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, 1999 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, 1999, the number of shares outstanding of the
registrant's common stock (excluding Treasury Shares) was
34,856,752
Page 1 of 28
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Consolidated Balance Sheets at
June 30, 1999 (Unaudited) and December 31, 1998................ 3
Consolidated Statements of Earnings for the
Three and Six Months Ended June 30, 1999 and 1998 (Unaudited).. 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 (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, 1999 and 1998 (Unaudited)............. 6
Notes to Unaudited Consolidated Financial Statements............... 7
Management's Discussion and Analysis............................... 12
Part II - Other Information
Item 4
Results of Votes of Security Holders........................... 27
Item 6
Exhibits and Reports on Form 8-K............................... 28
Signature ......................................................... 28
- - 2 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
June 30, December 31,
1999 1998
(Unaudited)
ASSETS
Investments:
Fixed maturities, at market (cost: $691,300 in 1999 and $600,482 in 1998)....................... $ 695,904 $ 619,267
Preferred stocks, at market (cost: $224,104 in 1999 and $200,270 in 1998)....................... 219,309 197,425
Common stocks, at market (cost: $297,573 in 1999 and $261,360 in 1998).......................... 292,622 283,961
Mortgage loans on real estate and collateral notes receivable (less allowance for possible loan
losses of $2,185 in 1999 and $2,301 in 1998)................................................... 70,395 73,510
Cash and short-term investments.................................................................. 19,296 75,912
Other investments (cost:$11,294 in 1999 and $7,450 in 1998)...................................... 11,668 7,825
Total investments............................................................................ 1,309,194 1,257,900
Accrued investment income.......................................................................... 15,065 13,662
Premiums receivable (less allowance for doubtful receivables of $1,451 in 1999 and 1998)........... 227,063 162,878
Deferred policy acquisition costs.................................................................. 104,268 88,759
Property and equipment, net of accumulated depreciation............................................ 35,724 35,854
Residual market receivable
Losses and loss adjustment expenses.............................................................. 112,931 111,784
Unearned premiums................................................................................ 44,038 41,436
Due from reinsurers................................................................................ 50,388 36,687
Deferred income taxes.............................................................................. 14,259 -
Non-compete agreement.............................................................................. 3,354 -
Other assets....................................................................................... 7,227 7,023
Total assets................................................................................. $1,923,511 $1,755,983
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses.............................................................. $ 688,888 $ 596,996
Unearned premiums................................................................................ 494,401 391,424
Current income taxes............................................................................. 3,353 4,061
Deferred income taxes............................................................................ - 3,769
Deferred income.................................................................................. 7,459 6,948
Contingent commissions accrued................................................................... 20,517 22,067
Payable for securities purchased................................................................. 4,967 62
Excess of book value of subsidiary interest over cost............................................ 11,281 -
Other liabilities and accrued expenses........................................................... 26,132 24,871
Total liabilities............................................................................ 1,256,998 1,050,198
Minority interest.................................................................................. 2,993 -
Stockholders' equity
Preferred stock, authorized 5,000,000 shares at $1.00 par value; none issued in 1999 and 1998.... - -
Common stock, authorized 100,000,000 shares at $.50 par value;
issued and outstanding 38,000,000 shares in 1999 and 1998...................................... 19,000 19,000
Paid-in capital.................................................................................. 29,621 29,621
Net accumulated other comprehensive income (loss), net of income taxes (benefits) of ($1,385)
in 1999 and $13,621 in 1998.................................................................... (2,575) 25,295
Retained earnings................................................................................ 688,768 670,556
734,814 744,472
Treasury stock 3,143,248 shares in 1999 and 1,957,348 shares in 1998............................. (71,294) (38,687)
Total stockholders' equity................................................................... 663,520 705,785
Total liabilities and stockholders' equity................................................... $1,923,511 $1,755,983
The accompanying notes are an integral part of these consolidated financial statements.
- - 3 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
Three and Six Months Ended June 30, 1999 and 1998
(Thousands of Dollars Except Share and Per Share Data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
Revenues
Direct premiums written....................................... $ 233,183 $ 195,831 $ 513,135 $ 444,134
Assumed premiums.............................................. 24,416 18,437 47,093 44,931
Ceded premiums................................................ (31,601) (26,142) (59,711) (50,386)
Net premiums written........................................ 225,998 188,126 500,517 438,679
(Increase) decrease in unearned premiums...................... (8,572) 3,513 (80,109) (59,989)
Earned premiums .............................................. 217,426 191,639 420,408 378,690
Net investment income......................................... 22,320 21,375 43,130 42,312
Premium finance and service fees.............................. 3,683 3,314 7,543 5,905
Amortization of excess book value of subsidiary interest
over cost................................................... 768 - 1,282 -
Net realized investment gains................................. 6,565 1,282 6,145 5,083
Total revenues....................................... 250,762 217,610 478,508 431,990
Expenses
Losses and loss adjustment expenses........................... 164,093 137,302 318,508 266,528
Policy acquisition costs...................................... 60,021 56,494 115,897 108,698
Total expenses....................................... 224,114 193,796 434,405 375,226
Earnings before income taxes and minority interest
in net loss of subsidiary.......................... 26,648 23,814 44,103 56,764
Income taxes.................................................... 4,277 4,229 7,039 11,944
Earnings before minority interest in net loss of
subsidiary......................................... 22,371 19,585 37,064 44,820
Minority interest in net loss of subsidiary..................... 421 - 409 -
NET EARNINGS......................................... $ 22,792 $ 19,585 $ 37,473 $ 44,820
COMPREHENSIVE INCOME................................. $ 14,633 $ 16,473 $ 9,603 $ 40,426
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE...... $ 0.65 $ 0.54 $ 1.06 $ 1.24
CASH DIVIDENDS PAID PER COMMON SHARE................. $ 0.28 $ 0.27 $ 0.55 $ 0.53
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING. 34,856,752 36,042,652 35,226,439 36,042,652
The accompanying notes are an integral part of these consolidated financial statements.
