1997
annual
report
The
CGI
The Commerce Group, Inc.
211 Main Street, Webster, Massachusetts 01570
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INDEX TO 1997 ANNUAL REPORT
Page
Financial Highlights............................................ 1
Letter to Stockholders.......................................... 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 4
Common Stock Price and Dividend Information..................... 17
Report of Management............................................ 19
Report of Independent Auditors.................................. 20
Consolidated Balance Sheets at December 31, 1997 and 1996....... 21
Consolidated Statements of Earnings for the Years Ended
December 31, 1997, 1996 and 1995............................... 22
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995......................... 23
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995............................... 24
Consolidated Statements of Cash Flows - Reconciliation of Net
Income to Net Cash Provided by Operating Activities for the
years ended December 31, 1997, 1996 and 1995................... 25
Notes to Consolidated Financial Statements...................... 26
Selected Consolidated Financial Data............................ 45
Management's Discussion of Supplemental Information on
Insurance Operations........................................... 46
Directors....................................................... 51
Officers........................................................ 53
Stockholder Information......................................... 54
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FINANCIAL HIGHLIGHTS
(Dollars in Thousands, Except Per Share Amounts)
1997 1996
1995
Net premiums written............................ $ 741,501 $
711,570 $ 603,421
Earned premiums................................. $ 730,497 $
668,716 $ 592,590
Net investment income........................... 80,794
77,402 71,313
Premium finance fees............................ 7,074
9,713 19,420
Net realized investment gains (losses).......... 22,770
(7,574) 712
Total revenues............................ $ 841,135 $
748,257 $ 684,035
Earnings before income taxes.................... $ 127,517 $
92,013 $ 149,742
Income taxes.................................... 31,302
18,049 39,541
Net earnings.............................. $ 96,215 $
73,964 $ 110,201
Basic and diluted net earnings per common share. $ 2.67 $
2.04 $ 2.93
Cash dividends paid per share................... $ 1.03 $
0.81 $ 0.23
Weighted average number of common shares
outstanding................................... 36,044,679
36,311,887 37,632,236
Total investments at market value............... $1,242,695
$1,167,671 $1,096,778
Total assets.................................... 1,754,753
1,676,799 1,564,175
Total liabilities............................... 1,104,957
1,089,760 1,014,461
Total stockholders' equity...................... 649,796
587,039 549,714
Total stockholders' equity per share............ 18.03
16.28 14.96
Certain Statutory Financial Ratios (Unaudited):
Loss and LAE ratio............................ 71.4%
70.9% 62.0%
Underwriting expense ratio.................... 25.1
27.1 29.0
Combined ratio............................ 96.5%
98.0% 91.0%
Net premiums written to policyholders'
surplus..................................... 143.3%
153.1% 137.1%
1
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THE COMMERCE GROUP, INC.
March 27, 1998
To Our Stockholders:
In 1997, your Company experienced satisfactory financial results
for the 22nd consecutive year. From the very first day the funding of
The Commerce Insurance Company was accomplished (April 3, 1972) through
December 31, 1997, we have achieved underwriting profit of $228.5
million on total premiums written of $6.0 billion. This underwriting
profit represents 3.8% of total premiums written. These results stand
out in a year that continued to witness changes in the nature and source
of competition within the insurance marketplace.
In 1998, the Massachusetts personal automobile insurance industry
saw state-mandated auto insurance rates drop again for the fourth
consecutive year this past January. Coupled with affinity group
marketing programs and safe driver rate deviations, the Massachusetts
marketplace continues in a highly competitive mode. Through these
evolving conditions, your Company saw its share of the Massachusetts
personal automobile market increase to 21.8% in 1997 versus 20.8% at the
end of 1996.
In California, Western Pioneer Insurance Company has completed its
second full year as a subsidiary of The Commerce Insurance Company with
improved profitability and a bright future. Plans have been implemented
to strengthen the agency force along with establishing an attractive and
competitive rate structure.
As we look to the future, your Company has begun writing insurance
in the state of Rhode Island in January 1998 and maintains licenses to
operate in the states of Connecticut, Maine, New Hampshire and Vermont.
With the use of new technologies, upgraded internal operating systems
and the continued monitoring of acquisition opportunities, we are
realizing our vision of expansion.
Through it all, your Company has continued to grow and prosper.
The Commerce Insurance Company continues to be the largest writer of
Massachusetts private passenger automobile insurance, as well as the
second largest writer of Massachusetts homeowners insurance. Written
premiums, earned premiums, investment income, total assets, total
stockholders' equity and total stockholders' equity per share, as
illustrated in the bar graph on the facing page, are all at new highs.
For those of you who are interested in the details, I draw your
attention to the pages in this report labeled "Management's Discussion
and Analysis of Financial Condition and Results of Operations". Behind
these numbers are an extremely dedicated group of people, both in
Massachusetts and California: Our Policyholders (represented by over
771,000 policies in force); Agents (692); Employees (1,495); Officers
(31); Directors (19); and of course, our Stockholders (over 4,300, not
including our Employee Stock Ownership Plan participants who now number
1,541).
Property-liability insurance remains a good business to be in--and
The Commerce Group, Inc. will continue its efforts to be one of the most
profitable long-term players. Your Company's management continues to
believe that owners' interests are its primary constituency.
Our sincere thanks to those who have helped in this building
process--especially our Agents, Employees, Officers and Board of
Directors. This diverse force of committed, ethical and hard working
people will continue to build on our past successes and look to the
future with excitement and opportunity. Their individual creativity,
energy and professionalism will continue to serve our shareholders well.
Your comments or questions regarding this report, or The Commerce
Group, Inc. affairs in general, are solicited as always, at any time.
Arthur J.
Remillard, Jr.
President
Caring in everything we do.
2
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The bar graph on page 3 illustrates the Company's annual total
stockholders' equity per share value and annual total stockholders'
equity per share value including cumulative cash dividends paid per
share on December 31, over the most recent fifteen year period. The X
axis lists the years beginning with 1983 through 1997. The Y axis lists
the dollar values starting at $0.00 and increasing in one dollar
increments to $21.00. The graph depicts a total stockholders' equity
per share value in 1983 of $0.50; 1984 of $0.67, 1985 of $0.81, 1986 of
$0.95, 1987 of $1.40, 1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991
of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of $14.96,
1996 of $16.28 and 1997 of $18.03. The graph also depicts the total
stockholders' equity per share value including cumulative dividends paid
per share in 1984 of $0.67, 1985 of $0.81, 1986 of $0.95, 1987 of $1.40,
1988 of $1.95, 1989 of $2.53, 1990 of $3.36, 1991 of $4.80, 1992 of
$7.42, 1993 of $10.09, 1994 of $11.03, 1995 of $15.34, 1996 of $17.47
and 1997 of $20.25.
3
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Thousands of Dollars Except Per Share Data)
General
The property and casualty industry has been and remains highly
cyclical in nature. The financial results of property and casualty
insurance companies are impacted by many forces unique to the market.
Market forces include competition, frequency and severity of losses
resulting from weather conditions, the state of the economy and the
general regulatory environment in those states in which the insurer
operates. During 1997, the industry experienced strong underwriting
results, despite slower premium growth as compared to 1996. The strong
underwriting results were attributable to the absence of severe weather,
improved cost management, safer cars and highways and increased drunk
driver awareness. The improved industry results have intensified
competition among insurers, which when coupled with lower rates,
emphasizes the advantages of operating efficiently. The Commerce Group,
Inc. ("Company") is well positioned to both lead in this environment and
to respond to these prevailing conditions in the market.
The Company, incorporated in 1976, is a regional property and
casualty insurer which, through its subsidiaries, offers predominantly
motor vehicle insurance, covering personal automobiles, in addition to a
broad range of other property and casualty insurance products. These
products are marketed to groups, individuals, families and businesses
through the Company's strong relationships with professional independent
insurance agencies. The Company writes insurance primarily in the state
of Massachusetts through The Commerce Insurance Company ("Commerce") and
Citation Insurance Company ("Citation"), both wholly-owned subsidiaries
of Commerce Holdings, Inc. ("CHI"). The Company also writes insurance
in the state of California through Western Pioneer Insurance Company
("Western Pioneer"), a wholly-owned subsidiary of Commerce.
The Company's business strategy remains focused on activities
primarily related to personal automobile insurance in the states of
Massachusetts and California. The Company has been the largest writer
of personal property and casualty insurance in the state of
Massachusetts in terms of market share of direct premiums written since
1990. The Company's share of the Massachusetts personal automobile
market increased in 1997 to approximately 21.8% from 20.8% in 1996. In
addition to Massachusetts and California, the Company is newly licensed
in the states of Connecticut, Maine, New Hampshire, Rhode Island and
Vermont. The Company began writing in Rhode Island in January 1998 and
is gearing internal operating systems to accommodate the remaining New
England states in the future.
During 1997, direct premiums written totalled $768,649, a 5.0%
increase over 1996. Direct premiums written in Massachusetts, written
through Commerce and Citation amounted to $741,163. Direct premiums
written in California, through Western Pioneer, amounted to $27,486. Of
the total direct premiums written, direct personal automobile premiums
written during 1997 totalled $661,077, an increase of 6.1% over 1996,
and direct homeowners insurance premiums written totalled $54,256, an
increase of 3.6% over 1996. The Company is also the fourth largest
writer of commercial automobile insurance in Massachusetts based on
direct premiums written. During 1997, direct commercial automobile
premiums written totalled $37,075, an 8.3% decrease compared to 1996.
Personal automobile insurance is subject to extensive regulation
in Massachusetts and California. Every owner of a registered automobile
is required to maintain certain minimum automobile insurance coverages.
In Massachusetts, with very limited exceptions, automobile insurers are
required by law to issue a policy to any applicant seeking to obtain
such coverages. Marketing and underwriting strategies for companies
operating in Massachusetts are limited by maximum automobile premium
rates and minimum agency commission levels for personal automobile
insurance which are mandated by the Massachusetts Commissioner of
Insurance ("Commissioner"). In Massachusetts, accident rates, bodily
injury claims, and medical care costs continue to be among the highest
in the nation.
4
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During the three-year period from 1995 to 1997, Massachusetts
personal automobile insurance premium rates decreased an average of 5.6%
per year. The Commissioner approved an average 4.0% decrease in
personal automobile premiums for 1998, the fourth decrease in as many
years. Rates decreased 6.2%, 4.5% and 6.1% in 1997, 1996 and 1995,
respectively. Coinciding with the 1998 rate decrease, the Commissioner
also approved a 7.4% decrease in the commissions agents receive from
selling private passenger automobile insurance for 1998. The decision
slightly offsets the financial impact of the average 4.0% decrease in
personal automobile premiums for 1998.
Although personal automobile premium rates decreased an average of
6.2% in 1997, the impact upon the Company resulted in only a 1.8%
decrease in the average personal automobile premium per exposure (each
vehicle insured). The 1.8% decrease for the Company is significantly
less than the average rate decrease of 6.2% due to the facts that the
rate decision did not anticipate purchases of new automobiles in the
year to which the rate decision applied and, secondly, the Company's mix
of personal automobile business differs from that of the industry.
The 1997 and 1998 decreases were partially driven by corrections
for an industry error that had impacted prior year rate decisions. The
industry error resulted from a miscalculation of industry expense
allowances that had the effect of overstating rates for 1991 through
1996. Rates for 1997 were adjusted to recoup an estimated $50 million
from the industry. Rates for 1998 and 1999 have and will be adjusted to
recoup the remaining amount estimated to be $150 million.
Additionally, 1997 and 1998 rates were decreased as a result of
the reconciliation of the Safe Driver Insurance Plan ("SDIP"), which is
designed to be revenue neutral. In most recent past years, the SDIP
reconciliation resulted in a deficit which was then added into the rates
for the subsequent years. The 1996 SDIP reconciliation, however,
resulted in a surplus.
The Company had performed an analysis of the 1997 rate decision in
early 1997. The Company estimated the impact of the above two items on
its results assuming its market share remained the same as it was at the
end of 1997. The Company's share of the Massachusetts personal
automobile market increased from 20.8% at the end of 1996 to 21.8% at
the end of 1997. The earned premium impact of the above two items has
been re-estimated at approximately $16.0 million for 1997, $24.1 million
for 1998 and $14.1 million for 1999. The earnings per share after-tax
impact resulting from lower earned premiums was $0.29 for 1997, and is
estimated to be $0.43 and $0.24 for 1998 and 1999, respectively. If the
Company's future market share increases (decreases), a larger (smaller)
financial impact will result.
In June 1997, the Massachusetts Supreme Judicial Court ("Court")
rejected an appeal filed by the Automobile Insurers Bureau of
Massachusetts ("AIB") that challenged the Commissioner's decision to
prospectively decrease future rates for the miscalculation of the
industry expense allowance. (The SDIP reconciliation component was not
challenged.) The AIB's argument was that, according to statute, there
is a prohibition against retroactive rate making in Massachusetts which
effectively bars the examination of past year's data once all involved
parties have agreed to the rate decision. The Court ruled that
retroactive rate making was indeed illegal, but indicated that special
circumstances permitted returning the money in the form of rate
reductions. In a related challenge, the Court rejected on technical
grounds, one insurers claim of an unfair adverse impact related to the
prospective nature of the rate reduction.
The 1998 rate decision also included a 7.4% reduction in agents'
commission rates. Again, as in 1997, companies will calculate
commissions on business subject to safe driver deviations, net of the
deviations. After the 1997 rate decision, a suit was filed by the
Massachusetts Association of Insurance Agents ("MAIA") challenging this
method of calculation. In July 1997, the Court upheld the
Commissioner's ruling that agents' commissions on 1997 premiums, subject
to safe driver deviations, would be based on net premium amounts. The
1996 commissions were based on premium amounts net of group discounts
but gross of safe driver deviations. The Commissioner's ruling resulted
in agents receiving fewer commission dollars on a per policy basis.
5
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The Company's performance in its personal and commercial
automobile insurance lines is integrally tied to its participation in
the Commonwealth Automobile Reinsurers ("C.A.R."). All companies
writing automobile insurance in Massachusetts share in the underwriting
results of C.A.R. business for their respective product line or lines.
Since its inception, C.A.R. has annually generated multi-million dollar
underwriting losses in both its personal and commercial automobile
pools. A company's proportionate share of the C.A.R. personal or
commercial deficit (its participation ratio) is based upon its market
share of the automobile risks for the particular pool, adjusted by a
utilization formula such that, in general, its participation ratio is
disproportionately and adversely affected if its relative use of C.A.R.
exceeds that of the industry, and favorably affected if its relative use
of C.A.R. is less than that of the industry. Automobile insurers
attempt to develop and implement underwriting strategies that will
minimize their relative share of the C.A.R. deficit while maintaining
acceptable loss ratios on risks not insured through C.A.R.
Significant changes in the utilization of the C.A.R. private
passenger pooling mechanism are not expected for 1998. Various C.A.R.
participation formula changes have been fully implemented since 1993
with only minor changes since then. The Company's strategy has been to
voluntarily retain more of the types of private passenger automobile
business that are factored as credits favorably impacting the
utilization formula. As a result, the credits impacting the utilization
formula have favorably affected the Company's participation ratio. As
of December 31, 1997, the Company estimates its private passenger
automobile participation ratio to be approximately 18.0% which is
several percentage points below the Company's estimated 21.8% share of
the Massachusetts personal automobile market. The Company continues to
expect the marketplace to make minor yearly adjustments to find the
optimum balance between voluntary and ceded writings.
Starting in 1991, and concluding in 1995, reforms were implemented
into the C.A.R. commercial automobile pooling mechanism. The primary
change was the gradual phase-in of a C.A.R. commercial utilization-based
participation formula, so as to reduce the percentage of commercial
business being ceded to C.A.R. The percentage of commercial premiums
ceded to C.A.R. by the industry has decreased from approximately 56% in
1990 to approximately 26% in 1997, (as estimated by the Company). This
also resulted in significant decreases in the percentage of commercial
automobile business ceded to C.A.R. by the Company, from approximately
68% in 1990 to approximately 24% in 1997. Continued industry-wide
gradual decreases in the percentage of ceded commercial premiums are
expected for 1998, as companies continue to look to increase their
voluntary retention levels. Finally, C.A.R. depopulation, coupled with
C.A.R. rate increases for ceded commercial business, has led to a
reduction in the size of the annual commercial deficits.
The Company intends to continue to respond to the incentives and
disincentives provided by C.A.R. rules, by further adjusting the
percentage of personal and commercial business ceded to C.A.R. in 1998.
The Company provides a separate rating tier for preferred
commercial automobile business through Citation. Approximately 22% of
the commercial automobile premiums produced by its voluntary agents in
1997 were written by Citation. The Company expects that this secondary
rating tier will continue to assist the Company in retaining its better
commercial automobile accounts, while also further increasing the
percentage of commercial automobile business that can be retained
voluntarily by the Company in 1998 and beyond.
