 0.51 $ 2.08 $ 1.71
CASH DIVIDENDS PAID PER COMMON SHARE................. $ 0.30 $ 0.29 $ 0.89 $ 0.86
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
BASIC.............................................. 33,650,563 34,118,038 33,718,712 34,181,427
DILUTED............................................ 33,918,388 34,118,038 33,871,028 34,181,427
</table>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 4 -
<page>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2001 and 2000
(Thousands of Dollars)
(Unaudited)
<table>
<caption>
2001 2000
<s> <c> <c>
Cash flows from operating activities:
Premiums collected.................................................... $ 788,834 $720,261
Net investment income received........................................ 75,614 68,524
Premium finance and service fees received............................. 13,260 11,463
Losses and loss adjustment expenses paid.............................. (570,189) (488,673)
Policy acquisition costs paid......................................... (210,832) (195,130)
Federal income tax payments........................................... (24,080) (28,931)
Net cash provided by operating activities......................... 72,607 87,514
Cash flows from investing activities:
Proceeds from maturity of fixed maturities............................ 16,169 16,148
Proceeds from sale of fixed maturities................................ 77,657 70,254
Proceeds from sale of equity securities............................... 34,844 24,611
Proceeds from sale of preferred stock mutual funds.................... 3,080 -
Proceeds from sale of other investments............................... 2,679 5,170
Payments received on mortgage loans and collateral notes receivable... 10,921 7,369
Purchase of fixed maturities.......................................... (13,993) (86,855)
Purchase of equity securities......................................... (28,984) (24,604)
Purchase of preferred stock mutual funds.............................. (14,195) (50,747)
Purchase of other investments......................................... (1,013) (14,240)
Mortgage loans and collateral notes originated........................ (1,649) (7,255)
Purchase of property and equipment.................................... (8,168) (2,631)
Other proceeds from investing activities.............................. 829 905
Net cash provided by (used in) investing activities............... 78,177 (61,875)
Cash flows from financing activities:
Dividends paid to stockholders........................................ (29,986) (29,374)
Purchase of treasury stock............................................ (13,588) (7,771)
Net cash used in financing activities............................. (43,574) (37,145)
Increase (decrease) in cash and cash equivalents...................... 107,210 (11,506)
Cash and cash equivalents at beginning of period...................... 70,521 22,535
Cash and cash equivalents at the end of period.................... $ 177,731 $ 11,029
</table>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 5 -
<page>
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating Activities
Nine Months Ended September 30, 2001 and 2000
(Thousands of Dollars)
(Unaudited)
<table>
<caption>
2001 2000
<s> <c> <c>
Cash flows from operating activities:
Net earnings.......................................................... $ 64,961 $ 76,584
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums receivable................................................. (54,624) (73,792)
Deferred policy acquisition costs................................... (9,453) (13,769)
Residual market receivable.......................................... (1,239) (4,517)
Due to/from reinsurers.............................................. (9,602) (13,718)
Losses and loss adjustment expenses................................. 14,040 58,398
Unearned premiums................................................... 73,659 100,223
Current income taxes................................................ (5,207) (15,570)
Deferred income taxes............................................... (5,255) 2,751
Deferred income..................................................... (763) 535
Contingent commissions.............................................. (8,090) (6,206)
Other assets, liabilities and accrued expenses...................... 3,577 2,393
Net realized investment (gains) losses.............................. 9,275 (24,166)
Other - net......................................................... 1,328 (1,632)
Net cash provided by operating activities.................... $ 72,607 $ 87,514
</table>
The accompanying notes are an integral part of these consolidated
financial statements.
- - 6 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
1. The financial information has been prepared on a basis consistent with
the accounting principles reflected in the audited consolidated
financial statements for the year ended December 31, 2000. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States, have been omitted pursuant to the
Securities and Exchange Commission rules and regulations, although the
Company believes the disclosures which have been made are adequate to
make the information presented not misleading.
2. The information furnished includes all adjustments and accruals
consisting of normal recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of results for the interim
periods. Certain previously reported 2000 account balances have been
reclassified to conform to the current period's presentation.
3. This Form 10-Q contains some statements that are not historical facts
and are considered "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve opinions, assumptions and predictions, and no
assurance can be given that the future results will be achieved since
events or results may differ materially as a result of risks facing the
Company. These include, but are not limited to, those risks and
uncertainties in our business that are described in the Company's Forms
10-K and 10-Q, Schedules 13D and 13G, and other documents filed with the
SEC, the possibility of adverse catastrophe experience and severe
weather, adverse trends in claim severity or frequency, adverse state
and federal regulation and legislation, interest rate risk, rate making
decisions for private passenger automobile policies in Massachusetts,
potential rate filings outside of Massachusetts, adverse impacts related
to consolidation activities, heightened competition, as well as
economic, market or regulatory conditions and risks associated with
entry into new markets and diversification.
4. The consolidated financial statements should be read in conjunction with
the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
5. Neither the results for the nine months ended September 30, 2001 nor
comparison with the corresponding nine months ended September 30, 2000
should be considered indicative of the results which may be expected for
the year ending December 31, 2001.
6. The company purchased 362,900 shares of treasury stock under the stock
buyback program through September 30, 2001, all purchased during the
third quarter (299,700 shares were purchased during the nine months
ended September 30, 2000). The Company currently holds 4,609,548 shares
of treasury stock. At September 30, 2001, the Company has the ability
to purchase 533,700 additional shares of Treasury stock under the
current Board of Directors' authorization.
- - 7 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(Continued)
7. 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. On May
10, 2000, the Massachusetts Commissioner of Insurance ("Commissioner")
filed a "Motion for order approving cancellation of policies" with the
Supreme Judicial Court for Suffolk County. This motion indicated that
"there is substantial risk that Trust Insurance may be insolvent" and
further asked the court that Trust's "insurance exposures be promptly
terminated, their liabilities runoff and their true financial condition
thereby determined". Based on this motion, all of Trust's remaining
36,000 homeowner policies and 99,300 personal automobile policies were
set for cancellation effective August 1, 2000 and October 1, 2000,
respectively. On July 27, 2000, the court ruled that Trust was
insolvent and was subsequently placed into liquidation on August 2,
2000. The Company experienced an increase in new business primarily in
the third and fourth quarter of 2000 as a result of this event. In the
latter part of 2000, another Massachusetts insurance company, New
England Fidelity Insurance Company, was ordered into liquidation by the
Commissioner. This company was the twenty-second largest writer in
Massachusetts based on year-end 1999 writings and was approximately one-
sixth the size of Trust. The Company experienced an increase in
Massachusetts personal automobile business primarily through the first
six months of 2001 as a result of agreeing to write the majority of the
New England Fidelity business effective January 1, 2001.
8. During 2001, as required by the Emerging Issues Task Force ("EITF") D-
46, the Company amended its policy in regard to its investments in
venture capital fund limited partnerships. EITF D-46 requires companies
who own more than a 5% share of a limited partnership to account for
these investments on an equity basis. The operating results of these
venture capital fund limited partnerships have been reflected in
realized gains and losses. Prior to this change, the operating results
were not material and were therefore reflected in accumulated other
comprehensive income and loss.
9. Beginning in the first quarter of 2001, the Company, in the 2001 and
prior years' results, classified its undistributed equity in the
earnings and losses on investments in closed-end preferred stock mutual
funds in net realized investment gains and losses. For the year ended
2000, the undistributed equity in the earnings and losses of these funds
was reported in net investment income. Prior to the December 31, 2000,
year-end reporting, the Company did not include the undistributed equity
in its quarterly or annual filings. The Company believes this new
classification better presents the undistributed equity component of
these funds. These investments are valued at original cost plus the
cumulative undistributed equity in earnings and losses of the funds and
adjusted over time by the premium or discount at the time of purchase to
the applicable underlying net asset value of the funds.
