Exhibit 13.1
Five Year Summary of Selected Financial Highlights
For the Years Ended December 31 1999 1998 1997 1996 1995
================================================================================================================================
(In millions, except per share data)
STATEMENT OF INCOME
Revenues
Premiums $ 1,950.5 $ 1,970.6 $ 1,980.5 $ 1,937.1 $ 1,952.2
Universal life and investment product policy fees 359.3 296.6 237.3 197.2 172.4
Net investment income 615.7 604.4 631.1 651.2 692.0
Net realized investment gains 91.0 59.2 76.0 65.6 40.3
Other income 128.7 103.2 81.5 77.7 80.0
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Total revenues 3,145.2 3,034.0 3,006.4 2,928.8 2,936.9
================================================================================================================================
Benefits, Losses and Expenses
Policy benefits, claims, losses and loss adjustment expenses 1,770.7 1,804.0 1,764.0 1,747.8 1,815.2
Policy acquisition expenses 429.9 449.6 408.5 454.4 452.7
Sales practice litigation expense -- 31.0 -- -- --
Loss from cession of disability income business -- -- 53.9 -- --
Restructuring costs (1.9) 9.0 -- -- --
Other operating expenses 478.5 440.3 440.0 421.4 392.3
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Total benefits, losses and expenses 2,677.2 2,733.9 2,666.4 2,623.6 2,660.2
================================================================================================================================
Income before federal income taxes 468.0 300.1 340.0 305.2 276.7
Federal income tax expense 106.9 56.1 84.7 66.2 73.6
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Income before minority interest, extraordinary item
and discontinued operations 361.1 244.0 255.3 239.0 203.1
Minority interest (16.0) (29.3) (62.7) (74.6) (73.1)
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Income from continuing operations 345.1 214.7 192.6 164.4 130.0
Discontinued operations:
(Loss) income from operations of discontinued group
life and health business, net of taxes (18.8) (13.5) 16.6 17.5 16.0
Loss from disposal of group life and health business,
net of taxes (30.5) -- -- -- --
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Income before extraordinary item 295.8 201.2 209.2 181.9 146.0
Extraordinary item - demutualization expenses -- -- -- -- (12.1)
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Net income $ 295.8 $ 201.2 $ 209.2 $ 181.9 $ 133.9
================================================================================================================================
Earnings per common share (diluted)(1) $ 5.33 $ 3.33 $ 3.82 $ 3.63 $ 0.82
Dividends declared per common share (diluted) $ 0.25 $ 0.15 $ 0.20 $ 0.20 $ 0.05
================================================================================================================================
Adjusted net income(2) $ 280.9 $ 212.5 $ 164.3 $ 121.1 $ 99.8
================================================================================================================================
BALANCE SHEET (AT DECEMBER 31)
Total assets $ 30,769.6 $ 27,653.1 $ 22,549.0 $ 18,970.3 $ 17,757.7
Long-term debt 199.5 199.5 202.1 202.2 202.3
Total liabilities 28,229.4 24,894.5 19,714.8 16,461.6 15,425.0
Minority interest 300.0 300.0 452.9 784.0 758.5
Shareholders' equity 2,240.2 2,458.6 2,381.3 1,724.7 1,574.2
(1) Represents earnings per common share for the period October 1, 1995 through
December 31, 1995. Pro forma earnings per common share (unaudited) for the year
ended December 31, 1995 was $2.61. The pro forma information is based on a
weighted average of the number of shares that would have been outstanding
between January 1, 1995 and December 31, 1995 had the demutualization
transaction occurred on January 1, 1995. This information is provided for
informational purposes only and should not be construed to be indicative of the
Company's consolidated results of operations had the transaction been
consummated at the beginning of 1995 and does not represent a projection or
forecast of the Company's consolidated results of operations for any future
period.
(2) Represents net income adjusted for certain items which management believes
are not indicative of overall operating trends, including net realized
investment gains (losses), net gains and losses on disposals of businesses,
extraordinary items, the cumulative effect of accounting changes, restructuring
costs, differential earnings tax adjustments, and certain other items. While
these items may be significant components in understanding and assessing the
Company's financial performance, management believes adjusted net income
enhances an investor's understanding of the Company's results of operations by
highlighting net income attributable to the normal, recurring operations of the
business. However, adjusted net income should not be construed as a substitute
for net income determined in accordance with generally accepted accounting
principles.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following analysis of the consolidated results of operations and financial
condition of the Company should be read in conjunction with the Consolidated
Financial Statements and related consolidated footnotes included elsewhere
herein.
INTRODUCTION
================================================================================
The results of operations for Allmerica Financial Corporation and subsidiaries
("AFC" or "the Company") include the accounts of AFC; First Allmerica Financial
Life Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary,
Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); Allmerica
Asset Management, Inc. ("AAM," a wholly-owned non-insurance subsidiary of AFC);
Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C," a wholly-owned
non-insurance subsidiary of AAM); The Hanover Insurance Company ("Hanover," a
wholly-owned subsidiary of Allmerica P&C); Citizens Corporation (a wholly-owned
non-insurance subsidiary of Hanover); Citizens Insurance Company of America
("Citizens," a wholly-owned subsidiary of Citizens Corporation) and certain
other insurance and non-insurance subsidiaries.
The results of operations reflect minority interest in Allmerica P&C and
its subsidiary, Hanover, of approximately 40.5% prior to the acquisition of
minority interest on July 16, 1997. The results of operations also reflect
minority interest in Citizens Corporation, prior to the acquisition of minority
interest on or about December 3, 1998, of approximately 16.8% and 17.5% in 1998
and 1997, respectively.
DESCRIPTION OF OPERATING SEGMENTS
================================================================================
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management; Allmerica Financial Services; and Allmerica Asset Management.
The separate financial information of each segment is presented consistent with
the way results are regularly evaluated by the chief operating decision maker in
deciding how to allocate resources and in assessing performance. A summary of
the Company's reportable segments is included below.
In 1999, the Company reorganized its Property and Casualty and Corporate
Risk Management Services operations within the Risk Management segment. Under
the new structure, the Risk Management segment manages its business through five
distribution channels identified as Hanover North, Hanover South, Citizens
Midwest, Allmerica Voluntary Benefits, and Allmerica Specialty. During the
second quarter of 1999, the Company approved a plan to exit its group life and
health business, consisting of its Employee Benefit Services ("EBS") business,
its Affinity Group Underwriters ("AGU") business and its accident and health
assumed reinsurance pool business ("reinsurance pool business"). Results of
operations from this business, relating to both the current and the prior
periods, have been segregated and reported as a component of discontinued
operations in the Consolidated Statements of Income. Operating results from this
business were previously reported in the Allmerica Voluntary Benefits and
Allmerica Specialty distribution channels. Prior to 1999, results of the group
life and health business were included in the Corporate Risk Management Services
segment, while all other Risk Management business was reflected in the Property
and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States, maintaining a
strong regional focus. Allmerica Voluntary Benefits focuses on worksite
distribution, which offers discounted property and casualty products through
employer sponsored programs, and affinity group property and casualty business.
Allmerica Specialty offers special niche property and casualty products in
selected markets.
The Asset Accumulation group includes two segments: Allmerica Financial
Services and Allmerica Asset Management. The Allmerica Financial Services
segment includes variable annuities, variable universal life and traditional
life insurance products distributed via retail channels as well as group
retirement products, such as defined benefit and 401(k) plans and tax-sheltered
annuities distributed to institutions.
Through its Allmerica Asset Management segment, the Company offers its
customers the option of investing in Guaranteed Investment Contracts ("GICs")
such as the traditional GIC, the synthetic GIC and other funding agreements.
Funding agreements are investment contracts issued to institu-
2
tional buyers, such as money market funds, corporate cash management programs
and securities lending collateral programs, which typically have short
maturities and periodic interest rate resets based on an index such as LIBOR.
This segment is also a Registered Investment Advisor providing investment
advisory services, primarily to affiliates and to other institutions, such as
insurance companies and pension plans.
In addition to the three operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt, Series A
Capital Securities ("Capital Securities") and corporate overhead expenses.
Corporate overhead expenses reflect costs not attributable to a particular
segment, such as those generated by certain officers and directors, Corporate
Technology, Corporate Finance, Human Resources and the Legal department.
RESULTS OF OPERATIONS
CONSOLIDATED OVERVIEW
================================================================================
The Company's consolidated net income increased $94.6 million to $295.8 million
in 1999. In 1998, the Company's consolidated net income decreased $8.0 million
to $201.2 million. Net income includes certain items which management believes
are not indicative of overall operating trends, such as net realized investment
gains and losses, net gains and losses on disposals of businesses, discontinued
operations, extraordinary items, the cumulative effect of accounting changes and
certain other items. While these items may be significant components in
understanding and assessing the Company's financial performance, management
believes that the presentation of adjusted net income enhances understanding of
the Company's results of operations by highlighting net income attributable to
the normal, recurring operations of the business. However, adjusted net income
should not be construed as a substitute for net income determined in accordance
with generally accepted accounting principles.
For purposes of assessing each segment's contribution to adjusted net
income, management evaluates the results of these segments on a pre-tax and
minority interest basis. The following table reflects each segment's
contribution to adjusted net income and a reconciliation to consolidated net
income as adjusted for these items.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Segment income (loss) before federal
income taxes and minority interest:
Risk Management $ 199.6 $ 149.6 $ 174.2
Asset Accumulation
Allmerica Financial Services 205.5 169.0 134.6
Allmerica Asset Management 23.5 23.7 18.4
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Subtotal 229.0 192.7 153.0
Corporate (59.3) (50.9) (48.0)
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Segment income before federal
income taxes and minority interest 369.3 291.4 279.2
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Federal income taxes on segment
income (72.4) (53.1) (63.4)
Minority interest on preferred dividends (16.0) (16.0) (14.5)
Minority interest on segment income -- (9.8) (37.0)
- -------------------------------------------------------------------------------
Adjusted net income 280.9 212.5 164.3
Adjustments (net of taxes, minority
interest and amortization, as applicable):
Net realized investment gains 63.0 28.8 37.3
Sales practice litigation expense -- (20.2) --
Gain from change in mortality
assumptions -- -- 30.5
Loss from cession of disability
income business -- -- (35.0)
Restructuring costs 1.2 (5.8) --
Other items -- (0.6) (4.5)
- -------------------------------------------------------------------------------
Income from continuing operations 345.1 214.7 192.6
Discontinued operations:
(Loss) income from operations of
discontinued group life and health
business (net of applicable taxes) (18.8) (13.5) 16.6
Loss on disposal of group life and
health business (net of applicable
taxes) (30.5) -- --
- -------------------------------------------------------------------------------
Net income $ 295.8 $ 201.2 $ 209.2
================================================================================
1999 Compared to 1998
The Company's segment income before taxes and minority interest increased $77.9
million, or 26.7%, to $369.3 million during 1999. This increase is primarily
attributable to increased income of $50.0 million from the Risk Management
segment and an increase of $36.5 million from the Allmerica Financial Services
segment. The increase in Risk Management segment income is primarily
attributable to a $56.2 million increase in favorable development on prior years
reserves, a
3
$15.9 million favorable impact from a whole account aggregate excess of loss
reinsurance agreement ("aggregate excess of loss reinsurance treaty"), and
decreased catastrophes of $13.4 million. Partially offsetting these favorable
items are a $14.3 million increase in involuntary pool underwriting losses and a
$13.9 million increase in current year claims activity, primarily in the
commercial lines. The increase in the Allmerica Financial Services segment is
primarily attributable to higher asset-based fee income resulting from market
appreciation and additional desposits in the variable annuity and variable
universal life product lines. These increased fees were partially offset by
higher policy acquisition and other operating expenses. Partially offsetting
these increases were increased losses from the Corporate segment of $8.4
million, due to lower investment and other income and to higher corporate
overhead costs.
The effective tax rate for segment income was 19.6% for 1999 as compared
to 18.2% in 1998. The increase in the tax rate was primarily due to improved
underwriting results in the Risk Management segment, partially offset by changes
in reserves for prior years tax liabilities.
Net realized gains on investments, after taxes, minority interest and
amortization, were $63.0 million during 1999, primarily due to after-tax net
realized gains from sales of appreciated equity securities of $92.2 million,
partially offset by $31.3 million of after-tax realized losses from impairments
recognized on fixed maturities. During 1998, net realized gains on investments,
after taxes, minority interest and amortization were $28.8 million, primarily
due to after-tax net realized gains from sales of appreciated equity securities
of $41.4 million and after-tax gains on real estate of $9.0 million. These were
partially offset by $20.1 million of after-tax realized losses from impairments
recognized on fixed maturities and $11.4 million of after-tax realized losses on
partnership investments.
Minority interest on segment income decreased in the current period
primarily due to the Company's acquisition of the outstanding common stock of
Citizens Corporation on or about December 3, 1998. Prior to the acquisition,
minority interest reflected approximately 16.8% of the results of operations
from Citizens Corporation.
In July 1997, a lawsuit on behalf of a putative class was instituted in
Louisiana against AFC and certain of its subsidiaries by individual plaintiffs
alleging fraud, unfair or deceptive acts, breach of contract, misrepresentation,
and related claims in the sale of life insurance policies. In October 1997, the
plaintiffs voluntarily dismissed the Louisiana suit and filed a substantially
similar action in Federal District Court in Worcester, Massachusetts. In early
November 1998, the Company and the plaintiffs entered into a settlement
agreement. The court granted preliminary approval of the settlement on December
4, 1998. On May 19, 1999, the court issued an order certifying the class for
settlement purposes and granting final approval of the settlement agreement. AFC
recognized a $20.2 million expense, net of taxes, during the third quarter of
1998 related to this litigation. Although the Company believes that this expense
reflects appropriate recognition of its obligation under the settlement, this
estimate assumes the availability of insurance coverage for certain claims, and
the estimate may be revised based on the amount of reimbursement actually
tendered by AFC's insurance carriers and based on changes in the Company's
estimate of the ultimate cost of the benefits to be provided to members of the
class.
On October 28, 1998, the Company announced that it was restructuring its
Risk Management segment. As part of the initiative, the segment consolidated its
property and casualty field support activities from fourteen regional branches
into three hub locations. As a result of this restructuring initiative, the
Company recognized a loss of $5.8 million, net of taxes, in the fourth quarter
of 1998. This loss was reduced by $1.2 million, net of taxes, in the fourth
quarter of 1999.
During the second quarter of 1999, the Company approved a plan to exit its
group life and health insurance business, consisting of its EBS business, its
AGU business and its reinsurance pool business. During the third quarter of
1998, the Company ceased writing new premium in the reinsurance pool business,
subject to certain contractual obligations. Prior to 1999, these businesses
comprised substantially all of the former Corporate Risk Management Services
segment. Accordingly, the operating results of the discontinued segment,
including its reinsurance pool business have been reported in the Consolidated
Statements of Income as discontinued operations in accordance with Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations -Reporting
the Effects of Disposal of a Segment of a Business, and Extra ordinary, Unusual
and Infrequently Occurring Events and Transactions" ("APB Opinion No. 30"). In
the third quarter of 1999, the operating results from the discontinued segment
were adjusted to reflect the recording of additional reserves related to
accident claims from prior years. On October 6, 1999, the Company entered into
an agreement with Great-West Life and Annuity Insurance Company of Denver, which
provides for the sale of the Company's EBS business effective March 1, 2000. The
Company has recorded a $30.5 million loss, net of taxes, on the disposal of its
group life and health business.
