UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 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 November 1, 1999, the number of shares outstanding of the
registrant's common stock (excluding Treasury Shares) was
34,564,952
Page 1 of 28
The Commerce Group, Inc.
Table of Contents
Page No.
Part I - Financial Information
Consolidated Balance Sheets at
September 30, 1999 (Unaudited) and December 31, 1998............... 3
Consolidated Statements of Earnings for the
Three and Nine Months Ended September 30, 1999 and 1998 (Unaudited).. 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 (Unaudited)........... 5
Consolidated Statements of Cash Flows - Reconciliation of Net
Earnings to Net Cash Provided by Operating Activities for the
Nine Months Ended September 30, 1999 and 1998 (Unaudited)............ 6
Notes to Unaudited Consolidated Financial Statements..................... 7
Management's Discussion and Analysis..................................... 12
Part II - Other Information
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)
September 30, December 31,
1999 1998
(Unaudited)
ASSETS
Investments:
Fixed maturities, at market (cost: $683,856 in 1999 and $600,482 in 1998)......................... $ 676,607 $ 619,267
Preferred stocks, at market (cost: $231,453 in 1999 and $200,270 in 1998)......................... 222,926 197,425
Common stocks, at market (cost: $320,811 in 1999 and $261,360 in 1998............................. 303,554 283,961
Mortgage loans on real estate and collateral notes receivable (less allowance for possible loan
losses of $2,312 in 1999 and $2,301 in 1998)..................................................... 70,062 73,510
Cash and short-term investments.................................................................... 13,296 75,912
Other investments (cost: $13,229 in 1999 and $7,450 in 1998)........................................ 14,237 7,825
Total investments.............................................................................. 1,300,682 1,257,900
Accrued investment income............................................................................ 15,721 13,662
Premiums receivable (less allowance for doubtful receivables of $1,451 in 1999 and $1,450 in 1998.... 227,829 162,878
Deferred policy acquisition costs.................................................................... 103,954 88,759
Property and equipment, net of accumulated depreciation.............................................. 34,772 35,854
Residual market receivable
Losses and loss adjustment expenses................................................................ 114,900 111,784
Unearned premiums.................................................................................. 47,873 41,436
Due from reinsurers.................................................................................. 53,915 36,687
Deferred income taxes................................................................................ 24,407 -
Receivable for securities sold....................................................................... 1,693 -
Non-compete agreement................................................................................ 3,267 -
Other assets......................................................................................... 8,035 7,023
Total assets................................................................................... $1,937,048 $1,755,983
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses................................................................ $ 696,669 $ 596,996
Unearned premiums.................................................................................. 495,381 391,424
Current income taxes............................................................................... 6,439 4,061
Deferred income taxes.............................................................................. - 3,769
Deferred income.................................................................................... 7,708 6,948
Contingent commissions accrued..................................................................... 26,567 22,067
Payable for securities purchased................................................................... 3,441 62
Excess of book value of subsidiary interest over cost.............................................. 10,661 -
Other liabilities and accrued expenses............................................................. 28,565 24,871
Total liabilities.............................................................................. 1,275,431 1,050,198
Minority interest.................................................................................... 2,181 -
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 ($10,724)
in 1999 and $13,621 in 1998...................................................................... (19,916) 25,295
Retained earnings.................................................................................. 706,029 670,556
734,734 744,472
Treasury stock 3,324,448 shares in 1999 and 1,957,348 shares in 1998............................... (75,298) (38,687)
Total stockholders' equity..................................................................... 659,436 705,785
Total liabilities, minority interest and stockholders' equity.................................. $1,937,048 $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 Nine Months Ended September 30, 1999 and 1998
(Thousands of Dollars Except Share and Per Share Data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
Revenues
Direct premiums written......................................... $ 232,380 $ 189,488 $ 745,515 $ 633,622
Assumed premiums................................................ 22,728 19,424 69,821 64,355
Ceded premiums.................................................. (33,908) (45,818) (93,619) (96,204)
Net premiums written.......................................... 221,200 163,094 721,717 601,773
(Increase) decrease in unearned premiums........................ 1,722 17,942 (78,387) (42,047)
Earned premiums ................................................ 222,922 181,036 643,330 559,726