- - 8 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(continued)
10. Disclosure of Statement of Financial Accounting Standards No. 130 -
Reporting Comprehensive Income:
<table>
<caption>
Three Months Ended
September 30,
2001 2000
<s> <c> <c>
Net earnings.......................................... $ 22,139 $ 35,974
Other comprehensive income, net of taxes:
Change in unrealized gains (losses), net of
income taxes (benefits) of ($1,852) in 2001
and $4,881 in 2000................................. (3,440) 9,065
Reclassification adjustment, net of income taxes
(benefits) of $605 in 2001 and ($64) in 2000....... 1,124 (118)
Other comprehensive income............................ (2,316) 8,947
Comprehensive income.................................. $ 19,823 $ 44,921
<caption>
Nine Months Ended
September 30,
2001 2000
<s> <c> <c>
Net earnings.......................................... $ 64,961 $ 76,584
Other comprehensive income, net of taxes:
Change in unrealized gains, net of
income taxes of $1,176 in 2001
and $8,817 in 2000................................. 2,184 16,374
Reclassification adjustment, net of income taxes
of $649 in 2001 and $362 in 2000.................. 1,205 672
Other comprehensive income............................ 3,389 17,046
Comprehensive income.................................. $ 68,350 $ 93,630
</table>
- - 9 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(continued)
11. Disclosure of Statement of Financial Accounting Standards No. 131 -
Disclosures about
Segments of an Enterprise and Related Information:
<table>
<caption>
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Three Months Ended September 30, 2001
<s> <c> <c> <c>
Property and casualty insurance
Massachusetts...................... $258,783 $ 28,633 $ 1,883,802
Other than Massachusetts........... 34,180 (4,259) 245,367
Real estate and commercial lending... 829 829 44,294
Corporate and other.................. 850 (328) 4,440
Consolidated...................... $294,642 $ 24,875 $ 2,177,903
Three Months Ended September 30, 2000
Property and casualty insurance
Massachusetts...................... $261,759 $ 44,945 $ 1,783,824
Other than Massachusetts........... 32,625 2,881 238,835
Real estate and commercial lending... 548 548 52,203
Corporate and other.................. 848 (855) 9,109
Consolidated...................... $295,780 $ 47,519 $ 2,083,971
<caption>
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Nine Months Ended September 30, 2001
<s> <c> <c> <c>
Property and casualty insurance
Massachusetts...................... $752,371 $ 79,594 $ 1,883,802
Other than Massachusetts........... 99,705 (2,883) 245,367
Real estate and commercial lending... 2,762 2,762 44,294
Corporate and other.................. 2,548 (1,756) 4,440
Consolidated...................... $857,386 $ 77,717 $ 2,177,903
<caption>
Nine Months Ended Sept 30, 2000
<s> <c> <c> <c>
Property and casualty insurance
Massachusetts...................... $711,739 $ 85,840 $ 1,783,824
Other than Massachusetts........... 89,819 4,729 238,835
Real estate and commercial lending... 4,818 4,818 52,203
Corporate and other.................. 2,576 (2,938) 9,109
Consolidated...................... $808,952 $ 92,449 $ 2,083,971
</table>
- - 10 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(continued)
12. Disclosure of Supplemental Information:
<table>
<caption>
OTHER INFORMATION:
September 30,
2001 2000
Massachusetts policies in force
<s> <c> <c>
Private passenger automobile......................... 682,493 644,703
Homeowners........................................... 145,351 134,046
Commercial automobile................................ 17,665 15,957
<caption>
OTHER EARNINGS STATEMENT INFORMATION:
Three Months Ended
September 30,
2001 2000
Earned premiums by Massachusetts subsidiaries
<s> <c> <c>
Private passenger automobile......................... $ 216,548 $ 197,815
Homeowners........................................... 4,871 4,330
Commercial automobile................................ 14,449 10,696
Other lines.......................................... 855 879
Earned premiums by subsidiaries in other states........ 31,087 25,966
Total........................................... $ 267,810 $ 239,686
Net investment income, after tax....................... $ 19,390 $ 19,726
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile......................... 64.4% 67.6%
Homeowners (gross of reinsurance).................... 54.1% 38.8%
Commercial automobile................................ 66.4% 61.6%
Pure loss ratios of subsidiaries in other states....... 63.3% 67.2%
Massachusetts private passenger automobile
exposures written..................................... 221,289 208,162
Massachusetts private passenger automobile direct
premiums written..................................... $ 213,511 $ 204,046
</table>
- - 11 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(continued)
12. Disclosure of Supplemental Information (continued):
<table>
<caption>
OTHER EARNINGS STATEMENT INFORMATION:
Nine Months Ended
September 30,
2001 2000
<s> <c> <c>
Earned premiums by Massachusetts subsidiaries
Private passenger automobile......................... $ 632,622 $ 577,066
Homeowners........................................... 14,183 12,819
Commercial automobile................................ 38,055 29,456
Other lines.......................................... 2,482 2,705
Earned premiums by subsidiaries in other states........ 88,764 77,727
Total........................................... $ 776,106 $ 699,773
Net investment income, after tax....................... $ 60,144 $ 58,657
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile......................... 65.1% 68.0%
Homeowners (gross of reinsurance).................... 52.1% 39.6%
Commercial automobile................................ 66.0% 61.7%
Pure loss ratios of subsidiaries in other states....... 64.8% 64.0%
Massachusetts private passenger automobile
exposures written..................................... 730,908 694,465
Massachusetts private passenger automobile direct
premiums written..................................... $ 680,267 $ 658,900
</table>
- - 12 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios
and Other Information)
(continued)
13. Closed-end Preferred Stock Mutual Funds
The following table reflects the shares held, percentage of ownership,
carrying value at equity, book value, market value, and value of shares at net
asset value, by fund for the nine months ended September 30, 2001 and the year
ended December 31, 2000:
<table>
<caption>
(Dollars in Thousands, Except Share Amounts)
At September 30, 2001
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol (1) Held Ownership at Equity Value Value Asset Value
<s> <c> <c> <c> <c> <c> <c>
PGD 2,228,800 26.7% $ 27,969 $ 24,037 $ 28,274 $ 30,401
PPF 2,365,200 32.6% 29,621 26,192 28,028 30,842
PDF 4,650,300 31.0% 44,284 42,064 40,690 45,294
PDT 4,962,300 33.1% 58,432 53,543 53,593 59,895
DIV 3,490,900 35.3% 50,261 48,389 50,305 52,014
PFD 2,981,500 30.3% 42,380 44,803 41,890 42,397
PFO 4,050,043 36.3% 45,723 48,914 44,064 45,968
Total $298,670 $287,942 $286,844 $306,811
<caption>
At December 31, 2000
Fund Carrying Quoted Value of
Fund Shares % of Value Book Market Shares at Net
Symbol (1) Held Ownership at Equity Value Value Asset Value
<s> <c> <c> <c> <c> <c> <c>
PGD 1,877,300 22.5% $ 23,478 $ 19,666 $ 22,528 $ 26,695
PPF 2,352,900 32.4% 28,322 26,048 25,882 30,470
PDF 4,638,800 31.0% 46,003 41,966 40,589 47,594
PDT 4,925,100 32.8% 60,453 53,144 52,021 63,091
DIV 3,080,500 31.2% 46,314 42,500 40,239 48,918
PDI (2) 5,253,400 48.5% 52,207 52,583 52,534 54,110
PFD 2,981,500 30.3% 39,834 44,803 36,151 40,012
PFO 3,892,543 34.9% 41,122 47,270 40,385 41,533
Total $337,733 $327,980 $310,329 $352,423
</table>
(1) John Hancock Patriot Global Dividend Fund ("PGD"), John Hancock Patriot
Preferred Dividend Fund, ("PPF"), John Hancock Patriot Premium Dividend I Fund
("PDF"), John Hancock Patriot Premium Dividend II Fund ("PDT"), John Hancock
Patriot Select Dividend Fund ("DIV"), Putnam Dividend Income Fund ("PDI"),
Preferred Income Fund ("PFD"), Preferred Income Opportunity Fund ("PFO").
(2) In 2001, PDI liquidated the fund. Commerce's pro-rata share of the
portfolio securities and cash of PDI was transferred to a separate trust fund
owned by the Company. At September 30, 2001 the trust fund was consolidated
into the Company's financial statements and equated to a value of $59,063.
The majority of the trust fund value is $54,441 and is included in preferred
stocks and $4,050 in cash and cash equivalents.
- - 13 -
<page>
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
13. Closed-end Preferred Stock Mutual Funds (continued)
The difference between the carrying value at equity and the value of
shares at net asset value is negative goodwill created at the time of purchase
of the shares. FAS 141, which was implemented on July 1, 2001, specifically
addresses the manner in which to account for negative goodwill. For purchases
prior to July 1, 2001 which created negative goodwill, the Company will
continue to amortize the negative goodwill on these securities through the end
of 2001. This negative goodwill is being amortized into investment income
over various periods ranging from 1.25 years to 4 years based on the turnover
ratios of the funds. For purchases subsequent to June 30, 2001 which create
negative goodwill, the negative goodwill was recognized as a realized gain of
$135 at the time of purchase.