4
1998 Compared to 1997
The Company's segment income before taxes and minority interest increased $12.2
million, or 4.4%, to $291.4 million during 1998. This increase is primarily
attributable to increased income of $39.7 million from the Asset Accumulation
group. This increase was partially offset by reduced income of $24.6 million
from the Risk Management segment and increased losses of $2.9 million from the
Corporate segment. The increase of $34.4 million in the Allmerica Financial
Services segment was primarily attributable to growth from additional deposits
and market appreciation in the variable annuity and variable universal life
assets resulting in increased fee revenue, partially offset by an increase in
related policy acquisition and other operating expenses. Segment income before
taxes and minority interest increased $5.3 million in the Allmerica Asset
Management segment, primarily due to increased sales of floating rate GICs. Risk
Management segment income declined primarily due to increased catastrophe
losses of $63.8 million and decreased net investment income of $24.4 million
resulting from lower average invested assets in the segment. These decreases
were partially offset by lower loss adjustment expenses ("LAE"), lower policy
acquisition and other operating expenses and increased fee revenue.
The effective tax rate for segment income was 18.2% in 1998 as compared to
22.7% in 1997. The decrease in the tax rate resulted from the reduction in
underwriting income from the Risk Management segment and a greater proportion of
pre-tax income from tax-exempt bonds in 1998.
Net realized gains on investments, after taxes, minority interest and
amortization, were $28.8 million during 1998, primarily due to after-tax net
realized gains from sales of appreciated equity securities of $41.4 million and
after-tax gains on real estate of $9.0 million. These were partially offset by
$20.1 million of after-tax realized losses from impairments recognized on fixed
maturities and $11.4 million of after-tax realized losses on partnership
investments. During 1997, net realized gains on investments, after taxes,
minority interest and amortization, of $37.3 million, resulted primarily from
the sale of appreciated equity securities, due to the Company's strategy of
shifting to a higher level of debt securities, as well as sales of real estate
investment properties.
Minority interest on segment income decreased in the current period as
compared to the prior year primarily due to the Company's merger with Allmerica
P&C on July 16, 1997. Prior to the acquisition, minority interest reflected
40.5% of the results of operations from this subsidiary. In addition, on or
about December 3, 1998, the Company acquired all of the outstanding common stock
of Citizens Corporation that it did not already own in exchange for cash of
$195.9 million. The Citizens acquisition has been recognized as a purchase. The
minority interest acquired totaled $158.5 million. A total of $40.8 million
representing the excess of the purchase price over the fair values of the net
assets acquired, net of deferred taxes, has been allocated to goodwill and is
being amortized over a 40-year period. Prior to the acquisition, minority
interest reflected approximately 16.8% and 17.5% of the results of operations
from Citizens Corporation in 1998 and 1997, respectively.
Effective October 1, 1997, the Company ceded substantially all of its
individual disability income line of business. The Company recognized a $35.0
million loss, net of taxes, during the first quarter of 1997 upon entering into
an agreement in principal to transfer the business. Additionally, effective
October 1, 1997, the Company revised the mortality assumptions used to determine
the amortization of policy acquisition costs and recognition of certain fees for
its universal life and variable universal life lines of business. As a result of
this change in assumptions, the Company recognized a benefit of $30.5 million,
net of taxes, during 1997.
SEGMENT RESULTS
================================================================================
The following is management's discussion and analysis of the Company's results
of operations by business segment. The segment results are presented before
taxes and minority interest and other items which management believes are not
indicative of overall operating trends, including realized gains and losses.
RISK MANAGEMENT
================================================================================
The following table summarizes the results of operations for the Risk Management
segment:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Segment revenues
Net premiums written $1,977.0 $1,956.7 $1,994.1
- --------------------------------------------------------------------------------
Net premiums earned $1,948.2 $1,967.9 $1,955.5
Net investment income 221.4 229.8 254.1
Other income 19.8 24.4 18.0
- --------------------------------------------------------------------------------
Total segment revenues 2,189.4 2,222.1 2,227.6
Losses and LAE(1) 1,420.3 1,495.4 1,443.7
Policy acquisition expenses 370.6 379.7 399.9
Other operating expenses 198.9 197.4 209.8
- --------------------------------------------------------------------------------
Segment income $ 199.6 $ 149.6 $ 174.2
================================================================================
(1) Includes policyholders' dividends of $12.3 million, $11.9 million and $9.3
million in 1999, 1998 and 1997, respectively.
5
1999 Compared to 1998
Risk Management's segment income increased $50.0 million, or 33.4%, to $199.6
million in 1999, compared to $149.6 million in 1998. The increase in segment
income is primarily attributable to a $56.2 million increase in favorable
development on prior year reserves and a $15.9 million favorable impact
resulting from the aggregate excess of loss reinsurance treaty. Also,
catastrophe losses decreased $13.4 million, to $76.9 million in 1999, compared
to $90.3 in 1998. Partially offsetting these items are a $14.3 million increase
in involuntary pool underwriting losses and a $13.9 million increase in current
year claims activity, primarily in the commercial lines. In addition, net
investment income before taxes decreased $8.4 million, or 3.7%, to $221.4
million in 1999, compared to $229.8 million in 1998. The decrease in net
investment income is primarily the result of a reduction in average invested
assets. Other income decreased $4.6 million to $19.8 million in 1999, primarily
as a result of management's decision to exit certain workers' compensation
servicing carrier business. The decline in net premiums earned is primarily
attributable to the aforementioned aggregate excess of loss reinsurance treaty.
During 1999, the Risk Management segment results were affected by the
aforementioned aggregate excess of loss reinsurance treaty with a highly rated
reinsurer. The reinsurance agreement provides accident year coverage for the
three years 1999 to 2001 for the Company's property and casualty business, and
is subject to cancellation or commutation annually at the Company's option. The
program covers losses and allocated loss adjustment expenses, including those
incurred but not yet reported, in excess of a specified whole account loss and
allocated LAE ratio. As a result of this agreement, the Company recognized a net
benefit of $15.9 million for the year ended December 31, 1999. Premiums, and
losses and LAE ceded under this treaty were $21.9 million and $35.0 million,
respectively. The Company realized an additional $4.3 million benefit from
commissions ceded under this contract, partially offset by $1.5 million of
interest costs. In accordance with the provisions of this contract, the Company
has exercised its option to cancel this contract effective January 1, 2000. The
effect of this agreement on the results of operations in future periods is not
currently determinable, as it will be based on future losses and allocated LAE.
The agreement may decrease or increase income in future periods.
1998 Compared to 1997
Risk Management's segment income decreased $24.6 million, or 14.1%, to $149.6
million in 1998, compared to $174.2 million in 1997. The decrease in segment
income is primarily the result of an increase in losses due to increased
catastrophes of $63.8 million, to $90.3 million in 1998, partially offset by
lower loss adjustment expenses. Also contributing to the decrease in the
segment's results was a decrease in pre-tax net investment income of $24.3
million, or 9.6%, to $229.8 million in 1998, compared to $254.1 million in 1997.
This decrease is primarily the result of a reduction in average invested assets
and a $7.0 million decrease in limited partnership income. These were partially
offset by lower policy acquisition and other operating expenses of $20.2 million
and $12.4 million, respectively. In addition, other income increased $6.4
million, to $24.4 million in 1998, primarily as a result of an increase in
finance charges on installment premiums.
6
Distribution channel results
The following table summarizes the results of operations for the distribution
channels of the Risk Management segment:
For the Year Ended December 31, 1999
======================================================================================================================
(In millions, except ratios)
Hanover Hanover Citizens Voluntary Allmerica
North South Midwest Benefits Specialty Other(2) Total
Net premiums written $668.1 $198.4 $521.3 $545.6 $ 40.2 $ 3.4 $1,977.0
Underwriting profit (loss) $ 4.4 $ (8.7) $ 1.8 $ (1.8) $(13.4) $(10.3) $ (28.0)
Statutory combined ratio(1) 102.1 105.8 102.9 103.6 127.7 N/M 101.2
For the Year Ended December 31, 1998
======================================================================================================================
(In millions, except ratios)
Hanover Hanover Citizens Voluntary Allmerica
North South Midwest Benefits Specialty Other(2) Total
Net premiums written $616.1 $208.1 $547.5 $527.5 $ 48.1 $ 9.4 $1,956.7
Underwriting (loss) profit $(36.6) $ (7.4) $(39.1) $ 15.3 $ (6.5) $(9.6) $ (83.9)
Statutory combined ratio(1) 106.4 104.5 106.8 99.2 104.8 N/M 104.6
(1) Statutory combined ratio is a common industry measurement of the results of
property and casualty insurance underwriting. This ratio is the sum of the ratio
of incurred claims and claim expenses to premiums earned and the ratio of
underwriting expenses incurred to premiums written. Federal income taxes, net
investment income and other non-underwriting expenses are not reflected in the
statutory combined ratio.
(2) Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
1999 Compared to 1998
Hanover North
Hanover North's net premiums written increased $52.0 million, or 8.4%, to $668.1
million for the year ended December 31, 1999, compared to $616.1 million for
1998. Net premiums written related to commercial lines increased $32.1 million,
or 13.8%, primarily due to an increase in policies in force of 6.7% since
December 31, 1998. Personal automobile net premiums written increased $14.0
million to $270.5 million, primarily resulting from the Company's decision to
reduce safe driver discounts and to an increase in policies in force of 5.2%. A
0.7% increase in the Massachusetts personal automobile rate during 1999 is also
contributing to this increase.
Hanover North's underwriting results improved $41.0 million to an
underwriting profit of $4.4 million for the year ended December 31, 1999,
compared to an underwriting loss of $36.6 million in 1998. The improvement in
underwriting results is primarily attributable to improved current year claims
severity in the personal lines, as well as to an increase in favorable
development on prior years' loss reserves in the personal automobile line. In
addition, catastrophe losses decreased $5.7 million to $13.3 million for the
year ended December 31, 1999, from $19.0 million in 1998.
Hanover South
Hanover South's net premiums written decreased $9.7 million, or 4.7%, to $198.4
million for the year ended December 31, 1999, compared to $208.1 million in
1998. The decrease is primarily due to an $11.1 million, or 20.5%, decrease in
the personal automobile line's net premiums written, resulting from an 18.1%
decrease in policies in force during 1999. This decline is attributable to the
Company having exited certain markets in the South. The Company believes this
exit plan to be substantially complete.
Underwriting results deteriorated $1.3 million to a loss of $8.7 million
for the year ended December 31, 1999, from an underwriting loss of $7.4 million
in 1998. The decrease in underwriting results is primarily attributable to a
$4.4 million increase in losses in the workers' compensation line attributed to
an increase in both frequency and severity in current year claims activity. This
deterioration is partially offset by a decrease in severity in the commercial
multiple peril line.
Citizens Midwest
Citizens Midwest's net premiums written decreased $26.2 million, or 4.8%, to
$521.3 million for the year ended December 31, 1999, compared to $547.5 million
for 1998. This decrease is primarily attributable to a $22.5 million decrease in
the personal automobile line's net premiums written to $154.0 million, compared
to $176.5 million for 1998. This decline is primarily
7
due to rate decreases in the Michigan personal automobile line of 3.6% and 3.7%
in the first and third quarters of 1999, respectively, resulting from continued
competitive conditions in Michigan. In addition, Citizens Midwest's net premiums
written decreased $9.9 million as a result of additional premiums ceded under
the aggregate excess of loss reinsurance treaty. These decreases are partially
offset by an increase of $6.8 million in the commercial multiple peril line
resulting from increases in both rate and policies in force of 5.9% and 4.9%,
respectively, during 1999.
Citizens Midwest's underwriting results improved $40.9 million to an
underwriting profit of $1.8 million for the year ended December 31, 1999, from
an underwriting loss of $39.1 million in 1998. This improvement is primarily
attributable to a $13.8 million decrease in policy acquisition and other
underwriting expenses resulting from continued efficiencies gained through
consolidation of underwriting processes, and a reduction in homeowners'
non-catastrophe claims activity totaling $9.5 million. In addition, a $9.0
million decrease in catastrophe losses to $19.7 million in 1999, compared to
$28.7 million in 1998, contributed to this improvement. Results were also
favorably impacted by $7.9 million due to the aforementioned aggregate excess of
loss reinsurance treaty.
Voluntary Benefits
Voluntary Benefits' net premiums written increased $18.1 million, or 3.4%, to
$545.6 million for the year ended December 31, 1999, compared to $527.5 million
in 1998. This increase is primarily attributed to an increase in policies in
force of 4.3%, partially offset by a $12.0 million increase in ceded premiums
written under the aggregate excess of loss reinsurance treaty.
Underwriting results deteriorated $17.1 million to a loss of $1.8 million
for the year ended December 31, 1999, from an underwriting gain of $15.3 million
in 1998. The deterioration in underwriting results is primarily attributable to
an increase in non-catastrophe claims activity in the personal automobile and
homeowners lines. Also contributing to this deterioration is a $6.5 million
increase in policy acquisition and other underwriting expenses resulting from
increased marketing initiatives. Partially offsetting these factors is a $9.5
million benefit from the aggregate excess of loss reinsurance treaty.
Specialty Markets
Specialty Markets' net premiums written decreased to $40.2 million for the year
ended December 31, 1999, compared to $48.1 million for the same period in 1998.
This decrease was primarily due to a decrease in the commercial multiple peril
line of $6.1 million, to $9.5 million, as a result of increased ceded premiums
written under the aggregate excess of loss reinsurance treaty, and to a 3.2%
reduction of policies in force.
Underwriting results deteriorated $6.9 million, to a loss of $13.4 million
for the year ended December 31, 1999, compared to a loss of $6.5 million in
1998. The deterioration in underwriting results is primarily attributable to an
increase in non-catastrophe claims activity in the commercial multiple peril
line.
For the Year Ended December 31, 1998
========================================================================================================================
(In millions, except ratios)
Hanover Hanover Citizens Voluntary Allmerica
North South Midwest Benefits Specialty Other(2) Total
Net premiums written $616.1 $208.1 $547.5 $527.5 $ 48.1 $ 9.4 $1,956.7
Underwriting (loss) profit $(36.6) $ (7.4) $(39.1) $ 15.3 $ (6.5) $(9.6) $ (83.9)
Statutory combined ratio(1) 106.4 104.5 106.8 99.2 104.8 N/M 104.6
For the Year Ended December 31, 1997
========================================================================================================================
(In millions, except ratios)
Hanover Hanover Citizens Voluntary Allmerica
North South Midwest Benefits Specialty Other(2) Total
Net premiums written $612.7 $231.7 $538.9 $491.1 $ 27.4 $92.3 $1,994.1
Underwriting loss $(30.5) $ (1.1) $(31.8) $ (6.8) $(22.9) $(5.3) $ (98.4)
Statutory combined ratio(1) 105.0 103.1 106.2 128.4 100.4 N/M 104.0
(1) Statutory combined ratio is a common industry measurement of the results of
property and casualty insurance underwriting. This ratio is the sum of the ratio
of incurred claims and claim expenses to premiums earned and the ratio of
underwriting expenses incurred to premiums written. Federal income taxes, net
investment income and other non-underwriting expenses are not reflected in the
statutory combined ratio.
(2) Includes results from certain property and casualty business which the
Company has exited, as well as purchase accounting adjustments.