Net investment income........................................... 22,210 21,116 65,340 63,428
Premium finance and service fees................................ 3,729 3,910 11,272 9,815
Amortization of excess of book value of subsidiary interest
over cost..................................................... 769 - 2,051 -
Net realized investment gains (losses).......................... 1,686 (2) 7,831 5,081
Total revenues......................................... 251,316 206,060 729,824 638,050
Expenses
Losses and loss adjustment expenses............................. 157,163 121,775 475,671 388,303
Policy acquisition costs........................................ 60,758 45,530 176,655 154,228
Total expenses......................................... 217,921 167,305 652,326 542,531
Earnings before income taxes and minority interest
in net loss of subsidiary............................ 33, 395 38,755 77,498 95,519
Income taxes...................................................... 6,626 8,894 13,665 20,838
Earnings before minority interest in net loss of
subsidiary........................................... 26,769 29,861 63,833 74,681
Minority interest in net loss of subsidiary....................... 252 - 661 -
NET EARNINGS........................................... $ 27,021 $ 29,861 $ 64,494 $ 74,681
COMPREHENSIVE INCOME................................... $ 9,680 $ 32,417 $ 19,283 $ 72,843
BASIC AND DILUTED NET EARNINGS PER COMMON SHARE........ $ 0.78 $ 0.83 $ 1.84 $ 2.07
CASH DIVIDENDS PAID PER COMMON SHARE................... $ 0.28 $ 0.27 $ 0.83 $ 0.80
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING... 34,819,012 36,042,652 35,089,137 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
Nine Months Ended September 30, 1999 and 1998
(Thousands of Dollars)
(Unaudited)
1999 1998
Cash flows from operating activities:
Premiums collected.................................................... $ 655,346 $ 578,490
Net investment income................................................. 65,085 61,667
Premium finance and service fees...................................... 11,272 9,815
Losses and loss adjustment expenses paid.............................. (448,535) (424,820)
Policy acquisition costs paid......................................... (180,392) (156,331)
Federal income tax payments........................................... (15,568) (20,508)
Net cash provided by operating activities......................... 87,208 48,313
Cash flows from investing activities:
Proceeds from maturity of fixed maturities........................... 77,053 49,806
Proceeds from sale of fixed maturities................................ 73,568 25,840
Proceeds from sale of equity securities............................... 72,730 58,096
Purchase of fixed maturities.......................................... (86,699) (134,540)
Purchase of equity securities......................................... (139,984) (187,439)
Purchase of other investments......................................... (5,862) (3,315)
Purchase of subsidiary, net of cash acquired.......................... (77,056) -
Payments received on mortgage loans and collateral notes receivable... 9,074 20,631
Mortgage loans and collateral notes originated........................ (6,418) (11,659)
Purchase of property and equipment.................................... (1,892) (3,596)
Other proceeds from investing activities.............................. 1,294 185
Net cash used in investing activities............................. (84,192) (185,991)
Cash flows from financing activities:
Dividends paid to stockholders........................................ (29,021) (28,834)
Purchase of treasury stock............................................ (36,611) -
Net cash used in financing activities............................. (65,632) (28,834)
Decrease in cash and short-term investments........................... (62,616) (166,512)
Cash and short-term investments at beginning of period................ 75,912 238,888
Cash and short-term investments at the end of period.............. $ 13,296 $ 72,376
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
Nine Months Ended September 30, 1999 and 1998
(Thousands of Dollars)
(Unaudited)
1999 1998
Cash flows from operating activities:
Net Earnings................................................................... $ 64,494 $ 74,681
Adjustments to reconcile net earnings to net cash provided by operating activities:
Premiums receivable.......................................................... (55,068) (29,348)
Deferred policy acquisition costs............................................ (8,828) (10,270)
Residual market receivable................................................... (9,553) 20,440
Due to/from reinsurers....................................................... (9,666) (14,146)
Losses and loss adjustment expenses.......................................... 36,561 (46,167)
Unearned premiums............................................................ 77,082 56,692
Current income taxes......................................................... 2,509 3,593
Deferred income taxes........................................................ (4,413) (3,263)
Deferred income.............................................................. 760 (19)
Contingent commissions....................................................... 4,500 7,643
Other assets, liabilities and accrued expenses............................... (6,263) (7,880)
Net realized investment gains................................................ (7,831) (5,081)
Other - net.................................................................. 2,924 1,438
Net cash provided by operating activities............................. $ 87,208 $ 48,313
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, 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 nine months ended September 30, 1999 nor
comparison with the corresponding nine months ended September 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. Since that announcement, the Company has purchased
181,200 shares of Treasury Stock, which occurred during the third
