UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended June 30, 1998 Commission File Number 0-16882
THE COMMERCE GROUP, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2599931
(State or other (IRS Employer
jurisdiction Identification
of Incorporation) No.)
211 Main Street Webster, Massachusetts 01570
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 943-9000
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes X No___
As of August 1, 1998, the number of shares outstanding of the
registrant's common stock (excluding Treasury Shares) was
36,042,652
Page 1 of 24
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Consolidated Balance Sheets at
June 30, 1998 (Unaudited) and December 31,
1997................................................... 3
Consolidated Statements of Earnings for the
Three and Six Months Ended June 30, 1998 and 1997
(Unaudited)............................. 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1998 and 1997
(Unaudited)............................................. 5
Consolidated Statements of Cash Flows - Reconciliation of Net Earnings
to Net Cash
Provided by Operating Activities for the Six Months Ended June 30,
1998
and 1997
(Unaudited).............................................................
................................... 6
Notes to Unaudited Consolidated Financial
Statements.................................................... 7
Management's Discussion and
Analysis................................................................
.......... 11
Part II - Other Information
Item 4
Results of Votes of Security
Holders.................................................................
.......... 23
Item 6
Exhibits and Reports on Form 8-
K.......................................................................
...... 24
Signature
........................................................................
.............................................. 24
- - 2 -
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
June 30, December 31,
1998 1997
(Unaudited)
ASSETS
Investments:
Fixed maturities, at market (cost: $625,574 in 1998 and $566,784
in 1997)....................... $ 645,295 $ 590,597
Preferred stocks, at market (cost: $196,258 in 1998 and $148,135
in 1997)....................... 195,413 148,499
Common stocks, at market (cost: $205,471 in 1998 and $160,371 in
1997).......................... 221,356 178,089
Mortgage loans on real estate and collateral notes receivable
(less allowance for possible loan
losses of $2,495 in 1998 and $2,812 in
1997)................................................... 73,887
82,839
Short-term
investments.............................................................
.............. 48,117 132,700
Cash and cash
equivalents.............................................................
........... 71,116 106,188
Other investments (cost: $5,891 in 1998 and $3,783 in
1997)..................................... 6,266 3,783
Total
investments.............................................................
............... 1,261,450 1,242,695
Accrued investment
income..................................................................
........ 13,529 12,237
Premiums receivable (less allowance for doubtful receivables of
$1,451 in 1998 and 1997)........... 205,497 169,469
Deferred policy acquisition
costs..................................................................
95,414 85,264
Property and equipment, net of accumulated
depreciation............................................ 36,505
36,280
Residual market receivable
Losses and loss adjustment
expenses..............................................................
117,595 129,137
Unearned
premiums................................................................
................ 44,429 51,662
Due from
reinsurers..............................................................
.................. 17,487 18,170
Current income
taxes...................................................................
............ 318 -
Other
assets..................................................................
..................... 10,372 9,839
Total
assets..................................................................
............... $1,802,596 $1,754,753
LIABILITIES AND
STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment
expenses..............................................................
$ 618,920 $ 649,473
Unearned
premiums................................................................
................ 439,459 379,599
Current income
taxes...................................................................
.......... - 2,656
Deferred income
taxes...................................................................
......... 10,409 13,443
Deferred
income..................................................................
................ 7,204 7,271
Contingent commissions
accrued.................................................................
.. 14,588 13,861
Payable for securities
purchased...............................................................
.. 15,342 11,500
Other liabilities and accrued
expenses...........................................................
25,555 27,154
Total
liabilities.............................................................
............... 1,131,477 1,104,957
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value;
none issued in 1998 and 1997.... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
issued and outstanding 38,000,000 shares in 1998 and
1997...................................... 19,000 19,000
Paid-in
capital.................................................................
................. 29,621 29,621
Net unrealized gains on fixed maturities, stocks, and other
investments net of income taxes of
$12,298 in 1998 and $14,663 in
1997............................................................
22,838 27,232
Retained
earnings................................................................
................ 638,347 612,630
709,806 688,483
Treasury stock 1,957,348 shares in 1998 and
1997................................................ (38,687)
(38,687)
Total stockholders'
equity..................................................................
. 671,119 649,796
Total liabilities and stockholders'
equity................................................... $1,802,596
$1,754,753
The accompanying notes are an integral part of these consolidated
financial statements.
- - 3 -
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three and Six Month Ended June 30, 1998 and 1997
(Thousands of Dollars Except Share and Per Share Data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
Revenues
Direct premiums written.........................................
$ 195,831 $ 186,339 $ 444,134 $ 430,467
Assumed premiums................................................
18,437 10,496 44,931 40,620
Ceded premiums..................................................
(26,142) (27,019) (50,386) (51,332)
Net premiums written..........................................
188,126 169,816 438,679 419,755
(Increase) decrease in unearned premiums........................
3,513 12,309 (59,989) (59,627)
Earned premiums ................................................
191,639 182,125 378,690 360,128
Net investment income...........................................
21,274 19,492 42,104 39,186
Premium finance and service fees................................