8
1998 Compared to 1997
Hanover North
Hanover North's net premiums written increased $3.4 million, or 0.6%, to $616.1
million for the year ended December 31, 1998, compared to $612.7 million in
1997. Net premiums written in the homeowners, commercial multiple peril and
commercial automobile lines increased $5.1 million, $4.5 million, and $4.1
million, respectively. The improvement in the homeowners line related to both an
increase in policies in force of 5.3% and a rate increase of 3.8% over prior
year. Commercial multiple peril and commercial automobile line increases
resulted from increases in policies in force of 7.0% and 14.3%, respectively.
Personal automobile net premiums written decreased $11.3 million, to $256.5
million, primarily resulting from a mandated 4.0% decrease in Massachusetts
personal automobile rates, which became effective January 1, 1998. Increased
safe driver discounts on automobile insurance premiums also contributed to the
decrease in premiums written.
Hanover North's underwriting results deteriorated $6.1 million to an
underwriting loss of $36.6 million for the year ended December 31, 1998,
compared to an underwriting loss of $30.5 million in 1997. The deterioration in
underwriting results is primarily attributable to a decrease in favorable
development on prior accident years' reserves in the workers' compensation and
commercial automobile lines, partially offset by a $12.7 million improvement in
current year claims activity in the personal automobile line. In addition,
catastrophe losses increased $14.6 million, primarily in the homeowners line, as
a result of an ice storm in the first quarter of 1998. Improved loss adjustment
expenses and policy acquisition and other underwriting expenses of $15.8 million
and $16.5 million, respectively, partially offset this deterioration.
Hanover South
Hanover South's net premiums written decreased $23.6 million, or 10.2%, to
$208.1 million for the year ended December 31, 1998, compared to $231.7 million
for the same period in 1997. The decrease is primarily due to a $16.0 million,
or 22.8%, decrease in the personal automobile line's net premiums written and a
$6.7 million, or 16.9%, decrease in the homeowners line, resulting from the
Company having exited certain markets in the South.
Underwriting results deteriorated $6.3 million from an underwriting loss
of $1.1 million for the year ended December 31, 1997, to a loss of $7.4 million
for the same period in 1998. The unfavorable change is primarily attributable to
a $9.0 million increase in losses in the commercial multiple peril line due to
increased non-catastrophe claims frequency. In addition, catastrophe losses
increased $7.3 million as a result of severe storms. Partially offsetting these
factors are a $6.3 million improvement in loss activity in the personal
automobile line and a decrease of $5.0 million in policy acquisition and other
underwriting expenses.
Citizens Midwest
Citizens Midwest's net premiums written increased $8.6 million, or 1.6%, to
$547.5 million for the year ended December 31, 1998. This increase is primarily
attributable to a $10.7 million increase in the commercial multiple peril line,
to $101.4 million, compared to $90.7 million in the prior year. This increase is
primarily the result of a 7.0% aggregate rate increase in 1998.
Citizens Midwest's underwriting results deteriorated $7.3 million to an
underwriting loss of $39.1 million for the year ended December 31, 1998, from an
underwriting loss of $31.8 million for 1997. This deterioration is attributable
to a $22.1 million decrease in favorable development on prior accident years'
reserves in the workers' compensation line and to a $19.1 million increase in
catastrophe losses, to $28.7 million in 1998, resulting from severe storms.
Partially offsetting these items are improvements in non-catastrophe claims
activity in both the commercial multiple peril and personal automobile lines of
$10.9 million and $8.0 million, respectively. Reductions in both loss adjustment
expenses and policy acquisition and other underwriting expenses of $9.8 million
and $4.3 million, respectively, also offset deteriorating results. The decreases
in expenses primarily resulted from efficiencies gained through consolidation
and re-engineering of both the claims and underwriting processes. Cost savings
were also achieved through reductions in employee-related expenses and decreased
rent expense resulting from the consolidation of processing centers.
Voluntary Benefits
Voluntary Benefits' net premiums written increased $36.4 million, or 7.4%, to
$527.5 million for the year ended December 31, 1998, compared to $491.1 million
for the same period in 1997. This increase is primarily attributed to an
increase in the personal automobile line of $30.2 million, or 7.8%, over prior
year resulting from an increase in affinity group business policies in force.
Underwriting results improved $22.1 million to a profit of $15.3 million
for the year ended December 31, 1998, from an underwriting loss of $6.8 million
for 1997. The improvement in underwriting results is primarily attributable to
improved non-catastrophe claims activity in the personal automobile and
homeowners lines.
9
Specialty Markets
Specialty Markets' net premiums written increased to $48.1 million for the year
ended December 31, 1998, compared to $27.4 million for 1997. Net premiums earned
increased $17.5 million to $39.4 million for the year ended December 31, 1998,
from $21.9 million for 1997. These increases are primarily attributable to
growth in the commercial multiple peril line.
Underwriting results improved $16.4 million to a loss of $6.5 million for
the year ended December 31, 1998, compared to a loss of $22.9 million for 1997.
The improvement is primarily attributable to improved claims activity in the
workers compensation line of $6.8 million. In addition, reductions in both loss
adjustment expenses and policy acquisition and other underwriting expenses of
$4.6 million and $4.4 million, respectively, contributed to the improvement in
underwriting results.
INVESTMENT RESULTS
================================================================================
Net investment income before taxes was $221.4 million, $229.8 million and $254.1
million for the years ended December 31, 1999, 1998 and 1997, respectively. The
decrease in net investment income in 1999, compared to 1998, primarily reflects
a reduction in average fixed maturity assets of $122.1 million, or 3.3%, to
$3,560.1 million in 1999 compared to $3,682.2 million in 1998. The reduction is
due to the transfer of $350.0 million in cash and securities to the Corporate
segment during the second quarter of 1999. Average pre-tax yields on debt
securities remained stable at 6.7% for 1999 and 1998. Average invested assets
decreased $385.9 million, or 9.2%, to $3,805.5 million in 1999 compared to
$4,191.4 million in 1998.
The decrease in net investment income in 1998, compared to 1997, primarily
reflects a reduction in invested assets as a result of a $117.1 million and a
$53.9 million transfer of assets to the Corporate Segment in April 1998 and
December 1997, respectively. In addition, net investment income in 1998 includes
a $0.8 million loss from partnerships, compared to $6.2 million of income from
partnerships in 1997. Average pre-tax yields on debt securities remained
relatively stable at 6.7% in 1998, compared to 6.8% for 1997. Average invested
assets decreased $80.6 million, or 1.9%, to $4,191.4 million in 1998 compared to
$4,272.0 million in 1997.
RESERVE FOR LOSSES AND
LOSS ADJUSTMENT EXPENSES
================================================================================
The Risk Management segment maintains reserves for its property and casualty
products to provide for the Company's ultimate liability for losses and loss
adjustment expenses with respect to reported and unreported claims incurred as
of the end of each accounting period. These reserves are estimates, involving
actuarial projections at a given point in time, of what management expects the
ultimate settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claim severity and judicial theories of liability and other factors.
The inherent uncertainty of estimating insurance reserves is greater for certain
types of property and casualty insurance lines, particularly workers'
compensation and other liability lines, where a longer period of time may elapse
before a definitive determination of ultimate liability may be made, and where
the technological, judicial and political climates involving these types of
claims are changing.
The Company regularly updates its reserve estimates as new information
becomes available and further events occur which may impact the resolution of
unsettled claims. Changes in prior reserve estimates are reflected in results of
operations in the year such changes are determined to be needed and recorded.
The table below provides a reconciliation of the beginning and ending
reserve for unpaid losses and LAE as follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Reserve for losses and LAE,
beginning of year $2,597.3 $2,615.4 $2,744.1
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events
of current year 1,601.4 1,609.0 1,564.1
Decrease in provision for
insured events of prior years (183.4) (127.2) (127.9)
- -------------------------------------------------------------------------------
Total incurred losses and LAE 1,418.0 1,481.8 1,436.2
- -------------------------------------------------------------------------------
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 861.1 871.9 775.1
Losses and LAE attributable to
insured events of prior years 638.0 643.0 732.1
- -------------------------------------------------------------------------------
Total payments 1,499.1 1,514.9 1,507.2
- -------------------------------------------------------------------------------
Change in reinsurance recoverable
on unpaid losses 102.5 15.0 (50.2)
Other(1) -- -- (7.5)
- -------------------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,618.7 $2,597.3 $2,615.4
================================================================================
(1) Includes purchase accounting adjustments.
10
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $183.4 million, $127.2 million and
$127.9 million in 1999, 1998 and 1997, respectively, reflecting increased
favorable development on reserves for both losses and loss adjustment expenses.
Favorable development on prior years' loss reserves was $93.1 million,
$58.9 million, and $87.2 million for the years ended December 31, 1999, 1998,
and 1997, respectively. The increase of $34.2 million in 1999 is primarily due
to improved personal automobile results in the Northeast and increased
reinsurance recoverables in the commercial multiple peril line. Favorable
development on prior years' loss adjustment expense reserves was $90.3 million,
$68.3 million, and $40.7 million for the years ended December 31, 1999, 1998,
and 1997, respectively. The increase in favorable development in both 1999 and
1998 is primarily attributable to claims process improvement initiatives taken
by the Company over the past two years. The Company has lowered claim settlement
costs through increased utilization of in-house attorneys and consolidation of
claim offices.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future. Management believes the favorable development
on prior accident years experienced in 1999 may not be sustainable in future
periods.
Due to the nature of the business written by the Risk Management segment,
the exposure to environmental liabilities is relatively small and therefore its
reserves are relatively small compared to other types of liabilities. Loss and
LAE reserves related to environmental damage and toxic tort liability, included
in the reserve for losses and LAE, were $47.3 million, $49.9 million and $53.1
million, net of reinsurance of $11.2 million, $14.2 million and $15.7 million in
1999, 1998 and 1997, respectively. The Company does not specifically underwrite
policies that include this coverage, but as case law expands policy provisions
and insurers' liability beyond the intended coverage, the Company may be
required to defend such claims. The Company estimated its ultimate liability for
these claims based upon currently known facts, reasonable assumptions where the
facts are not known, current law and methodologies currently available. Although
these claims are not significant, their existence gives rise to uncertainty and
are discussed because of the possibility, however remote, that they may become
significant. The Company believes that, notwithstanding the evolution of case
law expanding liability in environmental claims, recorded reserves related to
these claims are adequate. In addition, the Company is not aware of any
litigation or pending claims that may result in additional material liabilities
in excess of recorded reserves. The environmental liability could be revised in
the near term if the estimates used in determining the liability are revised.
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the Company varies by product. Property
and casualty insurance premiums are established before the amount of losses and
LAE, and the extent to which inflation may affect such expenses, are known.
Consequently, the Company attempts, in establishing rates, to anticipate the
potential impact of inflation in the projection of ultimate costs. The impact of
inflation has been relatively insignificant in recent years. However, inflation
could contribute to increased losses and LAE in the future.
The Company regularly reviews its reserving techniques, its overall
reserving position and its reinsurance. Based on (i) review of historical data,
legislative enactments, judicial decisions, legal developments in impositions of
damages, changes in political attitudes and trends in general economic
conditions, (ii) review of per claim information, (iii) historical loss
experience of the Company and the industry, (iv) the relatively short-term
nature of most policies and (v) internal estimates of required reserves,
management believes that adequate provision has been made for loss reserves.
However, establishment of appropriate reserves is an inherently uncertain
process and there can be no certainty that current established reserves will
prove adequate in light of subsequent actual experience. A significant change to
the estimated reserves could have a material impact on the results of
operations.
11
ASSET ACCUMULATION
================================================================================
Allmerica Financial Services
The following table summarizes the results of operations, including the Closed
Block, for the Allmerica Financial Services segment.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Segment revenues
Premiums $ 54.5 $ 58.1 $ 83.0
Fees 359.3 296.6 241.5
Investment and other income 392.5 369.3 389.4
- --------------------------------------------------------------------------------
Total segment revenues 806.3 724.0 713.9
- --------------------------------------------------------------------------------
Policy benefits, claims and losses 321.0 314.3 356.6
Policy acquisition and other operating
expenses 279.8 240.7 222.7
- --------------------------------------------------------------------------------
Segment income $ 205.5 $ 169.0 $ 134.6
================================================================================
1999 Compared to 1998
Segment income increased $36.5 million, or 21.6%, to $205.5 million in 1999.
This increase is primarily attributable to higher asset-based fee income
resulting from market appreciation and additional deposits in the variable
annuity and variable universal life product lines, partially offset by higher
policy acquisition and other operating expenses. In addition, segment income in
1998 was negatively impacted by losses incurred on hedge fund partnership
investments.
Segment revenues increased $82.3 million, or 11.4% in 1999 primarily due
to increased fees and other income. Fee income from variable annuities and
individual variable universal life policies increased $66.1 million, or 32.8%,
in 1999 due to market appreciation and additional deposits. In addition,
investment and other income increased $23.2 million primarily due to higher
investment management fees and brokerage income resulting from growth and
appreciation in variable product assets under management. Financial Profiles, a
financial software company acquired during the third quarter of 1998,
contributed $6.5 million of this $23.2 million increase. Net investment income
decreased $1.6 million in 1999 principally due to a reduction in average fixed
maturities invested resulting from asset transfers to the separate accounts in
the annuity and group retirement product lines, as well as cancellations of
certain accounts in the group retirement business. These decreases were
partially offset by the absence of losses incurred on hedge fund partnership
investments in 1998. Premiums and fees from traditional and non-variable
universal life insurance products declined $6.7 million primarily from the
Company's continued shift in focus to variable life insurance and annuity
products.
Policy benefits, claims and losses increased $6.7 million, or 2.1%, to
$321.0 million in 1999. This increase is primarily due to the Company's
establishment of a $7.4 million mortality reserve in the first quarter of 1999
related to the variable annuity line of business, subsequent increases in this
reserve of $5.8 million, and additional growth in this line. In addition,
annuity reserves increased $5.5 million related to an annuity program which
provides, for a limited time, enhanced crediting rates on deposits made into the
Company's general account. Under this program, general account deposits are
transferred ratably over a period of time into the Company's separate accounts.
These increases were partially offset by more favorable mortality experience in
the traditional life line of business, lower policy benefits due to a reduction
of policies in force in the universal life product line, as well as decreased
interest credited due to the aforementioned cancellations in the group
retirement business.
Policy acquisition and other operating expenses increased $39.1 million,
or 16.2%, to $279.8 million in 1999. This increase reflects growth in the
individual variable annuity and variable universal life product lines. In
addition, other operating expenses relating to trail commissions in the annuity
line of business and to Financial Profiles increased $9.2 million and $8.1
million, respectively. Partially offsetting these increases is a $3.5 million
decline in policy acquisition expenses resulting from the implementation of an
enhanced valuation system for the annuity line of business in 1999. This decline
consists of a one-time increase in the deferred acquisition cost asset of $13.5
million, partially offset by increased ongoing deferred acquisition expenses of
approximately $10.0 million. The Company expects the increase in deferred
acquisition expenses to continue.
1998 Compared to 1997
Segment income increased $34.4 million, or 25.6%, to $169.0 million in 1998.
This increase is primarily attributable to higher asset-based fee income
resulting from additional deposits and market appreciation in the variable
annuity and variable universal life product lines, partially offset by an
increase in policy acquisition and other operating expenses. Additionally, in
1997, the Company revised the mortality assumptions used to determine the
amortization of policy acquisition costs and recognition of certain fees for
this segment's universal life and variable universal life lines of business,
which resulted in decreased policy acquisition costs in 1998 of approximately
$8.4 million in these product lines. In addition, as a result of a January 1,
1998 agreement with a highly rated reinsurer to reinsure the mortality risk on
the universal life and variable universal life lines of business, policy
benefits, claims and
12
losses decreased approximately $3.1 million. The terms and provisions of the
reinsurance contract are consistent with the aforementioned change in mortality
assumptions. These increases were partially offset by lower net investment
income, which included losses incurred on hedge fund partnership investments
during 1998.