quarter of 1999, bringing total purchases of Treasury Stock to
3,324,448 as of September 30, 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:
Nine Months Ended
September 30,
1999 1998
Net earnings..................................... $ 64,494 $ 74,681
Other comprehensive income (loss), net of taxes
(tax benefits):
Change in unrealized gains (losses), net of
income taxes (benefits) of ($17,553) in 1999
and $1,161 in 1998............................ (32,598) 2,156
Reclassification adjustment, net of income tax
benefits of ($6,792) in 1999 and ($2,151) in
1998.......................................... (12,613) (3,994)
Other comprehensive loss......................... (45,211) (1,838)
Comprehensive income............................. $ 19,283 $ 72,843
Three Months Ended
September 30,
1999 1998
Net earnings..................................... $ 27,021 $ 29,861
Other comprehensive income (loss), net of taxes
(tax benefits):
Change in unrealized gains (losses), net of
income taxes (benefits) of ($7,180) in 1999
and $1,588 in 1998........................... (13,334) 2,949
Reclassification adjustment, net of income tax
benefits of ($2,158) in 1999 and ($212) in
1998.......................................... (4,007) (393)
Other comprehensive income (loss)................ (17,341) 2,556
Comprehensive income............................. $ 9,680 $ 32,417
- - 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
Nine Months Ended September 30, 1999
Property and casualty insurance
Massachusetts................................ $639,908 $ 69,124 $ 1,617,461
Other than Massachusetts..................... 84,438 2,152 238,240
Real estate and commercial lending............. 3,119 3,119 70,526
Corporate and other............................ 2,359 3,103 10,821
Consolidated................................ $729,824 $ 77,498 $ 1,937,048
Nine Months Ended September 30, 1998
Property and casualty insurance
Massachusetts................................ $610,434 $ 87,260 $ 1,677,858
Other than Massachusetts..................... 21,185 3,631 43,880
Real estate and commercial lending............. 3,805 3,805 75,407
Corporate and other............................ 2,626 823 12,290
Consolidated................................ $638,050 $ 95,519 $ 1,809,435
Earnings Before
Income Taxes and Identifiable
Revenue Minority Interest Assets
Three Months Ended September 30, 1999
Property and casualty insurance
Massachusetts................................ $218,649 $ 30,847 $ 1,617,461
Other than Massachusetts..................... 31,004 1,068 238,240
Real estate and commercial lending............. 953 953 70,526
Corporate and other............................ 710 527 10,821
Consolidated................................ $251,316 $ 33,395 $ 1,937,048
Three Months Ended September 30, 1998
Property and casualty insurance
Massachusetts................................ $197,486 $ 31,644 $ 1,677,858
Other than Massachusetts..................... 6,645 1,291 43,880
Real estate and commercial lending............. 1,271 1,271 75,407
Corporate and other............................ 658 4,549 12,290
Consolidated................................ $206,060 $ 38,755 $ 1,809,435
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:
September 30,
1999 1998
OTHER BALANCE SHEET INFORMATION:
Fixed maturities, at cost.............................. $ 683,856 $ 623,408
Statutory surplus...................................... $ 518,208 $ 531,668
OTHER INFORMATION:
Massachusetts policies in force
Private passenger automobile......................... 610,625 607,205
Homeowners........................................... 122,954 118,961
Commercial automobile................................ 14,448 14,677
Three Months Ended
September 30,
1999 1998
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned of Massachusetts subsidiaries
Private passenger automobile......................... $ 179,953 $ 162,622
Homeowners........................................... $ 4,160 $ 4,063
Commercial automobile................................ $ 9,840 $ 7,391
Net investment income, after tax....................... $ 18,628 $ 17,339
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile......................... 61.1% 59.7%
Homeowners (gross of reinsurance).................... 43.4% 38.2%
Commercial automobile................................ 55.2% 54.4%
Massachusetts private passenger automobile
exposures written..................................... 189,453 183,687
Massachusetts private passenger automobile
premiums written..................................... $ 173,247 $ 154,339
Nine Months Ended
September 30,
1999 1998
OTHER EARNINGS STATEMENT INFORMATION:
Premiums earned of Massachusetts subsidiaries
Private passenger automobile......................... $ 523,754 $ 488,386
Homeowners........................................... $ 12,412 $ 20,213
Commercial automobile................................ $ 28,634 $ 26,812
Net investment income, after tax....................... $ 54,574 $ 52,212
Pure loss ratios of Massachusetts subsidiaries
Private passenger automobile......................... 66.6% 61.7%
Homeowners (gross of reinsurance).................... 38.1% 30.9%
Commercial automobile................................ 60.1% 52.3%
Massachusetts private passenger automobile
exposures written..................................... 655,606 654,216
Massachusetts private passenger automobile
premiums written..................................... $ 574,763 $ 526,713
- - 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 September
30, 1999 and December 31, 1998, are as follows:
September 30, 1999 December 31, 1998
Fair Market Fair Market
Cost Value Cost Value
Preferred stock mutual funds................. $ 238,606 $ 219,916 $ 169,394 $ 172,455
Common stocks................................ 82,205 83,638 91,966 111,506
Total common stocks.............. $ 320,811 $ 303,554 $ 261,360 $ 283,961
- - 11 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30, 1999 compared to
three months ended September 30, 1998
Direct premiums written during the third quarter of 1999, increased
$42,892,000 or 22.6% to $232,380,000, as compared to the same period in 1998.