Beginning in the latter part of 1995, the Company began to
actively pursue group marketing programs. The primary purpose of group
marketing programs is to provide participating groups with a convenient
means of purchasing private passenger automobile insurance through
associations and employee groups. Emphasis is placed on writing larger
groups, although accounts with as few as 25 participants are considered.
Groups are eligible for rate discounts which must be filed annually with
the Division of Insurance. In general, the Company looks for groups
with mature/stable membership, favorable driving records and below
average turnover ratios. Participants who leave the sponsoring group
during the term of the policy are allowed to maintain the policy until
expiration. At expiration, a regular Commerce policy may be issued at
the insured's option.
6
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During the latter part of 1995, Commerce signed group marketing
agreements with the five American Automobile Association Clubs of
Massachusetts ("AAA clubs") offering a 10% discount on private passenger
automobile insurance to the clubs' members who reside in Massachusetts.
In 1997, two AAA clubs were consolidated, therefore leaving only four
clubs. Primarily as a result of the fourth consecutive private
passenger rate reduction, a 6.0% percent AAA club discount was approved
for policies effective as of January 1, 1998. Previously, a 10%
discount had been effective since the latter part of 1995. Membership
in these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public, and has been the primary reason for a
40.6% increase in the number of personal automobile exposures written by
Commerce since the groups inception. The Company expects this increase
to level off in 1998 as evidenced by an 8.3% increase in personal
automobile exposures in 1997 as compared to a 29.8% increase in 1996.
In 1998, total direct premiums written attributable to the AAA group
business were $422,074 or 54.9% of the Company's total direct premiums
written (66.6% of total Massachusetts personal automobile premium), an
increase of 22.6% over 1996. Total exposures attributable to the AAA
clubs group business were 522,098 or 65.8% of total personal automobile
exposures in 1997, an increase of 102,445 or 24.4% over 1996. Of this
amount, approximately 10% was written through insurance agencies owned
by the AAA clubs. The remaining 90% was written through the Company's
network of independent agents.
Initially, the Massachusetts statute governing group marketing
programs required that 35% of the eligible members must participate in a
group marketing program within the first year. Accordingly, Commerce
and the AAA clubs aggressively pursued AAA members for the AAA Group
Marketing Program. At December 31, 1996, Commerce had achieved the
objective of writing more than 35% of the AAA members within the first
year, as over 300,000 AAA members joined the program. The particular
portion of the statute, dealing with achieving the 35% penetration level
in one year, was amended by the Massachusetts Legislature in early 1997
to allow two years to reach the required penetration level. In December
1997, a bill was passed in the Massachusetts Legislature to further
waive, for an additional year, the requirement that 35% of a group's
members purchase insurance through the group in order for the group to
be renewed for 1998.
Commerce and the AAA clubs have agreed that Commerce shall be
their exclusive underwriter of Massachusetts personal automobile group
programs. This contract may be terminated by the AAA clubs upon written
notice to Commerce, whose termination shall take effect at a minimum of
three years from notice of termination.
During 1996 and 1997, the Company was granted licenses in the
states of Connecticut, New Hampshire, Rhode Island, and Vermont.
License approval in the state of Maine was received in February 1998.
Concurrent with the filings submitted for these licenses, the Company
entered into an agreement with Policy Management Services Corporation
("PMSC") and purchased software which will allow for the development of
internal operating systems which will enable the Company to process
policies in states outside of Massachusetts. Additionally, a
significant investment in new computer hardware was made to support this
effort. These systems are in place and the Company began writing
insurance in the state of Rhode Island during January 1998.
Underwriting profit margins are reflected by the extent to which
the combined ratio is less than 100%. This ratio is considered the best
simple index of current underwriting performance of an insurer. During
the five-year period ended December 31, 1997, the property and casualty
industry's combined ratio, as reported by A.M. Best and weighted to
reflect the Company's product mix ("weighted industry average"), has
ranged from a low of 102.6% in 1993 to a high of 104.2% in 1997 on a
statutory accounting principles basis. During this same period of time,
the Company's combined ratio has consistently remained below the
weighted industry average, ranging from as low as 91.0% in 1995 to a
high of 98.0% in 1996. On an average basis, the Company's combined
ratio was 94.2% for the five year period ended December 31, 1997
compared to a weighted industry average of 103.2%.
The Company's total revenues were supplemented in fiscal 1997,
1996 and 1995 by net investment income of $80,794, $77,402 and $71,313,
respectively. Additionally, the Company had realized investment gains
(losses) of $22,770, ($7,574) and $712 in 1997, 1996 and 1995,
respectively.
7
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Regulatory Matters
General
Although the U.S. federal government does not directly regulate
the insurance industry, federal initiatives often have an impact on the
business. Congress and certain federal agencies continue to investigate
the current condition of the insurance industry (encompassing both life
and health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Congress conducts hearings
relating, in general, to the solvency of insurers and has proposed
federal legislation from time to time on this and other subjects. The
Company is unable to predict whether or in what form initiatives will be
implemented and what the possible effects on the Company would be.
In May 1996, state legislation was passed offering insurers
incentives to write more inner city and coastal homeowners insurance.
The legislation, which arose over concerns of availability and
allegations of redlining, expands coverages and provides various credits
under the Massachusetts Property Insurance Underwriting Association
("Massachusetts Fair Plan").
In December 1996, a United States District Court, acting on a suit
filed in October 1996, ordered the Massachusetts Division of Insurance
to disregard the existing ban on bank sales of life, health and accident
insurance. The decision cited U.S. Supreme Court decisions in the
Barnett and VALIC cases that essentially preempt the State of
Massachusetts ban on the licensing of bank-owned insurance agencies.
Also, in December 1996, a bill was filed in the Massachusetts
Legislature that would allow banks to become licensed agents of an
insurance company or brokers of insurance, permitting such things as the
sale of insurance products in distinctly designated bank branch areas
separate and apart from retail deposit areas. The Company is unable to
predict the possible impacts of these issues at this time.
Various forms of automobile insurance reform are continuously
debated in the Massachusetts Legislature. New regulations and
legislation are often proposed with the goal of reducing the need for
premium increases. For further details, please refer to the general
discussion on insurance regulation and premium rates beginning on page
4.
As previously mentioned, beginning in 1995, the Company received
approval for group discounts to members of the AAA clubs. Membership in
these clubs is estimated to represent approximately one-third of the
Massachusetts motoring public. The Company increased its Massachusetts
private passenger automobile insurance writings by 6.3% in 1997
primarily as a result of this program, ending the year with
approximately 21.8% of the Massachusetts private passenger automobile
market as compared to 20.8% in 1996.
Personal Automobile Insurance
In March 1997, the Company was granted approval, for the 1997
calendar year, to offer their customers safe driver deviations of 10
percent to drivers with SDIP classifications of either Step 9 or 10.
These are the two best driver SDIP classifications in Massachusetts,
representing drivers with no at fault accidents and not more than one
minor moving vehicle violation in the last six years. For drivers that
qualified, the Company's group automobile discounts and SDIP deviations
could be combined for up to a 19% reduction from the state mandated
rates. In February 1998, approval of SDIP deviations of 15% for Step 9
and 4% for Step 10 SDIP classifications was granted for the 1998
calendar year. For drivers that qualify, the Company's group automobile
discounts and SDIP deviations can be combined for up to a 20.1%
reduction from the state mandated rates.
In November 1997, the Company received state regulatory approval
to implement an installment fee of $3.00 on each invoice following the
down payment, for all private passenger automobile policies effective
January 1, 1998. The same $3.00 installment fee also replaced the 1.25%
finance charge calculation for homeowner and dwelling policies paid on a
10-payment installment basis. Previously, for 1996 and 1997, the
Company eliminated interest based finance fees on personal automobile
insurance policies.
8
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Risk-Based Capital
In order to enhance the regulation of insurer insolvency, the
National Association of Insurance Commissioners ("NAIC") developed a
formula and model law to implement Risk-Based Capital ("RBC")
requirements for property and casualty insurance companies which are
designed to assess capital adequacy and to raise the level of protection
that statutory surplus provides for policyholder obligations. The RBC
model for property and casualty insurance companies measures three major
areas of risk facing property and casualty insurers: (i) underwriting,
which encompasses the risk of adverse loss development and inadequate
pricing; (ii) declines in asset values arising from credit risk; and,
(iii) other business risks from investments. Insurers having less
statutory surplus than required by the RBC calculation will be subject
to varying degrees of regulatory action, depending on the level of
capital inadequacy.
The RBC model formula proposes four levels of regulatory action.
The extent of regulatory intervention and action increases as the level
of surplus to RBC falls. The first level, the Company Action Level,
requires an insurer to submit a plan of corrective actions to the
regulator if surplus falls below 200% of the RBC amount. The Regulatory
Action Level (as defined by the NAIC) requires an insurer to submit a
plan containing corrective actions and permits the Commissioner to
perform an examination or other analysis and issue a corrective order if
surplus falls below 150% of the RBC amount. The Authorized Control
Level (as defined by the NAIC) allows the regulator to rehabilitate or
liquidate an insurer in addition to the aforementioned actions if
surplus falls below 100% of the RBC amount. The fourth action level is
the Mandatory Control Level (as defined by the NAIC) which requires the
regulator to rehabilitate or liquidate the insurer if surplus falls
below 70% of the RBC amount. The Company's subsidiaries, Commerce,
Citation and Western Pioneer, have RBC amounts at December 31, 1997 of
$56 million, $2 million and $3 million, respectively, and they have
statutory surplus of approximately $433 million, $83 million and $24
million, respectively. The statutory surplus of Commerce, Citation and
Western Pioneer at December 31, 1997 exceeded the RBC Company Action
Levels of $112 million, $5 million and $6 million, respectively, by
approximately $321 million, $78 million and $18 million, respectively.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Direct premiums written during 1997 increased $36,826, or 5.0% to
$768,649 as compared to 1996. The increase was primarily attributable
to a $38,223, or 6.1% increase in direct premiums written for personal
automobile insurance to $661,077. This increase was the result of a
$38,109 increase in direct premiums written for Massachusetts personal
automobile insurance and an increase of $114 which was derived from the
Company's California subsidiary, Western Pioneer. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from an increase of 8.3% in the number of personal automobile
exposures written, offset by a 1.8% decrease in the average personal
automobile premiums written per exposure (each vehicle insured). This
was primarily the result of the Company's affinity group marketing
programs, safe driver rate deviations and the effect of the 1997 state
mandated average rate decrease of 6.2%. In 1997, the Company offered
its customers safe driver deviations of 10% to drivers with SDIP
classifications of either Step 9 or 10. For drivers who qualify, the
Company's group discount and safe driver deviations could be combined
for up to a 19.0% reduction from state mandated rates. Direct premiums
written for commercial automobile insurance decreased by $3,363 or 8.3%,
due primarily to a decrease of approximately 6.7% in the number of
policies written, with the remainder due to a decrease in the average
commercial automobile premium per policy. Direct premiums written for
homeowners insurance (excluding the Massachusetts Fair Plan) increased
by $2,088, or 4.2% due primarily to an increase in the number of
policies written.
Net premiums written during 1997 increased $29,931, or 4.2% as
compared to 1996. The increase in net premiums written was due to the
growth in direct premiums written as described above, offset by the
effects of reinsurance. Written premiums assumed from C.A.R. decreased
$17,172, or 18.3% and written premiums ceded to C.A.R. decreased $11,045
or 13.3% as compared to 1996, both as a result of changes in the
industry's and the Company's utilization of C.A.R. reinsurance.
Premiums ceded to reinsurers other than C.A.R. increased $768 or 2.5% as
compared to 1996.
9
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Earned premiums increased $61,781 or 9.2% during 1997 as compared
to 1996. The increase in earned premiums was primarily due to changes
in 1997 and 1996 direct and net premiums written including the increase
in direct premiums written attributable to group marketing programs
during the latter part of 1996 and in 1997, as previously mentioned.
Earned premiums assumed from C.A.R. decreased $9,602 or 10.4% during
1997 compared to 1996. Earned premiums ceded to C.A.R. decreased
$14,000 or 16.3% during 1997 compared to 1996. Earned premiums
attributable to Western Pioneer increased $531 to $28,159 for 1997
compared to 1996.
Net investment income increased $3,392 or 4.4%, compared to 1996,
principally as a result of an increase in average invested assets (at
cost). Net investment income as a percentage of total average
investments was 6.8% in both 1997 and 1996. Net investment income after
tax as a percentage of total average investments was 5.5% in 1997
compared to 5.6% in 1996.
Premium finance fees decreased $2,639 or 27.2% during 1997. The
decrease was primarily attributable to a change from interest based
finance fees to a "late payment" based system for personal automobile
policies with effective dates of January 1, 1997 and forward. The
change was initiated in direct response to competitive forces that
occurred in the Massachusetts marketplace. In 1997, the Company
received state regulatory approval to charge a $3.00 installment on each
invoice following the down payment for all private passenger automobile
and homeowner policies with effective dates on or after January 1, 1998.
The market value of the Company's investment portfolio totaled
$1,242,695, at December 31, 1997 compared to $1,167,671 at December 31,
1996. Management's investment philosophy is to emphasize investment
yield while maintaining investment quality. Fixed maturities comprised
47.5% of the portfolio at December 31, 1997 compared to 61.4% at
December 31, 1996. Equity investments comprised 26.3% at December 31,
1997 compared to 20.0% at December 31, 1996. Cash and short-term
investments comprised 19.2% at December 31, 1997 compared to 12.0% at
December 31, 1996. The decrease in fixed maturities was the result of
the maturities and sales of fixed maturities with proceeds redeployed to
cash and short-term investments. The shift in the mix of investments
was partially driven by the current low interest rate environment and by
the Company's previously announced change in investment strategy. The
Company is seeking greater flexibility to provide for enhanced potential
future capital appreciation. The Company's strategy is to acquire
equity investments, including potential acquisitions, which forgo
current investment yield in favor of potential higher yielding capital
appreciation in the future.
The market value of the fixed maturities, which totaled $590,597
at December 31, 1997, is comprised of 69.3% tax-exempt and 30.7% taxable
investments as compared to total fixed maturities of $716,702, comprised
of 68.5% tax-exempt and 31.5% taxable investments at December 31, 1996.
The market value of equity investments, which totaled $326,588 at
December 31, 1997, is comprised of 45.5% preferred stocks and 54.5%
common stocks as compared to total equity investments of $233,721,
comprised of 63.2% preferred stocks and 36.8% common stocks at December
31, 1996. The increase in equity investments and decrease in fixed
maturities at December 31, 1997 compared to December 31, 1996 was
primarily attributable to a change in the mix of investments from
municipal and government bonds and Government National Mortgage
Association ("GNMA") mortgage-backed bonds to higher yielding preferred
stock mutual funds which are classified as common stocks. Of the common
stock portfolio approximately two-thirds of the balance is comprised of
preferred stock mutual funds versus pure common stocks.
10
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Gross realized gains and losses on fixed maturity investments
amounted to $4,306 and $2,887, respectively, for the year ended December
31, 1997 compared to gross realized gains and losses on fixed maturity
investments of $487 and $7,851, respectively, for the year ended
December 31, 1996. Gross realized investment gains and losses on
preferred stocks amounted to $2,688 and $2,682, respectively, for the
year ended December 31, 1997 compared to gross realized gains and losses
on preferred stocks of $22 and $371, respectively, for the year ended
December 31, 1996. Gross realized gains on common stocks amounted to
$21,440 for the year ended December 31, 1997 compared to gross realized
gains on common stocks of $456 for the year ended December 31, 1996.
Net realized investment gains totalled $22,770 during 1997 as compared
to net realized investment losses of $7,574 for 1996. A significant
portion of the realized gains in 1997 was primarily the result of a
merger of a major New England financial corporation and its property and
casualty subsidiary. The merger election and exchange of stock resulted
in realized investment gains of $15,178. Subsequent post merger sales
of this corporation's common stock resulted in additional realized
investment gains of $3,790. The remainder of the realized investment
gains were primarily the result of sales of non-taxable bonds offset by
minimal realized investment losses in the sales of GNMA's and preferred
stocks. Also included were realized losses on mortgage activity of $95
in 1997 compared to $317 in 1996.
Gross unrealized gains and losses on fixed maturity investments
totalled $24,189 and $376, respectively, at December 31, 1997 compared
to $17,890 and $1,699, respectively, at December 31, 1996. The
unrealized gains on fixed maturities increased, despite fewer fixed
maturity holdings, as a result of the favorable bond market in 1997.