Segment revenues increased $10.1 million, or 1.4% to $724.0 million in
1998 primarily due to increased fees and other income, partially offset by lower
premiums and net investment income. Fees from individual annuities increased
$47.1 million, or 52.4%, to $137.0 million in 1998. Distribution arrangements
with several third party mutual fund advisors contributed to the increase in
annuity sales in 1998. Fees from individual variable universal life policies
increased $10.8 million, or 20.0%, to $64.7 million in 1998. In addition, other
income increased $8.5 million primarily due to higher investment management fees
resulting from growth and appreciation in variable product assets under
management. Net investment income decreased $28.6 million primarily due to a
reduction in average fixed maturities invested resulting from the aforementioned
cession of the Company's individual disability income line of business, asset
transfers to the separate accounts in the annuity and group retirement product
lines and from losses incurred on hedge fund partnership investments in 1998. In
addition, premiums decreased $24.9 million, or 30.0%, to $58.1 million in 1998.
This decrease is primarily due to the cession, in 1997, of substantially all of
the Company's individual disability income line of business, which contributed
premiums of $0.6 million in 1998 compared to $22.8 million during 1997.
Policy benefits, claims and losses decreased $42.3 million, or 11.9%, to
$314.3 million in 1998. This decrease is primarily due to the aforementioned
cession of substantially all of the individual disability income line of
business, which incurred policy benefits of $3.4 million in 1998, compared to
$32.3 million in 1997. Also contributing to the overall decrease was a reduction
in interest credited on group retirement products of $3.8 million due to the
aforementioned shift to the separate accounts and to $3.1 million of improved
mortality experience in the universal life and variable universal life lines of
business.
Policy acquisition and other operating expenses increased $18.0 million,
or 8.1%, to $240.7 million in 1998. This increase was primarily attributable to
continued growth in the variable product lines, to increased technology costs,
and to increased interest expense related to commercial paper used to manage
short-term cash flows. These increases were partially offset by reductions in
employee related costs resulting from the restructuring of the group retirement
business during the fourth quarter of 1997.
Statutory Premiums and Deposits
The following table sets forth statutory premiums and deposits by product for
the Allmerica Financial Services segment.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Insurance:
Traditional life $ 77.4 $ 55.9 $ 58.4
Universal life 71.8 23.6 60.7
Variable universal life 187.0 158.7 148.8
Individual health 0.3 0.6 22.8
Group variable universal life 94.9 73.3 68.3
- --------------------------------------------------------------------------------
Total insurance 431.4 312.1 359.0
- --------------------------------------------------------------------------------
Annuities:
Separate account annuities 1,922.2 2,583.6 2,169.1
General account annuities 830.2 622.2 234.7
Retirement investment accounts 16.4 20.1 21.8
- --------------------------------------------------------------------------------
Total individual annuities 2,768.8 3,225.9 2,425.6
Group annuities 409.3 563.9 404.2
- --------------------------------------------------------------------------------
Total annuities 3,178.1 3,789.8 2,829.8
- --------------------------------------------------------------------------------
Total premiums and deposits $3,609.5 $4,101.9 $3,188.8
================================================================================
1999 Compared to 1998
For the year ended December 31, 1999, total premiums and deposits decreased
$492.4 million, or 12.0%, to $3,609.5 million. This decrease is primarily due to
lower individual and group annuity deposits, partially offset by increased
universal and variable universal life insurance premiums. The decrease in
individual annuity deposits was caused by a sharp decline in sales among third
party mutual fund advisors, slightly offset by growth in the career agency and
broker-dealer distribution channels. Decreases in sales at three specific mutual
fund advisors aggregating $538.0 million are responsible for the $457.1 million
overall contraction within this line. Two of these mutual fund advisors remain
committed to distributing the Company's annuities, while one advisor has shifted
to emphasize its proprietary products. While these reduced sales levels could
negatively impact future earnings, the Company continues to pursue additional
relationships in the marketplace. The increase in general account annuities
reflects the Company's aforementioned annuity program introduced in 1998, which
provides, for a limited time, enhanced crediting rates. In addition, group
annuity deposits declined $154.6 million in 1999 primarily due to cancellations
of certain accounts within the group retirement business. These decreases were
partially offset by higher variable universal life insurance premiums due to
increased sales and renewals in the current year.
13
1998 Compared to 1997
For the year ended December 31, 1998, total premiums and deposits increased
$913.1 million, or 28.6 %, to $4,101.9 million. This increase is primarily due
to growth in individual and group annuity deposits across all distribution
channels, particularly the aforementioned third party mutual fund advisors.
Deposits from this distribution channel increased $602.0 million, or 53.6%, in
1998. In addition, deposits from the Company's individual annuity products, sold
through the career agency and broker-dealer distribution channels, increased
$200.0 million, or 15.6%. Group annuity deposits grew $159.7 million as a result
of new sales and additional deposits to existing group retirement plans.
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica Asset
Management segment.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Interest margins on GICs:
Net investment income $ 137.9 $ 111.3 $ 82.3
Interest credited 118.6 89.3 64.2
- --------------------------------------------------------------------------------
Net interest margin 19.3 22.0 18.1
Fees and other income:
External 6.2 4.0 2.2
Internal 6.4 6.4 6.6
Other operating expenses 8.4 8.7 8.5
- --------------------------------------------------------------------------------
Segment income $ 23.5 $ 23.7 $ 18.4
================================================================================
1999 Compared to 1998
Income in the Allmerica Asset Management segment is generated by interest
margins earned on the Company's GICs and funding agreements, as well as
investment advisory fees earned on assets under management. Investment advisory
services are provided to affiliates and third parties, such as money market and
other fixed income clients. Related fees are based upon asset balances under the
Company's management. Segment income decreased $0.2 million, or 0.8%, to $23.5
million in 1999. This decrease is primarily attributable to the absence of a
one-time $2.6 million mortgage loan equity participation interest received in
1998 and lower mortgage prepayment fees in 1999. Excluding the effect of these
items, interest margins on GICs increased $3.8 million. This increase reflects
continued sales of funding agreements during the first six months of 1999,
partially offset by withdrawals during the fourth quarter of 1999. These
withdrawals reflected uncertainties in the market resulting in greater
redemptions for the industry overall. Management expects income from the GIC
product line to be unfavorably impacted in future periods due to funding
agreement withdrawals experienced in the fourth quarter of 1999 and a diminished
market for these products. Income from assets under management grew $1.6 million
in 1999 as a result of increased business from new and existing money market and
other external fixed income fund clients.
1998 Compared to 1997
Segment income increased $5.3 million, or 28.8%, to $23.7 million in 1998,
primarily due to an increase in GIC interest margins of $3.9 million and
additional asset management fees of $1.6 million. Interest margins on new
floating rate GICs increased $9.8 million in 1998, to $10.2 million, as compared
to $0.4 million in 1997. This increase more than offset a decrease in the
traditional GIC interest margins of $5.9 million, from $17.7 million in 1997,
which resulted from the continued run-off of the traditional GIC product.
Included in the traditional GIC interest margin in 1998 is the receipt of the
aforementioned $2.6 million mortgage loan equity participation payment, while
1997 reflects approximately $1.5 million of one-time benefits. Additionally, fee
revenue increased $1.6 million in 1998 due to growth in assets under management.
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Segment revenues
Investment and other income $ 6.0 $ 12.9 $ 16.1
Interest expense 15.4 16.0 18.1
Other operating expenses 49.9 47.8 46.0
- -------------------------------------------------------------------------------
Segment loss $ (59.3) $ (50.9) $ (48.0)
================================================================================
1999 Compared to 1998
Segment loss increased $8.4 million, or 16.5%, to $59.3 million in 1999,
primarily due to lower investment and other income and higher corporate overhead
costs. Investment and other income decreased $6.9 million in 1999 due to lower
average invested assets. This decline primarily reflects the sale of investments
which were used to fund the Company's stock repurchase program and the transfer
of $125.0 million of assets
14
from AFC to FAFLIC as part of a 1999 capital contribution. These decreases were
partially offset by assets transferred from the Risk Management segment of
$125.0 million and $225.0 million in April and May of 1999, respectively.
Interest expense for both periods relates principally to the interest paid
on the Senior Debentures of the Company. In addition, interest expense in 1998
includes $0.7 million related to the Company's short term revolving credit loan
associated with the acquisition of Citizens Corporation's minority interest.
Other operating expenses increased $2.1 million, or 4.4%, to $49.9 million
in 1999. This expense category consists primarily of corporate overhead
expenses, which reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the Legal department. The increase in
other operating expenses is primarily due to higher corporate overhead costs,
partially offset by a reduction in other corporate expenses.
1998 Compared to 1997
Segment loss increased $2.9 million, or 6.0%, to $50.9 million in 1998,
primarily due to lower investment and other income and higher corporate overhead
costs, partially offset by reduced interest and other corporate expenses.
Investment and other income decreased $3.2 million in 1998 primarily from
the absence of $9.1 million of short-term income generated by the temporary
investment of the net proceeds from the issuance of Capital Securities in 1997.
This was partially offset by additional income due to higher average invested
assets resulting from transfers of $117.1 million and $53.9 million from the
Risk Management segment in April 1998 and December 1997, respectively.
Interest expense for both periods relates principally to the interest paid
on the Senior Debentures of the Company. In addition, interest expense in 1998
includes $0.7 million related to the Company's short term revolving credit loan
which commenced on December 4, 1998 to affect the acquisition of Citizens
Corporation's minority interest, while interest expense in 1997 includes $2.8
million of Allmerica P&C merger-related interest expense.
Other operating expenses increased $1.8 million, or 3.9%, to $47.8 million
in 1998, primarily due to $5.8 million of higher corporate overhead costs,
partially offset by a reduction in other corporate expenses.
DISCONTINUED OPERATIONS
================================================================================
During the second quarter of 1999, the Company approved a plan to exit its group
life and health insurance business, consisting of its EBS business, its AGU
business and its reinsurance pool business. Prior to 1999, these businesses
comprised substantially all of the former Corporate Risk Management Services
segment. The operating results of the discontinued segment have been reported in
the Consolidated Statements of Income as discontinued operations in accordance
with APB Opinion No. 30 with a June 30, 1999 measurement date.
Reinsurance Pools
The reinsurance pool business consists primarily of assumed medical stop loss
business, the medical and disability portions of workers' compensation risks,
small group managed care pools, long-term disability and long-term care pools,
student accident and special risk business. During the third quarter of 1998,
the Company announced that it ceased writing new premium in the reinsurance pool
business, subject to certain contractual obligations. Concurrent with the
decision to exit the reinsurance pool business, the Company entered into a
reinsurance agreement that cedes current and future underwriting losses,
including unfavorable development of prior year reserves, up to a $40.0 million
maximum, relating to the reinsurance pool business. As a result of this
transaction, the Company recognized a $25.3 million pre-tax loss in the third
quarter of 1998. For the year ended December 31, 1999, the Company recognized
estimated future pre-tax losses of $40.6 million.
EBS
The EBS business provides managed care products and offers group life, medical,
dental, and disability insurance to the middle market. On October 6, 1999, the
Company entered into an agreement with Great-West Life and Annuity Insurance
Company of Denver, which provides for the sale of the Company's EBS business
effective March 1, 2000. The sales transaction effectively transfers the
business upon renewal subjecting the Company to losses on its existing book
during the runoff period. As required by APB Opinion No. 30, the loss from
disposal of the discontinued segment includes estimated pre-tax net proceeds
from the aforementioned sale of the Company's EBS business of $25.3 million, as
well as estimated pre-tax future losses of $15.7 million, expected from the
runoff of EBS after the June 30, 1999 measurement date. Accordingly,
15
the Company recognized a pre-tax net gain from disposal of discontinued EBS
business of $9.6 million. Net proceeds for the sale are comprised of the sales
price, which is a function of persistency levels at March 1, 2000 and 2001, less
estimated costs of sale, including severance, legal and retirement.
Additionally, in the fourth quarter of 1998, the Company closed nearly
half of its nationwide Corporate Risk Management Services' sales offices,
eliminated certain staff, and discontinued certain automation initiatives that
resulted in a $4.0 million pre-tax loss from restructuring.
AGU
AGU operates as a Managing Group Underwriting unit offering members of affinity
groups medical, life and disability insurance. Estimated pre-tax future losses
expected from runoff are $15.9 million.
The following table summarizes the loss from operations and disposal for
the discontinued group life and health insurance business for the periods
indicated.
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
(Loss) income from operations of
discontinued group life and health
business before federal income taxes $ (28.9) $ (20.5) $ 25.5
Federal income tax benefit (expense) 10.1 7.0 (8.9)
- -------------------------------------------------------------------------------
(Loss) income from operations of
discontinued group life and health
business, net of taxes (18.8) (13.5) 16.6
- -------------------------------------------------------------------------------
Loss from disposal of discontinued group
life and health business before federal
income taxes (46.9) -- --
Federal income tax benefit 16.4 -- --
- -------------------------------------------------------------------------------
Loss from disposal of discontinued
group life and health business, net of taxes (30.5) -- --
- -------------------------------------------------------------------------------
Net (loss) income from
discontinued segment $ (49.3) $ (13.5) $ 16.6
================================================================================
1999 Compared to 1998
The $28.9 million loss from operations before federal income taxes for the year
ended December 31, 1999 results primarily from additional reserves provided for
accident claims related to prior years. The loss from operations before federal
income taxes for the year ended December 31, 1998 of $20.5 million, reflects
primarily the $25.3 million loss recognized from the aforementioned reinsurance
agreement.
As required by APB Opinion No. 30, the loss from disposal of the
discontinued segment includes estimated proceeds from the aforementioned sale of
the Company's EBS business, as well as an estimate of future losses expected
from the runoff of the discontinued operations after the June 30, 1999
measurement date. Accordingly, the Company recognized a pre-tax loss from
disposal of its group life and health business of $46.9 million, which is
comprised of the following (in millions):
Proceeds from sale $ 25.3
Losses expected from runoff:
EBS (15.7)
Reinsurance pools (40.6)
AGU (15.9)
- ------------------------------------------------------------------------------
$(46.9)
================================================================================
The provision for anticipated future losses on the runoff of discontinued
operations was established based on estimates of cash flows from the assets
supporting the discontinued products offset by estimates of cash flows expected
to meet the obligations of outstanding contracts and estimates of cash flows
expected to meet operational funding requirements. These estimates are
continually reviewed and adjusted as necessary. To the extent that actual future
losses differ from these estimates, the Company's reported results from the
disposal of the discontinued segment would be affected. The Company believes the
provision established appropriately reflects expected future results. However,
due to the inherent volatility in this segment, and to its history of increased
losses, there can be no assurance that current reserves are adequate and future
losses will not arise.
1998 Compared to 1997
The loss from operations before federal income taxes for the year ended December
31, 1998 of $20.5 million, reflects primarily the $25.3 million loss recognized
from the aforementioned reinsurance agreement. Income from operations before
federal income taxes of $25.5 million for the year ended December 31, 1997
reflects the growth in the reinsurance, fully insured group dental and stop loss
products, as well as the assumption of a block of affinity group life and health
business in January 1997. In addition, the segment benefitted from improved
experience in the long-term disability, stop loss and risk sharing product lines
of business.