The increase was primarily attributable to a $19,028,000, or 10.4% increase in
Massachusetts direct premiums written and a $23,864,000 or 410.6% increase in
direct premiums written in states outside of Massachusetts. The increase in
Massachusetts direct premiums written was primarily attributable to a
$19,143,000 or 12.3% increase for Massachusetts personal automobile insurance
and a net decrease of $324,000 or 1.9% in Massachusetts homeowners insurance,
offset by a $209,000, or 1.9% increase 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. Direct premiums written for the Company's California subsidiary,
Commerce West Insurance Company ("CWIC") were $5,516,000 during the third
quarter of 1999, a decrease of $296,000 or 5.4% compared to the same period a
year ago.
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 third quarter of 1999 as compared to the third
quarter of 1998. Personal automobile exposures increased 3.1% as compared to
the same period in 1998. 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 decrease in Massachusetts homeowners
direct premiums written during the third quarter of 1999 resulted primarily
from a 0.3% increase in the number of policies offset by a 2.6% decrease in
average premium per policy as compared to the third quarter of 1998.
- - 12 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net premiums written during the third quarter of 1999 increased $58,106,000,
or 35.6% as compared to the third quarter of 1998, of which $23,741,000 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, coupled with the impact of last year's third quarter expanded non-
automobile reinsurance treaty, resulting in a decrease to ceded premiums.
Written premiums ceded (excluding those ceded to the Commonwealth Automobile
Reinsurers ("C.A.R.")) decreased $12,375,000, or 44.7% as compared to the
third quarter of 1998. The statements of earnings impact of this was offset
by a corresponding change in unearned premium due to the unearned premium
transfer associated with the expanded reinsurance treaty. Written premiums
assumed from C.A.R. increased $3,304,000, or 17.0% and written premiums ceded
to C.A.R. increased $465,000, or 2.6% as compared to the third quarter of
1998, as a result of changes in the industry's and the Company's utilization
of C.A.R. reinsurance. Net premiums written for CWIC were $5,514,000 for the
third quarter of 1999, a decrease of $292,000 or 5.0% compared to the same
period a year ago.
Earned premiums increased $41,886,000, or 23.1% during the third 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 $22,840,000
in earned premiums coupled with the changes in direct premiums written and the
change in coverage provided by non-automobile reinsurance treaties also
described above. Earned premiums assumed from C.A.R. increased $6,915,000 or
48.0% and earned premiums ceded to C.A.R. decreased $535,000, or 3.0% as
compared to the third quarter of 1998. Direct premiums earned for
Massachusetts personal automobile insurance increased $12,601,000, or 7.7%
compared to the same period in 1998. Direct premiums earned for CWIC were
$5,359,000 during the third quarter of 1999, a decrease of $621,000 or 10.4%
compared to the same period a year ago.
Commercial automobile insurance net premiums earned increased $1,440,000, or
17.1%, and homeowners net premiums earned increased $3,440,000, or 88.14%, as
compared to the third quarter of 1998. The increase in homeowners net
premiums earned is primarily attributable to $3,333,000 of homeowners premiums
earned by ACIC.
Net investment income increased by $1,094,000 or 5.2%, compared to the third
quarter of 1998. Net investment income as a percentage of total average
investments at cost was 6.8% in both the third quarter of 1999 and 1998. Net
investment income was also slightly impacted by the purchase of 181,200 shares
of Treasury Stock in the third quarter of 1999, for $4,004,000. Net
investment income after tax as a percentage of total average investments, at
cost, was 5.3% in the third quarter of 1999 as compared to 5.6% 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 decreased $181,000 or 4.6% during the third
quarter of 1999 as compared to the same period in 1998. The decrease for the
third quarter of 1999 versus 1998 was the result of fewer billing invoices
mailed to insureds primarily due to increased utilization of direct deposit
payments and the earlier payment of premiums.