Gross unrealized gains and losses on preferred stocks totaled $1,599 and
$1,235, respectively, at December 31, 1997 compared to $2,034 and
$2,837, respectively, at December 31, 1996. Gross unrealized gains and
losses on common stocks totaled $17,888 and $170, respectively, at
December 31, 1997 compared to $20,305 and $187, respectively, at
December 31, 1996.
Losses and loss adjustment expenses ("LAE") incurred as a
percentage of insurance premiums earned ("loss and LAE ratio") was
71.4% in 1997 compared to 70.9% in 1996. The ratio of net incurred
losses, excluding LAE, to premiums earned ("pure loss ratio") on
personal automobile decreased to 61.3% in 1997 compared to 63.9% in
1996. The commercial automobile pure loss ratio decreased to 45.4% in
1997 compared to 46.7% in 1996. For homeowners, the pure loss ratio
decreased to 48.9% in 1997 compared to 72.4% in 1996. The overall
decrease to the homeowner pure loss ratio for 1997 was due to more
normal weather conditions during 1997 as compared to the severe weather
experienced during the first half of 1996, coupled with favorable
development in the homeowners liability area.
Policy acquisition costs expensed increased by 3.6% in 1997,
compared to 8.6% in 1996. The increase in policy acquisition costs was
primarily due to higher volumes of business written during 1997 and
fewer acquisition costs being deferred as compared to 1996. This was
due to a higher rate of growth in 1996 primarily from affinity groups.
As a percentage of net premiums written, underwriting expenses for the
insurance companies (on a statutory basis) were 25.1% during 1997 as
compared to 27.1% for 1996. On a consolidated financial statement
basis, 1997 and 1996 policy acquisition costs, as a percentage of net
written premiums, were approximately equal. This occurred because lower
commission and contingent commission expenses in 1997 were offset by
higher management incentive compensation expenses and computer service
expenses. The higher management compensation expense was the direct
result of the increase in the average three month share price of the
Company's common stock during 1997 as compared to 1996.
The Company's effective tax rate was 24.5% and 19.6% for the years
ended December 31, 1997 and 1996, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income and the corporate dividends deduction. The
higher 1997 effective tax rate was primarily due to tax-exempt interest
comprising a lesser percentage of net income before taxes and more
realized gains in 1997 than in 1996.
Net earnings increased $22,251 or 30.1% to $96,215, during 1997 as
compared to net earnings of $73,964 in 1996, as a result of the factors
previously mentioned.
11
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Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Direct premiums written during 1996 increased $105,157, or 16.8%
to $731,823 as compared to 1995. The increase was primarily
attributable to a $108,212, or 21.0% increase in direct premiums written
for personal automobile insurance to $622,849. This increase was the
result of an $88,527 increase in direct premiums written for
Massachusetts personal automobile insurance and an increase of $19,685
which was derived from the Company's California subsidiary, Western
Pioneer, which was acquired August 31, 1995. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from an increase of 29.8% in the number of personal automobile
exposures written, offset by a 9.2% decrease in the average personal
automobile premiums written per exposure (each vehicle insured). This
was primarily the result of the Company's affinity group marketing
programs, safe driver rate deviations and the effect of the 1996 state
mandated average rate decrease of 4.5%. In January 1996, the Company
was granted approval to offer its customers safe driver deviations of
10%. For drivers who qualify, the Company's group discount and safe
driver deviations can be combined for up to a 19% reduction from state
mandated rates. Direct premiums written for commercial automobile
insurance decreased by $4,763, or 10.5%, due primarily to a decrease of
approximately 5.6% in the number of policies written, with the remainder
due to a decrease in the average commercial automobile premium per
policy. Direct premiums written for homeowners insurance (excluding the
Massachusetts Fair Plan) increased by $1,926, or 4.0%, due primarily to
an increase in the number of policies written.
Net premiums written during 1996 increased $108,149, or 17.9% as
compared to 1995. The increase in net premiums written was due to the
growth in direct premiums written as described above, as well as to the
effects of reinsurance. Written premiums assumed from C.A.R. increased
$1,454, or 1.6% and written premiums ceded to C.A.R. increased $47 as
compared to 1995, both as a result of changes in the industry's and the
Company's utilization of C.A.R. reinsurance. Premiums ceded to
reinsurers other than C.A.R. decreased $1,602 or 4.9% as compared to
1995.
Earned premiums increased $76,126 or 12.8% during 1996 as compared
to 1995. The increase in earned premiums was primarily due to changes
in direct premiums written and net premiums written as described above.
Earned premiums assumed from C.A.R. increased $1,860 or 2.1% during 1996
compared to 1995. Earned premiums attributable to Western Pioneer
increased $18,794 to $27,628 for 1996 compared to $8,834 for the four
months ended December 31, 1995. The Company acquired Western Pioneer on
August 31, 1995.
Net investment income increased $6,089, or 8.5%, compared to 1995,
principally as a result of an increase in average invested assets (at
cost) of 9.5% when compared to the year ended 1995. Net investment
income as a percentage of total average investments was 6.8% in 1996
compared to 6.9% in 1995. Net investment income after tax as a
percentage of total average investments was 5.6% in 1996 compared to
5.7% in 1995.
Premium finance fees decreased $9,707 or 50.0% during 1996. The
decrease was primarily attributable to a change from interest based
finance fees to a "late payment" based system for personal automobile
policies with effective dates of January 1, 1996 and forward. The
change was initiated in direct response to competitive forces that
occurred in the Massachusetts marketplace.
The market value of the Company's investment portfolio totaled
$1,167,671, at December 31, 1996 compared to $1,096,778 at December 31,
1995. Management's investment philosophy is to emphasize investment
yield while maintaining investment quality. Fixed maturities comprised
61.4% of the portfolio at December 31, 1996 compared to 74.3% at
December 31, 1995. Equity investments comprised 20.0% at December 31,
1996 compared to 13.8% at December 31, 1995.
12
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The market value of the fixed maturities, which totaled $716,702
at December 31, 1996, is comprised of 68.5% tax-exempt and 31.5% taxable
investments as compared to total fixed maturities of $815,277, comprised
of 72.8% tax-exempt and 27.2% taxable investments at December 31, 1995.
The market value of equity investments, which totaled $233,721 at
December 31, 1996, is comprised of 63.2% preferred stocks and 36.8%
common stocks as compared to total equity investments of $151,579,
comprised of 73.4% preferred stocks and 26.6% common stocks at December
31, 1995. The increase in equity investments and decrease in fixed
maturities at December 31, 1996 compared to December 31, 1995 is
primarily attributable to a change in the mix of investments from
municipal bonds to higher yielding preferred stocks and preferred stock
mutual funds which are classified as common stocks.
Gross realized gains and losses on fixed maturity investments
amounted to $487 and $7,851, respectively, for the year ended December
31, 1996 compared to $2,389 and $1,912, respectively, for the year ended
December 31, 1995. Gross realized gains and losses on preferred stocks
amounted to $22 and $371, respectively, for the year ended December 31,
1996 compared to $937 and $47, respectively, for the year ended December
31, 1995. Gross realized gains and losses on common stocks amounted to
$456 and $0, respectively, for the year ended December 31, 1996 compared
to $47 and $532, respectively, for the year ended December 31, 1995.
Net realized investment losses totalled $7,574 during 1996 as compared
to net realized investment gains of $712 for 1995. The realized gains in
1996 were primarily the result of sales of municipal bonds and common
stocks, offset by realized losses on sales of Government National
Mortgage Association ("GNMA") mortgage backed bonds, municipal bonds and
preferred stocks. Also included were realized losses on mortgage
activity of $317 in 1996 compared to $215 in 1995.
Gross unrealized gains and losses on fixed maturity investments
totalled $17,890 and $1,699, respectively, at December 31, 1996 compared
to $18,626 and $4,657, respectively, at December 31, 1995. The
unrealized gain on fixed maturities remained fairly consistent with 1995
as a result of stable interest rates during 1996. Gross unrealized
gains and losses on preferred stocks totaled $2,034 and $2,837,
respectively, at December 31, 1996 compared to $1,629 and $2,005,
respectively, at December 31, 1995. Gross unrealized gains and losses
on common stocks totaled $20,305 and $187, respectively, at December 31,
1996 compared to $11,801 and $3, respectively, at December 31, 1995.
The increase in unrealized gain on equity investments was primarily due
to the increase in equity investments, as described earlier, and the
performance of the stock market during 1996 favorably impacting the
market values of common stocks.
Losses and loss adjustment expenses ("LAE") incurred as a
percentage of insurance premiums earned ("loss and LAE ratio") was 70.9%
in 1996 compared to 62.0% in 1995. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on personal
automobile increased to 63.9% in 1996 compared to 56.6% in 1995. This
increase was primarily due to the adverse impact of severe weather
conditions experienced in the northeast during the first half of 1996,
adverse loss experience on personal automobile business assumed from
C.A.R. and a decrease in the personal automobile average earned premium
per exposure of approximately 7.9%. This decrease was due to the
effects of affinity group marketing programs, safe driver rate
deviations and the 1996 state mandated average rate decrease of 4.5%.
These factors were offset by improved loss development during 1996. The
commercial automobile pure loss ratio decreased to 46.7% in 1996
compared to 57.4% in 1995. This decrease was primarily due to improved
loss experience on commercial automobile business assumed from C.A.R.
and better loss development on voluntary business. For homeowners, the
pure loss ratio increased to 72.4% in 1996 compared to 49.6% in 1995.
This increase was due primarily to the severe weather during the first
half of 1996, compared to the mild weather experienced during 1995.
13
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Policy acquisition costs increased by 8.6% in 1996, compared to
5.9% in 1995. This increase was primarily due to the increase in net
premiums written as described previously, offset by a decrease of $9.5
million in the agents' profit sharing compensation resulting from the
impact of adverse weather conditions on the Company's loss and LAE ratio
and the impact of affinity group marketing service fee income. Agents'
profit sharing compensation is based, in part, on the underwriting
profits of agency business written with the Company. As a percentage of
net premiums written, underwriting expenses (on a statutory basis) were
27.1% for 1996, compared to 29.0% in 1995. This decrease was primarily
attributable to the reasons as mentioned above.
The Company's effective tax rate was 19.6% and 26.4% for the years
ended December 31, 1996 and 1995, respectively. In both years the
effective rate was lower than the statutory rate of 35% primarily due to
tax-exempt interest income. The lower 1996 effective tax rate was
primarily due to tax-exempt interest income comprising a higher
percentage of net income before taxes, the dividends received deduction
and lower capital gains in 1996 versus 1995.
Net earnings decreased $36,237 to $73,964 or 32.9%, during 1996,
as compared to net earnings of $110,201 in 1995, as a result of the
factors previously mentioned.
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is
on the Consolidated Balance Sheets on page 21 and the Consolidated
Statements of Cash Flows on pages 24 and 25. Stockholders' equity
increased by $62,757, or 10.7%, in 1997 as compared to 1996. Growth
stemmed from $96,215 in net earnings combined with the change in net
unrealized gains, net of income taxes, on fixed maturities and preferred
and common stocks of $4,153, partially offset by dividends paid to
stockholders of $37,124 and Treasury Stock purchased of $487. Total
assets at December 31, 1997 increased by $77,954, or 4.6%, to $1,754,753
as compared to total assets of $1,676,799 at December 31, 1996. The
majority of this growth was reflected in an increase of invested assets
of $75,024, or 6.4%, an increase in premiums receivable of $11,634, or
7.4%, offset by a decrease in all other assets of $8,704 or 2.5% as
compared to December 31, 1996. The increase in invested assets was
primarily attributable to the Company's growth during 1997. The change
in the mix of the Company's investments is attributable to the
previously announced change in investment strategy. The Company is
seeking greater flexibility to provide the potential for enhanced future
capital appreciation. The Company's strategy is to acquire equity
investments, which can include potential acquisitions, which forgo
current investment yield in favor of potentially higher yielding capital
appreciation. As a result, the Company is carrying $238,888, or 19.2%,
of the investment portfolio in cash and short-term investments which is
an increase of $98,353, or 70.0%, as compared to December 31, 1996. The
increase in premiums receivable was primarily attributable to the
increase in personal automobile business.
The Company's fixed maturity portfolio is comprised of GNMAs
(30.7%) and municipal bonds (69.3%). Of the Company's bonds, 100.0% are
rated in either of the two highest quality categories provided by the
NAIC.
The Company's liabilities totalled $1,104,957 at December 31, 1997
as compared to $1,089,760 at December 31, 1996. Loss and loss
adjustment expense reserves comprised 58.8% of the Company's liabilities
at December 31, 1997 compared with 60.8% at December 31, 1996. Unearned
premiums comprised 34.4% of the Company's liabilities at December 31,
1997 compared with 33.8% at December 31, 1996. All other liabilities
comprised 6.8% of the Company's liabilities at December 31, 1997
compared with 5.4% at December 31, 1996. The $15,197, or 1.4%, increase
in liabilities was primarily due to a decrease of $13,359 or 2.0%, in
losses and loss adjustment expense reserves and $11,851 or 46.1% in
contingent commissions, offset by increases of $11,608, or 3.2%, in
unearned premiums, $11,705 or 266.4%, to income tax liabilities and
$5,243 or 9.6%, to all other liabilities.
The primary sources of the Company's liquidity are funds generated
from insurance premiums, premium finance fees, net investment income and
the maturing and sales of investments as reflected in the Consolidated
Statements of Cash Flows on pages 24 and 25.
14
<PAGE
The Company's operating activities provided cash of $80,006 in
1997 as compared to $118,252 in 1996. These cash flows were primarily
impacted by the fact that while premiums collected increased 7.7% in
1997 as compared to 15.9% in 1996, losses and LAE paid increased 20.4%
in 1997 as compared to 30.0% in 1996 and policy acquisition costs paid
decreased 1.4% in 1997 as compared to an increase of 21.6% in 1996. The
increase in premiums was primarily the result of higher personal
automobile volume offset by a decrease in the personal automobile
premium rate. The average rate decrease was due to the effects of group
marketing programs, safe driver rate deviations and the 1997 state
mandated rate decrease of 6.2%. Net loss payments in the direct
personal automobile lines of business increased approximately 21.5% or
$71,300 which were offset by a decrease in payments for other than
automobile lines of business of approximately $16,200, compared to 1996.
The decrease in other than automobile loss payments was primarily the
result of more normal weather in 1997 versus the severe weather
experienced in 1996. The increase in automobile loss payments was
primarily attributable to three factors: increased payments for
collision coverages; increased payments for bodily injury claims and
increased payments for property damage liability claims. Bodily injury
payments were higher primarily due to increased business writings
coupled with initiatives in the claims department to accelerate the
claims settlement process in an effort to reduce the overall cost of
bodily injury claims in the long run, as well as to reduce the overall
number of open bodily injury claims.
The cash flows used in investing activities were primarily the
result of proceeds from the maturities and sales of fixed maturities
offset by the purchases of fixed maturities, preferred and common stocks
and short-term investments. Investing and financing activities were
funded by the cash provided by operating activities.
Cash flows used in financing activities totalled $37,611 in 1997
compared to $45,115 in 1996. The decease was primarily attributable to
a decrease in Treasury Stock purchases of $15,255 offset by an increase
in dividends paid to stockholders of $7,751.
The Company's funds are generally invested in securities with
maturities intended to provide adequate funds to pay claims without the
forced sale of investments. The carrying value (at market) of total
investments at December 31, 1997 was $1,242,695. At December 31, 1997,
the Company held cash and cash equivalents of $25,446 and short-term
investments of $213,442. These funds provide sufficient liquidity for
the payment of claims and other short-term cash needs. The Company
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 must file a report with the
Commissioner. An extraordinary dividend is any dividend or other
property, whose fair value together with other dividends or
distributions made within the preceding twelve months exceeds the
greater of ten percent of the insurer's surplus as regards to
policyholders as of the end of the preceding year, or the net income of
a non-life insurance company for the preceding year. No pro-rata
distribution of any class of the insurer's own securities is to be
included. No Massachusetts insurance company shall pay an extraordinary
dividend or other extraordinary distribution until thirty days after the
Commissioner has received notice of the intended distribution and has
not objected. No extraordinary dividends were paid in 1997, 1996 and
1995.
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.
The Company continues to monitor acquisition opportunities
consistent with a long-term growth strategy to expand outside
Massachusetts through acquisitions of smaller automobile insurance
companies that are in need of capital, have established management in
place and present significant growth opportunities in their market
areas. On August 31, 1995, the Company completed the acquisition of
Western Pioneer Insurance Company, a personal automobile insurer,
located in Pleasanton, California.
15
<PAGE
The Company's long-term growth objective is to expand its writings
outside of Massachusetts. In continued pursuit of this objective, the
Company became licensed in the states of Connecticut and Rhode Island
during 1996 and in the states of Vermont and New Hampshire in 1997.
License approval in the state of Maine was received in February 1998.