- - 4 -
THE COMMERCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1999 and 1998
(Thousands of Dollars)
(Unaudited)
1999 1998
Cash flows from operating activities:
Premiums collected.................................................... $ 437,243 $ 410,749
Net investment income................................................. 43,531 40,812
Premium finance and service fees...................................... 7,543 5,905
Losses and loss adjustment expenses paid.............................. (295,665) (291,804)
Policy acquisition costs paid......................................... (127,690) (123,713)
Federal income tax payments........................................... (11,217) (15,378)
Net cash provided by operating activities......................... 53,745 26,571
Cash flows from investing activities:
Proceeds from maturity of fixed maturities........................... 42,604 33,959
Proceeds from sale of fixed maturities................................ 58,409 18,229
Proceeds from sale of equity securities............................... 48,239 52,641
Purchase of fixed maturities.......................................... (43,320) (98,128)
Purchase of equity securities......................................... (85,474) (138,399)
Purchase of other investments......................................... (3,926) (2,029)
Purchase of subsidiary, net of cash acquired.......................... (77,056) -
Payments received on mortgage loans and collateral notes receivable... 7,275 16,870
Mortgage loans and collateral notes originated........................ (4,037) (7,748)
Purchase of property and equipment.................................... (1,662) (2,650)
Other proceeds from investing activities.............................. 455 132
Net cash used in investing activities............................. (58,493) (127,123)
Cash flows from financing activities:
Dividends paid to stockholders........................................ (19,261) (19,103)
Purchase of treasury stock............................................ (32,607) -
Net cash used in financing activities............................. (51,868) (19,103)
Decrease in cash and short-term investments........................... (56,616) (119,655)
Cash and short-term investments at beginning of period................ 75,912 238,888
Cash and short-term investments at the end of period.............. $ 19,296 $ 119,233
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, 1999 and 1998
(Thousands of Dollars)
(Unaudited)
1999 1998
Cash flows from operating activities:
Net Earnings................................................................... $ 37,473 $ 44,820
Adjustments to reconcile net earnings to net cash provided by operating activities:
Premiums receivable.......................................................... (54,302) (36,028)
Deferred policy acquisition costs............................................ (9,142) (10,150)
Residual market receivable................................................... (3,749) 18,775
Due to/from reinsurers....................................................... (6,139) 683
Losses and loss adjustment expenses.......................................... 28,780 (30,553)
Unearned premiums............................................................ 76,102 59,860
Current income taxes......................................................... (577) (2,974)
Deferred income taxes........................................................ (3,602) (668)
Deferred income.............................................................. 511 (67)
Contingent commissions....................................................... (1,550) 727
Other assets, liabilities and accrued expenses............................... (6,543) (13,632)
Net realized investment gains................................................ (6,145) (5,083)
Other - net.................................................................. 2,628 861
Net cash provided by operating activities............................. $ 53,745 $ 26,571
The accompanying notes are an integral part of these consolidated financial statements.
- - 6 -
<Page
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and
Other Information)
1. The financial information has been prepared on a basis consistent with
the accounting principles reflected in the audited consolidated
financial statements for the year ended December 31, 1998. 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 1998 and previously reported 1999 account
balances have been reclassified to conform to the current period's
presentation.
3. This Form 10-Q contains some statements that are not historical facts
and are considered "forward-looking statements". Such forward-looking
statements involve opinions and predictions, and no assurance can be
given that the future results will be achieved since events or results
may differ as a result of risks facing the Company. These include, but
are not limited to, economic, market or regulatory conditions as well as
risks associated with entry into new markets, diversification, and
catastrophic events.
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, 1999 nor
comparison with the corresponding six months ended June 30, 1998 should
be considered indicative of the results which may be expected for the
year ending December 31, 1999.
6. The Company, as part of a joint venture with AAA Southern New England
("AAA SNE"), completed the acquisition of Automobile Club Insurance
Company on January 29, 1999. Located in Columbus, Ohio, Automobile Club
Insurance Company, whose name was changed to American Commerce Insurance
Company ("ACIC"), writes personal automobile and homeowners business in
twenty eight states and is licensed in several others. The acquisition,
which was accounted for as a purchase, resulted in the new balance sheet
items: Non compete agreement, Excess of book value of subsidiary
interest over cost and Minority interest.
- - 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)
7. The Company purchased 1,042,652 shares of Treasury stock during the
three month period ended March 31, 1999, completing purchases under the
May 19, 1995 Board of Directors approved stock buy back program of up to
3 million shares of the Company's common stock. Additionally, under
prior Board of Directors authorizations, the Company purchased 143,248
shares of the Company's common stock bringing the total purchases of
Treasury Stock to 3,143,248 shares as of March 31, 1999. In May 1999,
in addition to all previously announced programs, the Board of Directors
approved an additional stock buy back program of up to 2 million shares.
No Treasury Stock was purchased in the second quarter of 1999.
8. In May 1999, the Board of Directors voted to increase its quarterly
stockholder dividend from $0.27 per share to $0.28 per share.
9. Disclosure of Statement of Financial Accounting Standards No. 130 -
Reporting Comprehensive Income:
Six Months Ended
June 30,
1999 1998
Net earnings................................. $ 37,473 $ 44,820
Other comprehensive income (loss), net of taxes
(tax benefits):
Change in unrealized gains (losses), net of
income taxes (benefits) of ($10,373) in 1999
and ($427) in 1998............................ (19,264) (793)
Reclassification adjustment, net of income tax
benefits of ($4,634) in 1999 and ($1,939) in
1998.......................................... (8,606) (3,601)
Other comprehensive loss......................... (27,870) (4,394)
Comprehensive income............................. $ 9,603 $ 40,426
Three Months Ended
June 30,
1999 1998
Net earnings..................................... $ 22,792 $ 19,585
Other comprehensive income (loss), net of taxes
(tax benefits):
Change in unrealized gains (losses), net of
income taxes (benefits) of ($105) in 1999
and ($1,284) in 1998......................... (195) (2,384)
Reclassification adjustment, net of income tax
benefits of ($4,288) in 1999 and ($392) in
1998.......................................... (7,964) (728)
Other comprehensive loss......................... (8,159) (3,112)
Comprehensive income............................. $ 14,633 $ 16,473
- - 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)
10. Disclosure of Statement of Financial Accounting Standards No. 131
- - Disclosures about Segments of an Enterprise and Related Information:
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Six Months Ended June 30, 1999
Property and casualty insurance
Massachusetts................................ $421,053 $ 38,071 $ 1,600,321
Other than Massachusetts..................... 53,434 1,084 241,311
Real estate and commercial lending............. 2,372 2,372 70,876
Corporate and other............................ 1,649 2,576 11,003
Consolidated................................ $478,508 $ 44,103 $ 1,923,511
Six Months Ended June 30, 1998
Property and casualty insurance
Massachusetts................................ $412,948 $ 55,616 $ 1,668,185
Other than Massachusetts..................... 14,540 2,340 46,480
Real estate and commercial lending............. 2,534 2,534 74,505
Corporate and other............................ 1,968 (3,726) 13,426
Consolidated................................ $431,990 $ 56,764 $ 1,802,596
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Three Months Ended June 30, 1999
Property and casualty insurance
Massachusetts................................ $217,956 $ 26,037 $ 1,600,321
Other than Massachusetts..................... 30,854 (927) 241,311
Real estate and commercial lending............. 1,163 1,163 70,876
Corporate and other............................ 789 375 11,003
Consolidated................................ $250,762 $ 26,648 $ 1,923,511
Three Months Ended June 30, 1998
Property and casualty insurance
Massachusetts................................ $208,797 $ 23,616 $ 1,668,185
Other than Massachusetts..................... 6,585 1,096 46,480
Real estate and commercial lending............. 1,247 1,247 74,505
Corporate and other............................ 981 (2,145) 13,426
Consolidated................................ $217,610 $ 23,814 $ 1,802,596
The acquisition of ACIC, on January 29,1999, resulted in an additional
property and casualty insurance segment entitled "Other than
Massachusetts" beginning with the first quarter ended March 31, 1999.