Net realized investment gains totaled $1,686,000 during the third quarter of
1999 as compared to net realized investment losses of $2,000 for the same
period in 1998. The net realized investment gains for the third quarter of
1999 were primarily the result of sales of common stocks offset by net
realized losses on 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 70.7%
for the third quarter of 1999 as compared to 68.9% 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 60.8% compared to
59.0% in the third quarter of 1998. The commercial automobile pure loss ratio
increased to 55.2% compared to 54.4% during the third quarter of 1998. For
homeowners, the pure loss ratio, gross of reinsurance, increased to 47.1%
compared to 38.2% during the third quarter of 1998. The increase was the
result of increased property and liability losses in 1999 versus 1998 and
fewer redundancies from prior year reserve development. In addition, total
expenses related to the Company's management incentive compensation plan
included in losses and loss adjustment expenses were $3,868,000 higher in the
third quarter of 1999 as compared to the same period in 1998. This increase
is the result of negative expense during the third quarter of 1998. Of this
increase, approximately $1,312,000 impacted the insurance companies with the
remainder impacting corporate expenses. The increase in the third quarter
1999 management incentive compensation plan expenses as compared to the same
period in 1998 was primarily driven by a more significant decrease in the
average market price of the Company's common stock during the third quarter of
1998 versus a relatively flat average market price during the third quarter of
1999. The increase was further impacted by the 1999 implementation of an
Agency Stock Option Plan for ACIC which resulted in an additional $232,000 in
expense during the third quarter of 1999. 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 (on a statutory
basis) for CWIC was 62.1% during the third quarter of 1999 as compared to
52.9% for the same period a year ago. The loss ratio (on a statutory basis)
for the Company's new acquisition ACIC was 76.6% for the third quarter of
1999.
- - 14 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy acquisition costs increased $15,228,000 or 33.4% during the third
quarter of 1999 compared to the same period in 1998, of which $7,263,000 was
attributable to ACIC. As a percentage of net premiums written, underwriting
expenses ("expense ratio") for the insurance companies (on a statutory basis)
were 27.5% during the third quarter of 1999 as compared to 26.8% for the same
period in 1998. The increase in policy acquisition costs was primarily the
result of higher underwriting expenses assumed from C.A.R. and higher
management incentive plan compensation during the third quarter of 1999 versus
lower underwriting expenses assumed from C.A.R. and negative management
incentive plan compensation expense during the same period a year ago.
Specifically, the total expenses related to the Company's management incentive
compensation plan included in policy acquisition costs were $3,384,000 higher
in the third quarter of 1999 as compared to the same period in 1998. Of this
increase, approximately $1,292,000 impacted the insurance companies with the
remainder impacting corporate expenses. The increase in the third quarter
1999 management incentive compensation plan expenses as compared to the same
period in 1998 was primarily driven by a more significant decrease in the
average market price of the Company's common stock during the third quarter of
1998 versus a relatively flat average market price during the third quarter of
1999. The increase was further impacted by the 1999 implementation of an
Agency Stock Option Plan for ACIC which resulted in an additional $232,000 in
expense during the third quarter of 1999. The expense ratio (on a statutory
basis) for CWIC was 38.4% during the third quarter of 1999 as compared to
36.8% for the same period a year ago. The expense ratio (on a statutory
basis) for the Company's new acquisition ACIC was 32.0% for the third quarter
of 1999.
The Company's effective tax rate was 19.8% for the third quarter of 1999 as
compared to 22.9% 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 third quarter of 1999 was the result of the tax
exempt interest and the dividends received deduction comprising a greater
portion of earnings before taxes during the third quarter of 1999 as compared
to the same period in 1998.
- - 15 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
Nine months ended September 30, 1999 compared to
Nine months ended September 30, 1998
Direct premiums written during the first nine months of 1999, increased
$111,893,000 or 17.7% to $745,515,000, as compared to the same period in 1998.
The increase was primarily attributable to a $50,625,000, or 8.2% increase in
Massachusetts direct premiums written and a $61,268,000 or 334.2% increase in
direct premiums written in states outside of Massachusetts. The increase in
Massachusetts direct premiums written was primarily attributable to a
$49,902,000 or 9.4% increase for Massachusetts personal automobile insurance,
a $1,258,000, or 3.0% increase to Massachusetts homeowners insurance offset by
a net decrease of $535,000 or 1.3% 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 SNE.