Concurrent with the filings submitted for these licenses, the Company
entered into an agreement with PMSC and purchased software which allows
for the development of internal operating systems which will enable the
Company to process policies in states outside of Massachusetts. To
facilitate this development and, at the same time, address the year 2000
processing issue facing computer system users, the Company established
the Team 2000 and Century Change projects which are corporate-wide
efforts to prepare the Company's systems for the next millennium. These
projects involve internal staff costs as well as consulting expenses to
prepare the systems for the year 2000. Costs to date for the Century
Change project have been approximately $1.1 million (all of which relate
to 1997). Administration, programming, testing and implementation of
system applications related to Century Change are expected to cost an
additional $6 million over the next 24 months. Approximately $4 million
is expected to be expensed during 1998 with the remainder through the
end of 1999.
The Company is utilizing both internal and external resources on
the Century Change Project. The Company has a formal plan to address
the Century Change issue and is progressing in accordance with that
plan. Programming changes dealing with policy issuance and maintenance
of same is expected to be completed by year-end 1998. Other internal
changes are scheduled to be completed in accordance with specified
delivery dates as outlined in the plan. The Company's plan has been
designed to, and is proceeding so as to, avoid any adverse business
production issues.
The Company has reviewed the Century Change status of vendors who
perform outside processing for the Company or whose software the Company
uses for internal processing. This review has determined that the
related software used by or provided by these vendors either is
currently century ready or will be ready without any adverse impact on
the Company.
Upon completion of the Century Change project, the Company expects
to focus its efforts on the Team 2000 project which will eventually
replace the Company's existing internal computer systems for
Massachusetts business utilizing software purchased from PMSC. Costs to
date for the Team 2000 effort have been approximately $28 million.
Costs applicable to 1997 were approximately $17 million, of which $15.6
million was expensed during the year. Total Team 2000 project costs
over the next 5 to 7 years have been estimated at approximately $60
million including funds expended to date. This amount includes the
purchase of a main frame computer, license fees and the costs associated
with programming, implementation and training. Systems enabling the
Company to process policies in Rhode Island have been in place since
January 1998. Other states will be brought on-line in the future.
Industry and regulatory guidelines suggest that the ratio of a
property and casualty insurer's annual net premiums written to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.43 to 1.00 and 1.53 to 1.00
for the years ended December 31, 1997 and 1996, respectively.
Recent Accounting Developments
In February 1997, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 128,
"Earnings Per Share". This statement is effective for financial
statements issued for periods ending after December 15, 1997, (including
interim periods) with earlier application not permitted. The statement
specifies the computation, presentation and disclosure requirements for
earnings per share. The adoption of this statement has not had a
material impact on the Consolidated Financial Statements.
16
<PAGE
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130")
effective for financial statements issued for periods beginning after
December 15, 1997. FAS 130 requires that a public company report
changes in equity during a period except those resulting from investment
by owners and distributions by owners. The financial information to be
reported includes foreign currency transactions, minimum pension
liability adjustments and unrealized gains and losses on certain
investments in debt and equity securities (i.e. available for sale
securities). The Company believes that the adoption of this statement
will not have a material impact on the consolidated financial
statements.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("FAS 131"), effective for financial statements
issued for periods beginning after December 15, 1997. FAS 131 requires
that a public company report financial and descriptive information about
its reportable operating segments pursuant to criteria that differ from
current accounting practice. The financial information to be reported
includes segment profit or loss, certain revenue and expense items and
segment assets and reconciliations to corresponding amounts in the
general purpose financial statements. The Company believes that the
adoption of this statement will not have a material impact on the
Consolidated Financial Statements.
Effects of Inflation and Recession
The Company generally is unable to recover the costs of inflation
in its personal automobile insurance line since the premiums it charges
are subject to state regulation. The premium rates charged by the
Company for personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in
premium rates may lag behind related cost increases. Economic
recessions will also have an impact upon the Company, primarily through
the policyholder's election to decrease non-compulsory coverages
afforded by the policy and decreased driving, each of which tends to
decrease claims.
To the extent inflation and economic recession influence yields on
investments, the Company is also affected. As each of these
environments affect current market rates of return, previously committed
investments may rise or decline in value depending on the type and
maturity of investment.
Inflation and recession must also be considered by the Company in
the creation and review of loss and LAE reserves since portions of these
reserves are expected to be paid over extended periods of time. The
anticipated effect of economic conditions is implicitly considered when
estimating liabilities for losses and LAE. The importance of
continually adjusting reserves is even more pronounced in periods of
changing economic circumstances.
COMMON STOCK PRICE AND DIVIDEND INFORMATION
The Company's common stock trades on the NYSE under the symbol
"CGI". The high, low and close prices for shares of the Company's
Common Stock for 1997 and 1996 were as follows:
1997 1996
High Low Close High
Low Close
First Quarter........... $29 $22-7/8 $23-1/4 $20-
3/4 $17-3/4 $19-3/4
Second Quarter.......... 24-3/4 21-3/8 24-5/8 22-
1/2 18-1/2 20-7/8
Third Quarter........... 33-3/8 23-7/8 30-7/8 22-
1/4 20-1/2 22
Fourth Quarter.......... 36 30 32-5/8 25-
3/4 22 25-1/4
As of March 1, 1998, there were 1,375 stockholders of record of
the Company's Common Stock, not including stock held in "Street Name" or
held in accounts for participants of the Company's Employee Stock
Ownership Plan ("E.S.O.P.").
17
<PAGE
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.03 per share
and $0.81 per share in 1997 and 1996, respectively. On May 30, 1997,
the Board voted to increase the quarterly stockholder dividend from
$0.25 to $0.26 per share to stockholders of record as of June 6, 1997.
Prior to that declaration, the Company had paid quarterly dividends of
$0.25 per share dating back to May 17, 1996 when the Board voted to
increase the dividend from $0.06 to $0.25 per share.
Treasury Stock purchased under the stock buyback program increased
by 20,000 shares during 1997 to 1,957,348 shares at December 31, 1997.
The stock buyback program, authorized by the Board in May 1995, enables
the Company to purchase up to three million shares of the Company's
common stock. The program is approximately two-thirds complete.
18
<PAGE
REPORT OF MANAGEMENT
The management of the Company is responsible for the consolidated
financial statements and all other information presented in this Annual
Report. The financial statements have been prepared in conformity with
generally accepted accounting principles determined by management to be
appropriate in the circumstances and include amounts based on
management's informed estimates and judgments. Financial information
presented elsewhere in this Annual Report is consistent with the
financial statements. The appropriateness of data underlying such
financial information is monitored through internal accounting controls,
an internal audit department, independent auditors and the Board of
Directors through its audit committee.
The Company maintains a system of internal accounting controls
designed to provide reasonable assurance to management and the Board of
Directors that assets are safeguarded and that transactions are executed
in accordance with management's authorization and recorded properly.
The system of internal accounting controls is supported by the selection
and training of qualified personnel combined with the appropriate
division of responsibilities.
Management recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to
the highest standards of personal and corporate conduct. Management
encourages open communication within the Company and requires the
confidential treatment of proprietary information and compliance with
all domestic laws, including those relating to financial disclosure.
The 1997 consolidated financial statements were audited by the
Company's independent auditors, Ernst & Young LLP, in accordance with
generally accepted auditing standards. Management has made available to
Ernst & Young LLP, all the Company's financial records and related data,
as well as the minutes of stockholders' and directors' meetings.
Furthermore, management believes that all representations made to Ernst
& Young LLP, during its audit were valid and appropriate.
19
<PAGE
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
The Commerce Group, Inc.
We have audited the accompanying consolidated balance sheet of The
Commerce Group, Inc. and Subsidiaries as of December 31, 1997, and the
related consolidated statements of earnings, stockholders' equity and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
The accompanying consolidated financial statements of the Company for
each of the two years in the period ended December 31, 1996, were
audited by other auditors whose report dated January 24, 1997, expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe our audit provides a reasonable basis for our
opinion.
In our opinion, the 1997 financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of The Commerce Group, Inc. and Subsidiaries as of December 31,
1997, and the consolidated results of their operations and their cash
flows for the year ended in conformity with generally accepted
accounting principles.
ERNST &
YOUNG LLP
Boston, Massachusetts
January 23, 1998
20
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Thousands of Dollars Except Per Share Data)
1997 1996
ASSETS
Investments (notes A2, A3, A4 and B)
Fixed maturities, at market (cost: $566,784 in 1997 and $700,511
in 1996).......................................................... $
590,597 $ 716,702
Preferred stocks, at market (cost: $148,135 in 1997 and $148,481
in 1996)..........................................................
148,499 147,680
Common stocks, at market (cost: $160,371 in 1997 and $65,925 in
1996).............................................................
178,089 86,041
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan losses of $2,812 in 1997
and $2,760 in 1996)...............................................
82,839 74,586
Short-term investments.............................................
213,442 -
Cash and cash equivalents..........................................
25,446 140,535
Other investments..................................................
3,783 2,127
Total investments..............................................
1,242,695 1,167,671
Accrued investment income............................................
12,237 12,819
Premiums receivable (less allowance for doubtful receivables of
$1,451 in 1997 and $1,500 in 1996).................................
169,469 157,835
Deferred policy acquisition costs (notes A5 and C)...................
85,264 82,968
Property and equipment, net of accumulated depreciation
(notes A6 and D)...................................................
36,280 32,100
Residual market receivable (note F)
Losses and loss adjustment expenses................................
129,137 145,726
Unearned premiums..................................................
51,662 49,487
Due from reinsurers (note F).........................................
18,170 19,659
Other assets.........................................................
9,839 8,534
Total assets...................................................
$1,754,753 $1,676,799
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses (notes A7, E and F)............ $
649,473 $ 662,832
Unearned premiums (note A8)........................................
379,599 367,991
Current income taxes (notes A9 and G)..............................
2,656 171
Deferred income taxes (notes A9 and G).............................
13,443 4,223
Deferred income (notes A10 and F)..................................
7,271 7,974
Contingent commissions accrued.....................................
13,861 25,712
Payable to securities broker.......................................
11,500 -
Other liabilities and accrued expenses.............................
27,154 20,857
Total liabilities..............................................
1,104,957 1,089,760
Stockholders' Equity (notes B, J, K and L)
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 1997 and 1996......................................
- - -
Common stock, authorized 100,000,000 shares at $.50 par value;
issued and outstanding 38,000,000 shares in 1997 and 1996.........
19,000 19,000
Paid-in capital....................................................
29,621 29,621
Net unrealized gains on fixed maturities and stocks,
net of income taxes of $14,663 in 1997 and $12,427 in 1996........
27,232 23,079
Retained earnings..................................................
612,630 553,539
688,483 625,239
Treasury Stock, 1,957,348 shares in 1997 and 1,937,348 shares in
1996, at cost (note A12)..........................................
(38,687) (38,200)
Total stockholders' equity.....................................
649,796 587,039
Total liabilities and stockholders' equity.....................
$1,754,753 $1,676,799
The accompanying notes are an integral part of these consolidated
financial statements.
21
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31,
(Thousands of Dollars Except Per Share Data)
1997
1996 1995
Revenues
Earned premiums (notes A8 and F)..................... $ 730,497 $
668,716 $ 592,590
Net investment income (note B)....................... 80,794
77,402 71,313
Premium finance fees................................. 7,074
9,713 19,420
Net realized investment gains (losses) (note B)...... 22,770
(7,574) 712
Total revenues.................................. 841,135
748,257 684,035
Expenses
Losses and loss adjustment expenses
(notes A7, E and F)................................. 526,127
475,231 367,552
Policy acquisition costs (notes A5 and C)............ 187,491
181,013 166,741
Total expenses.................................. 713,618
656,244 534,293
Earnings before income taxes.................... 127,517
92,013 149,742
Income taxes (notes A9 and G).......................... 31,302
18,049 39,541
NET EARNINGS.................................... $ 96,215 $
73,964 $ 110,201
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE
(note A11)..................................... $ 2.67 $
2.04 $ 2.93
CASH DIVIDENDS PAID PER SHARE................... $ 1.03 $
0.81 $ 0.23
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING............................. 36,044,679
36,311,887 37,632,236
The accompanying notes are an integral part of these consolidated
financial statements.
22
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31,
(Thousands of Dollars)
Net
Common Paid-in Unrealized Retained
Treasury
Stock Capital Gains/(Losses) Earnings
Stock Total
Balance January 1, 1995...... $19,000 $29,621 $(42,414) $407,382
$ - $413,589
Net earnings................ 110,201
110,201
Change in unrealized gains
(losses) net of taxes...... 58,918
58,918
Stockholder dividends.......
(8,635) (8,635)
Treasury stock purchased....
(24,359) (24,359)
Balance December 31, 1995.... 19,000 29,621 16,504 508,948
(24,359) 549,714
Net earnings................ 73,964
73,964
Change in unrealized gains
net of taxes............... 6,575
6,575
Stockholder dividends.......
(29,373) (29,373)
Treasury stock purchased....
(13,841) (13,841)
Balance December 31, 1996.... 19,000 29,621 23,079 553,539
(38,200) 587,039
Net earnings................ 96,215
96,215
Change in unrealized gains
net of taxes............... 4,153
4,153
Stockholder dividends.......
(37,124) (37,124)
Treasury stock purchased....
(487) (487)
Balance December 31, 1997.... $19,000 $29,621 $ 27,232 $612,630
$(38,687) $649,796
The accompanying notes are an integral part of these consolidated
financial statements.
23
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(Thousands of Dollars)
1997
1996 1995
Cash flows from operating activities
Premiums collected..................................... $ 727,530 $
675,683 $ 583,230
Net investment income received......................... 81,376
79,269 70,067
Premium finance fees received.......................... 7,074
9,713 19,420
Losses and loss adjustment expenses paid............... (516,130)
(428,541) (329,728)
Policy acquisition costs paid.......................... (198,011)
(200,922) (165,281)
Federal income tax payments............................ (21,833)
(16,950) (43,527)
Net cash provided by operating activities.......... 80,006
118,252 134,181
Cash flows from investing activities
Proceeds from maturity of fixed maturities............. 108,592
170,646 28,479
Proceeds from sale of fixed maturities................. 124,653
122,431 72,287
Proceeds from sale of equity securities................ 224,059
11,326 14,784
Purchase of fixed maturities........................... (98,098)
(200,113) (100,689)
Purchase of equity securities.......................... (296,714)
(85,480) (50,418)
Purchase of other investments.......................... (1,752)
(700) (800)
Net increase in short-term investments, net of
payable to securities broker......................... (201,942)
- - -
Payments received on mortgage loans and collateral
notes receivable..................................... 11,386
8,311 9,892
Mortgage loans and collateral notes originated......... (19,816)
(7,446) (28,667)
Purchase of property and equipment..................... (8,133)
(4,477) (3,664)
Other proceeds from investing activities............... 281
235 2,888
Net cash provided by (used in) investing activities (157,484)
14,733 (55,908)
Cash flows from financing activities
Dividends paid to stockholders......................... (37,124)
(29,373) (8,635)
Purchase of treasury stock............................. (487)
(15,742) (22,458)
Net cash used in financing activities.............. (37,611)
(45,115) (31,093)
Increase (decrease) in cash and cash equivalents......... (115,089)
87,870 47,180
Cash and cash equivalents at beginning of year........... 140,535
52,665 5,485
Cash and cash equivalents at end of year................. $ 25,446 $
140,535 $ 52,665
The accompanying notes are an integral part of these consolidated
financial statements.
24
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating
Activities
For the years ended December 31,
(Thousands of Dollars)
1997
1996 1995
Cash flows from operating activities
Net Earnings........................................... $ 96,215 $
73,964 $ 110,201
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Premiums receivable.................................. (11,634)
(30,788) (24,615)
Deferred policy acquisition costs.................... (2,296)
(15,808) (8,094)
Residual market receivable........................... 14,414
4,911 14,694
Due to/from reinsurers............................... 1,489
2,238 (5,005)
Losses and loss adjustment expenses.................. (13,359)
36,803 26,527
Unearned premiums.................................... 11,608
37,537 15,735
Current income taxes................................. 2,485
(1,009) (8,637)
Deferred income taxes................................ 6,984
2,098 4,650
Deferred income...................................... (703)
(980) (1,497)
Contingent commissions............................... (11,851)
(6,838) 8,100
Other assets, liabilities and accrued expenses....... 4,992
3,017 1,755
Net realized investment (gains) losses............... (22,770)
7,574 (712)
Other - net.......................................... 4,432
5,533 1,079
Net cash provided by operating activities......... $ 80,006 $
118,252 $ 134,181
The accompanying notes are an integral part of these consolidated
financial statements.
25
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies
1. Basis of Presentation
The consolidated financial statements of The Commerce Group, Inc.
(the "Company") have been prepared in accordance with generally accepted
accounting principles ("GAAP").