16
INVESTMENT PORTFOLIO
================================================================================
The Company had investment assets diversified across several asset classes, as
follows:
December 31 1999(1) 1998(1)
================================================================================
(In millions)
% of Total % of Total
Carrying Carrying Carrying Carrying
Value Value Value Value
Fixed maturities(2) $ 7,306.7 80.6% $ 8,195.0 79.0%
Equity securities(2) 83.2 0.9 397.1 3.8
Mortgages 657.5 7.3 698.3 6.7
Policy loans 371.6 4.1 365.2 3.5
Cash and cash equivalents 464.8 5.1 559.7 5.4
Real estate and other
invested assets 180.0 2.0 163.1 1.6
- --------------------------------------------------------------------------------
Total $ 9,063.8 100.0% $10,378.4 100.0%
================================================================================
(1) Includes Closed Block invested assets with a carrying value of $732.9
million and $770.5 million at December 31, 1999 and 1998, respectively.
(2) The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
Total investment assets decreased $1,314.6 million, or 12.7%, to $9.1
billion during 1999. This decrease resulted primarily from decreased fixed
maturities of $888.3 million, equity securities of $313.9 million and cash and
cash equivalents of $94.9 million. The decrease in fixed maturities is due to
sales of assets for the redemption of funding agreements, the purchase of AFC
common stock under the stock repurchase program, and the shift in assets from
the general to the separate accounts. In January 1999, sales of equity
securities resulted in proceeds of $310.0 million and realized gains of $116.0
million. Proceeds from the equity securities were used, in part, to repay the
loan used to fund the acquisition of minority interest of Citizens Corporation.
In addition, the decrease in cash and cash equivalents is due to the transfer of
funds into the separate accounts in association with an annuity program, which
provides, for a limited time, enhanced crediting rates on deposits made into the
Company's general account and transferred ratably over a period of time into the
Company's separate accounts.
The Company's fixed maturity portfolio is comprised of primarily
investment grade corporate securities, tax-exempt issues of state and local
governments, U.S. government and agency securities and other issues. Based on
ratings by the National Association of Insurance Commissioners, investment grade
securities comprised 84.4% and 84.7% of the Company's total fixed maturity
portfolio at December 31, 1999 and 1998, respectively. The average yield on debt
securities was 7.2% and 7.3% for 1999 and 1998, respectively. Although
management expects that new funds will be invested primarily in investment grade
fixed maturities, the Company may invest a portion of new funds in below
investment grade fixed maturities or equity interests.
MARKET RISK AND RISK MANAGEMENT POLICIES
================================================================================
Interest Rate Sensitivity
The operations of the Company are subject to risk resulting from interest rate
fluctuations to the extent that there is a difference between the amount of the
Company's interest-earning assets and the amount of interest-bearing liabilities
that are paid, withdrawn, mature or re-price in specified periods. The principal
objective of the Company's asset/liability management activities is to provide
maximum levels of net investment income while maintaining acceptable levels of
interest rate and liquidity risk and facilitating the funding needs of the
Company. The Company has developed an asset/liability management approach
tailored to specific insurance or investment product objectives. The investment
assets of the Company are managed in over 20 portfolio segments consistent with
specific products or groups of products having similar liability
characteristics. As part of this approach, management develops investment
guidelines for each portfolio consistent with the return objectives, risk
tolerance, liquidity, time horizon, tax and regulatory requirements of the
related product or business segment. Management has a general policy of
diversifying investments both within and across all portfolios. The Company
monitors the credit quality of its investments and its exposure to individual
markets, borrowers, industries, sectors, and in the case of mortgages and real
estate, property types and geographic locations. In addition, the Company
carries long and short-term debt, as well as mandatorily redeemable preferred
securities of a subsidiary trust holding solely junior subordinated debentures
of the Company.
The Company uses derivative financial instruments, primarily interest rate
swaps, with indices that correlate to on-balance sheet instruments to modify its
indicated net interest sensitivity to levels deemed to be appropriate.
Specifically, for floating rate GIC liabilities that are matched with fixed rate
securities, the Company manages the interest rate risk by hedging with interest
rate swap contracts designed to pay fixed and receive floating interest.
Additionally, the Company uses exchange
17
traded financial futures contracts to hedge against interest rate risk on
anticipated GIC sales.
The following tables for the years ended December 31, 1999 and 1998
provide information about the Company's financial instruments used for purposes
other than trading that are sensitive to changes in interest rates. The tables
present principal cash flows and related weighted-average interest rates by
expected maturities. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties, or the Company may have the right to put
or sell the obligations back to the issuers. Mortgage backed and asset backed
securities are included in the category representing their expected maturity.
Available-for-sale securities include both U.S. and foreign-denominated bonds,
but exclude interest rate swap contracts and foreign currency swap contracts,
which are disclosed in separate tables. Foreign-denominated bonds are also shown
separately in the tables of financial instruments subject to foreign currency
risk. For liabilities that have no contractual maturity, the tables present
principal cash flows and related weighted-average interest rates based on the
Company's historical experience, management's judgment, and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.
Additionally, the Company has assumed its available for sale securities are
similar enough to aggregate those securities for presentation purposes.
Specifically, variable rate available for sale securities and mortgage loans
comprise an immaterial portion of the portfolio and do not have a significant
impact on weighted average interest rates. Therefore, the variable rate
investments are not presented separately; instead they are included in the
tables at their current interest rate.
For the Year Ended December 31, 1999 2000 2001 2002 2003 2004
======================================================================================================
(Dollars in millions)
Rate Sensitive Assets:
Available for sale securities $466.3 $553.5 $533.8 $587.0 $522.7
Average interest rate 7.73% 7.46% 7.26% 6.89% 7.37%
Mortgage loans $119.4 $ 61.1 $ 32.3 $ 41.7 $ 77.5
Average interest rate 9.08% 8.27% 8.17% 7.33% 7.68%
Policy loans $ -- $ -- $ -- $ -- $ --
Average interest rate -- -- -- -- --
Rate Sensitive Liabilities:
Fixed interest rate GICs $ 70.0 $ 27.6 $ 46.4 $ -- $ --
Average interest rate 7.60% 7.10% 7.29% -- --
Variable interest rate GICs $107.8 $ 43.2 $ 50.1 $ 402.5 $463.4
Average interest rate 6.26% 6.24% 6.24% 6.28% 6.17%
Supplemental contracts without life contingencies $ 21.9 $ 11.2 $ 6.9 $ 4.7 $ 0.4
Average interest rate 4.03% 4.04% 4.05% 4.08% 4.13%
Other individual contract deposit funds $ 11.2 $ 9.3 $ 7.6 $ 6.0 $ 4.2
Average interest rate 5.77% 5.87% 6.12% 5.75% 5.89%
Other group contract deposit funds $107.9 $ 85.7 $ 49.8 $ 43.0 $ 35.8
Average interest rate 5.84% 5.17% 5.51% 5.45% 5.65%
Individual fixed annuity contracts $ 96.3 $106.9 $115.7 $124.3 $134.0
Average interest rate 5.37% 5.18% 5.09% 5.01% 4.84%
Trust instruments supported by funding obligations $ -- $ 50.6 $ -- $ -- $ --
Average interest rate -- 4.33% -- -- --
Long term debt $ -- $ -- $ -- $ -- $ --
Average interest rate -- -- -- -- --
Mandatorily redeemable preferred securities of a
subsidiary trust holding soley junior subordinated
debentures of the Company $ -- $ -- $ -- $ -- $ --
Average interest rate -- -- -- -- --
Fair
Value
For the Year Ended December 31, 1999 Thereafter Total 12/31/99
=============================================================================================
(Dollars in millions)
Rate Sensitive Assets:
Available for sale securities $4,563.9 $7,227.2 $7,260.5
Average interest rate 7.30% 7.31%
Mortgage loans $ 331.4 $ 663.4 $ 656.5
Average interest rate 7.65% 7.98%
Policy loans $ 371.6 $ 371.6 $ 371.6
Average interest rate 6.81% 6.81%
Rate Sensitive Liabilities:
Fixed interest rate GICs $ 105.0 $ 249.0 $ 253.8
Average interest rate 6.86% 7.17%
Variable interest rate GICs $ -- $1,067.0 $1,087.6
Average interest rate -- 6.23%
Supplemental contracts without life contingencies $ 3.7 $ 48.8 $ 48.8
Average interest rate 4.10% 4.04%
Other individual contract deposit funds $ 10.1 $ 48.4 $ 48.2
Average interest rate 5.55% 5.85%
Other group contract deposit funds $ 280.7 $ 602.9 $ 583.5
Average interest rate 5.65% 5.59%
Individual fixed annuity contracts $ 515.3 $1,092.5 $1,057.1
Average interest rate 3.86% 4.99%
Trust instruments supported by funding obligations $ -- $ 50.6 $ 49.6
Average interest rate -- 4.33%
Long term debt $ 199.5 $ 199.5 $ 187.4
Average interest rate 7.63% 7.63%
Mandatorily redeemable preferred securities of a
subsidiary trust holding soley junior subordinated
debentures of the Company $ 300.0 $ 300.0 $ 292.5
Average interest rate 8.21% 8.21%
18
Fair
Value
For the Year Ended December 31, 1998 1999 2000 2001 2002 2003 Thereafter Total 12/31/98
=================================================================================================================================
(Dollars in millions)
Rate Sensitive Assets:
Available for sale securities $527.4 $558.8 $574.8 $783.8 $811.7 $4,466.9 $7,723.4 $8,223.5
Average interest rate 8.22% 8.00% 7.71% 7.38% 6.90% 7.17% 7.33%
Mortgage loans $ 91.9 $143.8 $ 64.8 $ 33.5 $ 44.5 $ 331.3 $ 709.8 $ 729.5
Average interest rate 8.31% 9.24% 7.89% 8.30% 7.42% 7.79% 8.16%
Policy loans $ -- $ -- $ -- $ -- $ -- $ 365.2 $ 365.2 $ 365.2
Average interest rate -- -- -- -- -- 6.73% 6.73%
Rate Sensitive Liabilities:
Fixed interest rate GICs $337.1 $ 83.7 $ 25.8 $ 32.3 $ -- $ -- $ 478.9 $ 489.3
Average interest rate 6.51% 7.28% 6.87% 7.22% -- -- 6.71%
Variable interest rate GICs $151.0 $ 57.2 $ -- $301.6 $803.1 $ -- $1,312.9 $1,341.5
Average interest rate 5.14% 5.32% -- 5.31% 5.41% -- 5.35%
Supplemental contracts without life
contingencies $ 16.0 $ 4.1 $ 3.7 $ 3.3 $ 2.9 $ 7.3 $ 37.3 $ 37.3
Average interest rate 4.25% 4.56% 4.57% 4.58% 4.60% 4.61% 4.44%
Other individual contract deposit funds $ 16.1 $ 12.7 $ 9.7 $ 7.2 $ 4.8 $ 11.1 $ 61.6 $ 61.1
Average interest rate 4.08% 4.06% 4.04% 4.02% 4.00% 3.80% 4.01%
Other group contract deposit funds $243.8 $274.0 $ 77.3 $ 43.0 $ 28.2 $ 34.1 $ 700.4 $ 704.0
Average interest rate 6.23% 5.96% 5.77% 5.66% 5.18% 5.93% 5.97%
Individual fixed annuity contracts $108.7 $107.6 $103.6 $ 97.3 $ 90.9 $ 602.5 $1,110.6 $1,073.6
Average interest rate 4.49% 4.44% 4.40% 4.27% 4.20% 3.50% 3.90%
Long term debt $ -- $ -- $ -- $ -- $ -- $ 199.5 $ 199.5 $ 213.4
Average interest rate -- -- -- -- -- 7.63% 7.63%
Mandatorily redeemable preferred securities
of a subsidiary trust holding soley junior
subordinated debentures of the Company $ -- $ -- $ -- $ -- $ -- $ 300.0 $ 300.0 $ 334.7
Average interest rate -- -- -- -- -- 8.21% 8.21%
The following tables for the years ended December 31, 1999 and 1998 provide
information about the Company's derivative financial instruments used for
purposes other than trading that are sensitive to changes in interest rates. The
tables present notional amounts and, as applicable, weighted-average interest
rates by contractual maturity date. Notional amounts are used to calculate the
contractual payments to be exchanged under the contracts. Weighted-average
variable rates are indicated by the applicable floating rate index.
19
For the Year Ended December 31, 1999 2000 2001 2002 2003
========================================================================================================
(Dollars in millions)
Rate Sensitive Derivative
Financial Instruments:
Pay fixed/receive 3 month
LIBOR swaps $ 44.0 $ 43.1 $ 83.5 $ 191.0
Average pay rate 6.16% 5.63% 6.33% 5.85%
Average receive rate 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR
Pay fixed/receive 1 month
LIBOR swaps $ -- $ -- $ -- $ 195.0
Average pay rate -- -- -- 5.58%
Average receive rate -- -- -- 1 Mo. LIBOR
Pay fixed/receive Fed Funds
rate swaps $ -- $ -- $ -- $ 100.0
Average pay rate -- -- -- 5.89%
Average receive rate -- -- -- Fed Funds
Pay Fed Funds/receive 1 month
LIBOR swaps $ -- $ -- $ -- $ 50.0
Average pay rate -- -- -- Fed Funds
Average receive rate -- -- -- 1 Mo. LIBOR
Futures contracts (long) $ 33.2 $ -- $ -- $ --
Number of contracts
(5 year T notes) 334,000 -- -- --
Weighted average opening
price 99.258 -- -- --
Fair
Value
For the Year Ended December 31, 1999 2004 Thereafter Total 12/31/99
=========================================================================================================
(Dollars in millions)
Rate Sensitive Derivative
Financial Instruments:
Pay fixed/receive 3 month
LIBOR swaps $ 197.3 $ 23.6 $ 582.5 $ 18.1
Average pay rate 5.59% 7.34% 5.90%
Average receive rate 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR
Pay fixed/receive 1 month
LIBOR swaps $ -- $ -- $ 195.0 $ 8.2
Average pay rate -- -- 5.58%
Average receive rate -- -- 1 Mo. LIBOR
Pay fixed/receive Fed Funds
rate swaps $ 122.0 $ -- $ 222.0 $ 7.0
Average pay rate 5.63% -- 5.75%
Average receive rate Fed Funds -- Fed Funds
Pay Fed Funds/receive 1 month
LIBOR swaps $ -- $ -- $ 50.0 $ (0.1)
Average pay rate -- -- Fed Funds
Average receive rate -- -- 1 Mo. LIBOR
Futures contracts (long) $ -- $ -- $ 33.2 $ 32.7
Number of contracts
(5 year T notes) -- -- 334,000
Weighted average opening
price -- -- 99.258
20
For the Year Ended December 31, 1998 1999 2000 2001 2002
=========================================================================================================
(Dollars in millions)
Rate Sensitive Derivative
Financial Instruments:
Pay fixed/receive 3 month
LIBOR swaps $ -- $ 44.0 $ -- $ 102.5
Average pay rate -- 6.16% -- 6.23%
Average receive rate -- 3 Mo. LIBOR -- 3 Mo. LIBOR
Pay fixed/receive 1 month
LIBOR swaps $ -- $ -- $ -- $ 44.0
Average pay rate -- -- -- 6.22%
Average receive rate -- -- -- 1 Mo. LIBOR
Pay fixed/receive Fed Funds
rate swaps $ -- $ -- $ -- $ 88.0
Average pay rate -- -- -- 5.81%
Average receive rate -- -- -- FED FUNDS
Futures contracts (long) $ 86.5 $ -- $ -- $ --
Number of contracts
(5 year T notes) 758,000 -- -- --
Weighted average opening
price 114.098 -- -- --
Fair
Value
For the Year Ended December 31, 1998 2003 Thereafter Total 12/31/98
=========================================================================================================
(Dollars in millions)
Rate Sensitive Derivative
Financial Instruments:
Pay fixed/receive 3 month
LIBOR swaps $ 273.0 $ 23.6 $ 443.1 $ (13.6)
Average pay rate 5.71% 7.34% 5.96%
Average receive rate 3 Mo. LIBOR 3 Mo. LIBOR 3 Mo. LIBOR
Pay fixed/receive 1 month
LIBOR swaps $ 337.5 $ -- $ 381.5 $ (6.1)
Average pay rate 5.75% -- 5.80%
Average receive rate 1 Mo. LIBOR -- 1 Mo. LIBOR
Pay fixed/receive Fed Funds
rate swaps $ 200.0 $ -- $ 288.0 $ (8.6)
Average pay rate 5.80% -- 5.80%
Average receive rate FED FUNDS -- FED FUNDS
Futures contracts (long) $ -- $ -- $ 86.5 $ 85.9
Number of contracts
(5 year T notes) -- -- 758,000
Weighted average opening
price -- -- 114.098
Foreign Currency Sensitivity
A portion of the Company's investments consists of fixed interest securities
denominated in foreign currencies. A portion of the Company's liabilities
consists of fixed interest trust obligations backed by funding agreements
denominated in foreign currencies. The Company's operating results are exposed
to changes in exchange rates between the U.S. dollar and the Swiss Franc,
Japanese Yen, British Pound and Euro. From time to time, the Company may also
have exposure to other foreign currencies. To mitigate the short-term effect of
changes in currency exchange rates, the Company regularly hedges by entering
into foreign exchange swap contracts to hedge its net foreign currency exposure.