- - 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)
11. Disclosure of Supplemental Information:
June 30,
1999 1998
OTHER BALANCE SHEET INFORMATION:
Fixed maturities, at cost............................ $ 691,300 $ 625,574
Statutory surplus.................................... $ 499,123 $ 499,549
OTHER INFORMATION:
Massachusetts policies in force
Private passenger automobile....................... 606,217 603,813
Homeowners......................................... 122,705 118,753
Commercial automobile.............................. 14,317 14,756
Three Months Ended
June 30,
1999 1998
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned of Massachusetts subsidiaries
Private passenger automobile....................... $ 175,187 $ 172,392
Homeowners......................................... $ 4,101 $ 7,995
Commercial automobile.............................. $ 9,618 $ 8,816
Net investment income, after tax..................... $ 19,193 $ 17,720
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile....................... 69.7% 62.1%
Homeowners (gross of reinsurance).................. 24.1% 48.1%
Commercial automobile.............................. 50.8% 53.7%
Massachusetts private passenger automobile
exposures written................................... 189,433 189,422
Massachusetts private passenger automobile
premiums written................................... $ 172,966 $ 158,785
Six Months Ended
June 30,
1999 1998
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned of Massachusetts subsidiaries
Private passenger automobile....................... $ 343,801 $ 338,806
Homeowners......................................... $ 8,252 $ 15,549
Commercial automobile.............................. $ 18,794 $ 19,421
Net investment income, after tax..................... $ 36,882 $ 34,873
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile....................... 69.5% 62.0%
Homeowners (gross of reinsurance).................. 35.4% 31.8%
Commercial automobile.............................. 62.7% 51.4%
Massachusetts private passenger automobile
exposures written................................... 466,153 470,529
Massachusetts private passenger automobile
premiums written................................... $ 401,516 $ 372,376
- - 10 -
The Commerce Group, Inc. and Subsidiaries
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Thousands of Dollars Except Share, Per Share Data, Ratios and
Other Information)
(continued)
12. Common Stocks
The cost and approximate fair market value of common stocks at June 30,
1999 and December 31, 1998, are as follows:
June 30, 1999 December 31, 1999
Fair Market Fair Market
Cost Value Cost Value
Preferred stock mutual funds................. $ 208,103 $ 193,566 $ 169,394 $ 172,455
Common Stocks................................ 89,470 99,056 91,966 111,506
Total common stocks.............. $ 297,573 $ 292,622 $ 261,360 $ 283,961
- - 11 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended June 30, 1999 compared to
three months ended June 30, 1998
Direct premiums written during the second quarter of 1999, increased
$37,352,000 or 19.1% to $233,183,000, as compared to the same period in 1998.
The increase was primarily attributable to a $14,743,000, or 7.7% increase in
Massachusetts direct premiums written and a $22,609,000 or 416.3% increase in
direct premiums written in states outside of Massachusetts. The increase in
Massachusetts direct premiums written was primarily attributable to a
$14,805,000 or 9.1% increase for Massachusetts personal automobile insurance,
a $646,000, or 4.4% increase in Massachusetts homeowners insurance offset by a
net decrease of $708,000 or 5.4% in all other Massachusetts lines combined.
The increase in direct premiums written in states outside of Massachusetts was
primarily attributable to the Company's January 29, 1999 acquisition of
Automobile Club Insurance Company as part of a joint venture with AAA Southern
New England ("AAA SNE"). Located in Columbus, Ohio, Automobile Club Insurance
Company, whose name was changed to American Commerce Insurance Company
("ACIC") following the acquisition, is a property and casualty insurer with
policies written in 28 states and licenses in several others. ACIC direct
premiums written of $22,987,000 are included in the second quarter of 1999
results. For further details refer to the liquidity section of this 10-Q's
Management's Discussion and Analysis.
The increase in Massachusetts personal automobile direct premiums written
resulted primarily from changes to the Company's safe driver deviations which
were effective at the beginning of 1999 and the 1999 state mandated average
rate increase of 0.7%. Although the state mandated average rate increased
only 0.7%, the impact of this and the safe driver deviation changes resulted
in an 8.9% increase in the average personal automobile premium per exposure
(each vehicle insured) for the second quarter of 1999 as compared to the
second quarter of 1998. Personal automobile exposures remained relatively
constant to last years exposures. The 8.9% increase in average premium per
exposure was due to the facts that the rate decision does not anticipate
purchases of new automobiles in the year which the rate decision applies, and
secondly, the Company's mix of personal automobile business differs from that
of the industry. Additionally, in January 1999, the Company was granted, for
the 1999 calendar year, approval to offer its customers safe driver deviations
of 8.0% for Step 9 (15% in 1998) and 3.0% for Step 10 (4% in 1998). Companies
must re-apply annually, after the state sets rates, to offer safe driver
deviations. The Company's affinity group discount for 1999 policies remained
unchanged at 6%. For drivers who qualify, the Company's group discount and
safe driver deviations can be combined for up to a 13.5% (20.1% in 1998)
reduction from state mandated rates. The increase in Massachusetts homeowners
direct premiums written during the second quarter of 1999 resulted primarily
from a 3.6% increase in the number of policies as compared to the second
quarter of 1998.