14. Earnings Per Share
Earnings per diluted common share is based on the weighted average number
of diluted common shares outstanding during each period. The Company's only
potentially dilutive instruments are stock options outstanding, and dilution
from these is not significant.
15. Transfer of Business from Berkshire Mutual Insurance Company
The Company entered into an agreement on September 28, 2001, with
Berkshire Mutual Insurance Company for the transfer of Massachusetts personal
automobile business written by Berkshire to The Commerce Insurance Company,
effective January 1, 2002. Under terms of the agreement, Commerce Insurance
shall offer agency contracts to independent agencies that represent Berkshire
for personal automobile insurance in Massachusetts. This will allow agents of
Berkshire the opportunity to offer Commerce automobile insurance policies that
renew in 2002. Commerce will assume all of Berkshire's obligations for future
policy years beyond 2001 under the Massachusetts residual market system,
(commonly known as C.A.R.-Commonwealth Automobile Reinsurers), including
assignment of Berkshire's involuntary agents. The Company will receive
consideration of $7,000 from Berkshire in early January, 2002.
16. Events Subsequent to September 30, 2001
The Company announced the formation of a marketing alliance with Horace
Mann Educators Corporation on October 18, 2001. Under the terms of an agency
agreement between Commerce and Horace Mann Service Corporation ("HMSC"), a
licensed brokerage agency in the State of Massachusetts, HMSC will provide its
personal automobile customers with Commerce Insurance policies. New personal
automobile policies sold by HMSC will be insured with Commerce, beginning no
later than January 1, 2002. All personal auto policies currently written by
HMSC will convert to Commerce policies upon renewal in 2002.
The Commissioner of Insurance of the Commonwealth of Massachusetts
approved a stipulated settlement for 2002 personal automobile insurance rates
between the Automobile Insurers Bureau of Massachusetts, the State Rating
Bureau, the Office of the Attorney General and the Association of Insurance
Agents. The four parties to the Massachusetts private passenger automobile
rate setting case reached a settlement that will result in no change in rates
or commissions for 2002. The Company is analyzing the effects of the rate
decision and is in the process of estimating its impact on the Company.
During the fourth quarter of 2001 the Company received notice of an
assessment from the Massachusetts Insurers Insolvency Fund ("MIIF") amounting
to $3,100, 40% of which related to the Trust Insurance insolvency and 60%
related to the insolvency of Reliance Insurance Company. This amount will be
expensed in the fourth quarter of 2001. As of September 30, 2001, the Company
was unable to reasonably estimate this assessment and is unable to determine
if additional assessments are likely for either insolvency.
- - 14 -
<page>
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30, 2001 compared to
three months ended September 30, 2000
(Thousands of Dollars Except Per Share Data)
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the three months ended September 30, 2001 and
2000:
<table>
<caption>
(Dollars in thousands)
Three Months Ended September 30,
2001 2000 Change % Change
<s> <c> <c> <c> <c>
Direct Premiums Written:
Personal Automobile in Massachusetts........ $213,511 $204,046 $ 9,465 4.6%
Personal Automobile in all other states..... 30,251 26,967 3,284 12.2
Commercial Automobile in Massachusetts...... 13,640 9,429 4,211 44.7
Commercial Automobile in all other states... 647 - 647 -
Homeowners in Massachusetts................. 22,017 19,551 2,466 12.6
Homeowners in all other states.............. 5,099 4,512 587 13.0
Other Lines in Massachusetts................ 4,735 3,815 920 24.1
Other Lines in all other states............. 188 95 93 97.9
Total Direct Premiums Written............ $290,088 $268,415 $ 21,673 8.1%
Net Premiums Written:
Personal Automobile in Massachusetts........ $215,251 $205,966 $ 9,285 4.5%
Personal Automobile in all other states..... 30,234 26,629 3,605 13.5
Commercial Automobile in Massachusetts...... 14,720 10,534 4,186 39.7
Commercial Automobile in all other states... 636 - 636 -
Homeowners in Massachusetts................. 6,022 5,341 681 12.8
Homeowners in all other states.............. 1,254 1,147 107 9.3
Other Lines in Massachusetts................ 1,020 961 59 6.1
Other Lines in all other states............. 47 36 11 30.6
Total Net Premiums Written............... $269,184 $250,614 $ 18,570 7.4%
Earned Premiums:
Personal Automobile in Massachusetts........ $197,222 $182,773 $ 14,449 7.9%
Personal Automobile in all other states..... 29,771 24,954 4,817 19.3
Commercial Automobile in Massachusetts...... 11,331 8,376 2,955 35.3
Commercial Automobile in all other states... 181 - 181 -
Homeowners in Massachusetts................. 4,871 4,330 541 12.5
Homeowners in all other states.............. 1,094 870 224 25.7
Other Lines in Massachusetts................ 801 812 (11) (1.4)
Other Lines in all other states............. 41 142 (101) (71.1)
Assumed Premiums from C.A.R................. 22,444 17,362 5,082 29.3
Assumed Premiums from other than C.A.R...... 54 67 (13) (19.4)
Total Earned Premiums.................... $267,810 $239,686 $ 28,124 11.7%
Earned Premiums in Massachusetts............ $214,225 $196,291 $ 17,934 9.1
Earned Premiums-Assumed..................... 22,498 17,429 5,069 29.1
Earned Premiums in all other states......... 31,087 25,966 5,121 19.7
Total Earned Premiums.................... $267,810 $239,686 $ 28,124 11.7%
</table>
The $9,465 or 4.6% increase in Massachusetts personal automobile direct
premiums written during the third quarter of 2001 resulted primarily from
increases of 6.3% and 7.5% in the number of Massachusetts personal automobile
exposures for liability and physical damage coverage, respectively, offset by
decreases in the average written premium rate per exposure for Massachusetts
personal automobile liability and physical damage exposures.
- - 15 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The average written premium per exposure percentage decreases for the
third quarter of 2001 were primarily the result of rate modifications in the
individual coverage components in the 2001 state mandated average rate
decrease, offset by decreases in the Company's safe driver rate deviations.
The combination of these factors resulted in a 1.8% decrease in the average
personal automobile premium per exposure for the third quarter of 2001 as
compared to an increase of 6.0% during the third quarter of 2000. Despite the
2001 state mandated average rate decrease of 8.3%, the Company's smaller
decrease 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.
The accompanying table depicts the AAA Affinity Group Discount, SDIP
Deviations and their combined reduction from Massachusetts average mandated
rates:
<table>
<caption>
AAA Affinity Group Discount and SDIP Deviations* 2001 2000
<s> <c> <c>
AAA Affinity Group Discount..................................... 6% 6%
SDIP Step 9 Deviation........................................... 2% 6%
SDIP Step 10 Deviation.......................................... 0% 2%
Combined AAA Affinity Group Discount and Step 9 Deviation....... 7.9% 11.6%
Combined AAA Affinity Group Discount and Step 10 Deviation...... 6.0% 7.9%
</table>
* For Massachusetts policies with effective dates as of January 1, 2001 and
2000 or thereafter, respectively.
Other states personal automobile direct premiums written increased $3,284
or 12.2% during the third quarter of 2001 as compared to the same period in
2000, however an overall depressed rate environment resulted in diminished
underwriting profits. The Company is in the process of evaluating a number of
its other than Massachusetts state rating structures, has filed for increases
in several states and will seek additional rate increases where appropriate.
Personal automobile direct premiums written by American Commerce Insurance
Company ("American Commerce"), located in Columbus, Ohio, for the third
quarter of 2001 increased $860 or 4.3% to $21,057 as compared to $20,197 for
the same period a year ago. Personal automobile direct premiums written for
Commerce West Insurance Company ("Commerce West"), located in Pleasanton,
California, increased $2,424 or 35.8% to $9,194 during the third quarter of
2001 as compared to $6,770 during the same period a year ago. Both American
Commerce and Commerce West write predominantly personal automobile insurance.
American Commerce writes personal automobile insurance in 23 states while
Commerce West writes personal automobile insurance in the states of California
and Oregon. Both companies target preferred insurance risks, however Commerce
West's recent growth is attributable to the introduction of a non-standard
auto product in late 2000.