Located in Columbus, Ohio, Automobile Club Insurance Company, whose name was
changed to 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 $63,028,000 are included in the first nine months
of 1999 results, which represents eight months premium since the acquisition.
Direct premiums written for CWIC were $16,570,000 during the first nine months
of 1999, a decrease of $1,760,000 or 9.6% compared to the same period a year
ago.
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) through September 30, 1999 as compared to a year ago,
coupled with a 0.2% increase in personal automobile 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
first nine months of 1999 resulted primarily from a 3.1% increase in the
number of policies as compared to the first nine months of 1998.
- - 16 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Net premiums written during the first nine months of 1999 increased
$119,944,000, or 19.9% as compared to the first nine months of 1998, of which
$61,910,000 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. Written premiums ceded (excluding those ceded to
the Commonwealth Automobile Reinsurers ("C.A.R.")) decreased $629,000, or 1.5%
as compared to the first nine months of 1998. Written premiums assumed from
C.A.R. increased $5,466,000, or 8.5% and written premiums ceded to C.A.R.
decreased $1,956,000, or 3.6% as compared to the first nine months of 1998, as
a result of changes in the industry's and the Company's utilization of C.A.R.
reinsurance. Net premiums written for CWIC were $16,562,000 for the first
nine months of 1999, a decrease of $1,750,000 or 9.6% compared to the same
period a year ago.
Earned premiums increased $83,604,000, or 14.9% during the first nine 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
$59,691,000 in earned premiums coupled with the changes in direct premiums
written as described above. Earned premiums assumed from C.A.R. increased
$5,571,000 or 9.7% and earned premiums ceded to C.A.R. increased $709,000, or
1.4% as compared to the first nine months of 1998. Direct premiums earned for
Massachusetts personal automobile insurance increased $32,814,000, or 6.8%
compared to the same period in 1998. Direct premiums earned for CWIC were
$16,301,000 for the first nine months of 1999, a decrease of $2,721,000 or
14.3% compared to the same period a year ago.
Commercial automobile insurance net premiums earned increased $918,000, or
3.3%, and homeowners net premiums earned increased $1,134,000, or 5.8%, as
compared to the first nine months of 1998. The increase in homeowners net
premiums earned is attributable to an increase of $8,620,000 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 by $1,912,000 or 3.0%, compared to the first
nine months of 1998. Net investment income as a percentage of total average
investments at cost was 6.6% in the first nine months of 1999 as compared to
6.8% during the same period in 1998. Mitigating the decline in yield during
the first nine months of 1999, net invested assets at cost increased
$108,426,000 primarily as the result of the acquisition of ACIC. Net
investment income was also impacted by the purchase of 1,366,200 shares of
Treasury Stock for $36,611,000 in the first nine months of 1999. Net
investment income after tax as a percentage of total average investments, at
cost, was 5.5% in the first nine months of 1999 as compared to 5.6% 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 $1,457,000 or 14.8% during the
first nine months of 1999 as compared to the same period in 1998. The
increase for the first nine 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 $7,831,000 during the first nine months
of 1999 as compared to net realized investment gains of $5,081,000 for the
same period in 1998. The net realized investment gains for the first nine
months of 1999 were primarily the result of sales of shares of a major
international insurance company resulting in net realized gains of $6,465,000
and sales of other common stocks offset by losses in the sales of non-taxable
bonds and preferred stocks. Net realized investment gains during the first
nine months of 1998 were the result of sales of the common stocks resulting in
net realized gains of $7,002,000 which was partially offset by realized
investment losses in the sales of non-taxable bonds, preferred stocks and in
the maturity of GNMA's.
Losses and loss adjustment expenses ("LAE") incurred (on a statutory basis) as
a percentage of insurance premiums earned ("loss ratio") increased to 74.3%
for the first nine months of 1999 as compared to 69.6% 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 65.9% compared to
61.0% in the first nine months of 1998. The increase in the loss ratio was
primarily due to a continued decrease in redundancies arising from prior
accident year, and increases in the cost of adjusting losses. The commercial
automobile pure loss ratio increased to 60.1% compared to 52.3% during the
first nine 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 41.8% compared to 30.9% during the first nine months
of 1998. The increase was primarily the result of fewer prior year liability
redundancies in the 1999 figure. Offsetting the overall increase in pure loss
ratios, total expenses related to the Company's management incentive
compensation plan included in losses and loss adjustment expenses were
$1,741,000 lower in the first nine months of 1999 as compared to the same
period in 1998. Of this decrease, approximately $252,000 benefited the
insurance companies with the remainder benefiting corporate expenses. The
decrease was primarily driven by decreases, during the first nine months of
1999, in the market price of the Company's common stock and offset by the 1999
implementation of an Agency Stock Option Plan for ACIC which resulted in an
additional $507,000 in expenses during 1999. 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 0.6% due to a reduction in expenses related to the termination of
a contract for software development with an outside vendor which occurred
during the second quarter of 1999. The loss ratio was also favorably impacted
by additional reductions in computer services expenses paid to this vendor as
compared to last year. The loss ratio (on a statutory basis) for CWIC was
69.2% for the first nine months of 1999 as compared to 57.5% for the same
period a year ago. The loss ratio (on a statutory basis) for the Company's
new acquisition ACIC was 75.7% for the first nine months of 1999.