3,314 1,728 5,905 3,396
Net realized investment gains...................................
1,282 2,216 5,083 1,920
Total revenues.........................................
217,509 205,561 431,782 404,630
Expenses
Losses and loss adjustment expenses.............................
137,302 136,485 266,528 271,796
Policy acquisition costs........................................
56,494 44,270 108,698 87,620
Total expenses.........................................
193,796 180,755 375,226 359,416
Earnings before income taxes...........................
23,713 24,806 56,556 45,214
Income taxes......................................................
4,128 4,835 11,736 8,605
NET EARNINGS...........................................
$ 19,585 $ 19,971 $ 44,820 $ 36,609
COMPREHENSIVE INCOME...................................
$ 16,473 $ 30,028 $ 40,426 $ 42,363
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE........
$ 0.54 $ 0.56 $ 1.24 $ 1.02
CASH DIVIDENDS PAID PER COMMON SHARE...................
$ 0.27 $ 0.26 $ 0.53 $ 0.51
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING...
36,042,652 36,042,652 36,042,652 36,046,740
The accompanying notes are an integral part of these consolidated
financial statements.
- - 4 -
<page
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
1998 1997
Cash flows from operating activities:
Premiums
collected...............................................................
. $410,749 $363,684
Net investment
income.............................................................
40,812 39,981
Premium finance and service
fees..................................................
5,905 3,396
Losses and loss adjustment expenses
paid.......................................... (286,054)
(259,757)
Policy acquisition costs
paid.....................................................
(117,963) (113,816)
Federal income tax
payments.......................................................
(15,378) (9,563)
Net cash provided by operating
activities................................ 38,071
23,925
Cash flows from investing activities:
Proceeds from maturity of fixed
maturities....................................... 33,959
78,201
Proceeds from sale of fixed
maturities............................................
18,229 39,094
Proceeds from sale of equity
securities...........................................
52,641 46,502
Purchase of fixed
maturities......................................................
(98,128) (84,783)
Purchase of equity
securities.....................................................
(138,399) (93,091)
Purchase of other
investments.....................................................
(2,029) -
Net decrease in short-term
investments............................................
73,083 -
Payments received on mortgage loans and collateral notes
receivable............... 16,870 4,796
Mortgage loans and collateral notes
originated.................................... (7,748)
(2,773)
Purchase of property and
equipment................................................
(2,650) (3,915)
Other proceeds from investing
activities.......................................... 132
198
Net cash used in investing
activities.................................... (54,040)
(15,771)
Cash flows from financing activities:
Dividends paid to
stockholders....................................................
(19,103) (18,382)
Purchase of treasury
stock........................................................
- - (487)
Net cash used in financing
activities.................................... (19,103)
(18,869)
Decrease in cash and cash
equivalents...............................................
(35,072) (10,715)
Cash and cash equivalents at beginning of
period.................................... 106,188
140,535
Cash and cash equivalents at end of
period............................... $ 71,116
$129,820
The accompanying notes are an integral part of these consolidated
financial statements.
- - 5 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reconciliation of Net Earnings to Net Cash Provided by Operating
Activities
Six Months Ended June 30, 1998 and 1997
(Thousands of Dollars)
(Unaudited)
1998 1997
Cash flows from operating activities:
Net
Earnings................................................................
.......... $ 44,820 $ 36,609
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Premiums
receivable..............................................................
... (36,028) (52,808)
Deferred policy acquisition
costs...................................................
(10,150) (11,358)
Residual market
receivable..........................................................
18,775 1,649
Due to/from
reinsurers..............................................................
683 2,956
Losses and loss adjustment
expenses.................................................
(30,553) 5,888
Unearned
premiums................................................................
... 59,860 58,421
Current income
taxes................................................................
(2,974) (2,792)
Deferred income
taxes...............................................................
(668) 1,834
Deferred
income..................................................................
... (67) (243)
Contingent
commissions.............................................................
. 727 (14,020)
Other assets, liabilities and accrued
expenses...................................... (2,132)
(3,754)
Net realized investment
gains.......................................................
(5,083) (1,920)
Other -
net.....................................................................
.... 861 3,463
Net cash provided by operating
activities.................................... $ 38,071 $
23,925
The accompanying notes are an integral part of these consolidated
financial statements.
- - 6 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
1. The financial information has been prepared on a basis consistent
with the accounting principles reflected in the audited
consolidated financial statements for the year ended December 31,
1997. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been omitted
pursuant to the Securities and Exchange Commission rules and
regulations, although the Company believes the disclosures which
have been made are adequate to make the information presented not
misleading.
2. The information furnished includes all adjustments and accruals
consisting only of normal recurring adjustments which are, in the
opinion of management, necessary for a fair presentation of
results for the interim periods. Certain 1997 account balances
have been reclassified to conform to the current year's
presentation.
3. Statements in this Form 10-Q concerning future premium writings
and profit levels look forward in time and involve risks and
uncertainties that may affect the Company's actual results of
operations. Actual results may differ materially from those set
forth in the forward looking statements.