The following tables for the years ended December 31, 1999 and 1998
provide information about the Company's derivative financial instruments and
other financial instruments, used for purposes other than trading, by functional
currency and presents fair value information in U.S. dollar equivalents. The
tables summarize information on instruments that are sensitive to foreign
currency exchange rates, including fixed interest securities denominated in
foreign currencies, and foreign currency forward exchange agreements. For
foreign currency denominated securities with contractual maturities, the tables
present principal cash flows, related weighted-average interest rates by
contractual maturities, and applicable current forward foreign currency exchange
rates. For foreign currency forward exchange agreements, the tables present the
notional amounts and weighted-average exchange rates by expected (contractual)
maturity dates. These notional amounts are used to calculate the contractual
payments to be exchanged under the contracts.
21
For the Year Ended December 31, 1999 2000 2001 2002 2003
==============================================================================================
(Currencies in millions)
Fixed Interest Securities Denominated
in Foreign Currencies:
Fixed interest rate securities
denominated in Swiss Francs 10.0 -- -- --
Current forward foreign exchange rate 0.6281 -- -- --
Fixed interest rate securities
denominated in Japanese Yen 620.0 -- -- --
Current forward foreign exchange rate 0.0098 -- -- --
Fixed interest rate securities
denominated in British Pounds -- -- -- --
Current forward foreign exchange rate -- -- --
Currency Swap Agreements Related
to Fixed Interest Securities:
Pay Swiss Francs
Notional amount in foreign currency 10.0 -- -- --
Average contract rate 0.665 -- -- --
Current forward foreign exchange rate 0.6281 -- -- --
Pay Japanese Yen
Notional amount in foreign currency 620.0 -- -- --
Average contract rate 0.008 -- -- --
Current forward foreign exchange rate 0.0098 -- -- --
Pay British Pounds
Notional amount in foreign currency -- -- -- --
Average contract rate -- -- -- --
Current forward foreign exchange rate -- -- -- --
Fixed Interest Liabilities Denominated
in Foreign Currencies:
Trust instruments supported by funding
obligations denominated in Euros -- 50.0 -- --
Current forward foreign exchange rate -- 1.0062 -- --
Currency Swap Agreements Related
to Fixed Interest Trust Obligations:
Pay Euros
Notional amount in foreign currency -- 50.0 -- --
Average contract rate -- 1.006 -- --
Current forward foreign exchange rate -- 1.0062 -- --
Fair
Value
For the Year Ended December 31, 1999 2004 Thereafter Total 12/31/99
=========================================================================================
(Currencies in millions)
Fixed Interest Securities Denominated
in Foreign Currencies:
Fixed interest rate securities
denominated in Swiss Francs -- -- 10.0 $ 6.8
Current forward foreign exchange rate -- -- 0.6281
Fixed interest rate securities
denominated in Japanese Yen -- -- 620.0 $ 6.1
Current forward foreign exchange rate -- -- 0.0098
Fixed interest rate securities
denominated in British Pounds -- 9.5 9.5 $ 20.6
Current forward foreign exchange rate -- 1.6153 1.6153
Currency Swap Agreements Related
to Fixed Interest Securities:
Pay Swiss Francs
Notional amount in foreign currency -- -- 10.0 $ 0.2
Average contract rate -- -- 0.665
Current forward foreign exchange rate -- -- 0.6281
Pay Japanese Yen
Notional amount in foreign currency -- -- 620.0 $ (1.2)
Average contract rate -- -- 0.008
Current forward foreign exchange rate -- -- 0.0098
Pay British Pounds
Notional amount in foreign currency -- 9.5 9.5 $ (1.8)
Average contract rate -- 1.980 1.980
Current forward foreign exchange rate -- 1.6153 1.6153
Fixed Interest Liabilities Denominated
in Foreign Currencies:
Trust instruments supported by funding
obligations denominated in Euros -- -- 50.0 $ 49.6
Current forward foreign exchange rate -- -- 1.0062
Currency Swap Agreements Related
to Fixed Interest Trust Obligations:
Pay Euros
Notional amount in foreign currency -- -- 50.0 $ (2.7)
Average contract rate -- -- 1.006
Current forward foreign exchange rate -- -- 1.0062
22
For the Year Ended December 31, 1998 1999 2000 2001 2002
=============================================================================================
(Currencies in millions)
Fixed Interest Securities Denominated
in Foreign Currencies:
Fixed interest rate securities
denominated in Swiss Francs -- 10.0 -- --
Current forward foreign exchange rate -- 0.7077 -- --
Fixed interest rate securities
denominated in Canadian Dollars 20.0 -- -- --
Current forward foreign exchange rate 0.6535 -- -- --
Fixed interest rate securities
denominated in Japanese Yen -- 620.0 -- --
Current forward foreign exchange rate -- 0.0088 -- --
Fixed interest rate securities
denominated in British Pounds -- -- -- --
Current forward foreign exchange rate -- -- -- --
Fixed interest rate securities
denominated in Finnish Markkas 47.3 -- -- --
Current forward foreign exchange rate 0.1962 -- -- --
Currency Swap Agreements Related
to Fixed Interest Securities:
Pay Swiss Francs
Notional amount in foreign currency -- 10.0 -- --
Average contract rate -- 0.664 -- --
Current forward foreign exchange rate -- 0.7077 -- --
Pay Canadian Dollars
Notional amount in foreign currency 20.0 -- -- --
Average contract rate 0.750 -- -- --
Current forward foreign exchange rate 0.6535 -- -- --
Pay Japanese Yen
Notional amount in foreign currency -- 620.0 -- --
Average contract rate -- 0.008 -- --
Current forward foreign exchange -- 0.0088 -- --
Pay British Pounds
Notional amount in foreign currency -- -- -- --
Average contract rate -- -- -- --
Current forward foreign exchange rate -- -- -- --
Pay Finnish Markkas
Notional amount in foreign currency 47.3 -- -- --
Average contract rate 0.211 -- -- --
Current forward foreign exchange rate 0.1962 -- -- --
Fair
Value
For the Year Ended December 31, 1998 2003 Thereafter Total 12/31/98
============================================================================================
(Currencies in millions)
Fixed Interest Securities Denominated
in Foreign Currencies:
Fixed interest rate securities
denominated in Swiss Francs -- -- 10.0 $ 7.0
Current forward foreign exchange rate -- -- 0.7077
Fixed interest rate securities
denominated in Canadian Dollars -- -- 20.0 $ 15.3
Current forward foreign exchange rate -- -- 0.6535
Fixed interest rate securities
denominated in Japanese Yen -- -- 620.0 $ 5.5
Current forward foreign exchange rate -- -- 0.0088
Fixed interest rate securities
denominated in British Pounds -- 9.5 9.5 $ 25.0
Current forward foreign exchange rate -- 1.6595 1.6595
Fixed interest rate securities
denominated in Finnish Markkas -- -- 47.3 $ 10.1
Current forward foreign exchange rate -- -- 0.1962
Currency Swap Agreements Related
to Fixed Interest Securities:
Pay Swiss Francs
Notional amount in foreign currency -- -- 10.0 $ (0.9)
Average contract rate -- -- 0.664
Current forward foreign exchange rate -- -- 0.7077
Pay Canadian Dollars
Notional amount in foreign currency -- -- 20.0 $ 1.9
Average contract rate -- -- 0.750
Current forward foreign exchange rate -- -- 0.6535
Pay Japanese Yen
Notional amount in foreign currency -- -- 620.0 $ (0.1)
Average contract rate -- -- 0.008
Current forward foreign exchange -- -- 0.0088
Pay British Pounds
Notional amount in foreign currency -- 9.5 9.5 $ (2.3)
Average contract rate -- 1.980 1.980
Current forward foreign exchange rate -- 1.6595 1.6595
Pay Finnish Markkas
Notional amount in foreign currency -- -- 47.3 $ 1.2
Average contract rate -- -- 0.211
Current forward foreign exchange rate -- -- 0.1962
23
INCOME TAXES
================================================================================
AFC and its domestic subsidiaries (including certain non-insurance operations)
file a consolidated United States federal income tax return. Entities included
within the consolidated group are segregated into either a life insurance or a
non-life insurance company subgroup. The consolidation of these subgroups is
subject to certain statutory restrictions on the percentage of eligible non-life
tax losses that can be applied to offset life company taxable income. Prior to
the July 16, 1997 merger, Allmerica P&C and its subsidiaries filed a separate
United States federal income tax return.
The provision for federal income taxes before minority interest and
discontinued operations was $106.9 million during 1999 compared to $56.1 million
during 1998. These provisions resulted in consolidated effective federal tax
rates of 22.8% and 18.7%, respectively. The effective tax rates for FAFLIC and
AFLIAC and their non-insurance affiliates were 26.1% and 28.6% during 1999 and
1998, respectively. The decrease in the rate for AFLIAC and FAFLIC and their
non-insurance affiliates primarily reflects changes in reserves for prior years
tax liabilities. The effective tax rates for Allmerica P&C and its subsidiaries
were 20.6% and 10.7% during 1999 and 1998, respectively. The increase in the
rate for Allmerica P&C and its subsidiaries is primarily the result of a larger
proportion of pre-tax income from realized capital gains in 1999, as well as
improved underwriting results.
The provision for federal income taxes before minority interest and
discontinued operations was $56.1 million during 1998 compared to $84.7 million
during 1997. These provisions resulted in consolidated effective federal tax
rates of 18.7% and 24.9%, respectively. The effective tax rates for FAFLIC and
AFLIAC and their non-insurance subsidiaries were 28.6% and 37.8% during 1998 and
1997, respectively. The decrease in the rate for AFLIAC and FAFLIC and their
non-insurance subsidiaries resulted primarily from an increase in available tax
credits, as well as the reduction, in 1998, of any net increases in reserves for
prior years tax liabilities. The effective tax rates for Allmerica P&C and its
subsidiaries were 10.7% and 16.5% during 1998 and 1997, respectively. The
decrease in the rate for Allmerica P&C and its subsidiaries reflects higher
underwriting losses and a greater proportion of pre-tax income from tax-exempt
bonds in 1998.
LIQUIDITY AND CAPITAL RESOURCES
================================================================================
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. As a holding company,
AFC's primary source of cash is dividends from its insurance subsidiaries.
However, dividend payments to AFC by its insurance subsidiaries are subject to
limitations imposed by state regulators, such as the requirement that cash
dividends be paid out of unreserved and unrestricted earned surplus and
restrictions on the payment of "extraordinary" dividends, as defined.
During 1999, AFC received $350.0 million in extraordinary dividends from
its property and casualty businesses. These funds were principally used to
repurchase $250.2 million of AFC common stock and pay $39.9 million of interest
expense on the Senior Debentures and Capital Securities. Any additional
dividends from the property and casualty insurance companies to AFC prior to
April 2000 would require regulatory approval. During the third quarter of 1999,
the Company used the remaining funds from the aforementioned dividends, as well
as proceeds from sales of AFC holding company investments, to fund a $125.0
million capital contribution from AFC to FAFLIC. As of July 1, 1999, FAFLIC's
ownership of Allmerica P&C, as well as several non-insurance subsidiaries, were
transferred from FAFLIC to AFC. Under an agreement with the Commonwealth of
Massachusetts Insurance Commissioner ("the Commissioner"), AFC contributed the
aforementioned $125.0 million and agreed to maintain FAFLIC's statutory surplus
at specified levels during the following six years. Future capital contributions
from AFC to FAFLIC may be required. In addition, any dividend from FAFLIC to AFC
during the years 2000 and 2001 would require the prior approval of the
Commissioner.
During 1998, FAFLIC's Board of Directors declared and paid a common stock
dividend to AFC of $50.0 million. Additionally, Hanover's Board of Directors
declared and paid a $125.0 million dividend to Allmerica P&C, of which $117.1
million was transferred to AFC in exchange for shares of Allmerica P&C capital
stock. These funds were used for the acquisition of the minority interest of
Citizens Corporation. In addition, AFC paid $39.9 of interest expense during
1998 on Senior Debentures and Capital Securities.
Sources of cash for the Company's insurance subsidiaries are from premiums
and fees collected, investment income and maturing investments. Primary cash
outflows are paid benefits, claims, losses and loss adjustment expenses, policy
acquisition expenses, other underwriting expenses and investment purchases. Cash
outflows related to benefits, claims, losses and loss
24
adjustment expenses can be variable because of uncertainties surrounding
settlement dates for liabilities for unpaid losses and because of the potential
for large losses either individually or in the aggregate. The Company
periodically adjusts its investment policy to respond to changes in short-term
and long-term cash requirements.
Net cash provided by operating activities was $15.2 million and $37.9
million in 1999 and 1998, respectively, compared to net cash used in operating
activities of $173.2 million in 1997. The decrease in 1999 resulted primarily
from a decrease in premiums received due to the timing of certain agent billings
in the Risk Management segment. In addition, a decrease in cash resulted from
net payments made related to the 1998 reinsurance agreement to cede the
mortality risk of the Company's universal and variable universal life business.
These decreases in cash were partially offset by cash receipts from the
Company's separate accounts, as well as the absence of the 1998 payment of $30.3
million related to the Company's exit of its reinsurance pool business. The
increase in 1998 resulted primarily from the absence of a $207.0 million payment
made during 1997 for the cession of the disability income line of business,
partially offset by a 1998 payment of $30.3 million related to exiting
reinsurance pools. Also, cash was used in 1998 operations to fund increased
commissions and other deferred expenses related to continued growth in the
variable annuity product lines of the Allmerica Financial Services segment, and
to pay the federal taxes resulting from audits of prior return years.