Direct premiums written for Massachusetts commercial automobile insurance
increased by $4,211 or 44.7%, due primarily to an increase of approximately
11.5% in the number of policies written and a 29.7% increase in the average
commercial automobile premium per policy. The increase in premium per policy
was attributable to a hardening of the commercial automobile market, primarily
in larger commercial accounts. The Company continued to experience a
significant increase in accounts with premiums in excess of $50. In addition,
rates for other voluntary commercial automobile policies have increased
moderately combined with an approximate 10% increase in rates for policies
written through Commonwealth Automobile Reinsurers ("C.A.R."). The increased
business was attributable to the Company's initiative to expand writings,
especially those with premiums in excess of $50.
- - 16 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Direct premiums written for Massachusetts homeowners insurance increased
by $2,466 or 12.6% due primarily to a 5.7% increase in the number of policies
written coupled with a 6.5% increase in the average premium per policy. The
increase in business was primarily due to additional business from existing
and newly appointed agents. Other states homeowners insurance written by
American Commerce increased $587 or 13.0% to $5,099, due primarily to book
rollovers of business from existing agents as well as an increase in new
agents.
The $18,570 or 7.4% increase in net premiums written was primarily due to
the growth in direct premiums written as described above and by an increase of
premiums assumed from C.A.R. offset by a slight increase in premiums ceded to
C.A.R., as well as an increase to premiums ceded to reinsurers other than
C.A.R. Premiums ceded to reinsurers other than C.A.R., during the third
quarter of 2001, increased $2,908 or 13.9% as compared to the third quarter of
2000 primarily as a result of the effect from the 75% quota share treaty on
the increased business in homeowners previously mentioned. Of the $18,570
increase in net premiums written, $14,211 was associated with Massachusetts
business, $3,057 was attributable to increased writings for Commerce West due
to the increase in non-standard business previously mentioned, with the
remainder attributable to American Commerce.
The $28,124 or 11.7% increase in total earned premiums during the third
quarter of 2001 as compared to the third quarter of 2000 was primarily
attributable to increases in Massachusetts personal automobile liability and
physical damage exposures, coupled with an increase in earned premium per
exposure. The increase in earned premium per exposure occurs (versus a
decrease in written premium per exposure) because of the time lag it takes to
earn the premium once it is written. This primarily related to an increase in
written premium in the third and fourth quarter of last year. This resulted
in a $14,449 or 7.9% increase for Massachusetts personal automobile earned
premiums.
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio. The following table summarizes the
composition of the Company's investment portfolio, at cost, at September 30,
2001 and 2000 (the Company's investment portfolio, at market and equity is
shown in the table found on page 27):
<table>
<caption>
Investments, at cost September 30,
(Dollars in thousands) % of % of
2001 Invest. 2000 Invest.
<s> <c> <c> <c> <c>
Fixed maturities (GNMA & FNMA mortgage-
backed bonds, corporate bonds, U.S.
Treasury bonds and notes and tax-
exempt state and municipal bonds)...... $ 585,211 40.0% $ 664,570 47.9%
Preferred stocks......................... 259,164 17.7 223,653 16.1
Common stocks............................ 87,703 6.0 94,580 6.8
Closed-end preferred stock mutual funds.. 287,942 19.7 319,166 23.0
Mortgages and collateral loans (net of
allowance for possible loan losses).... 42,507 2.9 52,645 3.8
Cash and cash equivalents................ 177,731 12.1 11,029 0.8
Other investments........................ 24,286 1.6 22,200 1.6
Total investments.................... $1,464,544 100.0% $1,387,843 100.0%
</table>
The Company's investment strategy is to maximize after-tax investment
income through investing in 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.
- - 17 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
As depicted in the accompanying table, third quarter 2001 net investment
income increased $154 or 0.6%, compared to the same period in 2000,
principally as a result of an increase in average invested assets (at cost),
offset by a decrease in yield. The decrease in yield is primarily due to
lower short-term yields on larger cash and cash equivalents balances, coupled
with an environment of higher yielding fixed maturities being called. The
Company continues to monitor interest rates on long-term securities and
intends to maintain its short position until such time as the Company believes
long-term rates have appropriately firmed. Net investment income as a
percentage of total average investments was 6.4% in the third quarter of 2001
compared to 7.0% for the same period in 2000. Net investment income after tax
as a percentage of total average investments was 5.1% and 5.7% in the third
quarter of 2001 and 2000, respectively.
<table>
<caption>
Investment Return Quarter Ending September 30,
(Dollars in thousands) 2001 2000
<s> <c> <c>
Average month-end investments (at cost)... $1,507,813 $1,380,139
Net investment income..................... 24,274 24,120
Net investment income after-tax........... 19,390 19,726
Net investment income as a percentage
of average net investments (at cost).... 6.4% 7.0%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.1% 5.7%
</table>
Amortization of 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 January 29, 1999 was $16,947. The amount is being
amortized into revenue on a straight-line basis over a five-year period. The
amount amortized into revenue was $848 and $847 for the third quarter of 2001
and 2000, respectively.
Investment Gains and Losses
Net realized investment losses totaled $2,934 during the third quarter
of 2001 as compared to net realized investment gains of $27,213 during the
same period in 2000 as detailed below.
In 2001, the Company began to account for investments in certain venture
capital fund limited partnerships on an equity basis. The equity in the
operating results of these funds has been reflected in realized gains and
losses. Prior to this change, the operating results were not material and
were therefore reflected in accumulated other comprehensive income and loss.
Also during 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and
losses. Prior to the December 31, 2000, year-end reporting, the Company did
not include the undistributed equity in its quarterly or annual filings.
Prior period results have been reclassified to realized gains and losses to
conform with current period presentation. During the third quarters of 2001
and 2000, the Company reflected realized (losses) and gains of ($1,677) and
$24,791, respectively, as a result of this change.
- - 18 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net realized gains and (losses) by category for the quarter ended
September 30, are as follows:
<table>
<caption>
September 30, September 30,
2001 2000
<s> <c> <c>
*Closed-end preferred stock mutual funds.......... $ (1,677) $ 24,791
Venture capital fund investments................. 1,392 -
Bonds............................................ (1,345) (201)
Common and preferred stocks...................... (1,196) 3,702
Other............................................ (108) (1,079)
Net realized investment gains (losses)...... $ (2,934) $ 27,213
</table>
* Includes $1,789 in 2001 and $2,333 in 2000 for the three months ended,
respectively, relating to the amortization of the net discount, at the time of
purchase, of these securities.
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased $14,302 or
7.7% during the third quarter of 2001 as compared to the same period a year
ago. Massachusetts operations experienced improved underwriting results
primarily due to lower Massachusetts residual market losses. These
improvements were offset by increased losses in the homeowners property
business and in personal automobile physical damage compared to last year.
The loss ratio included a charge of $1.7 million (0.6% of the loss ratio) to
cover the estimated costs associated with the consolidation of several
functions from American Commerce in Ohio to Commerce in Massachusetts. Losses
and LAE incurred (on a statutory basis) as a percentage of insurance premiums
earned ("loss ratio") decreased to 75.1% for the third quarter of 2001
compared to 77.3% for the third quarter of 2000. The ratio of net incurred
losses, excluding LAE, to premiums earned ("pure loss ratio") on Massachusetts
personal automobile was 64.4% for the third quarter of 2001 compared to 67.6%
for the same period a year ago. In addition to the information noted above,
the pure loss ratio decreased due to an increase of 0.3% in earned premium per
earned exposure. The commercial automobile pure loss ratio increased to 66.4%
during the third quarter of 2001 as compared to 61.6% for the same period a
year ago primarily due to higher bodily injury losses. For Massachusetts
homeowners (gross of reinsurance), the pure loss ratio was 54.1% during the
third quarter of 2001 as compared to 38.8% for the same period a year ago.
This increase was primarily the result of more property losses during the
third quarter of 2001 as compared to the same period last year. Pure loss
ratios of subsidiaries in other states decreased to 63.3% during the third
quarter of 2001 as compared to 67.2% for the same period a year ago. This
decrease was due primarily to decreases in personal automobile physical damage
claims, coupled with lower personal automobile bodily injury losses. The loss
ratio (on a statutory basis) for Commerce West and American Commerce was 84.6%
and 87.0%, respectively, for the third quarter of 2001, compared to 79.4% and
88.1%, respectively, for the third quarter of 2000. The increase in the loss
ratio for Commerce West was primarily attributable to a substantial increase
in non-standard automobile writings with loss ratios that are significantly
higher than their regular business.