4. The consolidated financial statements should be read in
conjunction with the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
5. Neither the results for the six months ended June 30, 1998 nor
comparison with the corresponding six months ended June 30, 1997
should be considered indicative of the results which may be
expected for the year ending December 31, 1998.
6. In May 1995, the Board of Directors announced that it had approved
a stock buyback program of up to 3 million shares. As of June 30,
1998, 1,957,348 shares of Treasury Stock were purchased under the
program. No shares have been purchased in 1998.
7. In May 1998 the Board of Directors voted to increase its quarterly
stockholder dividend from $0.26 per share to $0.27 per share.
- - 7 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
8. Disclosure of Statement of Financial Accounting Standards No. 130
- - Reporting Comprehensive Income:
Six
Months Ended
June 30,
1998
1997
Other comprehensive income, net of tax:
Change in unrealized gains (losses),
net of income taxes (benefits) of ($427) in
1998 and $3,831 in 1997...................... $
(793) $ 7,114
Reclassification adjustment, net of
income tax benefits of ($1,939) in 1998
and ($732) in 1997...........................
(3,601) (1,360)
Other comprehensive income....................... $
(4,394) $ 5,754
Three
Months Ended
June 30,
1998
1997
Other comprehensive income, net of tax:
Change in unrealized gains (losses),
net of income taxes (benefits) of ($1,284)
in 1998 and $5,878 in 1997................... $
(2,384) $ 10,917
Reclassification adjustment, net of
income tax benefits of ($392) in 1998
and ($463) in 1997.. ........................
(728) (860)
Other comprehensive income....................... $
(3,112) $ 10,057
- - 8 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
9. Disclosure of Statement of Financial Accounting Standards No. 131
- - Disclosures about Segments of an Enterprise and Related
Information:
Earnings
Before Identifiable
Revenue Income
Taxes Assets
Six Months Ended June 30, 1998
Property and casualty insurance............ $427,488 $ 57,956
$1,714,665
Real estate and commercial lending......... 2,534 2,534
74,505
Corporate and other........................ 1,760
(3,934) 13,426
Consolidated............................ $431,782 $ 56,556
$1,802,596
Six Months Ended June 30, 1997
Property and casualty insurance............ $400,550 $ 44,016
$1,673,825
Real estate and commercial lending......... 2,401 2,401
72,400
Corporate and other........................ 1,679
(1,203) 8,730
Consolidated............................ $404,630 $ 45,214
$1,754,955
Earnings
Before Identifiable
Revenue Income
Taxes Assets
Three Months Ended June 30, 1998
Property and casualty insurance............ $215,382 $ 24,712
$1,714,665
Real estate and commercial lending......... 1,247 1,247
74,505
Corporate and other........................ 880
(2,246) 13,426
Consolidated............................ $217,509 $ 23,713
$1,802,596
Three Months Ended June 30, 1997
Property and casualty insurance............ $203,638 $ 23,491
$1,673,825
Real estate and commercial lending......... 1,090 1,090
72,400
Corporate and other........................ 833 225
8,730
Consolidated............................ $205,561 $ 24,806
$1,754,955
This basis of measurement utilized with the adoption of Statement No.
131 does not differ from prior disclosures of segment information as
part of the Notes to Consolidated Financial Statements found in the
Company's Annual Report.
- - 9 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and Other
Information)
(continued)
10. Disclosure of Supplemental Information:
June
30,
1998
1997
OTHER BALANCE SHEET INFORMATION:
Fixed maturities, at cost.......................... $ 625,574 $
667,706
Statutory surplus.................................. $ 499,549 $
453,691
OTHER INFORMATION:
Massachusetts policies in force
Private passenger automobile..................... 603,813
579,612
Homeowners....................................... 118,753
114,264
Commercial automobile............................ 14,756
14,781
Three Months
Ended
June 30,
1998
1997
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned
Private passenger automobile..................... $ 172,392 $
163,444
Homeowners....................................... $ 7,955 $
7,323
Commercial automobile............................ $ 8,816 $
8,946
Net investment income, after tax................... $ 17,720 $
16,018
Pure loss ratios
Private passenger automobile..................... 62.1%
65.9%
Homeowners....................................... 48.1%
62.3%
Commercial automobile............................ 53.7%
58.3%
Massachusetts private passenger automobile
exposures written................................. 189,422
182,690
Massachusetts private passenger automobile
premiums written................................. $ 158,785 $
149,287
Six Months
Ended
June
30,
1998
1997
Premiums earned
Private passenger automobile..................... $ 338,806 $
320,057
Homeowners....................................... $ 15,549 $
14,736
Commercial automobile............................ $ 19,421 $
20,474
Net investment income, after tax................... $ 34,873 $
31,949
Pure loss ratios
Private passenger automobile..................... 62.0%
66.9%
Homeowners....................................... 31.8%
61.3%
Commercial automobile............................ 51.4%
52.8%
Massachusetts private passenger automobile
exposures written................................ 470,529
463,865
Massachusetts private passenger automobile
premiums written................................. $ 372,376 $
358,484
- - 10 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended June 30, 1998 compared to
three months ended June 30, 1997
Direct premiums written during the second quarter of 1998, increased
$9,492,000, or 5.1% to $195,831,000, as compared to the same period in
1997. The increase was primarily attributable to a $9,923,000, or 6.5%
increase in direct premiums written for Massachusetts personal
automobile insurance, a $878,000, or 6.4% increase to homeowners
insurance and a $167,000 or 1.9% increase in direct premiums written for
commercial automobile insurance offset by a net decrease of $1,476,000
or 13.3% in all other lines combined. The increase in Massachusetts
personal automobile direct premiums written resulted primarily from a
6.7% increase in the number of physical damage exposures (Massachusetts
automobile exposures written with liability coverage increased 3.7%),
coupled with average rate increases in the physical damage side of the
business. The impact of this was partially offset by slight decreases
in the average rates for liability exposures. These changes were also
impacted by changes to the Company's safe driver deviations and group
discounts which were effective at the beginning of 1998. The
combination of these factors resulted in a 2.6% increase in the average
personal automobile premium per exposure (each vehicle insured).