- - 12 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net premiums written during the second quarter of 1999 increased $37,872,000,
or 20.1% as compared to the second quarter of 1998, of which $22,914,000 were
derived from the acquisition of ACIC. The remaining increase in net premiums
written was primarily due to changes in direct premiums written as described
above, offset by increased levels of coverage provided through non-automobile
reinsurance treaties resulting in an increase of ceded premiums. Primarily as
a result of these changes to the reinsurance treaties, which went into effect
during the third quarter of 1998, written premiums ceded (excluding those
ceded to the Commonwealth Automobile Reinsurers ("C.A.R.")) increased
$6,450,000, or 82.3% as compared to the second quarter of 1998. Written
premiums assumed from C.A.R. increased $5,979,000, or 32.4% and written
premiums ceded to C.A.R. decreased $991,000, or 5.4% as compared to the second
quarter of 1998, as a result of changes in the industry's and the Company's
utilization of C.A.R. reinsurance.
Earned premiums increased $25,787,000, or 13.5% during the second quarter of
1999 as compared to the same period in 1998. The increase in earned premiums
was primarily the result of the acquisition of ACIC which produced $22,301,000
in earned premiums coupled with the changes in direct premiums written as
described above offset by the increased levels of coverage provided by non-
automobile reinsurance treaties also described above. Earned premiums assumed
from C.A.R. decreased $834,000 or 3.5% and earned premiums ceded to C.A.R.
decreased $483,000, or 2.7% as compared to the second quarter of 1998. Direct
premiums earned for Massachusetts personal automobile insurance increased
$10,338,000, or 6.5% compared to the same period in 1998.
Commercial automobile insurance net premiums earned decreased $237,000, or
2.4%, and homeowners net premiums earned decreased $718,000, or 9.0%, as
compared to the second quarter of 1998. The decrease in homeowners net
premiums earned is attributable to an increase of $3,270,000 from ACIC, offset
by increased levels of coverage provided through the other than automobile
quota share reinsurance treaty that resulted in increased ceded earned
premiums on Massachusetts business.
Net investment income increased slightly by $945,000 or 4.4%, compared to the
second quarter of 1998. Net investment income as a percentage of total
average investments at cost was 6.8% in the second quarter of 1999 as compared
to 6.9% during the same period in 1998. Net investment income was also
impacted by the purchase of 1,185,900 shares of Treasury Stock in the first
quarter of 1999, for $32,607,000. Net investment income after tax as a
percentage of total average investments, at cost, was 5.8% in the second
quarter of 1999 as compared to 5.7% for the same period in 1998. As
previously announced the Company is seeking greater flexibility to provide for
enhanced potential future capital appreciation. The Company's continuing
strategy is to acquire equity investments, including potential acquisitions,
which may forego current investment yield in favor of potential higher
yielding capital appreciation in the future.
- - 13 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Premium finance and service fees increased $369,000 or 11.1% during the second
quarter of 1999 as compared to the same period in 1998. The increase for the
second quarter of 1999 versus 1998 was primarily attributable to the impact of
implementing a $3.00 installment on each invoice following the down payment,
for personal lines policies with effective dates of January 1, 1998 and
beyond. This program is now into its second year since implementation.
Previously, for 1996 and 1997, the Company had utilized a "late fee" system.
Net realized investment gains totaled $6,565,000 during the second quarter of
1999 as compared to $1,282,000 for the same period in 1998. The net realized
investment gains for the second quarter of 1999 were primarily the result of
sales of stock of a major international insurance company resulting in net
realized gains of $6,465,000 and sales of other common stocks offset by net
realized losses on the sales of non-taxable bonds and preferred stock. Net
realized investment gains during the second quarter of 1998 were the result of
sales of stock of an energy company resulting in net realized gains of
$1,886,000 which was partially offset by realized investment losses in the
sales of non-taxable bonds and preferred stocks.
Losses and loss adjustment expenses ("LAE") incurred (on a statutory basis) as
a percentage of insurance premiums earned ("loss ratio") increased to 75.6%
for the second quarter of 1999 as compared to 71.1% for the same period in
1998. The ratio of net incurred losses, excluding LAE, to premiums earned
("pure loss ratio") on personal automobile increased to 69.3% compared to
62.1% in the second quarter of 1998. The increase in the loss ratio was
primarily due to a continued decrease in redundancies arising from prior
accident years. The commercial automobile pure loss ratio decreased to 50.8%
compared to 53.7% during the second quarter of 1998. For homeowners, the pure
loss ratio, gross of reinsurance, decreased to 29.8% compared to 38.9% during
the second quarter of 1998. The decrease was the result of better property
experience coupled with higher prior year redundancies in 1999 versus 1998.
Offsetting these, total expenses related to the Company's management incentive
compensation plan included in losses and loss adjustment expenses were
$2,451,000 lower in the second quarter of 1999 as compared to the same period
in 1998. Of this decrease, approximately $627,000 benefited the insurance
companies with the remainder benefiting corporate expenses. The decrease was
primarily driven by decreases, during the quarter, in the market price of the
Company's common stock. The expenses related to the management incentive
compensation plan are directly impacted by the average market price of the
Company's common stock. The loss ratio was favorably impacted by 1.7% due to
a reduction in expenses related to the termination of a contract for software
development with an outside vendor. The loss ratio was also favorably
impacted by additional reductions in computer services expenses.
- - 14 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy acquisition costs increased $3,527,000 or 6.2% during the second
quarter of 1999 compared to the same period in 1998. As a percentage of net
premiums written, however, underwriting expenses for the insurance companies
(on a statutory basis) were 25.8% during the second quarter of 1999 as
compared to 27.7% for the same period in 1998. This decrease in policy
acquisition costs, as a percentage of net premiums written, was primarily
impacted by lower computer services expenses during the second quarter of 1999
as compared to the same period in 1998. A portion of the computer services
expense decrease resulted from the termination of a contract for software
development with an outside vendor which favorably impacted the underwriting
expense ratio by 1.3%. Total expenses related to the Company's management
incentive compensation plan included in policy acquisition costs were
$2,101,000 lower in the second quarter of 1999 as compared to the same period
in 1998. Of this decrease, approximately $609,000 benefited the insurance
companies with the remainder benefiting corporate expenses. The decrease was
primarily driven by decreases, during the quarter, in the market price of the
Company's common stock.
The Company's effective tax rate was 16.1% for the second quarter of 1999 as
compared to 17.8% for the same period in 1998. 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 1999 was the result of the tax
exempt interest and the dividends received deduction comprising a greater
portion of net earnings before taxes during the second quarter of 1999 as
compared to the same period in 1998.