- - 18 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
Policy acquisition costs increased $22,427,000 or 14.5% during the first nine
months of 1999 compared to the same period in 1998, of which $19,034,000 was
attributable to ACIC. As a percentage of net premiums written, however,
underwriting expenses for the insurance companies (on a statutory basis) were
26.1% during the first nine 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 nine 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 during the second quarter for software
development with an outside vendor which favorably impacted the underwriting
expense ratio by 0.4% through reduced computer services expenses paid to this
vendor as compared to last year. Total expenses related to the Company's
management incentive compensation plan included in policy acquisition costs
were $1,453,000 lower in the first nine months of 1999 as compared to the same
period in 1998. Of this decrease, approximately $235,000 benefited the
insurance companies with the remainder benefiting corporate expenses. The
decrease was primarily driven by decreases, during the first nine months of
1999, in the market price of the Company's common stock and offset by the 1999
implementation of an Agency Stock Option Plan for ACIC which resulted in an
additional $507,000 in expense during 1999. The expenses related to the
management incentive compensation plan are directly impacted by the average
market price of the Company's common stock. The expense ratio (on a statutory
basis) for CWIC was 40.1% for the first nine months of 1999 as compared to
34.9% for the same period a year ago. The expense ratio (on a statutory
basis) for the Company's new acquisition ACIC was 30.9% for the first nine
months of 1999.
The Company's effective tax rate was 17.6% for the first nine months of 1999
as compared to 21.8% 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 first nine months of 1999 was the result of the tax
exempt interest and the dividends received deduction comprising a greater
portion of 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 $46,349,000 or
6.6%, during the first nine months of 1999. This decrease was the result of
net earnings of $64,494,000, 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 $45,211,000 (primarily
due to the increase in interest rates during 1999) dividends paid to
stockholders of $29,021,000 and Treasury Stock purchased of $36,611,000.
Total assets at September 30, 1999 increased by $181,065,000 or 10.3%, to
$1,937,048,000 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,
at market value, increased $42,782,000 or 3.4% primarily as a result of the
addition of $157,553,000 of invested assets from ACIC, offset by the initial
$90,800,000 investment in the joint venture and treasury stock purchases
impacting cash and short-term investments. Premiums receivable increased
$64,951,000 or 39.9%, $10,179,000 attributable to ACIC. Deferred policy
acquisition costs increased $15,195,000 or 17.1%, $6,744,000 attributable to
ACIC. Receivable from reinsurers increased $17,228,000 or 47.0%, $7,151,000
attributable to ACIC. All other remaining assets increased $40,909,000 or
19.5%, $12,733,000 attributable to ACIC. The increase in premiums receivable
from December 31, 1998, was primarily attributable to the seasonality of the
policy effective dates of the Company's business, higher average premiums per
exposure for Massachusetts auto business and the acquisition of ACIC.
As of September 30, 1999, the amortized cost of the Company's fixed maturity
portfolio exceeded its market value by $7,249,000 ($4,712,000 after taxes, or
$0.14 per share). At December 31, 1998 the market value of the Company's
fixed maturity portfolio exceeded its amortized cost by $18,785,000
($12,210,000 after taxes, or $0.34 per share). At September 30, 1999, the
cost of the Company's preferred stocks exceeded market value by $8,527,000
($5,543,000 after taxes, or $0.16 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 September 30, 1999 the cost of the Company's
common stocks exceeded market value by $17,257,000 ($11,217,000 after taxes,
or $0.32 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).