Despite the 1998 state mandated average rate decrease of 4.0%, the
increase in the average personal automobile premium per exposure was
primarily due to the fact that the rate decision does not anticipate
purchases of new automobiles in the year in which the rate decision
applies, the Company's mix of personal automobile business differs from
that of the industry and the factors mentioned above. In February 1998,
the Company was granted, for the 1998 calendar year, approval to offer
its customers safe driver deviations of 15% for Step 9 (10% in 1997) and
4% for Step 10 (10% in 1997). Companies must re-apply annually, after
the state sets rates, to offer safe driver deviations. The AAA group
discount for 1998 policies was established at 6% (10% for 1997
policies). For drivers who qualify, both group discount and safe driver
deviations can be combined for up to a 20.1% reduction from state
mandated rates.
Net premiums written during the second quarter of 1998 increased
$18,310,000 or 10.8% as compared to the second quarter of 1997. The
increase in net premiums written was primarily due to changes in direct
premiums written as described above, as well as to the effects of
reinsurance. Written premiums assumed from the Commonwealth Automobile
Reinsurers ("C.A.R.") increased $7,941,000 or 75.7% and written premiums
ceded to C.A.R. decreased $815,000, or 4.3% as compared to the second
quarter of 1997, as a result of changes in the industry's and the
Company's utilization of C.A.R. reinsurance.
Earned premiums increased $9,514,000, or 5.2% during the second quarter
of 1998 as compared to the same period in 1997. Earned premiums assumed
from C.A.R. increased $472,000 or 2.0% and earned premiums ceded to
C.A.R. decreased $924,000, or 7.2% as compared to the second quarter of
1997. Direct premiums earned for Massachusetts personal automobile
insurance increased $8,328,000, or 5.5% compared to the same period in
1997. Commercial automobile insurance direct premiums earned decreased
$447,000, or 4.7%, and homeowners direct premiums earned increased
$728,000, or 5.6%, as compared to the second quarter of 1997.
- - 11 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net investment income increased $1,782,000 or 9.1%, compared to the
second quarter of 1997 principally as a result of a 6.9% increase in
average invested assets for the period. Net investment income as a
percentage of total average investments was 6.9% in the second quarter
of 1998 as compared to 6.7% during the same period in 1997. Net
investment income after tax as a percentage of total average investments
was 5.7% in the second quarter of 1998 as compared to 5.5% during the
same period in 1997. As previously announced 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 forego current investment yield
in favor of potential higher yielding capital appreciation in the
future. As a result, the Company is carrying approximately $119 million
in cash and short-term investments which yield lower returns than its
current long-term investment portfolio.
Premium finance and service fees increased $1,586,000 or 92.0% during
the second quarter of 1998 as compared to the same period in 1997. The
increase for the second quarter of 1998 versus 1997 was primarily
attributable to a change from a "late payment" fee based system to an
installment fee of $3.00 on each invoice following the down payment, for
personal lines policies with January 1, 1998 or subsequent effective
dates. Previously, for 1996 and 1997, the Company eliminated interest
based finance fees on personal automobile insurance policies.
Net realized investment gains totaled $1,282,000 during the second
quarter of 1998 as compared to net realized investment gains $2,216,000
for the same period in 1997. A significant portion of the net realized
investment gains during the second quarter of 1998 was the result of a
sale of common stock of an energy company resulting in net realized
investment gain of $1,886,000. This realized investment gain was
partially offset by realized investment losses in the sales of non-
taxable bonds, preferred stocks and in the maturity of GNMA's.