- - 15 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Six months ended June 30, 1999 compared to
six months ended June 30, 1998
Direct premiums written during the first six months of 1999, increased
$69,001,000 or 15.5% to $513,135,000, as compared to the same period in 1998.
The increase was primarily attributable to a $31,597,000, or 7.3% increase in
Massachusetts direct premiums written and a $37,404,000 or 298.8% increase in
direct premiums written in states outside of Massachusetts. The increase in
Massachusetts direct premiums written was primarily attributable to a
$30,759,000 or 8.1% increase for Massachusetts personal automobile insurance,
a $1,582,000, or 6.3% increase to Massachusetts homeowners insurance offset by
a net decrease of $744,000 or 2.6% in all other Massachusetts lines combined.
The increase in direct premiums written in states outside of Massachusetts was
primarily attributable to the Company's January 29, 1999 acquisition of
Automobile Club Insurance Company as part of a joint venture with AAA Southern
New England ("AAA SNE"). Located in Columbus, Ohio, Automobile Club Insurance
Company, whose name was changed to American Commerce Insurance Company
("ACIC") following the acquisition, is a property and casualty insurer with
policies written in 28 states and licenses in several others. ACIC direct
premiums written of $38,868,000 are included in the first six months of 1999
results, which represents five months premium since the acquisition. For
further details refer to the liquidity section of this 10-Q's Management's
Discussion and Analysis.
The increase in Massachusetts personal automobile direct premiums written
resulted primarily from changes to the Company's safe driver deviations which
were effective at the beginning of 1999 and the 1999 state mandated average
rate increase of 0.7%. Although the state mandated average rate increased
only 0.7%, the impact of this and the safe driver deviation changes resulted
in an 8.8% increase in the average personal automobile premium per exposure
(each vehicle insured) for the second quarter of 1999 as compared to the
second quarter of 1998. This was offset by a 0.9% decrease in personal
automobile exposures primarily due to agents that no longer represent the
Company. The 8.8% increase in average premium per exposure was due to the
facts that the rate decision does not anticipate purchases of new automobiles
in the year which the rate decision applies, and secondly, the Company's mix
of personal automobile business differs from that of the industry.
Additionally, in January 1999, the Company was granted, for the 1999 calendar
year, approval to offer its customers safe driver deviations of 8.0% for Step
9 (15% in 1998) and 3.0% for Step 10 (4% in 1998). Companies must re-apply
annually, after the state sets rates, to offer safe driver deviations. The
Company's affinity group discount for 1999 policies remained unchanged at 6%.
For drivers who qualify, the Company's group discount and safe driver
deviations can be combined for up to a 13.5% (20.1% in 1998) reduction from
state mandated rates. The increase in Massachusetts homeowners direct
premiums written during the first six months of 1999 resulted primarily from a
5.0% increase in the number of policies as compared to the first six months of
1998.
- - 16 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net premiums written during the first six months of 1999 increased
$61,838,000, or 14.1% as compared to the first six months of 1998, of which
$38,169,000 were derived from the acquisition of ACIC. The remaining increase
in net premiums written was primarily due to changes in direct premiums
written as described above offset by increased levels of coverage provided
through non-automobile reinsurance treaties resulting in an increase of ceded
premiums on Massachusetts business. Primarily as a result of these changes to
the reinsurance treaties, which went into effect during the third quarter of
1998, written premiums ceded (excluding those ceded to the Commonwealth
Automobile Reinsurers ("C.A.R.")) increased $11,746,000, or 82.5% as compared
to the first six months of 1998. Written premiums assumed from C.A.R.
increased $2,162,000, or 4.8% and written premiums ceded to C.A.R. decreased
$2,421,000, or 6.7% as compared to the first six months of 1998, as a result
of changes in the industry's and the Company's utilization of C.A.R.
reinsurance.
Earned premiums increased $41,718,000, or 11.0% during the first six months of
1999 as compared to the same period in 1998. The increase in earned premiums
was primarily the result of the acquisition of ACIC which produced $36,851,000
in earned premiums coupled with the changes in direct premiums written as
described above offset by the increased levels of coverage provided by non-
automobile reinsurance treaties also described above. Earned premiums assumed
from C.A.R. decreased $1,344,000 or 3.1% and earned premiums ceded to C.A.R.
increased $1,244,000, or 3.7% as compared to the first six months of 1998.
Direct premiums earned for Massachusetts personal automobile insurance
increased $20,213,000, or 6.4% compared to the same period in 1998.
Commercial automobile insurance net premiums earned decreased $522,000, or
2.7%, and homeowners net premiums earned decreased $2,306,000, or 14.8%, as
compared to the first six months of 1998. The decrease in homeowners net
premiums earned is attributable to an increase of $5,287,000 from ACIC, offset
by increased levels of coverage provided through the other than automobile
quota share reinsurance treaty that resulted in increased ceded earned
premiums on Massachusetts business.
Net investment income increased slightly by $1,026,000 or 2.4%, compared to
the first six months of 1998. Net investment income as a percentage of total
average investments at cost was 6.7% in the first six months of 1999 as
compared to 6.8% during the same period in 1998. Mitigating the decline in
yield during the first six months of 1999, net invested assets at cost
increased $79,932,000 primarily as the result of the acquisition of ACIC. Net
investment income was also impacted by the purchase of 1,185,900 shares of
Treasury Stock for $32,607,000 in the first quarter of 1999. Net investment
income after tax as a percentage of total average investments, at cost, was
5.7% in the first six months of 1999 as compared to 5.7% for the same period
in 1998. As previously announced the Company is seeking greater flexibility
to provide for enhanced potential future capital appreciation. The Company's
continuing 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.
- - 17 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Premium finance and service fees increased $1,638,000 or 27.7% during the
first six months of 1999 as compared to the same period in 1998. The increase
for the first six months of 1999 versus 1998 was primarily attributable to the
impact of implementing a $3.00 installment on each invoice following the down
payment, for personal lines policies with effective dates of January 1, 1998
and beyond. This program is now into its second year since implementation.
Previously, for 1996 and 1997, the Company had utilized a "late fee" system.