The consolidated financial statements include The Commerce Group,
Inc., and its wholly-owned subsidiaries, Bay Finance Company, Inc.,
Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI").
The Commerce Insurance Company ("Commerce") and Citation Insurance
Company ("Citation") are wholly-owned subsidiaries of CHI. Western
Pioneer Insurance Company ("Western Pioneer") is a wholly-owned
subsidiary of Commerce. All intercompany transactions and balances have
been eliminated in consolidation. Certain prior year account balances
have been reclassified to conform to 1997 presentation.
The insurance subsidiaries, Commerce, Citation and Western Pioneer
prepare statutory financial statements in accordance with accounting
practices prescribed by the National Association of Insurance
Commissioners ("NAIC"), the Commonwealth of Massachusetts, and the State
of California.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Investments
All investment transactions have credit exposure to the extent
that a counterparty may default on an obligation to the Company. Credit
risk is a consequence of carrying investment positions. The financial
instruments that potentially subject the Company to credit risk consist
primarily of cash and cash equivalents, premium receivables, investments
and mortgage loans on real estate. Concentrations of credit risk with
respect to premiums receivable result from the fact that the Company's
policyholders are concentrated primarily in one geographic area, as the
Company, the largest writer of personal automobile insurance in the
state of Massachusetts, writes primarily in Massachusetts. To manage
credit risk, the Company focuses on higher quality fixed-income
securities, reviews the credit strength of all companies which it
invests in, limits its exposure in any one investment and monitors the
portfolio quality, taking into account credit ratings assigned by
recognized statistical rating organizations.
Investments in fixed maturities, which include taxable and non-
taxable bonds, and investments in common and non-redeemable preferred
stocks, are carried at fair market value and are classified as available
for sale. Unrealized investment gains and losses on common and non-
redeemable preferred stocks and fixed maturities, to the extent that
there is no permanent impairment of value, are credited or charged to a
separate component of stockholders' equity until realized, net of any
tax effect. When investment securities are sold, the realized gain or
loss is determined based upon specific identification. Fair market
value of fixed maturities and common and non-redeemable preferred stocks
is based on quoted market prices. For other securities held as
investments, fair market value equals quoted market price, if available.
If a quoted market price is not available, fair market value is
estimated using quoted market prices for similar securities. The
Company has not invested more than 7% in fixed maturities of any one
state or political subdivision.
26
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
The Company originates and holds mortgage loans on real estate
primarily on properties located in the Commonwealth of Massachusetts and
the State of Connecticut. The Company controls credit risk through
credit approvals, credit limits and monitoring procedures. The Company
performs in-depth credit evaluations on all new customers. Bad debt
expenses have not been material in recent years.
Mortgage loans on real estate and collateral notes receivable are
stated at the amount of unpaid principal, less an allowance for possible
loan losses. The adequacy of the allowance for possible loan losses is
evaluated on a regular basis by Management. Factors considered in
evaluating the adequacy of the allowance include previous loss
experience, current economic conditions and their effect on borrowers
and the performance of individual loans in relation to contract terms.
The provision for possible loan losses charged to operating expenses is
based upon Management's judgment of the amount necessary to maintain the
allowance at a level adequate to absorb possible losses. Loan losses
are charged against the allowance when Management believes the
collectibility of the principal is unlikely and recoveries are credited
to the allowance when received.
Interest on mortgage loans is included in income as earned based
upon rates applied to principal amounts outstanding. Accrual of
interest on mortgage loans is discontinued either when reasonable doubt
exists as to the full, timely collection of interest or principal, or
when a loan becomes contractually past due more than ninety days. When
a loan is placed on nonaccrual status, all unpaid interest previously
accrued is reversed against current period earnings.
3. Short-Term Investments
Short-term investments which consist of Commercial Paper, Auction
Rate Preferred Stocks and Variable Rate Municipal Bonds, are carried at
cost, which approximates market value.
4. Cash and Cash Equivalents
Cash and cash equivalents include cash currently on hand to cover
operating expenses. In 1997, the Company held $17,051 in a U.S.
Government Repurchase Agreement at The Bank of New York. In 1996, the
Company held $118,015 in a U.S. Government Repurchase Agreement at The
First National Bank of Boston. When the Company enters into a
repurchase agreement through its custodian, it receives delivery of the
underlying collateral. The amount of collateral, at the time of
purchase and each subsequent business day, is required to be maintained
at such a level that market value is equal to 102% of the resale price.
5. Deferred Policy Acquisition Costs
Policy acquisition costs relating to unearned premiums, consisting
of commissions, premium taxes and other underwriting expenses incurred
at the policy issuance, are deferred and amortized over the period in
which the related premiums are earned, the amount being reduced by any
potential premium deficiency. If any potential premium deficiency
exists, it represents future estimated losses, loss adjustment expenses
and amortization of deferred acquisition costs in excess of the related
unearned premiums. There was no premium deficiency in 1997, 1996 and
1995. In determining whether a premium deficiency exists, the Company
considers anticipated investment income on unearned premiums.
27
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
6. Property and Equipment
Property and equipment are stated at cost and are depreciated on
the straight line method over the estimated useful lives of the assets
using the following rates:
Percent
Asset Classification Per
Annum
Buildings.......................................
2.5
Building improvements (prior to 1992)...........
2.5
Building improvements (1992 and subsequent).....
5.0
Equipment and office furniture..................
10.0
EDP equipment and copiers.......................
20.0
Automobiles.....................................
33.3
Maintenance and repairs are charged to operations; betterments are
capitalized. The cost of property sold or otherwise disposed of and the
accumulated depreciation thereon are eliminated from the related
property and accumulated depreciation accounts and any resulting gain or
loss is credited or charged to income.
7. Losses and Loss Adjustment Expenses
The liability for unpaid losses and loss adjustment expenses
("LAE") represents the accumulation of individual case estimates for
reported losses and estimates for incurred but not reported ("IBNR")
losses and LAE. Assumed losses and LAE are recorded as reported by the
ceding organization with additional adjustments for IBNR. The liability
for losses and LAE is intended to cover the ultimate net cost of all
losses and loss adjustment expenses incurred through the balance sheet
date. Liability estimates are continually reviewed and updated, and
therefore, the ultimate liability may be more or less than the current
estimate. The effects of changes in the estimates are included in the
results of operations in the period in which the estimates are revised.
8. Premiums
Insurance premiums are recognized as income ratably over the terms
of the policies. Unearned premiums are determined by prorating policy
premiums on a daily basis over the terms of the policies. A significant
portion of the Company's premiums written is derived through the
American Automobile Association Clubs of Massachusetts ("AAA clubs")
group marketing program. Of the Company's total direct premiums
written, the portion attributable to the AAA group business was $422,074
or 55% in 1997 as compared to $344,297 or 47% in 1996. Of these
amounts, 10% and 9% were written through insurance agencies owned by the
AAA clubs and 90% and 91% were written through the Company's network of
independent agents in 1997 and 1996, respectively.
9. Income Taxes
The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events
other than changes in the tax law or rates, unless enacted. Valuation
allowances are established when necessary to reduce deferred tax assets
to the amount expected to be realized.
10. Deferred Income
Income consisting of group marketing service fees and expense
reimbursements which include servicing carrier fees from Commonwealth
Automobile Reinsurers ("C.A.R."), a state-mandated reinsurance
mechanism, on policies written for C.A.R., are deferred and amortized
over the term of the related insurance policies (see note F).
28
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE A-Summary of Significant Accounting Policies - (continued)
11. Net Earnings Per Common Share
In 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share. Statement 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted
earnings per share. The adoption of this new standard had no effect on
the calculation of earnings per share for any period presented in these
financial statements.
Net earnings per common share is computed by dividing net earnings
by the weighted average number of common shares outstanding. The
weighted average number of common shares outstanding for the years ended
December 31, 1997, 1996 and 1995 was 36,044,679, 36,311,887 and
37,632,236, respectively.
12. Treasury Stock
On May 19, 1995, the Board of Directors of the Company, announced
the approval of a stock buyback program of up to three million shares.
Through December 31, 1997, the Company purchased 1,957,348 shares of
Treasury Stock under this program.
NOTE B-Investments and Investment Income
1. Fixed Maturities
The amortized cost and estimated fair market values of investments
in fixed maturities are as follows:
Gross
Gross Estimated
Amortized Unrealized
Unrealized Fair Market
Cost Gains
Losses Value
At December 31, 1997:
GNMA mortgage-backed bonds........... $175,788 $ 5,292 $
(11) $181,069
Obligations of states and
political subdivisions.............. 390,996 18,898
(366) 409,528
Totals.......................... $566,784 $ 24,190 $
(377) $590,597
At December 31, 1996:
GNMA mortgage-backed bonds........... $223,590 $ 2,589 $
(627) $225,552
Obligations of states and
political subdivisions.............. 476,921 15,301
(1,072) 491,150
Totals.......................... $700,511 $ 17,890 $
(1,699) $716,702
29
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
Proceeds from sales of investments in fixed maturities, gross
gains and gross losses realized on those sales were as follows:
Proceeds
Gross Gross
From
Realized Realized
Sales
Gains Losses
For the year ended December 31, 1997:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 124,653
3,994 (390)
Totals........................................ $124,653 $
3,994 $ (390)
For the year ended December 31, 1996:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 122,431
367 (3,685)
Totals........................................ $122,431 $
367 $ (3,685)
For the year ended December 31, 1995:
GNMA mortgage-backed bonds......................... $ - $
- - $ -
Obligations of states and political subdivisions... 72,287
2,340 (695)
Totals........................................ $ 72,287 $
2,340 $ (695)
The amortized cost and approximate fair market value of fixed
maturities at December 31, 1997 and 1996, by contractual maturity, are
as follows:
1997
1996
Fair
Fair
Amortized Market
Amortized Market
Cost Value
Cost Value
Obligations of states and political subdivisions:
Due in one year or less.......................... $ - $ -
$ 508 $ 517
Due after one year through five years............ 2,083 2,200
94 102
Due after five years through ten years........... 1,321 1,324
1,669 1,681
Due after ten years.............................. 387,592 406,004
474,648 488,847
390,996 409,528
476,919 491,147
GNMA mortgage-backed bonds....................... 175,788 181,069
223,592 225,555
Total fixed maturities........................... $566,784 $590,597
$700,511 $716,702
Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations.
30
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
2. Common Stocks
The cost and approximate fair market value of common stocks at
December 31, 1997 and 1996, are as follows:
1997
1996
Fair
Fair
Market
Market
Cost Value
Cost Value
Preferred stock mutual funds................ $115,943 $119,439
$ 28,553 $ 29,087
Common stocks............................... 44,428 58,650
37,372 56,954
$160,371 $178,089
$ 65,925 $ 86,041
3. Mortgage Loans on Real Estate and Collateral Notes Receivable
At December 31, 1997 and 1996, mortgage loans on real estate and
collateral notes receivable consisted of the following:
December 31,
1997
1996
Residential (1st Mortgages)............ $58,430
$58,263
Residential (2nd Mortgages)............ 523
1,077
Commercial (1st Mortgages)............. 14,755
15,805
Commercial (2nd Mortgages)............. 172
196
73,880
75,341
Collateral notes receivable............ 11,771
2,005
85,651
77,346
Allowance for possible loan losses..... (2,812)
(2,760)
Mortgage loans on real estate and
collateral notes receivable....... $82,839
$74,586
Fair value of the Company's mortgage loans on real estate and
collateral notes receivable is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit and for the same remaining maturities.
The future cash flows associated with certain non-performing loans are
estimated based on expected payments from borrowers either through work
out arrangements or the disposition of collateral. The fair value of
mortgage loans on real estate and collateral notes receivable at
December 31, 1997 and 1996, prior to the allowance for possible loan
losses, was $87,867 and $78,920, respectively, which was estimated by
discounting the future cash flows of the mortgages.
At December 31, 1997 and 1996, mortgage loans which were on
nonaccrual status were
$2,021 and $2,095, respectively. The reduction in interest income
associated with nonaccrual loans was $207, $152 and $287 for the years
ended December 31, 1997, 1996 and 1995, respectively.
The Company originates and services residential and commercial
mortgages primarily in Massachusetts and generally its exposure is 80%
or less of the appraised value of any collateralized real property. The
ability and willingness of residential and commercial borrowers to honor
their repayment commitments is generally dependent upon the level of
overall economic activity and real estate values.
31
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
A summary of the changes in the allowance for possible loan losses
follows:
Year
ended December 31,
1997 1996
Balance, beginning of year........................ $
2,760 $ 3,173
Increase (decrease) in provision for possible
loan losses...................................
52 (413)
Loans charged off...............................
- - -
Balance, end of year.............................. $
2,812 $ 2,760
The following table describes mortgage principal balances by
maturity and discloses over 90 days past due and foreclosure
information:
1997 1996
Fixed Rate Mortgages Maturing:
One year or less................................ $
4 $ 632
More than one year to five years................
2,062 2,248
More than five years to ten years...............
4,608 4,700
Over ten years..................................
46,868 42,902
Total Fixed Mortgages...................... $
53,542 $ 50,482
Adjustable Rate Mortgages Maturing:
One year or less................................ $
- - $ -
More than one year to five years................
- - 43
More than five years to ten years...............
498 569
Over ten years..................................
19,840 24,247
Total Adjustable Mortgages................. $
20,338 $ 24,859
Past due over 90 days............................. $
2,021 $ 2,095
Mortgages in Foreclosure.......................... $
1,459 $ 938
4. Net Investment Income
The components of net investment income were as follows:
Year ended
December 31,
1997
1996 1995
Interest on fixed maturities.................. $ 46,449 $
56,034 $ 56,467
Dividends on common and preferred stocks...... 19,799
12,765 8,486
Interest on cash and short-term investments... 10,544
4,022 2,466
Interest on mortgage loans.................... 6,578
6,737 6,141
Other......................................... 122
105 478
Total investment income.............. 83,492
79,663 74,038
Investment expenses........................... 2,698
2,261 2,725
Net investment income................ $ 80,794 $
77,402 $ 71,313
32
<PAGE
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE B-Investments and Investment Income - (continued)
5. Net Realized and Unrealized Investment Gains (Losses)
Net realized investment gains and the net increases (decreases) in
unrealized investment gains or losses, less applicable income tax
expense, were as follows:
Year ended
December 31,
1997
1996 1995
Net realized investment gains (losses):
Fixed maturities................................. $ 1,419 $
(7,364) $ 477
Preferred stocks................................. 6
(349) 890
Common stocks.................................... 21,440
456 (485)
Other............................................ (95)
(317) (170)
Total........................................ $ 22,770 $
(7,574) $ 712
Net increase (decrease) in unrealized gains (losses):
Fixed maturities................................. $ 7,622 $
2,222 $ 70,335
Preferred stocks................................. 1,165
(424) 10,123
Common stocks.................................... (2,398)
8,317 10,185
Tax expense...................................... (2,236)
(3,540) (31,725)
Total........................................ $ 4,153 $
6,575 $ 58,918
A summary of accumulated unrealized gains and losses on stocks and
fixed maturity investments in 1997, 1996 and 1995 follows:
Year ended
December 31,
1997
1996 1995
Unrealized gains....................... $ 43,675 $
40,227 $ 32,056
Unrealized losses...................... (1,780)
(4,721) (6,665)
Tax expense............................ (14,663)
(12,427) (8,887)
Net unrealized gains............. $ 27,232 $
23,079 $ 16,504
NOTE C-Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized to income are as
follows:
Year ended
December 31,
1997
1996 1995
Balance, beginning of year............. $ 82,968 $
67,160 $ 59,066
Costs deferred during the year......... 189,787
196,821 174,835
Amortization charged to expense........ (187,491)
(181,013) (166,741)
Balance, end of year................... $ 85,264 $
82,968 $ 67,160
33
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE D-Property and Equipment
A summary of property and equipment at December 31, is as follows:
1997
1996
Buildings................................. $ 27,873
$ 27,506
Equipment and office furniture............ 30,286
24,993
Building improvements..................... 828
811
58,987
53,310
Less accumulated depreciation.......
(25,081) (22,015)
33,906
31,295
Land...................................... 934
805
Construction in progress.................. 1,440
- -
$ 36,280
$ 32,100
Depreciation expense incurred was $4,213, $3,202 and $3,151 for
the years ended December 31, 1997, 1996 and 1995, respectively.
Depreciation expense is allocated between losses and loss adjustment
expenses and policy acquisition costs.
NOTE E-Losses and Loss Adjustment Expenses
Liabilities for unpaid losses and loss adjustment expenses at
December 31, consist of:
1997
1996
Unpaid loss and LAE reserves.............. $725,886
$718,593
Salvage and subrogation recoverable.......