Net cash provided by investing activities was $794.9 million and $120.5
million in 1999 and 1997, respectively, while net cash used in investing
activities was $617.1 million in 1998. The $1.4 billion increase from 1998 to
1999 primarily results from $469.2 million in net proceeds from fixed maturities
in 1999 principally used to fund net withdrawals and maturities of funding
agreements, as compared to net purchases of fixed maturities totaling $595.6
million during 1998. Proceeds from net sales of equity securities increased
approximately $180.0 million in 1999 as compared to 1998. Additionally, the
increase in cash provided by investing activities in 1999 over the prior year
reflects the absence in 1999, of $195.9 million of cash used to fund the
purchase of the minority interest of Citizens Corporation during 1998. The
change in 1998 primarily reflects the absence of proceeds from sales of fixed
maturities in 1997 used to fund the aforementioned cession of the disability
income line of business, the aforementioned purchase of the minority interest of
Citizens Corporation during 1998 for $195.9 million, and the greater net
purchases of fixed maturities resulting from an increase in funds available from
floating rate GIC deposits. These were partially offset by increased net sales
of equity securities in 1998.
Net cash used in financing activities was $905.0 million in 1999, as
compared to net cash provided by financing activities of $898.7 million and
$90.3 million in 1998 and 1997, respectively. During 1999, the Company had net
withdrawals of funding agreements of $522.9 million as compared to net deposits
in 1998 of $794.2 million. Also, the Company repurchased an additional $250.2
million of AFC common stock as compared to the initial repurchase of $82.7
million in 1998. In addition, during 1999 cash was used to repay $180.0 million
in short term debt used to finance the aforementioned acquisition of the
minority interest of Citizens Corporation. In 1998, cash provided by financing
activities was positively impacted by net deposits for funding agreements of
$794.2 million compared to net withdrawals of $189.6 million in 1997. In
addition, short term borrowings increased by $188.3 million primarily related to
the Citizens acquisition in 1998. These increases were partially offset by the
absence in 1998, of the 1997 receipt of net proceeds of $296.3 million from the
issuance of Capital Securities and $82.7 million of common stock repurchases in
1998.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C, or through available credit facilities
to meet its obligations to pay interest on the Senior Debentures, Capital
Securities and dividends, when and if declared by the Board of Directors, on the
common stock. Whether the Company will pay dividends in the future depends upon
the costs of administering a dividend program as compared to the benefits
conferred, and upon the earnings and financial condition of AFC.
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and long-term cash
requirements. The Company maintains a high degree of liquidity within the
investment portfolio in fixed maturity investments, common stock and short-term
investments. AFC has $150.0 million available under a committed syndicated
credit agreement which expires on May 28, 2000. Borrowings under this agreement
are unsecured and incur interest at a rate per annum equal to, at the Company's
option, a designated base rate or the eurodollar rate plus applicable margin. At
December 31, 1999, no amounts were outstanding under this agreement. The Company
had $45.0 million of commercial paper borrowings outstanding at December 31,
1999.
25
CONTINGENCIES
================================================================================
The Company has been named a defendant in various legal proceedings arising in
the normal course of business. In the Company's opinion, the ultimate resolution
of these proceedings will not have a material effect on the Company's
consolidated financial statements. However, liabilities related to these
proceedings could be established in the near term if estimates of the ultimate
resolution of these proceedings are revised.
RECENT DEVELOPMENTS
================================================================================
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("Statement No. 133"), which establishes accounting and
reporting standards for derivative instruments. Statement No. 133 requires that
an entity recognize all derivatives as either assets or liabilities at fair
value in the statement of financial position, and establishes special accounting
for the following three types of hedges: fair value hedges, cash flow hedges,
and hedges of foreign currency exposures of net investments in foreign
operations. This statement is effective for fiscal years beginning after June
15, 2000. The Company is currently assessing the impact of the adoption of
Statement No. 133.
YEAR 2000
================================================================================
The Year 2000 issue resulted from computer programs being written using two
digits rather than four to define the applicable year. Computer programs that
have date-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. Any of these specific events, depending
on duration, could have a material adverse impact on the results of operations
and the financial position of the Company.
The Company met the objectives of its Year 2000 remediation plan, which
had three mission critical elements: internal systems, desktop systems, and
external partners. All of its inventoried systems have been corrected, tested
for year 2000 dates and are in production; its desktop computers are capable of
correctly processing year 2000 dates, and third party software installed on the
Company's desktop machines has been confirmed capable of processing year 2000
dates properly. Through an aggressive communications process, the Company
obtained verification of Year 2000 readiness from its suppliers.
During the fourth quarter and throughout the millennium rollover period,
the Company's systems functioned without any apparent Year 2000-related
disruptions. As such, the Company does not believe that there is a material
contingency associated with the Year 2000 issue, however, there can be no
assurance that exposure for material contingencies will not arise.
The cost of the Year 2000 project was expensed as incurred and has been
funded primarily through a reallocation of resources from discretionary projects
and a reduction in systems maintenance and support costs. Therefore, the Year
2000 project did not result in any significant incremental technology costs, and
thus did not have a material effect on the results of operations. The Company
incurred and expensed approximately $64 million related to the assessment, plan
development and completion of the Year 2000 project through December 31, 1999.
An additional $4 million is estimated for residual fixed costs which may be
incurred in 2000.
26
FORWARD-LOOKING STATEMENTS
================================================================================
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected and in the future could affect, the
Company's actual results and could cause the Company's actual results for 1999
and beyond to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company. When used in the MD&A
discussion, the words "believes", "anticipates", "expects" and similar
expressions are intended to identify forward looking statements. See "Important
Factors Regarding Forward-Looking Statements" filed as Exhibit 99-2 to the
Company's Annual Report on Form 10-K for the period ended December 31, 1999.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include among others, the following possibilities: (i)
adverse catastrophe experience and severe weather; (ii) adverse loss development
for events the Company insured in prior years or adverse trends in mortality and
morbidity; (iii) heightened competition, including the intensification of price
competition, the entry of new competitors, and the introduction of new products
by new and existing competitors; (iv) adverse state and federal legislation or
regulation, including decreases in rates, limitations on premium levels,
increases in minimum capital and reserve requirements, benefit mandates,
limitations on the ability to manage care and utilization, and tax treatment of
insurance and annuity products; as well as continued compliance with state and
federal regulations; (v) changes in interest rates causing a reduction of
investment income or in the market value of interest rate sensitive investments;
(vi) failure to obtain new customers, retain existing customers or reductions in
policies in force by existing customers; (vii) higher service, administrative,
or general expense due to the need for additional advertising, marketing,
administrative or management information systems expenditures; (viii) loss or
retirement of key executives; (ix) increases in medical costs, including
increases in utilization, costs of medical services, pharmaceuticals, durable
medical equipment and other covered items; (x) termination of provider contracts
or renegotiations at less cost-effective rates or terms of payment; (xi) changes
in the Company's liquidity due to changes in asset and liability matching; (xii)
restrictions on insurance underwriting, based on genetic testing and other
criteria; (xiii) adverse changes in the ratings obtained from independent rating
agencies, such as Moody's, Standard and Poor's, A.M. Best, and Duff & Phelps;
(xiv) lower appreciation on and decline in value of managed investments,
resulting in reduced variable products, assets and related fees; (xv) possible
claims relating to sales practices for insurance products; (xvi) uncertainty
related to the Year 2000 issue; (xvii) failure of a reinsurer of the Company's
policies to pay its liabilities under reinsurance contracts; (xviii) earlier
than expected withdrawals from the Company's general account annuities, GICs
(including funding agreements), and other insurance products; (xix) changes in
the mix of assets comprising the Company's investment portfolio and the
fluctuation of the market value of such assets; (xx) losses resulting from the
Company's participation in certain reinsurance pools; and (xxi) adverse results
of regulatory audits related to the Company's prior years' federal income tax
filings.
27
Report of Independent Accountants
[LOGO] PriceWaterhouseCoopers
To the Board of Directors and Shareholders of
Allmerica Financial Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, comprehensive income, shareholders' equity,
and cash flows present fairly, in all material respects, the financial position
of Allmerica Financial Corporation and its subsidiaries (the "Company") at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PriceWaterhouseCoopers LLP
Boston, Massachusetts
February 1, 2000
Management's Report on Responsibility
for Financial Reporting
The management of Allmerica Financial Corporation has the responsibility for
preparing the accompanying consolidated financial statements and for their
integrity and objectivity. The statements were prepared in conformity with
generally accepted accounting principles and include amounts based on
management's informed estimates and judgments. We believe that these statements
present fairly the Company's financial position and results of operations and
that the other information contained in the annual report is accurate and
consistent with the financial statements.
Allmerica Financial Corporation's Board of Directors annually appoints
independent accountants to perform an audit of its consolidated financial
statements. The financial statements have been audited by PricewaterhouseCoopers
LLP, independent accountants, in accordance with generally accepted auditing
standards. Their audit included consideration of the Company's system of
internal control in order to determine the audit procedures required to express
their opinion on the consolidated financial statements.
Management of Allmerica Financial Corporation has established and
maintains a system of internal control that provides reasonable assurance that
assets are safeguarded and that transactions are properly authorized and
recorded. The system of internal control provides for appropriate division of
responsibility and is documented by written policies and procedures that are
communicated to employees with significant roles in the financial reporting
process and updated as necessary. Management continually monitors the system of
internal control for compliance. Allmerica Financial Corporation and its
subsidiaries maintain a strong internal audit program that independently
assesses the effectiveness of the internal controls and recommends possible
improvements thereto. Management recognizes the inherent limitations in all
internal control systems and believes that our system of internal control
provides an appropriate balance between the costs and benefits desired.
Management believes that the Company's system of internal control provides
reasonable assurance that errors or irregularities that would be material to the
financial statements are prevented or detected in the normal course of business.
The Audit Committee of the Board of Directors, composed solely of outside
directors, oversees management's discharge of its financial reporting
responsibilities. The committee meets periodically with management, our internal
auditors and our independent accountants, PricewaterhouseCoopers LLP. Both our
internal auditors and PricewaterhouseCoopers LLP have direct access to the Audit
Committee.
Management recognizes its responsibility for fostering a strong ethical
climate. This responsibility is reflected in the Company's policies which
address, among other things, potential conflicts of interest; compliance with
all domestic and foreign laws including those relating to financial disclosure
and the confidentiality of proprietary information. Allmerica Financial
Corporation maintains a systematic program to assess compliance with these
policies.
/s/ John F. O'Brien /s/ Edward J. Parry, III
John F. O'Brien Edward J. Parry, III
President and Chief Vice President,
Executive Officer Chief Financial Officer and
Principal Accounting Officer
28
Consolidated Statements of Income
For the Years Ended December 31 1999 1998 1997
====================================================================================================================
(In millions, except per share data)
Revenues
Premiums $ 1,950.5 $ 1,970.6 $ 1,980.5
Universal life and investment product policy fees 359.3 296.6 237.3
Net investment income 615.7 604.4 631.1
Net realized investment gains 91.0 59.2 76.0
Other income 128.7 103.2 81.5
- --------------------------------------------------------------------------------------------------------------------
Total revenues 3,145.2 3,034.0 3,006.4
- --------------------------------------------------------------------------------------------------------------------
Benefits, Losses and Expenses
Policy benefits, claims, losses and loss adjustment expenses 1,770.7 1,804.0 1,764.0
Policy acquisition expenses 429.9 449.6 408.5
Sales practice litigation -- 31.0 --
Loss from cession of disability income business -- -- 53.9
Restructuring costs (1.9) 9.0 --
Other operating expenses 478.5 440.3 440.0
- --------------------------------------------------------------------------------------------------------------------
Total benefits, losses and expenses 2,677.2 2,733.9 2,666.4
- --------------------------------------------------------------------------------------------------------------------
Income before federal income taxes 468.0 300.1 340.0
- --------------------------------------------------------------------------------------------------------------------
Federal income tax expense (benefit)
Current 88.1 72.5 70.8
Deferred 18.8 (16.4) 13.9
- --------------------------------------------------------------------------------------------------------------------
Total federal income tax expense 106.9 56.1 84.7
- --------------------------------------------------------------------------------------------------------------------
Income before minority interest 361.1 244.0 255.3
Minority interest:
Distributions on mandatorily redeemable preferred securities of a subsidiary
trust holding solely junior subordinated debentures of the Company (16.0) (16.0) (14.5)
Equity in earnings -- (13.3) (48.2)
- --------------------------------------------------------------------------------------------------------------------
Total minority interest (16.0) (29.3) (62.7)
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations 345.1 214.7 192.6
- --------------------------------------------------------------------------------------------------------------------
(Loss) income from operations of discontinued business (less applicable
income taxes (benefit) of $(10.1), $(7.0) and $8.9 for the years ended
December 31, 1999, 1998 and 1997, respectively) (18.8) (13.5) 16.6
Loss on disposal of group life and health business, including provision of
$72.2 for operating losses during phase-out period for the year ended
December 31, 1999 (less applicable income tax benefit of $16.4) (30.5) -- --
- --------------------------------------------------------------------------------------------------------------------
Net income $ 295.8 $ 201.2 $ 209.2
====================================================================================================================
Earnings per common share:
Basic:
Income from continuing operations $ 6.27 $ 3.59 $ 3.53
(Loss) income from operations of discontinued business (less applicable
income taxes (benefit) of $(0.19), $(0.12) and $0.17 for the years ended
December 31, 1999, 1998 and 1997, respectively) (0.34) (0.23) 0.30
Loss on disposal of group life and health business, including provision of
$1.31 for operating losses during phase-out period for the year ended
December 31, 1999 (less applicable income tax benefit of $0.30) (0.55) -- --
- --------------------------------------------------------------------------------------------------------------------
Net income per share $ 5.38 $ 3.36 $ 3.83
Weighted average shares outstanding 55.0 59.9 54.7
====================================================================================================================
Diluted:
Income from continuing operations $ 6.21 $ 3.56 $ 3.52
(Loss) income from operation of discontinued business (less applicable
income taxes (benefit) of $(0.19), $(0.12) and $0.17 for the years
ended December 31, 1999, 1998 and 1997, respectively) (0.33) (0.23) 0.30
Loss on disposal of group life and health business, including provision
of $1.30 for operating losses during phase-out period for the year
ended December 31, 1999 (less applicable income tax benefit of $0.29) (0.55) -- --
- --------------------------------------------------------------------------------------------------------------------
Net income per share $ 5.33 $ 3.33 $ 3.82
Weighted average shares outstanding 55.5 60.3 54.8
====================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
29
Consolidated Balance Sheets
December 31 1999 1998
====================================================================================================================
(In millions, except per share data)
Assets
Investments:
Fixed maturities-at fair value (amortized cost of $7,095.0 and $7,618.2) $ 6,933.8 $ 7,780.8
Equity securities-at fair value (cost of $49.5 and $253.1) 83.2 397.1
Mortgage loans 521.2 562.3