Net realized investment gains totaled $6,145,000 during the first six months
of 1999 as compared to net realized investment gains of $5,083,000 for the
same period in 1998. The net realized investment gains for the fist six
months of 1999 were primarily the result of sales of a major international
insurance company resulting in net realized gains of $6,465,000 offset by
losses in the sales of non-taxable bonds and preferred stock. Net realized
investment gains during the first six months of 1998 were the result of sales
of the common stocks resulting in net realized gains of $6,940,000 which was
partially offset by realized investment losses in the sales of non-taxable
bonds and preferred stocks.
Losses and loss adjustment expenses ("LAE") incurred (on a statutory basis) as
a percentage of insurance premiums earned ("loss ratio") increased to 76.1%
for the first six months of 1999 as compared to 69.9% for the same period in
1998. The ratio of net incurred losses, excluding LAE, to premiums earned
("pure loss ratio") on personal automobile increased to 68.6% compared to
62.0% in the first six months of 1998. The increase in the loss ratio was
primarily due to a continued decrease in redundancies arising from prior
accident years, and increases in the cost of adjusting losses. The commercial
automobile pure loss ratio increased to 62.7% compared to 51.4% during the
first six months of 1998 primarily due to a decrease in redundancies arising
from prior accident years. For homeowners, the pure loss ratio, gross of
reinsurance, increased to 39.0% compared to 27.1% during the first six months
of 1998. The increase was primarily the result of fewer prior year liability
redundancies in the 1999 figure. Offsetting these, total expenses related to
the Company's management incentive compensation plan included in losses and
loss adjustment expenses were $5,609,000 lower in the first six months of 1999
as compared to the same period in 1998. Of this decrease, approximately
$1,564,000 benefited the insurance companies with the remainder benefiting
corporate expenses. The decrease was primarily driven by decreases, during
the first six months of 1999, in the market price of the Company's common
stock. The expenses related to the management incentive compensation plan are
directly impacted by the average market price of the Company's common stock.
The loss ratio was favorably impacted by 0.9% due to a reduction in expenses
related to the termination of a contract for software development with an
outside vendor. The loss ratio was also favorably impacted by additional
reductions in computer services expenses.
- - 18 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy acquisition costs increased $7,199,000 or 6.6% during the first six
months of 1999 compared to the same period in 1998. As a percentage of net
premiums written, however, underwriting expenses for the insurance companies
(on a statutory basis) were 25.5% during the first six months of 1999 as
compared to 26.7% for the same period in 1998. This decrease in policy
acquisition costs, as a percentage of net premiums written, was primarily
impacted by lower computer services expenses during the first six months of
1999 as compared to the same period of 1998. A portion of the computer
services expense decrease resulted from the termination of a contract for
software development with an outside vendor which favorably impacted the
underwriting expense ratio by 0.6%. Total expenses related to the Company's
management incentive compensation plan included in policy acquisition costs
were $4,837,000 lower in the first six months of 1999 as compared to the same
period in 1998. Of this decrease, approximately $1,527,000 benefited the
insurance companies with the remainder benefiting corporate expenses. The
decrease was primarily driven by decreases, during the first six months of
1999, in the market price of the Company's common stock. The expenses related
to the management incentive compensation plan are directly impacted by the
average market price of the Company's common stock.
The Company's effective tax rate was 16.0% for the first six months of 1999 as
compared to 21.0% for the same period in 1998. 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 first six months of 1999 was the result of the tax
exempt interest and the dividends received deduction comprising a greater
portion of net earnings before taxes.
- - 19 -
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 decreased by $42,265,000 or
6.0%, during the first six months of 1999. This decrease was the result of
net earnings of $37,473,000, offset by other comprehensive loss (formerly
known as net unrealized losses), net of income tax benefits, on fixed
maturities, equity securities and other investments of $27,870,000, dividends
paid to stockholders of $19,261,000 and Treasury Stock purchased of
$32,607,000. Total assets at June 30, 1999 increased by $167,528,000 or 9.5%,
to $1,923,511,000 as compared to total assets of $1,755,983,000 at December
31, 1998, most of which resulted from the acquisition of ACIC. Invested
assets increased $51,294,000 or 4.1% primarily as a result of the addition of
$159,590,000 of invested assets from ACIC, offset by the initial $90,800,000
investment in the joint venture and treasury stock purchases. Premiums
receivable increased $64,185,000 or 39.4%, $9,337,000 attributable to ACIC.
Deferred policy acquisition costs increased $15,509,000 or 17.5%, $6,508,000
attributable to ACIC. Receivable from reinsurers increased $13,701,000 or
37.3%, $7,453,000 attributable to ACIC. All other remaining assets increased
$22,839,000 or 10.9%, $6,618,000 attributable to ACIC. The increase in
premiums receivable was primarily attributable to the seasonality of the
policy effective dates of the Company's business coupled with higher average
premiums per exposure for Massachusetts auto business.
As of June 30, 1999, the market value of the Company's fixed maturity
portfolio exceeded its book value by $4,604,000 ($2,993,000 after taxes, or
$0.09 per share). At December 31, 1998 the market value of the Company's
fixed maturity portfolio exceeded its book value by $18,785,000 ($12,210,000
after taxes, or $0.34 per share). At June 30, 1999, the cost of the Company's
preferred stocks exceeded market value by $4,795,000 ($3,117,000 after taxes,
or $0.09 per share). At December 31, 1998 the cost of preferred stocks
exceeded market value by $2,845,000 ($1,849,000 after taxes, or $0.05 per
share). At June 30, 1999 the cost of the Company's common stocks exceeded
market value by $4,951,000 ($3,218,000 after taxes, or $0.09 per share). At
December 31, 1998 the market value of common stocks exceeded cost by
$22,601,000 ($14,691,000 after taxes, or $0.41 per share).
The market value of preferred stocks increased $21,884,000 or 11.1% and the
market value of common stocks (primarily composed of closed-end preferred
stock mutual funds) increased $8,661,000 or 3.1%, during the first six months
of 1999 primarily as a result of additional purchases offset by decreases in
the market value caused by increase in interest rates during the first six
months of 1999. 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.
- - 20 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's liabilities totalled $1,256,998,000 at June 30, 1999 as compared
to $1,050,198,000 at December 31, 1998. The $206,800,000 or 19.7% increase
resulted primarily from the acquisition of ACIC. Losses and loss adjustment
expenses increased $91,892,000 or 15.4%, $60,077,000 attributable to ACIC.