(76,413) (55,761)
$649,473
$662,832
Significant periods of time can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer and the
insurer's payment of that loss. To recognize liabilities for unpaid
losses, insurers establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported
losses and LAE. Quarterly, the Company reviews these reserves
internally. Regulations of the Division of Insurance require the
Company to obtain annually a certification from either a qualified
actuary or an approved loss reserve specialist that its loss and LAE
reserves are reasonable.
When a claim is reported to the Company, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate
payment. The amount of the reserve is primarily based upon an
evaluation of the type of claim involved, the circumstances surrounding
the claim and the policy provisions relating to the loss. The estimate
reflects the informed judgment of such personnel based on general
insurance reserving practices and on the experience and knowledge of the
claims person. During the loss adjustment period, these estimates are
revised as deemed necessary by the Company's claims department based on
subsequent developments and periodic reviews of the cases.
In accordance with industry practice, the Company also maintains
reserves for estimated IBNR. IBNR reserves are determined on the basis
of historical information and the experience of the Company.
Adjustments to IBNR are made periodically to take into account changes
in the volume of business written, claims frequency and severity, the
mix of business, claims processing and other items that can be expected
to affect the Company's liability for losses and LAE over time.
34
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
When reviewing reserves, the Company analyzes historical data and
estimates the impact of various factors such as (i) per claim
information, (ii) the historical loss experience of the Company and
industry and (iii) legislative enactments, judicial decisions, legal
developments in the imposition of damages, changes and trends in general
economic conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for
predicting future events. There is no precise method, however, for
subsequently evaluating the impact of any specific factor on the
adequacy of reserves, because the eventual development of reserves is
affected by many factors.
By using both individual estimates of reported claims and
generally accepted actuarial reserving techniques, the Company estimates
the ultimate net liability for losses and LAE. After taking into
account all relevant factors, management believes that the provision for
losses and LAE at December 31, 1997 is adequate to cover the ultimate
net cost of losses and claims incurred as of that date. The ultimate
liability, however, may be greater or lower than reserves.
Establishment of appropriate reserves is an inherently uncertain
process, and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience.
The Company does not discount to present value that portion of its loss
reserves expected to be paid in future periods.
Included in the loss reserve methodologies described above, are
liabilities for unpaid claims and claim adjustment expenses for
environmental related claims such as oil spills and lead paint.
Reserves have been established to cover these claims for both known and
unknown losses. Because of the Company's limited exposure to these
types of claims, management believes they will not have a material
impact on the consolidated financial position of the Company in the
future. Loss reserves on environmental related claims amounted to
$6,924, $8,783 and $10,708 in 1997, 1996 and 1995, respectively.
The following table sets forth a reconciliation of beginning and
ending reserves for losses and loss adjustment expenses, net of
reinsurance deductions from all reinsurers including C.A.R., as shown in
the Company's consolidated financial statements for the periods
indicated.
Year ended
December 31,
1997
1996 1995
Reserves for losses and loss adjustment
expenses, beginning of year......................... $533,980
$493,911 $455,460
Incurred losses and loss adjustment expenses:
Provision for insured events of the current year.. 609,930
562,997 442,027
Decrease in provision for insured events of
prior years...................................... (83,803)
(87,766) (74,475)
Total incurred losses and loss adjustment
expenses....................................... 526,127
475,231 367,552
Payments:
Losses and loss adjustment expenses attributable
to insured events of the current year............ 322,882
267,653 184,073
Losses and loss adjustment expenses attributable
to insured events of prior years................. 207,148
167,509 145,028
Total payments.................................. 530,030
435,162 329,101
Loss and loss adjustment expense reserves prior to
effect of ceded reinsurance recoverable.......... 530,077
533,980 493,911
Ceded reinsurance recoverable..................... 119,396
128,852 132,118
Reserves for losses and loss adjustment expenses
at the end of year per financial statements......... $649,473
$662,832 $626,029
35
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTE E-Losses and Loss Adjustment Expenses - (continued)
The provision for loss and LAE reserves relating to prior years
decreased by $83,803, $87,766 and $74,475 in 1997, 1996 and 1995,
respectively due to favorable loss development experienced in both the
voluntary and involuntary private passenger auto business.
The increases in payments and incurred losses primarily resulted
from increases in total loss and loss adjustment expense payments on the
direct personal automobile lines of business of approximately 20.4%.
Net loss payments in the direct personal automobile lines of business
increased approximately 21.5% or $71,300 which were offset by a decrease
in payments for other than automobile lines of business of approximately
$16,200, compared to 1996. The decrease in other than automobile loss
payments was primarily the result of more normal weather in 1997 versus
the severe weather experienced in 1996. The increase in automobile loss
payments was attributable primarily to three factors: increased
payments for collision coverages; increased payments for bodily injury
claims; and increased payments for property damage liability claims.
Bodily injury payments were higher primarily due to increased business
writings coupled with initiatives in the claims department to accelerate
the claims settlement process in an effort to reduce the overall cost of
bodily injury claims in the long run as well as to reduce the overall
number of open bodily injury claims.
The Company's loss and LAE reserves reflect its share of the
aggregate loss and LAE reserves of all Servicing Carriers. The Company
is a defendant in various legal actions arising from the normal course
of its business. These proceedings are considered to be ordinary and
incidental to operations or without foundation in fact. Management is
of the opinion that these actions will not have a material adverse
effect on the consolidated financial statements of the Company.
NOTE F-Reinsurance Activity
The Company has reinsurance contracts for casualty and catastrophe
coverages. These reinsurance arrangements minimize the Company's losses
arising from large risks and protect the Company against numerous losses
from a single occurrence or event. The Company also has a combined
quota share and excess loss reinsurance contract on its other than
automobile property business.
Property and Catastrophe Reinsurance
From the inception, on September 30, 1993, through the third
quarter of 1995, the Company's combined property quota share and excess
loss reinsurance contract was written with five domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnified the Company for 36% of the loss and LAE, and paid
a commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company paid to the reinsurers 40% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement was $40.0 million and the maximum annual aggregate
occurrence loss reimbursement was $60.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsured each
risk, retaining $125 and reinsuring 100% of the next $875.
Effective September 30, 1995, the Company increased its coverage
under the combined property quota share and excess loss reinsurance
contract. The contract is now written with six domestic reinsurance
companies. Under the quota share portion of the arrangements, the
reinsurers indemnify the Company for 45% of the loss and LAE, and pay a
commission allowance based on the ratio of losses incurred to premiums
earned. In exchange, the Company pays to the reinsurers 49% of the net
premium pertaining to the related business. The maximum per occurrence
loss reimbursement is $50.0 million and the maximum annual aggregate
occurrence loss reimbursement is $75.0 million. Under the excess loss
reinsurance portion of the arrangements, the Company reinsures each
risk, retaining $125 and reinsuring 100% of the next $875. This
reinsurance contract is continuous through September 30, 1998, but
cancelable quarterly with ninety days notice. Written premiums ceded in
1997, 1996 and 1995 under the property quota share and excess loss
reinsurance contract were $27.5 million, $26.6 million and $21.5
million, respectively.
36
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
Effective March 1, 1995, through February 29, 1996, the Company
had catastrophe reinsurance coverage for that portion of the loss not
covered under the property quota share arrangement. Catastrophe
reinsurance coverage was in force for approximately 88.0% of the amounts
incurred for all property claims arising from a single event or
occurrence up to a maximum loss of $100.0 million, after first
subtracting property quota share losses. Coverage under the catastrophe
program was as follows: a net retention of $5.0 million; 50.0% of the
next $5.0 million; and, 95.0% of the next $90.0 million. Including the
Company's retention, total catastrophe coverage was $100.0 million.
This coverage was placed with a number of reinsurers, both foreign and
domestic.
Effective March 1, 1996, through February 28, 1998, the Company's
catastrophe reinsurance program was tailored in conjunction with the
property quota share arrangement to provide catastrophe reinsurance
protection at varying levels of losses. The Company's two separate
catastrophe only programs provide a maximum amount of protection of $18
million and $42 million. These two programs expire on March 1, 1998 and
May 1, 1998, respectively. The table below provides information
depicting the approximate combined recoveries of all property
reinsurance programs (catastrophe and quota share) at various loss
scenarios if a catastrophe were to strike:
Net Loss
Total Reinsurance Retained by
Loss Recovery the Company
$ 25,000 $ 11,300 $13,700
50,000 35,000 15,000
75,000 58,800 16,200
100,000 82,500 17,500
125,000 105,000 20,000
150,000 110,000 40,000
Under the above scenario, the Company had no reinsurance
recoveries for total loss amounts in excess of $150.0 million. The
Company is currently negotiating with several of its existing quota-
share and excess loss reinsurance providers to expand the quota share
portion of the program. A 75% quota-share reinsurance program is
contemplated, covering all non-automobile property and liability
business except umbrella policies. The excess loss portion of the
program would be reduced on July 1, 1998 and completely eliminated on
September 30, 1998. The Company intends to incept this expanded program
on July 1, 1998. Based on this, the Company's catastrophe reinsurance
program will consist solely of the current quota-share and excess loss
reinsurance contract for a period of time between May 1, 1998 and June
30, 1998.
Casualty Reinsurance
Through December 31, 1996, casualty reinsurance was on an excess
of loss basis for any one event or occurrence with a maximum recovery of
$4.0 million over a net retention of $1.0 million. Effective January 1,
1997, casualty reinsurance is on an excess of loss basis for any one
event or occurrence with a maximum recovery of $9.0 million over a net
retention of $1.0 million. This coverage is placed with Swiss
Reinsurance America Corporation, formerly North American Reinsurance
Corporation (rated A by A.M. Best).
Effective January 1, 1995, personal and commercial liability
umbrella policies are reinsured on a 95% quota share basis in regard to
limits up to $1.0 million and 100% quota share basis for limits in
excess of $1.0 million but not exceeding $5.0 million for policies with
underlying automobile coverage of $250/$500 or more. Effective January
1, 1996, the Company added personal liability umbrella reinsurance
coverage for policies with underlying automobile coverage of $100/$300,
on a 65% quota share basis in regard to limits up to $1.0 million and
100% quota share basis for limits in excess of $1.0 million but not
exceeding $3.0 million. These coverages are placed with Munich American
Reinsurance Corporation (rated A+ by A.M. Best).
37
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
C.A.R.
C.A.R., a state-mandated reinsurance mechanism, enables the
Company and approximately 40 other writers of automobile insurance in
Massachusetts ("Servicing Carriers") to reinsure any automobile risk
that the insurer perceives to be underpriced at the premium level
permitted by the Massachusetts Insurance Commissioner (the
"Commissioner"). Servicing Carriers, who are responsible for over 99.0%
of total direct premiums written for personal automobile insurance in
Massachusetts, are required to offer automobile insurance coverage to
all eligible applicants pursuant to "take-all-comers" regulations, but
may reinsure undesirable business with C.A.R.
The Company pays to C.A.R. all of the premiums generated by the
policies it has ceded and C.A.R. reimburses the Company for all losses
incurred on account of ceded policies. In addition, the Company
receives a fee for servicing ceded policies based on the expense
structure established by C.A.R. For the years ended December 31, 1997,
1996 and 1995, these servicing fees amounted to $17,333, $17,127 and
$21,669, respectively.
Since its inception, C.A.R. has annually generated multi-million
dollar underwriting losses in both the personal and commercial pools.
The Company is required to share in the underwriting results of C.A.R.
business for its respective product lines. Under current regulations,
the Company's share of the C.A.R. personal or commercial deficit is
based upon its market share for retained automobile risks for the
particular pool, adjusted by a "utilization" concept, such that, in
general, the Company is disproportionately and adversely affected if its
relative use of C.A.R. reinsurance exceeds that of the industry, and
favorably affected if its relative use of C.A.R. reinsurance is less
than that of the industry. During 1997, 1996 and 1995, the Company's
net participation in the C.A.R. personal automobile pool approximated
18.0%, 19.0% and 16.0%, respectively.
Written premiums, earned premiums, losses incurred and the
liabilities for unearned premiums, unpaid losses ceded to and assumed
from C.A.R. were as follows:
Year ended December 31,
1997 1996
1995
Ceded Assumed Ceded Assumed
Ceded Assumed
Income Statement
Written premiums... $ 71,816 $ 76,530 $ 82,861 $ 93,703 $
82,814 $ 92,249
Earned premiums.... 71,977 82,866 85,977 92,469
92,664 90,609
Losses incurred.... 83,240 89,081 84,074 93,278
75,475 87,786
Balance Sheet
Unearned premiums.. $ 51,662 $ 40,345 $ 49,487 $ 46,681 $
47,045 $ 45,446
Unpaid losses...... 129,137 102,819 145,726 117,237
153,079 110,003
In accordance with Statement of Financial Accounting Standards No.
113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts", the company presents assets and liabilities
gross of reinsurance. The Residual Market Receivable represents the
gross amount of reinsurance recoverable from C.A.R. including unpaid
losses, unearned premiums, paid losses recoverable and unpaid ceded and
assumed premiums.
The current C.A.R. utilization-based participation ratio has been
in place for the personal automobile market since 1993. During 1997,
1996 and 1995 the Company's amount of personal automobile risks it
reinsured through C.A.R. approximated 6.6%, 8.0% and 11.0%,
respectively.
38
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE F-Reinsurance Activity - (continued)
Earned premiums and losses and loss adjustment expenses are stated
in the accompanying consolidated financial statements after deductions
for ceded reinsurance. Those deductions for reinsurance other than
C.A.R. are as follows:
Year ended
December 31,
1997
1996 1995
Earned premiums ceded............................. $ 33,847 $
36,261 $ 28,056
Losses and loss adjustment expenses ceded......... 10,616
22,453 21,454
The Company, as primary insurer, would be required to pay losses
in their entirety in the event that the reinsurers were unable to
discharge their obligations under the reinsurance agreements.
NOTE G-Income Taxes
The Company and its subsidiaries file a consolidated federal
income tax return.
The Federal income tax expense consisted of the following:
Year ended
December 31,
1997
1996 1995
Current............................ $ 24,318 $
15,951 $ 34,891
Deferred........................... 6,984
2,098 4,650
$ 31,302 $
18,049 $ 39,541
Deferred taxes arise from temporary differences in the bases of
assets and liabilities for tax and financial statement purposes. The
sources of these differences and the related tax effects consisted of
the following:
Year ended
December 31,
1997
1996 1995
Unearned premiums.................................. $ (769) $
(3,695) $ (1,469)
Discounting of loss reserves....................... 2,421
(2,954) (370)
Bad debt expense................................... 129
131 92
Deferred policy acquisition costs.................. 1,297
6,022 5,087
Salvage and subrogation recoverable................ (406)
425 151
Tax depreciation in excess of book depreciation.... 151
192 205
Book value rights/book value awards/stock
appreciation rights............................... 4,912
1,686 334
Deferred items not included above.................. (751)
291 620
Deferred income tax.......................... 6,984
2,098 4,650
Change in unrealized gains......................... 2,236
3,540 31,726
Change in deferred tax liability............. $ 9,220 $
5,638 $ 36,376
39
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE G-Income Taxes - (continued)
Realization of a deferred tax asset is dependent on generating
sufficient taxable income in future years. Although realization is not
assured, Management believes it is more likely than not that all of the
deferred tax assets will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term
if estimates of future taxable income are reduced. Deferred tax
liabilities (assets) were comprised of the following components at
December 31, 1997 and 1996:
1997 1996
Unearned premiums................................................
$(20,608) $(19,839)
Discounting of loss reserves.....................................
(21,379) (23,800)
Bad debt allowances..............................................
(772) (901)
Deferred tax assets........................................
(42,759) (44,540)
Deferred policy acquisition costs................................
25,832 24,535
Salvage and subrogation recoverable..............................
2,001 2,407
Tax depreciation in excess of book depreciation..................
2,856 2,705
Book value rights/book value awards/stock appreciation rights....
8,199 3,287
Unrealized gains.................................................
14,663 12,427
Deferred items not included above................................
2,651 3,402
Deferred tax liabilities...................................
56,202 48,763
Net deferred tax liability................................. $
13,443 $ 4,223
Federal income tax on income is less than the amount computed by
applying the statutory rate of 35% for the years ended 1997, 1996 and
1995 for the following reasons:
Year ended December 31,
1997 1996
1995
Tax at statutory rate.. $ 44,631 35.0% $32,205 35.0%
$52,410 35.0%
Tax exempt interest.... (8,036) (6.3) (10,062) (10.9)
(11,067) (7.4)
Dividends paid to ESOP
participants......... (782) (0.6) (1,169) (1.3)
- - -
Dividends received
deduction............ (4,567) (3.6) (3,167) (3.4)
(2,038) (1.4)
Other.................. 56 0.0 242 0.2
236 0.2
Tax at effective rate.. $ 31,302 24.5% $18,049 19.6%
$39,541 26.4%
NOTE H-Related-Party Transactions
The Company has made loans to insurance agencies and other
organizations with which the Company transacts business on a regular
basis. At December 31, 1997, seven of these loans which had an
aggregate outstanding principal balance of $12,161 were collateralized
by the assets of the agencies. At December 31, 1996, eleven of these
loans which had an aggregate outstanding principal balance of $2,384
were collateralized by the assets of the agencies. Mortgage loans to
agents collateralized by real estate had an aggregate outstanding
balance of $317 at December 31, 1996. There were no such mortgage loans
outstanding at December 31, 1997.