- - 19 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy Acquisition Costs
Policy acquisition costs expensed increased by $7,204 or 11.4% during the
third quarter of 2001 as compared to the same period a year ago. As a
percentage of net premiums written, underwriting expenses for the insurance
companies (on statutory basis) decreased to 25.2% for the third quarter of
2001 as compared to 26.6% for the same period a year ago. The decrease, as
compared to the same period a year ago, was primarily attributable to a $4,900
charge in 2000 (2.0% of the ratio) which represented the Company's allocation
from the MIIF for the Trust insolvency. The underwriting ratio for the third
quarter of 2001 included a charge of $0.8 million (0.3% of the underwriting
expense ratio) to cover the estimated costs associated with the consolidation
of several functions from American Commerce to Commerce. The underwriting
expense ratio (on a statutory basis) for Commerce West and American Commerce
was 32.6% and 38.1%, respectively, for the third quarter of 2001, compared to
34.2% and 32.3%, respectively, for the same period a year ago. The decrease
in the Commerce West ratio was primarily a function of enhanced economies of
scale as premium writings increased.
Income Taxes
The Company's effective tax rate was 13.5% for the third quarter of 2001
as compared to 24.3% for the same period a year ago. 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 the third quarter of 2001 was the result of
realized investment losses in the third quarter as compared to realized
investment gains in the prior year third quarter, coupled with the tax-exempt
interest and the dividends received deduction comprising a larger portion of
earnings before taxes. The third quarter 2000 tax rate was high due primarily
to the significant amount of gains reported on preferred stock mutual funds.
Minority Interest
As a result of the joint venture with AAA Southern New England ("AAA
SNE") and the acquisition of American Commerce, the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly owned subsidiary of Commerce
Holdings, Inc. ("Commerce Holdings"), is represented by ownership of 80% of
the outstanding shares of ACIC Holding Co., Inc. common stock at September 30,
2001. AAA SNE maintains a 20% common stock ownership. The minority interest
in net loss of subsidiary of $626 included in these consolidated financial
statements for the third quarter of 2001 represents 20% of the net loss during
the third quarter for ACIC Holding Co., Inc. which is calculated after the
$2,334 preferred stock dividend paid to Commerce. This compares to the
minority interest in net losses of subsidiary of $25 after $2,310 in preferred
stock dividend paid to Commerce in the third quarter of 2000.
Net Earnings
Net earnings decreased $13,835 or 38.5% to $22,139 during the third
quarter of 2001 as compared to $35,974 for the same period a year ago.
Operating earnings, which exclude the after-tax impact of net realized
investment gains and losses, increased $5,950 or 34.1% to $23,419 ($0.70 per
share basic and $0.69 per share diluted) during the third quarter of 2001 as
compared to $17,469 ($0.51 per share basic and diluted) for the same period a
year ago, both as a result of the factors previously mentioned.
- - 20 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Nine months ended September 30, 2001 compared to
nine months ended September 30, 2000
(Thousands of Dollars Except Per Share Data)
Premiums
The following table compares direct premiums written, net premiums
written and earned premiums for the nine months ended September 30, 2001 and
2000:
<table>
<caption>
(Dollars in thousands)
Nine Months Ended September 30,
2001 2000 Change % Change
<s> <c> <c> <c> <c>
Direct Premiums Written:
Personal Automobile in Massachusetts....... $680,267 $658,900 $ 21,367 3.2%
Personal Automobile in all other states.... 90,874 77,409 13,465 17.4
Commercial Automobile in Massachusetts..... 43,709 31,750 11,959 37.7
Commercial Automobile in all other states.. 993 - 993 -
Homeowners in Massachusetts................ 54,160 48,495 5,665 11.7
Homeowners in all other states............. 13,935 12,482 1,453 11.6
Other Lines in Massachusetts............... 13,133 11,237 1,896 16.9
Other Lines in all other states............ 505 322 183 56.8
Total Direct Premiums Written........... $897,576 $840,595 $ 56,981 6.8%
Net Premiums Written:
Personal Automobile in Massachusetts....... $684,485 $666,138 $ 18,347 2.8%
Personal Automobile in all other states.... 90,828 77,344 13,484 17.4
Commercial Automobile in Massachusetts..... 45,422 32,737 12,685 38.7
Commercial Automobile in all other states.. 973 - 973 -
Homeowners in Massachusetts................ 15,112 13,557 1,555 11.5
Homeowners in all other states............. 3,426 (2,574) 6,000 (233.1)
Other Lines in Massachusetts............... 2,868 3,021 (153) (5.1)
Other Lines in all other states............ 118 50 68 136.0
Total Net Premiums Written.............. $843,232 $790,273 $ 52,959 6.7%
Earned Premiums:
Personal Automobile in Massachusetts....... $580,998 $524,182 $ 56,816 10.8%
Personal Automobile in all other states.... 85,110 74,502 10,608 14.2
Commercial Automobile in Massachusetts..... 30,965 23,596 7,369 31.2
Commercial Automobile in all other states.. 394 - 394 -
Homeowners in Massachusetts................ 14,183 12,819 1,364 10.6
Homeowners in all other states............. 3,144 3,042 102 3.4
Other Lines in Massachusetts............... 2,286 2,494 (208) (8.3)
Other Lines in all other states............ 116 183 (67) (36.6)
Assumed Premiums from C.A.R................ 58,714 58,744 (30) (0.1)
Assumed Premiums from other than C.A.R..... 196 211 (15) (7.1)
Total Earned Premiums................... $776,106 $699,773 $ 76,333 10.9%
Earned Premiums in Massachusetts........... $628,432 $563,091 $ 65,341 11.6
Earned Premiums-Assumed.................... 58,910 58,955 (45) (0.1)
Earned Premiums in all other states........ 88,764 77,727 11,037 14.2
Total Earned Premiums................... $776,106 $699,773 $ 76,333 10.9%
</table>
- - 21 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The $21,367 or 3.2% increase in Massachusetts personal automobile direct
premiums written during the first nine months of 2001 resulted primarily from
increases of 5.2% and 6.6% in the number of Massachusetts personal automobile
exposures for liability and physical damage coverage, respectively, offset by
decreases in the average written premium rate per exposure for Massachusetts
personal automobile liability and physical damage exposures, respectively.
The average written premium per exposure percentage decreases for the
first nine months of 2001 were primarily the result of rate modifications in
the individual coverage components in the 2001 state mandated average rate
decrease, offset by decreases in the Company's safe driver rate deviations.
The combination of these factors resulted in a 2.1% decrease in the average
personal automobile premium per exposure for the first nine months of 2001 as
compared to an increase of 6.5% during the first nine months of 2000. Despite
the 2001 state mandated average rate decrease of 8.3%, the Company's smaller
decrease 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.
The accompanying table depicts the AAA Affinity Group Discount, SDIP
Deviations and their combined reduction from Massachusetts average mandated
rates:
<table>
<caption>
AAA Affinity Group Discount and SDIP Deviation* 2001 2000
<s> <c> <c>
AAA Affinity Group Discount..................................... 6% 6%
SDIP Step 9 Deviation........................................... 2% 6%
SDIP Step 10 Deviation.......................................... 0% 2%
Combined AAA Affinity Group Discount and Step 9 Deviation....... 7.9% 11.6
Combined AAA Affinity Group Discount and Step 10 Deviation...... 6.0% 7.9%
</table>
* For Massachusetts policies with effective dates as of January 1, 2001 and
2000 or thereafter, respectively.
Other states personal automobile direct premiums written increased
$13,465 or 17.4% during the first nine months of 2001 as compared to the same
period in 2000, however, an overall depressed rate environment resulted in
diminished underwriting profits. The Company is in the process of evaluating
a number of its other than Massachusetts state rating structures, has filed
for increases in several states and will seek additional rate increases where
appropriate. Personal automobile direct premiums written by American
Commerce for the first nine months of 2001 increased $3,580 or 6.1% to
$62,218 as compared to $58,638 for the same period a year ago due primarily
to book rollovers of business from existing agents, an increase in new
agents, partially offset by decreases in states where the Company is not
actively pursuing writings. Personal automobile direct premiums written for
Commerce West increased $9,885 or 52.7% to $28,656 during the first nine
months of 2001 as compared to $18,771 during the same period a year ago.