Unearned premiums increased $102,977,000 or 26.3%, $27,421,000 attributable to
ACIC as a result of the seansonality of the policy effective dates of the
Company's business coupled with higher average premiums per exposure for
Massachusetts auto business. Excess of book value of subsidiary interest over
cost (formerly referred to as Negative Goodwill) associated with the January
29, 1999 acquisition of ACIC was $11,281,000. The net effect of all other
liabilities increased $650,000 or 1.0%. The increase in the liability for
loss and loss adjustment expenses is attributed primarily to the acquisition
of ACIC as mentioned, coupled with increased reported losses, as described
below for Massachusetts business, during the first six months of 1999. The
remaining 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. This program is now into its second year
since implementation. Previously, for 1997 and 1996, the Company utilized a
"late fee" system. The impact of this change through the second quarter of
1999 has resulted in a 27.2% increase in combined premium finance and service
fees as compared to the same period in 1998.
The Company's operating activities provided cash of $53,745,000 in the first
six months of 1999 as compared to $26,571,000 in 1998. These cash flows were
primarily impacted during the first six month of 1999 by premiums collected
which increased $26,494,000, or 6.5%.
Net losses and LAE paid, which includes the change in the losses and LAE
liability, increased $3,861,000, or 1.3%. For Massachusetts business, net
payments on automobile liability claims increased $1,835,000 or 1.3% and net
payments on collision losses increased $2,504,000 or 4.9%. The remaining
amount is primarily the result of decreased payments for the management
incentive compensation plan coupled with reduced computer services expenses
resulting from the termination of a contract for software development with an
outside vendor.
- - 21 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The net cash flows used in investing activities were primarily the result of
purchases of fixed maturities and equity securities and by the acquisition of
ACIC, net of cash acquired offset by proceeds from the sale and maturity of
fixed maturities and equity securities. Investing activities were funded by
accumulated cash and cash provided by operating activities during 1999 and
1998.
Cash flows used in financing activities totaled $51,868,000 during the first
six months of 1999 compared to $19,103,000 during the same period in 1998.
The 1998 cash flows used in financing activities consisted exclusively of
dividends paid to stockholders. The 1999 cash flows used in financing
activities consisted of $19,261,000 in dividends paid to stockholders and
$32,607,000 used to purchase 1,185,900 shares of Treasury Stock under the
Company's stock buyback programs.
The Company's funds are generally invested in securities with maturities
intended to provide adequate funds to pay claims without the forced sale of
investments. At June 30, 1999, the Company held cash and short-term
investments of approximately $19,296,000. These funds provide sufficient
liquidity for the payment of claims and other short-term cash needs.
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 1.62 to 1.00 and 1.52 to 1.00 for the six months ended June
30, 1999 and 1998, respectively.
The Company has also monitored potential acquisition opportunities 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. This objective has been exemplified by the 1995 acquisition of
Commerce West Insurance Company ("Commerce West"), a personal automobile
insurer, located in Pleasanton, California and, most recently, by the
Company's formation of a joint venture (ACIC Holding Co., Inc.) in November
1998, and the subsequent acquisition, in January 1999, of ACIC, located in
Columbus, Ohio.
ACIC writes automobile and homeowners insurance solely through 38 AAA
automobile clubs. Commerce and AAA SNE intend that ACIC will retain its
management team and staff and continue to have its principle office in
Columbus, Ohio.
- - 22 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
In early 1999, Commerce, a subsidiary of the Company, invested $90.8 million
in the joint venture (ACIC Holding Co., Inc.) to fund the ACIC acquisition and
to capitalize the joint venture that is owned together with AAA SNE. Of this
$90.8 million, Commerce invested $90 million in the form of preferred stock
and an additional $800,000 representing its 80% common stock ownership. The
terms of the preferred stock call for quarterly cash dividends at the rate of
10% per annum. AAA SNE invested $200,000 representing its 20% common stock
ownership. Commerce consolidates ACIC Holding Co., Inc. and it's wholly-owned
subsidiary, ACIC, for financial reporting purposes. Since 1995, Commerce has
maintained an affinity group marketing relationship with AAA Insurance Agency,
Inc., a subsidiary of AAA SNE. AAA Insurance Agency, Inc. has been an agent
of Commerce since 1985.
Year 2000 Compliance
The year 2000 issue exists primarily because most computer programs were
originally coded to recognize only the last two digits in the date field. If
not addressed and corrected, many systems could fail and produce erroneous
results. The impact of this could lead to a material adverse impact upon the
Company's business including policy and claims processing. As a result,
considerable effort has taken place to assess the impact and determine whether
to replace and/or reprogram the systems in order for the systems to
distinguish the intended year. The Company subsequently initiated the Century
Change project to address all internal/external systems, software, agents,
third parties and vendors in dealing with year 2000 compliance.
The Century Change project, enlisting both a redeployment of internal
resources and additional external consultant resources, involved the
development of a formal plan to address the Year 2000 problem and has
progressed in accordance with that plan. The Company's plan, which was
designed to, and is proceeding so as to, avoid any material adverse business
production issues, organized corporate systems into four sub-categories: Data
Exchange, AS400 Systems/Programs, PC Applications and PC Based Vendor
Purchased Application Software. Different sub-plans were established for each
category with the same Year 2000 objective in mind. As a result of this
effort, the majority of the programming changes dealing with policy issuance,
claims processing and maintenance have been completed as of October 1998.
Other internal changes are expected to be completed in accordance with
specified delivery dates as outlined in the plan. Looking forward, the
project has and will continue to move into the testing phases of the plan
which will primarily conclude at the end of third quarter 1999.
The Company has reviewed the Century Change status of vendors who perform
outside processing, those whose software the Company uses for internal
processing and those third parties with whom the Company does significant
business. Accordingly, the Company has recognized that year 2000 non-
compliance could materially adversely affect the financial position, results
of operations and cash flows of the Company.
- - 23 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
As a result, the Company has contacted all significant related third parties
in an effort to determine year 2000 compliance. This program includes sending
out questionnaires to our major business partners, including our agents,
regarding their year 2000 readiness. Based on the responses received to date,
the Company does not anticipate any material impact on its operations or
financial condition. If there are instances where the Company ascertains a
potential non-compliance, the Company will seek alternative year 2000
compliant third parties. This process is on-going and the Company has started
to conduct system testing, as needed, with such third parties, which will
conclude in 1999. While the Company is taking what it believes are the
appropriate safeguards, there can be no assurances that the failure of such
third parties to be year 2000 compliant will not have a material adverse
impact on the Company.
The Company expects that the implementation of the contingency plans, if
necessary, will not have a material adverse effect on the Company's ability to
conduct its business or on its operating results or financial condition.