- - 12 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Losses and loss adjustment expenses ("LAE") incurred (on a statutory
basis) as a percentage of insurance premiums earned ("loss ratio")
decreased to 71.1% for the second quarter of 1998 as compared to 75.1%
for the same period in 1997. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on personal
automobile decreased to 62.1% compared to 65.9% in the second quarter of
1997. The improvement in the loss ratio was primarily due to better
underwriting results during the current period, offset by less favorable
loss development from the residual market. The commercial automobile
pure loss ratio decreased to 53.7% compared to 58.3% during the second
quarter of 1997. This decrease was primarily due to favorable
underwriting results, as mentioned above. For homeowners, the pure loss
ratio decreased to 48.1% compared to 62.3% during the second quarter of
1997. This decrease was due to more favorable weather conditions during
the second quarter of 1998 as compared to the same period in 1997,
coupled with favorable development in the homeowners liability area.
Additionally, total expenses related to the Company's management
incentive compensation plan included in losses and loss adjustment
expenses were $2,328,000 higher in the second quarter of 1998 as
compared to the same period in 1997. Of this increase, approximately
$707,000 was absorbed by the insurance companies with the remainder
incurred as a corporate expense. The increase was primarily driven by
increases in the market price of the Company's common stock which a
significant portion of the management incentive compensation plan is
comprised.
Policy acquisition costs increased by 27.6% during the second quarter of
1998 compared to the same period in 1997. As a percentage of net
premiums written, underwriting expenses for the insurance companies (on
a statutory basis) were 27.7% during the second quarter of 1998 as
compared to 22.7% for the same period in 1997. This increase in policy
acquisition costs was primarily impacted by higher contingent commission
accruals due to the improved loss ratio described earlier and higher
computer services expense related to upgrading the Company's computer
systems. Additionally, total expenses related to the Company's
management incentive compensation plan included in policy acquisition
costs were $2,019,000 higher in the second quarter of 1998 as compared
to the same period in 1997. Of this increase, approximately $694,000
was absorbed by the insurance companies with the remainder incurred as a
corporate expense. The increase was primarily driven by increases in
the market price of the Company's common stock which a significant
portion of the management incentive compensation plan is comprised.
The Company's effective tax rate was 17.4% for the second quarter of
1998 as compared to 19.5% for the same period in 1997. In both years
the effective tax rate was lower than the statutory rate of 35.0%
primarily due to tax-exempt interest income and the corporate dividends
deduction. The lower effective tax rate for the second quarter of 1998
was the result of the tax exempt interest and the dividends received
deduction comprising a greater portion of net earnings before taxes.
Net earnings decreased $386,000 during the second quarter of 1998 as
compared to the same period in 1997, as a result of the factors
mentioned above.
- - 13 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Six months ended June 30, 1998 compared to
six months ended June 30, 1997
Direct premiums written during the first six months of 1998, increased
$13,667,000, or 3.2% to $444,134,000, as compared to the same period in
1997. The increase was primarily attributable to a $14,450,000, or 4.0%
increase in direct premiums written for Massachusetts personal
automobile insurance and a $1,356,000, or 5.7% increase to homeowners
insurance offset by a $568,000 or 2.7% decrease in direct premiums
written for commercial automobile insurance and by a net decrease of
$1,571,000, or 7.2% in all other lines combined. The increase in
Massachusetts personal automobile direct premiums written resulted
primarily from a 3.9% increase in the number of physical damage
exposures (Massachusetts automobile exposures written with liability
coverage increased 1.4%), coupled with average rate increases in the
physical damage side of the business. The impact of this was partially
offset by slight decreases in the average rates for liability exposures.
These changes were also impacted by changes to the Company's safe driver
deviations and group discounts. The combination of these factors
resulted in a 2.4% increase in the average personal automobile premium
per exposure (each vehicle insured). Despite the 1998 state mandated
average rate decrease of 4.0%, the increase in the average personal
automobile premium per exposure was primarily due to the fact that the
rate decision does not anticipate purchases of new automobiles in the
year in which the rate decision applies, the Company's mix of personal
automobile business differs from that of the industry and the factors
mentioned above. In February 1998, the Company was granted, for the
1998 calendar year, approval to offer its customers safe driver
deviations of 15% for Step 9 (10% in 1997) and 4% for Step 10 (10% in
1997). Companies must re-apply annually, after the state sets rates, to
offer safe driver deviations. The AAA group discount for 1998 policies
was established at 6% (10% for 1997 policies). For drivers who qualify,
both group discount and safe driver deviations can be combined for up to
a 20.1% reduction from state mandated rates.
Net premiums written during the first six months of 1998 increased
$18,924,000 or 4.5% as compared to 1997. The increase in net premiums
written was primarily due to changes in direct premiums written as
described above, as well as to the effects of reinsurance. Written
premiums assumed from the Commonwealth Automobile Reinsurers ("C.A.R.")
increased $4,311,000 or 10.6% and written premiums ceded to C.A.R.
decreased $1,100,000, or 3.0% as compared to the first six months of
1997, as a result of changes in the industry's and the Company's
utilization of C.A.R. reinsurance.