Both companies target preferred insurance risks, however Commerce West's
recent growth is attributable to the introduction of a non-standard auto
product in late 2000. Both American Commerce and Commerce West write
predominantly personal automobile insurance. American Commerce writes
personal automobile insurance in 23 states while Commerce West writes
personal automobile insurance in the states of California and Oregon.
- - 22 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Direct premiums written for Massachusetts commercial automobile
insurance increased by $11,959 or 37.7%, due primarily to an increase of
approximately 8.5% in the number of policies written and by a 26.9% increase
in the average commercial automobile premium per policy. The increase in
premium per policy was attributable to a hardening of the commercial
automobile market, primarily in larger commercial accounts. The Company
experienced a significant increase in accounts with premiums in excess of
$50. In addition, rates for other voluntary commercial automobile policies
have increased moderately combined with an approximate 10% increase in rates
for policies written through C.A.R. The increased business was attributable
to the Company's initiative to expand writings, especially those with
premiums in excess of $50.
Direct premiums written for Massachusetts homeowners insurance increased
by $5,665 or 11.7% due primarily to a 6.5% increase in the number of policies
written coupled with a 5.0% increase in the average premium per policy. The
increase in business was primarily due to additional business from former
Trust agents, business formerly written by New England Fidelity Insurance
Company, which was declared insolvent in 2000, and existing and newly
appointed agents. Other states homeowners insurance written by American
Commerce increased $1,453 or 11.6% to $13,935 due primarily to book rollovers
of business from existing agents.
The $52,959 or 6.7% increase in net premiums written was primarily due
to the growth in direct premiums written as described above offset by an
increase in premiums ceded to C.A.R. coupled with an increase to premiums
ceded to reinsurers other than C.A.R. as well as a decrease of premiums
assumed from C.A.R. Premiums ceded to reinsurers other than C.A.R., during
the first nine months of 2001, increased $557 or 1.1% as compared to the
first nine months of 2000 primarily as a result of American Commerce joining
the quota-share reinsurance program effective January 1, 2000. An unearned
premium transfer of $6,033 occurred effective January 1, 2000. Of the
$52,959 increase in net premiums written, $32,434 was associated with
Massachusetts business, and $9,887 was attributable to increased writings for
Commerce West due to the increase in non-standard business previously
mentioned. The balance of the increase was primarily attributable to
American Commerce's increase in premiums and the unearned premium transfer
mentioned earlier.
The $76,333 or 10.9% increase in total earned premiums during the first
nine months of 2001 as compared to the first nine months of 2000 was
primarily attributable to increases in Massachusetts personal automobile
liability and physical damage exposures, coupled with an increase in earned
premium per exposure. The increase in earned premium per exposure occurs
(versus a decrease in written premium per exposure) because of the time lag
it takes to earn the premium once it is written. Overall, this resulted in a
$56,816 or 10.8% increase for Massachusetts personal automobile earned
premium.
- - 23 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Investment Income
Net investment income is affected primarily by the composition of the
Company's investment portfolio. The following table summarizes the
composition of the Company's investment portfolio, at cost, at September 30,
2001 and 2000 (the Company's investment portfolio, at market and equity is
shown in the table found on page 27):
<table>
<caption>
Investments, at cost September 30,
(Dollars in thousands) % of % of
2001 Invest. 2000 Invest.
<s> <c> <c> <c> <c>
Fixed maturities (GNMA & FNMA mortgage-
backed bonds, corporate bonds, U.S.
Treasury bonds and notes and tax-
exempt state and municipal bonds)..... $ 585,211 40.0% $ 664,570 47.9%
Preferred stocks........................ 259,164 17.7 223,653 16.1
Common stocks........................... 87,703 6.0 94,580 6.8
Closed-end preferred stock mutual funds. 287,942 19.7 319,166 23.0
Mortgages and collateral loans (net of
allowance for possible loan losses)... 42,507 2.9 52,645 3.8
Cash and cash equivalents............... 177,731 12.1 11,029 0.8
Other investments....................... 24,286 1.6 22,200 1.6
Total investments................... $1,464,544 100.0% $1,387,843 100.0%
</table>
The Company's investment strategy is to maximize after-tax investment
income through investing in 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.
As depicted in the accompanying table, nine month 2001 net investment
income increased $3,745 or 5.3%, compared to the same period in 2000,
principally as a result of an increase in average invested assets (at cost),
offset by a decrease in yield. The decrease in yield is primarily due to
lower short-term yields on larger cash and cash equivalent balances, coupled
with an environment of higher yielding fixed maturities being called. The
Company continues to monitor interest rates on long-term securities and
intends to maintain its short position until such time as the Company believes
long-term rates have appropriately firmed. Net investment income as a
percentage of total average investments was 6.6% in 2001 compared to 6.9% for
the first nine months of 2000. Net investment income after tax as a
percentage of total average investments was 5.3% and 5.7% for the first nine
months of 2001 and 2000, respectively.
<table>
<caption>
Investment Return At September 30,
(Dollars in thousands) 2001 2000
<s> <c> <c>
Average month-end investments (at cost)... $1,503,942 $1,371,730
Net investment income..................... 74,753 71,008
Net investment income after-tax........... 60,144 58,657
Net investment income as a percentage
of average net investments (at cost).... 6.6% 6.9%
Net investment income after-tax as a
percentage of average net
investments (at cost)................... 5.3% 5.7%
</table>
Amortization of 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 January 29, 1999 was $16,947. The amount is being amortized
into revenue on a straight-line basis over a five-year period. The amount
amortized into revenue in both 2001 and 2000 was $2,542.
- - 24 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Investment Gains and Losses
Net realized investment losses totaled $9,275 during the first nine
months of 2001 as compared to gains of $24,166 during the same period in 2000.
Of the net realized losses during 2001, $6,624 was a result of the Company's
investments in certain venture capital fund limited partnerships. These
venture capital funds primarily provide seed capital for start-up companies
with emerging high technology initiatives in the financial services industry.
In 2001, the Company began to account for these investments on an equity
basis. The equity in the operating results of these funds has been reflected
in realized gains and losses. Prior to this change, the operating results
were not material and were therefore reflected in accumulated other
comprehensive income and loss.
Also during 2001, the undistributed operating results of closed-end
preferred stock mutual funds have been reflected in realized gains and losses.
Prior to December 31, 2000, year-end reporting, the Company did not include
the undistributed equity in its quarterly or annual filings. Prior period
results previously reflected in investment income, have been reclassified to
realized gains and losses to conform with current period presentation. During
the first nine months of 2001 and 2000, the Company reflected realized gains
of $976 and $21,414, respectively, as a result of this change.
<table>
<caption>
Net realized gains and (losses) by category as of September 30, are as follows:
September 30, September 30,
2001 2000
<s> <c> <c>
*Closed-end preferred stock mutual funds............ $ 976 $ 21,414
Venture capital fund investments................... (6,624) 460
Bonds.............................................. (1,237) (1,886)
Common and preferred stocks........................ (2,234) 4,457
Other.............................................. (156) (279)
Net realized investment gains (losses)........ $ (9,275) $ 24,166
</table>
* Includes $1,458 in 2001 and $6,965 in 2000 for the nine months ended,
respectively, relating to the amortization of the net discount, at the time of
purchase, of these securities.
Loss and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") incurred increased $44,953 or
8.4% during the first nine months of 2001 as compared to the same period a
year ago. Massachusetts operations experienced improved underwriting results
primarily due to lower bodily injury losses and lower Massachusetts residual
market losses. These improvements were offset by increased losses in the
homeowners property business and in personal automobile physical damage due to
more adverse weather conditions compared to last year. Losses and LAE
incurred (on a statutory basis) as a percentage of insurance premiums earned
("loss ratio") decreased to 75.2% for the first nine months of 2001 compared
to 77.0% for the first nine months of 2000. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on Massachusetts
personal automobile was 65.1% for the first nine months of 2001 compared to
68.0% for the same period a year ago. In addition to the information noted
above, the pure loss ratio decreased due to an increase of 2.2% in earned
premium per earned exposure. The commercial automobile pure loss ratio
increased to 66.0% during the first nine months of 2001 as compared to 61.7%
for the same period a year ago. This increase was primarily due to higher
bodily injury losses and to higher physical damage losses coupled with worse
experience in the business assumed from C.A.R. during this period. For
Massachusetts homeowners (gross of reinsurance), the pure loss ratio was 52.1%
during the first nine months of 2001 as compared to 39.6% for the same period
a year ago. This increase was the result of more claims for Massachusetts
home-owner business due to unfavorable weather conditions primarily during the
first six months of 2001. Pure loss ratios of subsidiaries in other states
increased to 64.8% during the first nine months of 2001 as compared to 64.0%
for the same period a year ago.