- - 20 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's liabilities totalled $1,275,431,000 at September 30, 1999 as
compared to $1,050,198,000 at December 31, 1998. The $225,233,000 or 21.4%
increase resulted partially from the acquisition of ACIC. Losses and loss
adjustment expenses increased $99,673,000 or 16.7%, $58,509,000 attributable
to ACIC. Unearned premiums increased $103,957,000 or 26.6%, $28,336,000
attributable to ACIC, as a result of the seasonality of the policy effective
dates of the Company's business coupled with higher average premiums per
exposure for Massachusetts auto business. 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 $10,661,000. The net effect of
all other liabilities increased $10,942,000 or 17.7%. 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 and
higher assumed losses from C.A.R., as described below for Massachusetts
business, during the first nine 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 third quarter of
1999 has resulted in a 14.8% increase in combined premium finance and service
fees as compared to the same period in 1998.
The Company's operating activities provided cash of $87,208,000 in the first
nine months of 1999 as compared to $48,313,000 in 1998. These cash flows were
primarily impacted during the first nine months of 1999 by premiums collected
which increased $76,856,000, or 13.3%.
Net losses and LAE paid, which includes the change in the losses and LAE
liability, increased $23,715,000, or 5.6% primarily as a result of ACIC,
higher assumed losses from C.A.R. and higher payments on Massachusetts
collision losses. Offsetting these were reduced computer services expenses
resulting from the termination of a contract for software development with an
outside vendor, the effects of the expanded other than automobile reinsurance
program and decreased expenses for the management incentive compensation plan,
as previously described.
- - 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 $65,632,000 during the first
nine months of 1999 compared to $28,834,000 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 $29,021,000 in dividends paid to stockholders and
$36,611,000 used to purchase 1,366,200 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 September 30, 1999, the Company held cash and short-term
investments of approximately $13,296,000. 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 1.67 to 1.00 and 1.41 to 1.00 for the nine months ended
September 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 programming changes dealing with policy issuance, claims
processing and maintenance were completed as of October 1998. Other
internal changes were completed in accordance with specified delivery dates as
outlined in the plan. In addition, system testing for Year 2000 modifications
successfully concluded as of 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 remains on-going and the Company has
completed the majority of system testing, as needed, with such third parties,
which will conclude in December 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's Executive Committee, as well as all departments in the Company,
have reviewed 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 have and will continue to be
developed, where deemed appropriate, for all material systems and
relationships and will conclude during the fourth quarter of 1999.
Previously, contingency plans have been 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 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 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 $7.0 million ($2.1 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 $147,000 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.
- - 24 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
In conducting investing activities, the Company is subject to, and assumes,
market risk. Market risk is the risk of an adverse financial impact from
changes in interest rates and market prices. The level of risk assumed by the
Company is a function of the Company's overall objectives, liquidity needs and
market volatility.
The Company manages its overall market risk by focusing on higher quality
equity and fixed income investments, by monitoring the credit strength of
various 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 September 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 September
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 an $84,868,000 decrease in the market value of the
fixed maturities and preferred stocks. A 200 basis point decrease would
result in a $47,208,000 increase in the market value of the same securities.
The equity price risk impact at September 30, 1999, based upon a 10% increase
in the fair value of common stocks, would be an increase of $30,355,000.
Based upon a 10% decrease, common stocks would decrease $30,355,000. This
analysis was exemplified during 1999 as the Company experienced a decline in
the market value of investments, net of taxes, of $45,211,000 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 March 31, 1999. In May
1999, the Board of Directors approved an additional stock buy back program of
up to 2 million shares. Since that announcement, the Company has purchased
181,200 shares of Treasury Stock, bringing total purchase of Treasury Stock to
$3,324,448 as of September 30, 1999.
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The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
The Company's Employee Stock Ownership Plan has purchased more than 944,000
shares in open market transactions since the May, 1995 buyback program was
announced, of which 189,350 shares were purchased during the first nine months
of 1999 for $5,429,000 as compared to 89,000 shares for $3,017,000 during the
same period in 1998.
On September 17, 1999, the Company paid a quarterly dividend of $0.28 to
stockholders of record as of September 3, 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 adopted SOP 97-3 for 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 adopted SOP 98-1 for
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.
- - 26 -
The Commerce Group, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued)
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.
Subsequent Events
In November, 1999, the Massachusetts Commissioner of Insurance
("Commissioner") approved an average 0.7% increase in personal automobile
premiums for 2000, the same average increase that was approved for 1999. This
approval was the culmination of the previously negotiated settlement agreement
involving the Massachusetts automobile insurance industry, the Attorney
General's office and the Division of Insurance State Rating Bureau, who each
provide data to the Commissioner supporting their respective positions
concerning the new year rates.
- - 27 -
The Commerce Group, Inc. and Subsidiaries
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Form 8-K - none filed during the third quarter of 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 third 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 -