- - 14 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Earned premiums increased $18,562,000, or 5.2% during the first six
months of 1998 as compared to the same period in 1997. Earned premiums
assumed from C.A.R. increased $462,000 or 1.1% and earned premiums ceded
to C.A.R. decreased $2,200,000, or 6.3% as compared to the same period
in 1997. Direct premiums earned for Massachusetts personal automobile
insurance increased $16,410,000, or 5.5% compared to the same period in
1997. Commercial automobile insurance direct premiums earned decreased
$1,117,000, or 5.8%, homeowners direct premiums earned increased
$1,338,000, or 5.1%, and as compared to the same period in 1997.
Net investment income increased $2,918,000 or 7.4%, compared to the
first six months of 1997 principally as a result of a 6.8% increase in
average invested assets for the period. Net investment income as a
percentage of total average investments was 6.7% in both the first six
months of 1998 and 1997. Net investment income after tax as a
percentage of total average investments was 5.6% in the first six months
of 1998 as compared to 5.5% during the same period in 1997. As
previously announced 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 forego current investment yield in favor of
potential higher yielding capital appreciation in the future. As a
result, the Company is carrying approximately $119 million in cash and
short-term investments which yield lower returns than its current long-
term investment portfolio.
Premium finance and service fees increased $2,509,000 or 73.9% during
the first six months of 1998 as compared to the same period in 1997.
The increase for the first six months of 1998 versus 1997 was primarily
attributable to a change from a "late payment" fee based system to an
installment fee of $3.00 on each invoice following the down payment, for
personal lines policies with January 1, 1998 or subsequent effective
dates. Previously, for 1996 and 1997, the Company eliminated interest
based finance fees on personal automobile insurance policies.
Net realized investment gains totaled $5,083,000 during the first six
months of 1998 as compared to net realized investment gains of
$1,920,000 for the same period in 1997. A significant portion of the
net realized investment gains were the result of sales of common stocks
resulting in net realized investment gain of $6,940,000. These realized
investment gains were partially offset by realized investment losses in
the sales of non-taxable bonds, preferred stocks and in the maturity of
GNMA's.
- - 15 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Losses and loss adjustment expenses ("LAE") incurred (on a statutory
basis) as a percentage of insurance premiums earned ("loss ratio")
decreased to 69.9% for the first six months of 1998 as compared to 75.4%
for the same period in 1997. The ratio of net incurred losses,
excluding LAE, to premiums earned ("pure loss ratio") on personal
automobile decreased to 62.0% compared to 66.9% in the first six months
of 1997. The improvement in the loss ratio for the first six months of
1998 was due to better current accident year underwriting results and
similar favorable loss development for prior accident years. The
commercial automobile pure loss ratio decreased to 51.4% compared to
52.8% during the first six months of 1997. This decrease was primarily
due to favorable loss development. For homeowners, the pure loss ratio
decreased to 31.8% compared to 61.3% during the first six months of
1997. This decrease was due to favorable weather conditions during the
first six months of 1998 as compared to normal weather conditions
experienced during the same period in 1997, coupled with favorable
development in the homeowners liability area. Additionally, total
expenses related to the Company's management incentive plan included in
losses and loss adjustment expenses were $2,680,000 higher in the second
quarter of 1998 as opposed to the same period in 1997. Of this increase
approximately $744,000 was absorbed by the insurance companies with the
remainder incurred as a corporate expense. The increase was primarily
driven by increases in the market price of the Company's common stock
which a significant portion of the management incentive compensation
plan is comprised.
Policy acquisition costs increased by 24.1% during the first six months
of 1998 compared to the same period in 1997. As a percentage of net
premiums written, underwriting expenses for the insurance companies (on
a statutory basis) were 26.7% during the first six months of 1998 as
compared to 23.5% for the same period in 1997. This increase in policy
acquisition costs was primarily impacted by higher contingent commission
accruals due to the improved loss ratio described earlier and higher
computer services expense related to upgrading the Company's computer
systems. Additionally, total expenses related to the Company's
management incentive plan included in policy acquisition costs were
$2,313,000 higher in the second quarter of 1998 as opposed to the same
period in 1997. Of this increase approximately $730,000 was absorbed by
the insurance companies with the remainder incurred as a corporate
expense. The increase was primarily driven by increases in the market
price of the Company's common stock which a significant portion of the
management incentive compensation plan is comprised.
The Company's effective tax rate was 20.8% for the first six months of
1998 as compared to 19.0% for the same period in 1997. The increase was
primarily attributable to better underwriting results and net realized
investment gains in 1998 both of which are taxed at the 35% rate. In
both years the effective tax rate was lower than the statutory rate of
35.0% primarily due to tax-exempt interest income and the corporate
dividends deduction.
Net earnings increased $8,211,000 during the first six months of 1998 as
compared to the same period in 1997, as a result of the factors
mentioned above.