- - 25 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The loss ratio (on a statutory basis) for Commerce West and American Commerce
was 84.3% and 82.5%, respectively, for the first nine months of 2001, compared
to 72.4% and 85.7%, respectively, for the first nine months of 2000. The
increase in the loss ratio for Commerce West was primarily attributable to a
substantial increase in non-standard automobile writings with loss ratios that
are significantly higher than their regular business.
Not withstanding the occurrence of items of a forward looking nature as
described in Note 3 to the unaudited consolidated financial statements, the
Company does not anticipate significant fluctuations in the loss ratio during
the fourth quarter of 2001 as compared to the 2001 nine month year to date
results.
Policy Acquisition Costs
Policy acquisition costs expensed increased by $18,213 or 10.2% during
the first nine months of 2001 as compared to the same period a year ago. The
increase, as compared to the same period a year ago, was primarily
attributable to higher levels of business written. As a percentage of net
premiums written, underwriting expenses for the insurance companies (on
statutory basis) remained stable at 24.2% for the first nine months of 2001
and 2000. The underwriting expense ratio (on a statutory basis) for Commerce
West and American Commerce was 31.9% and 32.3%, respectively, for the first
nine months of 2001, compared to 35.3% and 30.0%, respectively, for the same
period a year ago.
Income Taxes
The Company's effective tax rate was 17.5% for the first nine months of
2001 as compared to 17.4% for the same period a year ago. 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.
Minority Interest
As a result of the joint venture with AAA Southern New England ("AAA
SNE") and the acquisition of American Commerce, the Company's interest in ACIC
Holding Co., Inc., through Commerce, a wholly owned subsidiary of Commerce
Holdings, Inc. ("Commerce Holdings"), is represented by ownership of 80% of
the outstanding shares of ACIC Holding Co., Inc. common stock at September 30,
2001. AAA SNE maintains a 20% common stock ownership. The minority interest
in net loss of subsidiary of $863 included in these consolidated financial
statements for the first nine months of 2001 represents 20% of the net loss
during the first nine months for ACIC Holding Co., Inc. which is calculated
after the $7,190 preferred stock dividend paid to Commerce. This compares to
the minority interest in net losses of subsidiary of $247 after $6,810 in
preferred stock dividend paid to Commerce in the first nine months of 2000.
Net Earnings
Net earnings decreased $11,623 or 15.2% to $64,961 during the first nine
months of 2001 as compared to $76,584 for the same period a year ago.
Operating earnings, which exclude the after-tax impact of net realized
investment gains and losses, increased $12,041, or 20.6% to $70,479 ($2.09 per
share basic and $2.08 per share diluted) during the first nine months of 2001
as compared to $58,438 ($1.71 per share basic and diluted) for the same period
a year ago, both as a result of the factors previously mentioned.
- - 26 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on the
Consolidated Balance Sheets on page 3 and the Consolidated Statements of Cash
Flows on pages 5 and 6. Stockholders' equity increased by $24,776 during the
first nine months of 2001 as compared to December 31, 2000. The increase
resulted from $64,961 in net earnings coupled with changes in other
comprehensive income, net of income taxes, on fixed maturities and preferred
and common stocks of $3,389, offset by dividends paid to stockholders of
$29,986 coupled with treasury stock purchases of $13,588. Total assets at
September 30, 2001 increased $102,289 or 4.9% to $2,177,903 as compared to
total assets of $2,075,614 at December 31, 2000. This growth is reflected in
an increase of $54,624 or 23.7% in premiums receivable, a $9,453 or 8.5%
increase in deferred policy acquisition costs, a $9,602 or 15.6% increase in
receivable from reinsurers, a $19,147 or 1.3% increase to invested assets, at
market value and equity, and by a $9,463 or 4.7% increase in all other assets
combined. The increase to premiums receivable is attributable to increased
Massachusetts business coupled with the seasonality of the policy effective
dates of the Company's business.
The Company's investment portfolio, at market and equity, is shown below
as of September 30, 2001 and December 31, 2000 (for investments, at cost,
refer to the table found on pages 17 and 24):
<table>
<caption>
September 30, December 31,
Investments, at market and equity % of % of
(Dollars in thousands) 2001 Invest. 2000 Invest.
<s> <c> <c> <c> <c>
Fixed maturities (GNMA & FNMA mortgage-
backed bonds Corporate bonds, U.S.
Treasury bonds and notes Tax-
exempt state and municipal bonds).... $ 599,469 40.2% $ 669,935 45.5%
Preferred stocks....................... 251,905 16.9 200,083 13.6
Common stocks.......................... 104,242 7.0 115,827 7.9
Equity in closed-end
preferred stock mutual funds......... 298,670 20.0 337,733 22.9
Mortgages and collateral loans (net of
allowance for possible loan losses).. 42,507 2.8 51,661 3.5
Cash and cash equivalents.............. 177,731 11.9 70,521 4.8
Other investments...................... 17,185 1.2 26,802 1.8
Total investments.................. $1,491,709 100.0% $1,472,562 100.0%
</table>
The Company's fixed maturity portfolio is comprised of GNMAs and FNMA
mortgage backed bonds (8.7%), municipal bonds (67.7%), corporate bonds (23.5%)
and U.S. Treasury bonds (0.1%). As of September 30, 2001, the market value of
the Company's fixed maturity portfolio exceeded its book value by $14,258
($9,268 after taxes, or $0.28 per share). The cost of the Company's preferred
stocks exceeded market value by $7,259 ($4,718 after taxes, or $0.14 per
share). The market value of the Company's common stocks exceeded cost by
$16,539 ($10,750 after taxes, or $0.32 per share).
- - 27 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Preferred stocks increased $51,822 or 25.9% and common stocks decreased
$11,585 or 10.0%, during the first nine months of 2001. Preferred stock
mutual funds at equity, decreased $39,063 or 11.6% during the first nine
months of 2001. The majority of the increase in preferred stocks and the
corresponding decrease in preferred stock mutual funds were primarily the
result of the newly created trust fund as a result of the PDI liquidation,
mentioned previously. Other invested assets at equity, primarily comprised of
the Conning Limited Partnership, decreased $9,617 or 35.9% during the first
nine months of 2001. The Company's strategy continues to focus on maximizing
after-tax investment income through investing in 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. The Company continues to monitor interest rates on long-term
securities and intends to maintain its short position until such time as the
Company believes the long-term rates have appropriately firmed.
The Company's liabilities totaled $1,371,246 at September 30, 2001 as
compared to $1,292,665 at December 31, 2000. The $78,581 or 6.1% increase was
comprised of an increase of $73,659 or 14.2% in unearned premiums coupled with
a $14,040 or 2.1% increase in unpaid loss and loss adjustment expenses, offset
by a decrease of $8,090 or 22.9% in contingent commissions accrued, a decrease
of $5,207 or 37.2% in current income taxes and a decrease of $2,033 or 24.1%
in excess of book value of subsidiary interest over cost. The significant
increase to the Company's unearned premiums was attributable to the increased
business in the latter part of 2000 and the first nine months of 2001, coupled
with seasonality of the policy effective dates of the Company's business.
Liabilities for unpaid losses and loss adjustment expenses at September
30, 2001 and December 31, 2000 consist of:
<table>
<caption>
September 30, December 31,
2001 2000
<s> <c> <c>
Net voluntary unpaid losses and LAE reserves............. $570,156 $544,585
Voluntary salvage and subrogation recoverable............ (76,639) (65,505)
Assumed unpaid loss and LAE reserves from C.A.R.......... 122,623 127,631
Assumed salvage and subrogation recoverable from C.A.R... (20,844) (20,844)
Total voluntary and assumed unpaid loss and LAE reserves 595,296 585,867
Adjustment for ceded unpaid loss and LAE reserves........ 101,884 97,273
Adjustment for ceded salvage and subrogation recoverable. (9,000) (9,000)
Total unpaid loss and LAE reserves...................... $688,180 $674,140
</table>
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 5 and 6.