The Company's Executive Committee, as well as all departments in the Company,
are currently reviewing issues dealing with identifying possible year 2000
worst case scenarios and the development of contingency plans to respond to
the likelihood of these scenarios. Contingency Plans will be discussed and
developed, where deemed appropriate, for all material systems and
relationships during the second half of 1999. At a minimum, contingency plans
will be developed for the continuation of policy and claim processing in the
event that the Company's computer systems are not available due to a year 2000
related failure.
The project to date has involved internal staff costs as well as consulting
expenses to prepare the systems for the year 2000. Total costs to date for
the Century Change project have been approximately $6.5 million ($1.6 million
which relates to 1999). Administration, programming, testing and
implementation of system applications relating to the Century Change project
are expected to cost an additional $0.6 million in 1999.
Market Risk: Interest Rate Sensitivity and Equity Price Risk
The Company's investment strategy emphasizes investment yield while
maintaining investment quality. The Company's investment objective is to
maintain high quality diversified investments structured to maximize after-tax
investment income while minimizing risk. The Company's funds are generally
invested in securities with maturities intended to provide adequate funds to
pay claims and meet other operating needs without the forced sale of
investments. Periodically sales have been made from the Company's fixed
maturity portfolio to actively manage portfolio risks, including credit-
related concerns, to optimize tax planning and to realize gains. This
practice will continue in the future.
In conducting investing activities, the Company is subject to, and assumes,
market risk. Market risk is the risk of an adverse financial impact from
changes in interest rates and market prices. The level of risk assumed by the
Company is a function of the Company's overall objectives, liquidity needs and
market volatility.
- - 24 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company manages its overall market risk by focusing on higher quality
equity and fixed income investments, by continuously monitoring the credit
strength of all companies in which investments are made, by limiting exposure
in any one investment and by monitoring the quality of the investment
portfolio by taking into account credit ratings assigned by recognized rating
organizations.
As part of its investing activities, the Company assumes positions in fixed
maturity, equity, short-term and cash equivalents markets. The Company is,
therefore, exposed to the impacts of interest rate changes in the market value
of investments. As of June 30, 1999, the Company's exposure to interest rate
changes and equity price risk has been estimated using sensitivity analysis.
The interest rate impact is defined as the effect of a hypothetical interest
rate change of plus-or-minus 200 basis points on the market value of fixed
maturities and preferred stocks. The equity price risk is defined as a
hypothetical change of plus-or-minus 10% in the fair value of common stocks.
Changes in interest rates would result in unrealized gains or losses in the
market value of the fixed maturity and preferred stock portfolio due to
differences between current market rates and the stated rates for these
investments. Based on the results of the sensitivity analysis at June 30,
1999, the Company's estimated market exposure for a 200 basis point increase
(decrease) in interest rates was calculated. A 200 basis point increase would
result in a $69,803,000 decrease in the market value of the fixed maturities
and preferred stocks. A 200 basis point decrease would result in a
$44,485,000 increase in the market value of the same securities. The equity
price risk impact at June 30, 1999, based upon a 10% increase in the fair
value of common stocks, would be an increase of $29,262,000. Based upon a 10%
decrease, common stocks would decrease $29,262,000. This analysis was
exemplified during 1999 as the Company experienced a decline in the market
value of investments of $27,870,000 primarily as evidenced by an increase in
long term interest rates during this period.
Stock Buyback and Dividends
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,
authorized the Company to purchase up to 3 million shares of Treasury Stock.
Through March 31, 1999, the Company completed its share purchases under that
program. Under prior Board of Director authorizations, the Company purchased
an additional 143,248 shares during the first quarter of 1999, bringing total
purchases of Treasury Stock to 3,143,248 shares as of June 30, 1999. In May
1999, the Board of Directors approved an additional stock buy back program of
up to 2 million shares.
The Company's Employee Stock Ownership Plan has purchased more than 926,000
shares in open market transactions since the buyback program was announced, of
which 171,750 shares were purchased during the first six months of 1999 for
$5,024,000 as compared to 89,000 shares for $3,017,000 during the same period
in 1998.
- - 25 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
On June 18, 1999, the Company paid a quarterly dividend of $0.28 to
stockholders of record as of June 4, 1999. The Company increased its
quarterly dividend to stockholders from $0.27 to $0.28 during the second
quarter of 1999.
Recent Accounting Developments
In 1997, the Accounting Standards Executive Committee ("AcSEC") issued
Statement of Position 97-3 Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments ("SOP 97-3") effective for financial statements
issued for periods ending after December 31, 1998. This statement provides
guidance on accounting by insurance companies on the timing of recognition,
the methods of measurement, and the required disclosures for guaranty fund and
other related assessments. The Company initially adopted SOP 97-3 in the
quarter ended March 31, 1999, which resulted in no material impact on the
Consolidated Financial Statements.
In 1998, the AcSEC issued Statement of Position 98-1, Accounting for Costs of
Computer Software Developed or Obtained for Internal Use ("SOP 98-1")
effective for financial statements issued for periods beginning after December
15, 1998. This statement establishes guidance on accounting for the costs
incurred related to internal use software. The Company initially adopted SOP
98-1 in the quarter ended March 31, 1999 and such adoption had no 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
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.
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The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORmation
Item 4. RESULTS OF VOTES OF SECURITY HOLDERS
On May 21, 1999, at the Annual Meeting of the stockholders of the Company, the
number of Directors was fixed at 19 and 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 29,787,511 136,341
Joseph A. Borski, Jr. 29,787,625 136,227
Eric G. Butler 29,787,511 136,341
Henry J. Camosse 29,787,625 136,227
Gerald Fels 29,787,605 136,247
David R. Grenon 29,787,625 136,227
Robert W. Harris 29,787,625 136,227
Robert S. Howland 29,787,511 136,341
John J. Kunkel 29,786,101 137,751
Raymond J. Lauring 29,786,501 137,351
Roger E. Lavoie 29,733,811 190,041
Normand R. Marois 29,787,625 136,227
Suryakant M. Patel 29,787,625 136,227
Arthur J. Remillard, Jr. 29,787,625 136,227
Arthur J. Remillard, III 29,787,625 136,227
Regan P. Remillard 29,787,375 136,477
Antranig A. Sahagian 29,732,801 191,051
Gurbachan Singh 29,787,625 136,227
John W. Spillane 29,784,175 139,677
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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 1999.
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
- - 28 -
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 1999.
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
- - 28 -