40
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE H-Related-Party Transactions (continued)
During 1992, the Company insured a mortgage note in the principal
amount of $28,750 issued by a corporation to a bank. Two directors of
the Company, were, with others, guarantors of this note. The Company's
liability under this insurance policy, which expired on October 15,
1995, was $12,000. For this insurance, the Company received the full
premium of $1,080 in 1992, which was earned pro-rata through the
expiration date of the policy.
One Director of the Company, is the Chairman Emeritus and
Assistant Clerk of an insurance agency which is one of the Company's
independent insurance agencies. This Director sold his ownership
interest in that agency in 1994, although he remains associated with it
in the above stated capacity. This Director also continues to receive
payments under non-competition and loan agreements. This Director
receives no direct or indirect compensation based on the commissions
paid to the agency by the Company. During the years ended December 31,
1997, 1996 and 1995 the agency received from the Company commissions of
$834, $906 and $885, respectively, in the aggregate, for policies
written. The Company also purchased certain insurance coverages through
the agency and paid premiums for these policies of $367, $360 and $218
in 1997, 1996 and 1995, respectively.
NOTE I-Employee Stock Ownership Plan
The Company offers an Employee Stock Ownership Plan for the
benefit of substantially all employees, including those of the Company's
subsidiaries. The E.S.O.P. is noncontributory on the part of
participants and contributions are made at the discretion of the Board
of Directors. The Company is under no obligation to make contributions
or maintain the Plan for any length of time, and may completely
discontinue or terminate the Plan at any time without liability.
Contributions by the Company and subsidiaries to the Plan for the
years ending December 31, 1997, 1996 and 1995 were $4,841, $6,216 and
$5,729, respectively.
NOTE J-Stockholders' Equity
Book Value Rights, Book Value Awards and Stock Appreciation Rights
Program
The Board of Directors authorized a Book Value Rights Program
which provided for the payment of awards in cash to key employees based
upon increases in the book value of the Company at the end of the
program period, which is December 31st of the third year after the
rights have been granted. The Board of Directors authorized advance
payments of $1,888 in December, 1995 applicable to Book Value Rights
maturing in 1996. Expenses relating to this Book Value Rights Program
were $234 and $3,738 in 1996 and 1995, respectively.
The Management Incentive Plan approved by the Company's
stockholders in May, 1994 provides for the award of incentive stock
options, non-qualified stock options, book value awards, stock
appreciation rights, restricted stock and performance stock units. Up
to 2,500,000 shares of common stock (subject to increase for anti-
dilution adjustments) may be issued under the Plan, including shares
that may be issued pursuant to awards of restricted stock or upon the
exercise of common stock equivalent awards such as stock options and
stock appreciation rights payable in the form of common stock. All
directors, officers and other senior management employees of the Company
or any of its subsidiaries are eligible to participate in this
Management Incentive Plan. Book value awards issued relating to this
Plan totalled 453,488, 468,381 and 606,088 in 1997, 1996 and 1995,
respectively. Stock appreciation rights issued also relating to this
Plan totalled 493,492, 520,625 and 672,358 in 1997, 1996 and 1995,
respectively. The outstanding book value awards and stock appreciation
rights entitle the holders to cash payments based upon the extent to
which, if at all, the per share book value or market value, as
applicable, of the common stock exceeds certain thresholds set at the
time the award was granted. Expenses relating to book value awards were
$3,068, $2,140 and $714 in 1997, 1996 and 1995. Expenses relating to
stock appreciation rights were $15,657, $6,224 and $366 in 1997, 1996
and 1995.
41
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars Except for Per Share Data)
NOTE K-Net Capital Requirements
The insurance companies included in the consolidated financial
statements are subject to the financial capacity guidelines established
by their respective state Divisions of Insurance. Every Massachusetts
insurance company seeking to make any dividend or other distributions to
its stockholders must file a report with the Commissioner. An
extraordinary dividend is any dividend or other property, whose fair
value together with other dividends or distributions made within the
preceding twelve months exceeds the greater of ten percent of the
insurer's surplus as regards policyholders as of the end of the
preceding year, or the net income of a non-life insurance company for
the preceding year. No pro-rata distribution of any class of the
insurer's own securities is to be included. No Massachusetts insurance
company shall pay an extraordinary dividend or other extraordinary
distribution until thirty days after the Commissioner has received
notice of the intended distribution and has not objected. No
extraordinary dividends were paid in 1997, 1996 and 1995.
To the extent Commerce and Citation are restricted from paying
dividends to CHI, CHI will be limited in its ability to pay dividends to
the Company. On this basis, the Company's ability to pay dividends to
its stockholders is limited. During 1997 Commerce and Citation paid
$39,375 and $7,040 in dividends, respectively, to CHI; CHI then paid $
46,305 to the Company in March 1997. During 1996, Commerce and Citation
paid $58,630 and $6,600 in dividends, respectively, to CHI; CHI then
paid $43,470 to the Company in March 1996.
The Board of Directors of the Company voted to declare four
quarterly dividends to stockholders of record totaling $1.03 per share
and $0.81 per share in 1997 and 1996, respectively. On May 30, 1997,
the Board voted to increase the quarterly stockholder dividend from
$0.25 to $0.26 per share to stockholders of record as of June 6, 1997.
Prior to that declaration, the Company had paid quarterly dividends of
$0.25 per share dating back to May 17, 1996 when the Board voted to
increase the dividend from $0.06 to $0.25 per share.
Treasury Stock purchased under the stock buyback program increased
by 20,000 shares during 1997 to 1,957,348 shares at December 31, 1997.
The stock buyback program, authorized by the Board in May 1995, enables
the Company to purchase up to three million shares of the Company's
common stock. The program is approximately two-thirds complete.
42
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars)
NOTE L-Statutory Balances
Following is a GAAP to Statutory reconciliation for both earnings
and policyholders surplus for the combined operations of Commerce,
Citation and effective August 31, 1995, Western Pioneer:
1997 1996
1995
Earnings Equity Earnings Equity
Earnings Equity
GAAP............................ $101,528 $609,416 $ 74,432
$550,151 $110,450 $512,875
Deferred income taxes........... 4,039 8,352 929
2,165 4,152 (2,650)
Deferred acquisition costs...... (2,296) (85,264) (15,808)
(82,968) (8,094) (67,160)
Bonds-book versus market........ - (23,812) -
(16,194) - (14,432)
Preferred stock-market versus
book........................... - (429) -
(331) - (1,607)
Deferred income................. (697) 7,071 (963)
7,768 (1,496) 6,766
Deferred service fee income..... 1,784 3,139 1,538
1,538 - -
Deferred reinsurance
commissions.................... (1,267) 4,424 2,082
5,796 2,060 5,614
Statutory reserve over statement
reserves....................... - (8,567) -
(5,397) - (1,940)
Goodwill in subsidiary.......... (291) 2,226 (270)
2,515 (97) 2,806
Difference in GAAP to statutory
net income in subsidiary....... 57 - 416 -
(74) -
Other........................... - 42 4
(304) (4) (162)
Total adjustments.......... 1,329 (92,818) (12,072)
(85,412) (3,553) (72,765)
Statutory....................... 102,857 516,598 62,360
464,739 106,897 440,110
Add back subsidiary net loss
from January 1, 1995 through
August 30, 1995................ - - - -
429 -
Adjusted statutory.............. $102,857 $516,598 $ 62,360
$464,739 $107,326 $440,110
NOTE M-Segment Information
Selected information by industry segment for 1997, 1996 and 1995 is
summarized as follows:
Earnings
Before Identifiable
Revenue Income
Taxes Assets
1997
Property and casualty insurance............ $833,304 $132,544
$1,659,374
Real estate and commercial lending......... 4,448 4,448
83,420
Corporate and other........................ 3,383
(9,475) 11,959
Consolidated........................... $841,135 $127,517
$1,754,753
1996
Property and casualty insurance............ $740,707 $ 91,242
$1,590,695
Real estate and commercial lending......... 4,249 4,249
75,255
Corporate and other........................ 3,301
(3,478) 10,849
Consolidated........................... $748,257 $ 92,013
$1,676,799
1995
Property and casualty insurance............ $677,217 $147,378
$1,479,898
Real estate and commercial lending......... 3,804 3,804
76,642
Corporate and other........................ 3,014
(1,440) 7,635
Consolidated........................... $684,035 $149,742
$1,564,175
43
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Thousands of Dollars Except for Per Share Data)
NOTE N-Supplement to Consolidated Statements of Cash Flows
During the years ended December 31, 1996 and 1995, the Company
acquired property through foreclosure of mortgages held with remaining
principle balances at the time of foreclosure of $245 and $641,
respectively. No such property was acquired in 1997.
NOTE O-Insolvency Fund Assessments
As provided in the statutes, insurance companies which write
business in Massachusetts are assessed for losses attributable to the
insolvency of other insurance companies by the Massachusetts Insurers
Insolvency Fund ("M.I.I.F."). From its inception, on August 2, 1972
through December 31, 1997, the M.I.I.F. has approved assessments
totaling $133,474, of which the Company's share was approximately
$7,540. It is anticipated that there will be additional assessments
from time to time relating to various insolvencies. By statute, no
insurer may be assessed in any year an amount greater than two percent
of that insurer's net direct written premiums for the calendar year
preceding the assessment. Although the timing and amounts of any such
assessments are not known, Management is of the opinion that such
assessments will not have a material effect on the consolidated
financial position of the Company. The Company's policy is to expense
these assessments as assessed. According to statute, the assessed
insurance companies have the right to recoup amounts paid to the
M.I.I.F., over a reasonable length of time, through premium rates
approved by the Commissioner. The Company's policy is to recognize the
recovery of the assessed amounts as received. Refund of assessments by
the M.I.I.F. for the year ended December 31, 1997 was $283. Assessments
by the M.I.I.F. for the years ended December 31, 1996 and 1995 were $742
and $338, respectively.
NOTE P-Quarterly Results of Operations (Unaudited)
An unaudited summary of the Company's 1997 and 1996 quarterly
performance is as follows:
1997 FIRST SECOND
THIRD FOURTH
QUARTER QUARTER
QUARTER QUARTER
Total revenues................................. $199,069 $205,561
$225,082 $211,423
Net earnings................................... 16,638 19,971
35,012 24,594
Net earnings per weighted average common
share (basic and diluted).................... 0.46 0.56
0.97 0.68
Cash dividends paid per share.................. 0.25 0.26
0.26 0.26
1996
Total revenues................................. $173,802 $186,448
$192,333 $195,674
Net earnings................................... 14,593 16,265
21,436 21,670
Net earnings per weighted average common
share (basic and diluted).................... 0.40 0.45
0.59 0.60
Cash dividends paid per share.................. 0.06 0.25
0.25 0.25
NOTE Q-Subsequent Events
The Company was notified in February 1998 that its application for
a license in the State of Maine was approved.
44
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be
read in conjunction with the consolidated financial statements of the
Company and the notes thereto. This financial data has been extracted
from financial statements audited by Ernst & Young LLP in 1997 and by
other auditors in 1993 through 1996. All dollar amounts set forth in
the following tables are in thousands except per share data.
Year ended
December 31,
1997 1996 1995
1994 1993
Statement of Earnings Data:
Net premiums written........... $ 741,501 $ 711,570 $ 603,421
$ 589,197 $ 563,416
Increase in unearned premiums.. (11,004) (42,854) (10,831)
(17,144) (14,856)
Earned premiums................ 730,497 668,716 592,590
572,053 548,560
Net investment income.......... 80,794 77,402 71,313
62,901 53,068
Premium finance fees........... 7,074 9,713 19,420
18,497 16,666
Net realized investment gains
(losses)...................... 22,770 (7,574) 712
45,612 7,506
Total revenues............ 841,135 748,257 684,035
699,063 625,800
Losses and loss adjustment
expenses...................... 526,127 475,231 367,552
369,660 373,959
Policy acquisition costs....... 187,491 181,013 166,741
157,415 150,195
Total expenses............ 713,618 656,244 534,293
527,075 524,154
Earnings before income taxes... 127,517 92,013 149,742
171,988 101,646
Income taxes................... 31,302 18,049 39,541
49,405 26,330
Net earnings.............. $ 96,215 $ 73,964 $ 110,201
$ 122,583 $ 75,316
Per Share Data:
Basic and diluted
net earnings per share.. $ 2.67 $ 2.04 $ 2.93
$ 3.23 $ 1.98
Cash dividends paid per
share................... $ 1.03 $ 0.81 $ 0.23
$ 0.15 $ -
Weighted average number of
shares outstanding.............. 36,044,679 36,311,887 37,632,236
38,000,000 38,000,000
December 31,
1997 1996 1995
1994 1993
Balance Sheet Data:
Total investments.............. $1,242,695 $1,167,671 $1,096,778
$ 905,031 $ 873,234
Premiums receivable............ 169,469 157,835 127,047
102,432 95,103
Total assets................... 1,754,753 1,676,799 1,564,175
1,382,226 1,298,371
Unpaid losses and loss
adjustment expenses........... 649,473 662,832 626,029
599,502 574,049
Unearned premiums.............. 379,599 367,991 330,454
314,719 283,526
Stockholders' equity........... 649,796 587,039 549,714
413,589 383,348
Stockholders' equity per share. 18.03 16.28 14.96
10.88 10.09
45
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS
(Thousands of Dollars)
The following exhibits depict the progress of the insurance
operations of the Company over the past fifteen years. For these years
of operation, net premiums written amounted to $4,783,113. During this
period, the average statutory financial ratios were 67.7% for losses and
loss expenses and 26.8% for underwriting expenses resulting in an
average combined ratio of 94.5%. Total net investment income amounted
to $515,735 or 10.8% of net premiums written. Net realized gains were
$87,868. Stockholders' equity was $11,693 at the beginning of 1983 and
$609,416, at the end of 1997, resulting in an average annual increase in
excess of 30%. The progress of the insurance operations during the most
recent five year period, compared to the two previous five year periods,
can best be illustrated by the following comparison:
5-Year
Period
1993-97
1988-92 1983-87
Direct premiums written............................ $3,353,450
$2,029,313 $526,055
Net premiums written............................... 3,209,105
1,305,018 268,990
Net investment income.............................. 345,079
135,579 35,077
Net realized gains................................. 60,831
22,887 4,150
Stockholders' equity at end of period.............. 609,416
265,616 46,081
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to premiums earned...... 67.7%
65.6% 76.7%
Underwriting expenses to net premiums written.... 26.7
27.6 24.8
Combined ratio............................... 94.4%
93.2% 101.5%
Increase in Stockholders' Equity................... 129.4%
476.4% 294.1%
The insurance operations of the Company include the operating results of
Commerce, its subsidiary company Western Pioneer and Citation. Citation
commenced business in 1981 as a wholly-owned subsidiary of Commerce. On
December 31, 1989, the ownership of Citation was transferred to The
Commerce Group, Inc. Capital stock, paid-in capital and retained
earnings of Commerce and Citation as of January 1, 1989 were combined
due to the effect of the transfer in ownership of Citation to The
Commerce Group, Inc. on December 31, 1989. In September 1993, ownership
of both Commerce and Citation was transferred from The Commerce Group,
Inc. to CHI, a subsidiary of The Commerce Group, Inc. Results of
Western Pioneer are included since its acquisition by Commerce on August
31, 1995. The combined balance sheets of these insurance subsidiaries
appear on pages 47 and 48. The combined statements of earnings of
insurance operations appear on pages 49 and 50.