The Company's operating activities provided cash of $72,607 in the first
nine months of 2001, as compared to $87,514 during the same period a year ago.
These cash flows were primarily impacted by the fact that while premiums
collected increased $68,573 or 9.5% in the first nine months of 2001, losses
and LAE paid increased $81,516 or 16.7%, policy acquisition costs paid
increased $15,702 or 8.0%, and federal income tax payments decreased $4,851 or
16.8% in the first nine months of 2001 as compared to the same period a year
ago. The increase in losses and LAE paid were primarily attributable to
increased business, with increased auto and homeowner property payments due to
adverse weather conditions primarily in the first six months of 2001 as
compared to the same period last year, coupled with a lag in salvage and
subrogation activity. The increase in policy acquisition costs relates
primarily to increased business. Premium finance and service fees increased
15.7% as compared to the same period a year ago, primarily as a result of
increased business.
- - 28 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
For the first nine months of 2001 net cash flows from investing
activities provided cash of $78,177, as compared to net cash flows used in
investing activities of $61,875 for the same period in 2000. The majority of
the $140,052 difference was a $72,862 decrease in purchases of fixed
maturities, a $36,552 decrease in the purchase of preferred stock mutual
funds, a $10,233 increase from proceeds from sale of equity securities, a
$13,227 decrease in purchases of other invested assets, and a $7,424 increase
in proceeds from sales and maturities of fixed maturities, offset by a $4,380
increase in purchase of equity securities. Investing activities were funded
by accumulated cash and cash provided by operating activities during 2001 and
2000.
Cash flows used in financing activities totaled $43,574 during the first
nine months of 2001 compared to $37,145 during the same period a year ago.
The 2001 cash flows used in financing activities consisted of dividends paid
to stockholders of $29,986 and $13,588 used to purchase 362,900 shares of
treasury stock under the company's stock buy-back program. The 2000 cash
flows used in financing activities consisted of dividends paid to stockholders
of $29,374 and $7,771 used to purchase 299,700 shares of Treasury Stock under
the Company's stock buyback programs.
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 and equity) of total investments
at September 30, 2001 was $1,491,709. At September 30, 2001, the Company held
cash and cash equivalents of $177,731. These funds provide sufficient
liquidity for the payment of claims and other short-term cash needs. The
Company continues to monitor interest rates on long-term securities and
intends to maintain its short position until such time as the Company believes
long-term rates have appropriately firmed. 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. No extraordinary
dividends were paid in 2001 or 2000. Similar laws exist in California and
Ohio. No extraordinary dividend was paid by American Commerce in 2001 or 2000
and no dividends were paid by Commerce West since its acquisition.
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 annualized statutory
premiums to surplus ratio was 1.55 to 1.00 and 1.82 to 1.00 for the period
ended September 30, 2001 and 2000, respectively.
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 continues
to focus on maximizing after-tax investment income through investing in 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.
- - 29 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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.
Although the Company has significant holdings of various closed-end preferred
stock mutual funds, these funds are comprised primarily of preferred stocks
traded on national stock exchanges, thus limiting exposure to any one
investment.
As part of its investing activities, the Company assumes positions in
fixed maturity, stock, 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 2001, 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 June 30,
2001 and 2000, the Company's estimated market exposure for a 200 basis point
increase (decrease) in interest rates were calculated. A 200 basis point
increase results in a decrease in the market value of the fixed maturities and
preferred stocks of $82,255 and $92,081, respectively. A 200 basis point
decrease results in an increase in the market value of the same securities of
$51,647 and $53,676, respectively. The equity price risk impact at September
30, 2001, based upon a 10% increase in the fair value of common stocks and
preferred stock mutual funds, would be an increase of $10,424 and $30,681
respectively. Based upon a 10% decrease, common stocks and preferred stock
mutual funds would decrease $10,424 and $30,681 respectively. Long-term
interest rates (30-year Treasury Bond) were 5.42% at September 30, 2001 and
5.87% at September 30, 2000. Long-term interest rates (30-year Treasury Bond)
decreased to 5.46% at December 31, 2000 from 6.48% at December 31, 1999.
Stock Buyback and Dividends
The Company purchased 362,900 shares of Treasury stock under the buyback
program through September 30, 2001 at an average cost of $37.44, all purchased
during the third quarter (299,700 shares were purchased during the nine months
ended September 30, 2000 at an average cost of $26.33). The Company currently
holds 4,609,548 shares of Treasury stock. At September 30, 2001, the Company
has the ability to purchase 533,700 additional shares of Treasury stock under
the current Board of Directors authorization.
On September 20, 2001, the Company paid a quarterly dividend of $0.30 to
stockholders of record as of September 1, 2001. The Company increased its
quarterly dividend to stockholders from $0.29 to $0.30 during the second
quarter of 2001.
- - 30 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Recent Accounting Developments
The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual became effective
January 1, 2001 for all insurance companies. The domiciliary states of the
Company's insurance subsidiaries have adopted the provisions of the revised
manual. The revised manual has changed certain prescribed statutory
accounting practices and will result in changes to the accounting practices
that the Company's insurance subsidiaries use to prepare their statutory-basis
financial statements. The impact of these changes to the Company's insurance
subsidiaries statutory-basis capital and surplus as of January 1, 2001 did not
have a significant detrimental effect.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 ("SFAS" 133"), "Accounting for Certain Derivative Instruments and
Hedging Activities," as amended in June 2000 by Statement of Financial
Accounting Standards No. 138 ("SFAS 138"), "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," which requires companies to
recognize all derivatives as either assets or liabilities in the balance sheet
and measure such instruments at fair value. SFAS 138 amended Statement of
Financial Accounting Standards No. 137 ("SFAS 137"), "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133." The provisions of SFAS 133 require adoption for
fiscal year beginning after June 15, 2000. The Company had no derivative or
hedging activity in 2001, 2000, or 1999.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," which replaced Statement
of Financial Accounting Standards No. 125 ("SFAS 125"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." The Statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of
liabilities. Those standards are based on consistent application of a
"financial components" approach that focuses on control. Under that approach,
after a transfer of financial assets, a company recognizes the financial and
servicing assets it controls and the liabilities it has incurred, does not
recognize financial assets when control has been surrendered, and does not
recognize liabilities when extinguished. The Statement provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. The Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. Adoption of SFAS 140 is not expected to have
a material impact on the Company's consolidated financial statements.
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that all business combinations be
accounted for under a single method - the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS No. 141 also
clarifies the criteria to recognize intangible assets separately from
goodwill. SFAS No. 142 requires that goodwill and intangible assets deemed to
have indefinite lives no longer be amortized to earnings, but instead be
reviewed at least annually for impairment. Other intangible assets will
continue to be amortized over their useful lives.
- - 31 -
<page>
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
SFAS No. 141 requires that the purchase method of accounting be used for
business combinations initiated after June 30, 2001. SFAS No. 142 will be
effective January 1, 2002. The Company has evaluated the impact of adopting
the provisions of SFAS No. 142 on earnings and financial position for the year
ended December 31, 2002. Effective January 1, 2002, in accordance with SFAS
No. 142, the Company will cease amortizing the "excess of book value of
subsidiary interest over cost" which is estimated to be valued at $5.0 million
at year end 2001. The amortization of this amount results in approximately
$0.10 per share of annual operating earnings after taxes. Additionally, the
Company will no longer amortize the negative goodwill resulting from the
purchase of preferred stock mutual funds effective January 1, 2002. The
amount of negative goodwill at year-end is estimated to be $6.8 million. The
estimated amortization in 2001 of negative goodwill resulting from the
purchase of preferred stock mutual funds will be approximately $0.25 per share
of earnings classified as capital gains. Both the excess of book value of
subsidiary interest over cost and the negative goodwill on preferred stock
mutual funds will be written off to income in the first quarter of 2002 and
classified as a change in accounting principle. The estimated per share
income impact for this change is $0.35.
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. Additionally, 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 may 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.
Company Website
Additional supplemental financial information is available on the
Company's website at http://www.commerceinsurance.com, under the "Links"
section of the "News & Investors" tab.
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<page>
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the third quarter of 2001.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
RANDALL V. BECKER
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 33 -
<page>
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the third quarter of 2001.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 33 -
<page>