- - 16 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Liquidity and Capital Resources
The focus of the discussion of liquidity and capital resources is on the
Consolidated Balance Sheets on page 3 and the Consolidated Statements of
Cash Flows on pages 5 and 6. Stockholders' equity increased by
$21,323,000 or 3.3%, during the first six months of 1998. This increase
was the result of net earnings of $44,820,000, offset by a decrease in
net unrealized gains, net of income taxes, on fixed maturities, equity
securities and other investments of $4,394,000 and dividends paid to
stockholders of $19,103,000. Total assets at June 30, 1998 increased by
$47,843,000 or 2.7%, to $1,802,596,000 as compared to total assets of
$1,754,753,000 at December 31, 1997. The majority of this growth was
reflected in an increase in invested assets of $18,755,000 or 1.5%, of
$36,028,000 or 21.3% in premiums receivable, of $10,150,000, or 11.9% in
deferred policy acquisition costs, offset by a decrease in all other
assets of $17,090,000 or 6.6%. The increase in premiums receivable was
primarily attributable to the seasonality of the policy effective dates
of the Company's business.
As of June 30, 1998, the market value of the Company's fixed maturity
portfolio exceeded its book value by $19,721,000 ($12,819,000 after
taxes, or $0.36 per share). At December 31, 1997 the market value of
the Company's fixed maturity portfolio exceeded its book value by
$23,813,000 ($15,478,000 after taxes, or $0.43 per share). The cost of
the Company's preferred stocks exceeded market value by $845,000
($549,000 after taxes, or $0.02 per share). At December 31, 1997 the
market value of preferred stocks exceeded cost by $364,000 ($237,000
after taxes, or $0.01 per share). At June 30, 1998 the market value of
the Company's common stocks exceeded cost by $15,885,000 ($10,325,000
after taxes, or $0.29 per share). At December 31, 1997 the market value
of common stocks exceeded cost by $17,718,000 ($11,517,000 after taxes,
or $0.32 per share).
Preferred stocks increased $46,914,000 or 31.6% and common stocks
(primarily composed of closed-end preferred stock mutual funds)
increased $43,267,000 or 24.3%, during the first six months of 1998
primarily as a result of the Company's previously announced change in
investment strategy. The Company's strategy is to acquire equity
investments, including potential acquisitions, which forego current
investment yield in favor of future potentially higher yielding capital
appreciation. As a result, the Company is carrying approximately $119
million in cash and short-term investments which yield lower returns
than its current long-term investment portfolio.
- - 17 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's liabilities totalled $1,131,477,000, at June 30, 1998 as
compared to $1,104,957,000 at December 31, 1997. The $26,520,000 or
2.4% increase was comprised of a decrease of $30,553,000 or 4.7% in loss
and loss adjustment expenses, offset by an increase of $59,860,000 or
15.8% in unearned premiums, an increase of $727,000 or 5.2% in
contingent commissions accrued, an increase of $3,842,000 or 33.4% in
securities broker payables and a $7,356,000 or 14.6% decrease in all
other liabilities. The decrease in loss and loss adjustment expenses is
attributed primarily to the milder weather experienced during the first
six months of 1998, coupled with lower losses ceded to C.A.R. and higher
loss payments. The change in unearned premiums primarily resulted from
the increase in Massachusetts personal automobile direct premiums
written and the expected seasonality impact of policy effective dates
previously mentioned.
The primary sources of the Company's liquidity are funds generated from
insurance premiums, net investment income, premium finance and service
fees and the maturing and sales of investments as reflected in the
Consolidated Statements of Cash Flows on pages 5 and 6. 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
personal lines policies with January 1, 1998 effective dates.
Previously, for 1997 and 1998, the Company eliminated interest based
finance fees on personal automobile insurance policies, utilizing
instead a "late fee" system. The impact of this change through the
second quarter of 1998 has resulted in a 73.9% increase in combined
premium finance and service fees as compared to the same period in 1997.
The Company's operating activities provided cash of $38,071,000 in the
first six months of 1998 as compared to $23,925,000 in 1997. These cash
flows were primarily impacted by premiums collected which increased
12.9% during the first six months of 1998, losses and LAE paid which
increased 10.1% and policy acquisition costs paid which increased 3.6%.
The increase in premiums was primarily the result of higher physical
damage exposures written, coupled with average rate increases in the
physical damage side of the business. The impact of this was partially
offset by slight decreases in the average rates for liability exposures.
(However, this impact was reduced with the slight increases of liability
exposures written.) Net losses and LAE paid, which includes the change
in the losses and LAE liability, increased $26,297,000. This amount
resulted primarily from increased net loss payments in the direct
personal liability lines of business of $15,632,000 or 12.8%. The
remaining amount is primarily the result of increased salary and
computer services expenses associated with claims and increased payments
assumed from C.A.R. Offsetting this, payments for other than automobile
lines of business, after reinsurance, decreased approximately 36.1% or
$3,608,000, compared to 1997.
- - 18 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The increase in automobile liability loss payments was primarily
attributable to two factors: increased payments for bodily injury
claims and increased payments for property damage liability claims. The
liability payments were higher primarily due to increased business
writings coupled with continued efforts 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 liability claims.
The net cash flows used in investing activities were primarily the
result of purchases of fixed maturities and equity securities offset by
a net decrease in short-term investments and by proceeds from the sale
and maturity of fixed maturities and equity securities. Investing
activities were funded by accumulated cash and cash provided by
operating activities during 1998 and 1997.