46
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1997 1996 1995
1994 1993
ASSETS
Cash and short-term investments.... $ 238,685 $ 140,102 $ 52,308
$ 4,560 $ 12,615
Bonds, at market (at amortized cost
prior to 1993).................... 590,597 716,702 815,277
745,010 649,491
Preferred stocks, at market (at
amortized cost prior to 1993)..... 148,499 147,680 111,220
85,574 80,059
Common stocks, at market........... 178,089 86,041 40,359
9,656 47,462
Mortgage loans on real estate...... 57,425 45,398 31,404
35,715 42,042
Other investments.................. 3,783 127 -
- - -
Premium balances receivable........ 169,311 157,673 126,090
101,529 94,333
Investment income receivable....... 12,103 12,655 14,440
13,285 10,205
Residual market receivable......... 180,799 195,213 200,124
214,818 220,312
Reinsurance receivable............. 18,170 19,659 21,897
16,892 12,868
Deferred acquisition costs......... 85,264 82,968 67,160
59,066 53,647
Current income taxes............... - - -
- - -
Deferred income taxes.............. - - 2,100
38,180 -
Real estate, furniture and equipment 29,060 26,011 24,642
25,246 22,371
Total assets................ $1,711,785 $1,630,229 $1,507,021
$1,349,531 $1,245,405
LIABILITIES
Unpaid losses and loss expenses.... $ 637,094 $ 657,854 $ 618,791
$ 592,373 $ 567,797
Unearned premiums.................. 379,599 367,991 330,454
314,719 283,526
Notes payable...................... - - -
- - -
Deferred income.................... 7,271 7,974 8,954
10,451 7,351
Accounts payable, accrued and other
liabilities....................... 60,332 41,368 34,351
43,433 16,564
Current income taxes............... 9,635 2,726 1,596
10,254 4,867
Deferred income taxes.............. 8,438 2,165 -
- - 13,669
Total liabilities........... 1,102,369 1,080,078 994,146
971,230 893,774
STOCKHOLDERS' EQUITY
Capital stock...................... 3,600 3,600 3,450
3,450 3,450
Paid-in capital.................... 45,050 45,050 23,700
23,700 8,700
Retained earnings
Balance, January 1............... 501,501 485,725 351,151
339,481 253,466
Net earnings..................... 101,528 74,432 110,450
113,892 79,837
Unrealized gains (losses) on
investments..................... 4,152 6,574 58,919
(77,622) 21,928
Dividends paid................... (46,415) (65,230) (34,795)
(24,600) (15,750)
Balance, December 31............... 560,766 501,501 485,725
351,151 339,481
Total stockholders' equity.. 609,416 550,151 512,875
378,301 351,631
Total liabilities and
stockholders' equity...... $1,711,785 $1,630,229 $1,507,021
$1,349,531 $1,245,405
47
<PAGE
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES
December 31,
(Thousands of Dollars)
1992 1991 1990 1989 1988 1987 1986
1985 1984 1983
ASSETS
$ 25,809 $ 11,190 $ 38,654 $ 84,308 $ 60,885 $ 21,051 $ 10,048 $
11,802 $ 7,953 $ 3,864
505,565 329,935 242,735 153,621 133,867 116,220 88,755
56,985 34,422 22,352
2,261 869 1,010 1,324 1,606 2,295 6,755
9,956 10,837 7,986
43,545 30,055 4,869 2,900 1,921 1,438 149
134 1,494 1,540
60,697 66,122 56,124 52,244 42,882 15,931 -
- - 7,825 5,860
67,876 55,510 57,733 56,713 33,727 19,329 11,817
8,194 6,028 5,430
- - - - - - -
- - - -
9,710 6,063 4,235 3,093 2,889 2,370 2,485
1,722 1,286 887
274,426 277,196 290,440 268,951 198,177 132,725 87,178
50,327 29,187 20,513
365 - - - - - -
- - - -
55,442 33,981 27,273 22,702 15,699 10,898 7,129
5,417 3,968 3,057
- - - 341 266 - 2,209
1,294 - -
- 883 1,666 - - - -
- - - -
23,183 24,163 25,046 23,118 9,684 8,356 7,370
5,648 3,136 2,799
$1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613 $223,895
$151,479 $106,136 $74,288
LIABILITIES
$ 495,800 $439,551 $403,752 $345,020 $270,628 $169,539 $113,513 $
71,525 $ 44,425 $32,860
264,567 192,785 175,334 174,345 118,079 84,876 55,378
36,024 23,585 14,190
- - 1,662 1,837 2,013 2,204 3,772
4,140 2,858 1,313
8,384 12,918 20,264 23,689 23,307 11,058 7,503
4,208 3,173 1,658
20,863 7,677 21,065 27,513 19,350 14,532 8,532
4,162 4,479 2,482
9,249 5,811 3,542 - - 470 -
- - 418 1,487
4,400 - - 1,623 1,021 1,853 3,736
3,623 2,610 2,079
803,263 658,742 625,619 574,027 434,398 284,532 192,434
123,682 81,548 56,069
STOCKHOLDERS' EQUITY
3,450 3,450 3,450 3,450 2,350 2,350 2,350
2,350 2,350 2,250
8,700 8,700 8,700 8,700 6,500 6,500 6,500
6,500 6,500 5,500
165,075 112,016 83,138 62,877 37,231 22,611 18,947
15,738 10,469 5,693
91,980 55,214 32,414 21,966 21,837 15,614 4,362
4,025 6,033 5,213
9,811 2,545 (86) 645 321 (54) 7
(158) (179) 63
(13,400) (4,700) (3,450) (2,350) (1,034) (940) (705)
(658) (585) (500)
253,466 165,075 112,016 83,138 58,355 37,231 22,611
18,947 15,738 10,469
265,616 177,225 124,166 95,288 67,205 46,081 31,461
27,797 24,588 18,219
$1,068,879 $835,967 $749,785 $669,315 $501,603 $330,613 $223,895
$151,479 $106,136 $74,288
48
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
1997 1996 1995
1994 1993
Underwriting
Direct premiums written.............. $768,649 $731,823 $626,666
$625,023 $601,289
Net premiums written................. $741,501 $711,570 $603,421
$589,197 $563,416
Increase in unearned premiums........ 11,004 42,854 10,831
17,144 14,856
Earned premiums.................. 730,497 668,716 592,590
572,053 548,560
Expenses
Losses and loss expenses............. 521,775 474,173 367,258
369,764 373,243
Underwriting expenses................ 185,146 194,873 171,892
162,446 147,290
(Increase) decrease in deferred
acquisition costs................... (2,296) (15,809) (5,723)
(5,420) 1,796
Total expenses................... 704,625 653,237 533,427
526,790 522,329
Underwriting income (loss)............. 25,872 15,479 59,163
45,263 26,231
Net investment income.................. 81,218 76,867 71,007
63,119 52,868
Premium finance fees................... 7,056 9,666 19,246
18,315 16,486
Net realized investment gains (losses). 22,909 (7,863) 720
32,025 13,040
Earnings before Federal income
taxes and withdrawing companies'
settlements...................... 137,055 94,149 150,136
158,722 108,625
Other income
Withdrawing companies' settlements... - - -
- - -
Earnings before Federal income taxes... 137,055 94,149 150,136
158,722 108,625
Federal income taxes (benefits)........ 35,527 19,717 39,686
44,830 28,788
Earnings before cumulative effect of
change in accounting principle........ 101,528 74,432 110,450
113,892 79,837
Cumulative effect on prior years (to
December 31, 1986) of changing to
different method of accounting for
income taxes.......................... - - -
- - -
NET EARNINGS..................... $101,528 $ 74,432 $110,450
$113,892 $ 79,837
Statutory Financial Ratios (Unaudited)
Losses and loss expenses to
premiums earned..................... 71.4% 70.9% 62.0%
64.6% 68.0%
Underwriting expenses to net
premiums written.................... 25.1 27.1 29.0
27.1 25.7
Combined ratio................... 96.5% 98.0% 91.0%
91.7% 93.7%
Underwriting profit (loss)....... 3.5% 2.0% 9.0%
8.3% 6.3%
49
MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION
ON INSURANCE OPERATIONS (continued)
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS
Year Ended December 31,
(Thousands of Dollars)
1992 1991 1990 1989 1988 1987 1986
1985 1984 1983
$525,495 $429,780 $401,077 $366,492 $306,469 $206,231 $131,807
$85,000 $65,699 $37,318
$508,847 $310,999 $219,936 $140,313 $124,923 $ 99,193 $ 60,808
$49,229 $33,943 $25,817
98,353 30,193 34,692 12,655 9,678 13,428 6,775
6,392 2,137 2,258
410,494 280,806 185,244 127,658 115,245 85,765 54,033
42,837 31,806 23,559
271,848 173,901 125,219 88,564 80,203 65,299 44,205
33,548 19,567 15,242
138,669 85,655 55,551 44,181 33,115 25,882 18,460
15,177 11,241 6,532
(21,462) (6,708) (4,571) (7,003) (4,801) (3,769) (1,712)
(1,448) (911) (1,327)
389,055 252,848 176,199 125,742 108,517 87,412 60,953
47,277 29,897 20,447
21,439 27,958 9,045 1,916 6,728 (1,647) (6,920)
(4,440) 1,909 3,112
39,685 32,661 25,978 21,256 15,999 10,896 7,554
6,835 5,684 4,108
13,734 11,165 10,074 8,095 4,592 3,021 1,436
531 324 39
12,368 7,529 74 618 2,298 3,423 185
336 (108) 314
87,226 79,313 45,171 31,885 29,617 15,693 2,255
3,262 7,809 7,573
43,168 - - - - - -
- - - -
130,394 79,313 45,171 31,885 29,617 15,693 2,255
3,262 7,809 7,573
38,414 24,099 12,757 9,919 7,780 2,987 (2,107)
(763) 1,776 2,360
91,980 55,214 32,414 21,966 21,837 12,706 4,362
4,025 6,033 5,213
- - - - - 2,908 -
- - - -
$ 91,980 $ 55,214 $ 32,414 $ 21,966 $ 21,837 $ 15,614 $ 4,362 $
4,025 $ 6,033 $ 5,213
66.2% 61.9% 65.7% 68.0% 69.5% 79.4% 83.5%
79.7% 63.6% 63.8%
28.1 30.0 26.7 26.3 22.0 22.5 24.4
28.1 27.8 23.9
94.3% 91.9% 92.4% 94.3% 91.5% 101.9% 107.9%
107.8% 91.4% 87.7%
5.7% 8.1% 7.6% 5.7% 8.5% (1.9%) (7.9%)
(7.8%) 8.6% 12.3%
50
THE COMMERCE GROUP, INC.
DIRECTORS
Herman F. Becker......................... President and owner,
Sterling Realty and Huguenot
Development Corporation
Joseph A. Borski, Jr..................... Self-employed Certified
Public Accountant
Eric G. Butler........................... Retired Vice President and
General Claims Manager of
Commerce and Citation
Henry J. Camosse......................... Retired President, Henry
Camosse & Son Co., Inc., a
building and masonry supplies company
Gerald Fels.............................. Executive Vice President and
Chief Financial Officer of
the Company
David R. Grenon.......................... Chairman Emeritus and
Assistant Clerk of The
Protector Group Insurance
Agency, Inc., a property
and casualty insurance
agency
Robert W. Harris......................... Retired Treasurer, H.C.
Bartlett Insurance Agency, Inc.
Robert S. Howland........................ Retired Clerk, H.C. Bartlett
Insurance Agency, Inc.
John J. Kunkel........................... President and Treasurer,
Kunkel Buick and GMC
Truck, Treasurer, Kunkel Bus
Company
Raymond J. Lauring....................... Retired President, Lauring
Construction Company
Roger E. Lavoie.......................... Retired President and
Treasurer, Lavoie Toyota-
Dodge, Inc.
Normand R. Marois........................ Retired Chairman of the
Board, Marois Bros., Inc.,
a contracting firm
Suryakant M. Patel....................... Physician specializing in
internal medicine
Arthur J. Remillard, Jr.................. President, Chief Executive
Officer and Chairman
of the Board of the Company
Arthur J. Remillard, III................. Senior Vice President and
Assistant Clerk of
the Company, Senior Vice
President of Commerce
and Citation in charge of
Policyholder Benefits
Regan P. Remillard....................... Senior Vice President and
General Counsel
of the Company, President
and Secretary of
Western Pioneer Insurance
Company
Antranig Sahagian........................ Retired Owner, A. Sahagian
Service Center
Gurbachan Singh.......................... Physician specializing in
general surgery
John W. Spillane......................... Clerk of the Company and
practicing attorney
51
DIRECTORS OF
COMMERCE HOLDINGS, INC.
The Commerce Insurance Company
Western Pioneer Insurance Company
Citation Insurance Company
Arthur J. Remillard, Jr................ President, Chief Executive
Officer and Chairman
of the Board
Gerald Fels............................ Executive Vice President and
Chief Financial Officer
Arthur J. Remillard, III (1)........... Senior Vice President and
Clerk
Regan P. Remillard..................... Senior Vice President and
General Counsel, President
and Secretary of Western
Pioneer Insurance Company
David R. Grenon (1).................... Chairman Emeritus and
Assistant Clerk of The
Protector Group Insurance
Agency
John M. Nelson (1)..................... Chairman of TJX Companies
Suryakant M. Patel (1)................. Physician specializing in
internal medicine
William G. Pike (1).................... Executive Vice President and
Chief Financial Officer of
Granite State Bankshares,
Inc.
DIRECTORS OF
BAY FINANCE COMPANY, INC.
Arthur J. Remillard, Jr................ President and Chairman of
the Board
Gerald Fels............................ Executive Vice President and
Chief Financial Officer
John W. Spillane....................... Clerk and practicing
attorney
Arthur J. Remillard, III............... Assistant Clerk
Regan P. Remillard..................... Senior Vice President
DIRECTORS OF
CLARK-PROUT INSURANCE AGENCY, INC.
Arthur J. Remillard, Jr................ President and Chairman of
the Board
Gerald Fels............................ Executive Vice President and
Chief Financial Officer
John W. Spillane....................... Clerk and practicing
attorney
Arthur J. Remillard, III............... Assistant Clerk
Elizabeth M. Edwards................... Vice President
(1) Commerce Holdings, Inc., The Commerce Insurance Company and
Citation Insurance Company
only.
52
THE COMMERCE GROUP, INC.
Commerce Holdings, Inc.
The Commerce Insurance Company
Western Pioneer Insurance Company
Citation Insurance Company
Bay Finance Company, Inc.
Clark-Prout Insurance Agency, Inc.
OFFICERS OF THE COMMERCE GROUP, INC.
President, Chief Executive Officer and Chairman of the Board...
Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer...........
Gerald Fels
Senior Vice President and Assistant Clerk......................
Arthur J. Remillard, III
Senior Vice President and General Counsel......................
Regan P. Remillard
Senior Vice President.......................................... Mary
M. Fontaine
Clerk.......................................................... John
W. Spillane
Treasurer and Chief Accounting Officer.........................
Randall V. Becker
Assistant Treasurer............................................
Thomas A. Gaylord
Assistant Vice President.......................................
Robert E. McKenna
* Officers of Subsidiaries
President, Chief Executive Officer and Chairman of the Board...
Arthur J. Remillard, Jr.
Executive Vice President and Chief Financial Officer...........
Gerald Fels
Senior Vice Presidents.........................................
David H. Cochrane
Peter J. Dignan
Mary
M. Fontaine
Arthur J. Remillard, III
Joyce B. Virostek
Senior Vice President and General Counsel......................
Regan P. Remillard
Vice Presidents................................................
Elizabeth M. Edwards
Michael J. Richards
Angelos Spetseris
Henry R. Whittier, Jr.
Assistant Vice Presidents..............Robert M. Blackmer
Ronald J. Lareau
Stephen R. Clark
Karen A. Lussier
Raymond J. DeSantis
Donald G. MacLean
Warren S. Ehrlich
Robert E. McKenna
John V. Kelly
Robert L. Mooney
Kenneth E. Morrison
Treasurer and Chief Accounting Officer.........................
Randall V. Becker
Assistant Treasurer............................................
Thomas A. Gaylord
Officers of Western Pioneer Insurance Company
President and Secretary........................................
Regan P. Remillard
Chief Financial Officer........................................
Albert E. Peters
Vice President.................................................
Howard M. Dreyfus
Assistant Vice Presidents......................................
Michael J. Berryessa
Robert M. Keppel
Treasurer and Controller....................................... Joan
M. Kelly
* Officers often hold positions with several operating subsidiaries.
The titles listed
represent their primary office as of March 1, 1998.
53
<PAGE
Stockholder Information
Annual Meeting
The Annual meeting of stockholders will be held at 9:00 a.m. on Friday,
May 15, 1998 at the Company's Underwriting Building, 11 Gore Road (Route
16), Webster, MA.
Form 10-K
Stockholders interested in the detailed information contained in the
Company's annual report on Form 10-K, as filed with the Securities and
Exchange Commission, may obtain a copy without charge, by writing to the
Assistant to the President at 211 Main Street, Webster, MA 01570.
Transfer Agent
The Commerce Group, Inc.
c/o BANKBOSTON, NA
Boston EquiServe, L.P.
P.O. Box 8040
Boston, MA 02266-8040
(781) 575-3100
Executive Offices
211 Main Street
Webster, MA 01570
(508) 943-9000
Trading of Common Stock
The Company's Common Stock trades on the NYSE under the symbol "CGI".
Independent Auditors
Ernst & Young LLP
200 Clarendon Street
Boston, MA 02116
(617) 266-2000
54