Cash flows used in financing activities totaled $19,103,000 during the
first six months of 1998 compared to $18,869,000 during the same period
in 1997. The 1998 cash flows used in financing activities consisted
exclusively of dividends paid to stockholders. The 1997 cash flows used
in financing activities consisted of $18,382,000 in dividends paid to
stockholders and $487,000 used to purchase 397,115 shares of Treasury
Stock under the Company's stock buyback program. There have been no
Treasury Stock purchases in 1998.
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. At June 30, 1998, the Company held cash and cash
equivalents of approximately $48,117,000. These funds, coupled with
short-term investments of $71,116,000, provide sufficient liquidity for
the payment of claims and other short-term cash needs. The Company also
relies upon dividends from its subsidiaries for its cash requirements.
Periodically, sales have been made from the Company's fixed maturity
investment portfolio to actively manage portfolio risks, including
credit-related concerns and matching of asset and liability cash flows,
to optimize tax planning and to realize gains. This practice will
continue in the future.
Industry and regulatory guidelines suggest that the ratio of a property
and casualty insurer's annual net written premiums to statutory
policyholders' surplus should not exceed 3.00 to 1.00. The Company's
statutory premiums to surplus ratio was 1.52 to 1.00 and 1.61 to 1.00
for the twelve months ended June 30, 1998 and 1997, respectively.
- - 19 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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 Policy Management Services Corporation
("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 $3.4 million ($2.1 of which relate to
1998). Administration, programming, testing and implementation of
system applications related to Century Change are expected to cost an
additional $5.0 million over the next 15 months. Approximately $4.4
million, including costs to date in 1998, 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.
The majority of programming changes dealing with policy issuance and
maintenance of same are expected to be completed by mid-October 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. The Company is currently reviewing issues dealing with
contingency planning for Century Change from an internal and external
processing scenario.
- - 20 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Upon completion of the Century Change project the Company expects to
focus its efforts primarily on the Team 2000 project, which will provide
the Company with systems to write insurance in other states and
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 $38.4 million.
Costs applicable to 1998 have been approximately $9.8 million, with
$10.3 million expensed during the year. Total additional Team 2000
project costs over the next 5 to 7 years have been estimated at
approximately $60.0 million. Funds expended to date include 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. Since that time, the Company has begun writing insurance
in Rhode Island on a limited basis. Through the second quarter ending
June 30, 1998, the Company produced premiums written of $135,600 in the
state of Rhode Island. Other states will be brought on-line 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.
The Company began a stock buyback program during the second quarter of
1995. The program, which was approved by the Board of Directors on May
19, 1995, authorizes the Company to purchase up to 3 million shares of
Treasury Stock. Since the inception of the program through June 30,
1998, the Company has purchased 1,957,348 shares of Treasury Stock, none
of which were purchased during the first six months of 1998.
Additionally, the Company's Employee Stock Ownership Plan has purchased
more than 699,000 shares in open market transactions since the buyback
program was announced, of which 89,000 shares were purchased during the
first six months of 1998 for $3,017,000.
On June 19, 1998, the Company paid a quarterly dividend of $0.27 to
stockholders of record as of June 5, 1998. The Company increased its
quarterly dividend to stockholders from $0.26 to $0.27 during the second
quarter of 1998.
- - 21 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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 Massachusetts personal automobile insurance are adjusted by the
Commissioner only at annual intervals. Such annual adjustments in
Massachusetts 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.
- - 22 -
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 4. RESULTS OF VOTES OF SECURITY HOLDERS
On May 15, 1998, at the Annual Meeting of the stockholders of the
Company, the slate of Directors as presented in the Annual Proxy was
approved. The votes as tabulated by Boston EquiServe, L.P. were as
follows:
Total Vote For Total Vote
Withheld
Each Director From Each
Director
Herman F. Becker 31,929,249 43,602
Joseph A. Borski, Jr. 31,932,054 40,797
Eric G. Butler 31,932,536 40,315
Henry J. Camosse 31,932,936 39,915
Gerald Fels 31,928,196 44,655
David R. Grenon 31,932,936 39,915
Robert W. Harris 31,932,936 39,915
Robert S. Howland 31,931,979 40,872
John J. Kunkel 31,932,936 39,915
Raymond J. Lauring 31,932,936 39,915
Roger E. Lavoie 31,932,936 39,915
Normand R. Marois 31,932,936 39,915
Suryakant M. Patel 31,932,836 40,015
Arthur J. Remillard, Jr. 31,929,779 43,072
Arthur J. Remillard, III 31,930,636 42,215
Regan P. Remillard 31,931,829 41,022
Antranig A. Sahagian 31,932,936 39,915
Gurbachan Singh 31,922,361 50,490
John W. Spillane 31,927,686 45,165
- - 23 -
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the second quarter of 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
RANDALL V. BECKER
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 24 -
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the second quarter of 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE COMMERCE GROUP, INC.
Randall V. Becker
Treasurer and Chief Accounting Officer
- - 24 -