Policy loans 170.5 154.3
Real estate and other long-term investments 180.0 163.1
- --------------------------------------------------------------------------------------------------------------------
Total investments 7,888.7 9,057.6
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 442.2 550.3
Accrued investment income 134.7 142.3
Deferred policy acquisition costs 1,386.8 1,161.2
Reinsurance receivable on unpaid losses, benefits and unearned premiums 1,279.9 1,136.0
Deferred federal income taxes 141.7 19.8
Premiums, accounts and notes receivable 583.5 555.7
Other assets 510.2 529.4
Closed Block assets 772.3 803.1
Separate account assets 17,629.6 13,697.7
- --------------------------------------------------------------------------------------------------------------------
Total assets $30,769.6 $27,653.1
====================================================================================================================
Liabilities
Policy liabilities and accruals:
Future policy benefits $ 2,825.0 $ 2,802.2
Outstanding claims, losses and loss adjustment expenses 2,838.6 2,816.3
Unearned premiums 890.2 843.2
Contractholder deposit funds and other policy liabilities 2,041.0 2,637.0
- --------------------------------------------------------------------------------------------------------------------
Total policy liabilities and accruals 8,594.8 9,098.7
- --------------------------------------------------------------------------------------------------------------------
Expenses and taxes payable 795.5 716.1
Reinsurance premiums payable 73.0 95.4
Trust instruments supported by funding obligations 50.6 --
Short-term debt 45.0 221.3
Long-term debt 199.5 199.5
Closed Block liabilities 842.1 872.0
Separate account liabilities 17,628.9 13,691.5
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 28,229.4 24,894.5
- --------------------------------------------------------------------------------------------------------------------
Mandatorily redeemable preferred securities of a subsidiary trust holding solely
junior subordinated debentures of the Company 300.0 300.0
- --------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 17 and 22)
Shareholders' Equity
Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued -- --
Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million
shares issued 0.6 0.6
Additional paid-in capital 1,770.5 1,768.8
Accumulated other comprehensive income (75.3) 180.5
Retained earnings 882.2 599.9
Treasury stock at cost (6.2 and 1.8 million shares) (337.8) (91.2)
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 2,240.2 2,458.6
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $30,769.6 $27,653.1
====================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
30
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31 1999 1998 1997
====================================================================================================================
(In millions)
Preferred Stock $ -- $ -- $ --
Common Stock
Balance at beginning of year 0.6 0.6 0.5
Issuance of common stock -- -- 0.1
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year 0.6 0.6 0.6
Additional Paid-In Capital
Balance at beginning of year 1,768.8 1,755.0 1,382.5
Issuance of common stock 1.7 13.8 376.2
Issuance costs of mandatorily redeemable preferred securities of a subsidiary
trust holding solely junior subordinated debentures of the Company -- -- (3.7)
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year 1,770.5 1,768.8 1,755.0
Accumulated Other Comprehensive Income
Net Unrealized (Depreciation) Appreciation on Investments:
Balance at beginning of year 180.5 217.9 131.6
(Depreciation) appreciation during the period:
Net (depreciation) appreciation on available-for-sale securities (393.8) (82.7) 171.3
Benefit (provision) for deferred federal income taxes 138.0 28.8 (59.9)
Minority interest -- 16.5 (25.1)
- --------------------------------------------------------------------------------------------------------------------
(255.8) (37.4) 86.3
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year (75.3) 180.5 217.9
Retained Earnings
Balance at beginning of year 599.9 407.8 210.1
Net income 295.8 201.2 209.2
Dividends to shareholders (13.5) (9.1) (11.5)
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year 882.2 599.9 407.8
- --------------------------------------------------------------------------------------------------------------------
Treasury Stock
Balance at beginning of year (91.2) -- --
Shares purchased at cost (252.8) (91.2) --
Shares reissued at cost 6.2 -- --
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year (337.8) (91.2) --
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity $2,240.2 $2,458.6 $2,381.3
====================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
31
Consolidated Statements of Comprehensive Income
For the Years Ended December 31 1999 1998 1997
====================================================================================================================
(In millions)
Net income $ 295.8 $ 201.2 $ 209.2
Other comprehensive (loss) income:
Net (depreciation) appreciation on available for sale securities (393.8) (82.7) 171.3
Benefit (provision) for deferred federal income taxes 138.0 28.8 (59.9)
Minority interest -- 16.5 (25.1)
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (255.8) (37.4) 86.3
- --------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 40.0 $ 163.8 $ 295.5
====================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements
32
Consolidated Statements of Cash Flows
For the Years Ended December 31 1999 1998 1997
====================================================================================================================
(In millions)
Cash Flows From Operating Activities
Net Income $ 295.8 $ 201.2 $ 209.2
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Minority interest -- 13.3 48.2
Net realized investment gains (90.4) (61.0) (77.5)
Net amortization and depreciation 34.2 21.9 31.6
Deferred federal income taxes 18.8 (16.4) 13.9
Loss on disposal of group life and health business 30.5 -- --
Loss from exiting reinsurance pools -- 25.3 --
Sales practice litigation expense -- 31.0 --
Loss from cession of disability income business -- -- 53.9
Payment related to exiting reinsurance pools -- (30.3) --
Payment related to cession of disability income business -- -- (207.0)
Change in deferred acquisition costs (183.8) (185.8) (189.7)
Change in premiums and notes receivable, net of reinsurance payable (50.2) 56.7 (15.1)
Change in accrued investment income 7.7 -- 7.0
Change in policy liabilities and accruals, net 28.7 168.1 (134.7)
Change in reinsurance receivable (143.8) (115.4) 27.1
Change in expenses and taxes payable 29.6 9.1 46.8
Separate account activity, net 5.3 (48.5) 5.7
Other, net 32.8 (31.3) 7.4
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 15.2 37.9 (173.2)
Cash Flows From Investing Activities
Proceeds from disposals and maturities of available-for-sale fixed maturities 2,996.5 1,970.6 3,046.0
Proceeds from disposals of equity securities 424.3 285.3 162.7
Proceeds from disposals of other investments 31.4 120.8 116.3
Proceeds from mortgages matured or collected 128.2 171.2 204.7
Purchase of available-for-sale fixed maturities (2,527.3) (2,566.2) (2,727.6)
Purchase of equity securities (78.9) (119.9) (67.0)
Purchase of other investments (140.7) (274.4) (175.0)
Capital expenditures (30.1) (22.3) (15.3)
Purchase of minority interest in Citizens Corporation -- (195.9) --
Purchase of Financial Profiles, Inc. -- (13.0) --
Purchase of minority interest in Allmerica P&C -- -- (425.6)
Other investing activities, net (8.5) 26.7 1.3
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 794.9 (617.1) 120.5
Cash Flows From Financing Activities
Deposits and interest credited to contractholder deposit funds 1,514.6 1,419.2 457.6
Withdrawals from contractholder deposit funds (2,037.5) (625.0) (647.2)
Change in trust instruments supported by funding obligations 50.6 -- --
Change in short-term debt (176.3) 188.3 (5.4)
Change in long-term debt -- (2.6) (0.1)
Proceeds from the issuance of mandatorily redeemable preferred securities of a
subsidiary trust holding solely junior subordinated debentures of the Company -- -- 296.3
Dividends paid to shareholders (13.5) (9.9) (13.7)
Net proceeds from issuance of common stock 1.1 11.4 2.8
Treasury stock purchased at cost (250.2) (82.7) --
Treasury stock reissued at cost 6.2 -- --
- --------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (905.0) 898.7 90.3
- --------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (94.9) 319.5 37.6
Net change in cash held in the Closed Block (13.2) 15.7 (1.0)
Cash and cash equivalents, beginning of year 550.3 215.1 178.5
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 442.2 $ 550.3 $ 215.1
====================================================================================================================
Supplemental Cash Flow Information
Interest paid $ 19.9 $ 21.6 $ 20.1
Income taxes paid $ 77.8 $ 133.5 $ 66.3
The accompanying notes are an integral part of these consolidated financial
statements.
33
Notes To Consolidated Financial Statements
1.
================================================================================
Summary of Significant Accounting Policies
A. Basis of Presentation and Principles of Consolidation
The consolidated financial statements of Allmerica Financial Corporation ("AFC"
or the "Company") include the accounts of First Allmerica Financial Life
Insurance Company ("FAFLIC"); its wholly-owned life insurance subsidiary,
Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"); non-insurance
subsidiaries (principally brokerage and investment advisory services); Allmerica
Asset Management, Inc. ("AAM", a wholly-owned noninsurance subsidiary of AFC);
Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned
non-insurance subsidiary of AAM); The Hanover Insurance Company ("Hanover", a
wholly-owned subsidiary of Allmerica P&C); Citizens Corporation (a wholly-owned
subsidiary of Hanover); and Citizens Insurance Company of America ("Citizens", a
wholly-owned subsidiary of Citizens Corporation). The Closed Block (See Note 1B)
assets and liabilities and its results of operations are presented in the
consolidated financial statements as single line items. Unless specifically
stated, all disclosures contained herein supporting the consolidated financial
statements exclude the Closed Block related amounts. All significant
intercompany accounts and transactions have been eliminated.
On or about December 3, 1998, the Company acquired all of the outstanding
common stock of Citizens Corporation (formerly an 82.5% owned non-insurance
subsidiary of Hanover) in exchange for cash of $195.9 million (See Note 3). The
acquisition has been recognized as a purchase. The minority interest acquired
totaled $158.5 million. A total of $40.8 million representing the excess of the
purchase price over the fair values of the net assets acquired, net of deferred
taxes, has been allocated to goodwill and is being amortized over a 40-year
period.
The financial statements reflect minority interest in Allmerica P&C and
its subsidiary, Hanover of approximately 40.5% prior to the merger on July 16,
1997. In addition, prior to the December 3, 1998 acquisition, the financial
statements reflect minority interest in Citizens Corporation and its
wholly-owned subsidiary, Citizens of approximately 16.8% and 17.5% in 1998 and
1997, respectively. Minority interest also includes distributions on mandatorily
redeemable preferred securities of a subsidiary trust holding solely junior
subordinated debentures of the Company.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
B. Closed Block
FAFLIC established and began operating a closed block (the "Closed Block") for
the benefit of the participating policies included therein, consisting of
certain individual life insurance participating policies, individual deferred
annuity contracts and supplementary contracts not involving life contingencies
which were in force as of FAFLIC's demutualization on October 16, 1995; such
policies constitute the "Closed Block Business". The purpose of the Closed Block
is to protect the policy dividend expectations of such FAFLIC dividend paying
policies and contracts. Unless the Commissioner consents to an earlier
termination, the Closed Block will continue to be in effect until the date none
of the Closed Block policies are in force. FAFLIC allocated to the Closed Block
assets in an amount that is expected to produce cash flows which, together with
future revenues from the Closed Block Business, are reasonably sufficient to
support the Closed Block Business, including provision for payment of policy
benefits, certain future expenses and taxes and for continuation of policyholder
dividend scales payable in 1994 so long as the experience underlying such
dividend scales continues. The Company expects that the factors underlying such
experience will fluctuate in the future and policyholder dividend scales for
Closed Block Business will be set accordingly.
Although the assets and income allocated to the Closed Block inure solely
to the benefit of the holders of policies included in the Closed Block, the
excess of Closed Block liabilities over Closed Block assets as measured on a
GAAP basis represent the expected future post-tax income from the Closed Block
which may be recognized in income over the period the policies and contracts in
the Closed Block remain in force.
If the actual income from the Closed Block in any given period equals or
exceeds the expected income for such period as determined at the inception of
the Closed Block, the expected income would be recognized in income for that
period. Further, any excess of the actual income over the expected income would
also be recognized in income to the extent that the aggregate expected income
for all prior periods exceeded the aggregate actual income. Any remaining excess
of actual income over expected income would be accrued as a liability for
policyholder dividends in the Closed Block to be paid to the Closed Block
policyholders. This accrual for future dividends effectively limits the actual
Closed Block income recognized in income to the Closed Block income expected to
emerge from operation of the Closed Block as determined at inception.
If, over the period the policies and contracts in the Closed Block remain
in force, the actual income from the Closed Block is less than the expected
income from the Closed Block, only such actual income (which could reflect a
loss) would be recognized in income. If the actual income from the Closed Block
in any given period is less than the expected income for that period and changes
in dividend scales are inadequate to offset the negative performance in relation
to the expected performance,
34
the income inuring to shareholders of the Company will be reduced. If a
policyholder dividend liability had been previously established in the Closed
Block because the actual income to the relevant date had exceeded the expected
income to such date, such liability would be reduced by this reduction in income
(but not below zero) in any periods in which the actual income for that period
is less than the expected income for such period.
C. Valuation of Investments
In accordance with the provisions of Statement of Financial Accounting Standards
No. 115 ("Statement No. 115"), "Accounting for Certain Investments in Debt and
Equity Securities", the Company is required to classify its investments into one
of three categories: held-to-maturity, available-for-sale or trading. The
Company determines the appropriate classification of debt securities at the time
of purchase and re-evaluates such designation as of each balance sheet date.
Debt securities and marketable equity securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, net of tax, reported in a separate
component of shareholders' equity. The amortized cost of debt securities is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in investment income.
Mortgage loans on real estate are stated at unpaid principal balances, net
of unamortized discounts and reserves. Reserves on mortgage loans are based on
losses expected by the Company to be realized on transfers of mortgage loans to
real estate (upon foreclosure), on the disposition or settlement of mortgage
loans and on mortgage loans which the Company believes may not be collectible in
full. In establishing reserves, the Company considers, among other things, the
estimated fair value of the underlying collateral.
Fixed maturities and mortgage loans that are delinquent are placed on
non-accrual status, and thereafter interest income is recognized only when cash
payments are received.
Policy loans are carried principally at unpaid principal balances.
During 1997, the Company adopted a plan to dispose of all real estate
assets. As of December 31, 1999, there were 4 properties remaining in the
Company's real estate portfolio, all of which are being actively marketed. These
assets are carried at the estimated fair value less costs of disposal.
Depreciation is not recorded on these assets while they are held for disposal.
Realized investment gains and losses, other than those related to separate
accounts for which the Company does not bear the investment risk, are reported
as a component of revenues based upon specific identification of the investment
assets sold. When an other than temporary impairment of the value of a specific
investment or a group of investments is determined, a realized investment loss
is recorded. Changes in the valuation allowance for mortgage loans are included
in realized investment gains or losses.
D. Financial Instruments
In the normal course of business, the Company enters into transactions involving
various types of financial instruments, including debt, investments such as
fixed maturities, mortgage loans and equity securities, investment and loan
commitments, swap contracts and interest rate futures contracts. These
instruments involve credit risk and also may be subject to risk of loss due to
interest rate fluctuation. The Company evaluates and monitors each financial
instrument individually and, when appropriate, obtains collateral or other
security to minimize losses.
Derivative financial instruments are accounted for under three different
methods: fair value accounting, deferral accounting and accrual accounting.
Interest rate swap contracts used to hedge interest rate risk are accounted for
using a combination of the fair value method and accrual method, with changes in
fair value reported in unrealized gains and losses in equity consistent with the
underlying hedged security, and the net payment or receipt on the swaps reported
in net investment income. Foreign currency swap contracts used to hedge the
foreign currency exchange risk associated with investment securities are
accounted for using a combination of the fair value method and accrual method,
with changes in fair value reported in unrealized gains and losses in equity
consistent with the underlying hedged security, and the net payment or receipt
on the swaps reported in net investment income. Foreign currency swap contracts
used to hedge foreign currency exchange risk associated with trust obligations
backed by funding agreements are accounted for using the fair value method, with
changes in fair value reported in other operating income consistent with the
underlying hedged trust obligation. Futures contracts used to hedge interest
rate risk are accounted for using the deferral method, with gains and losses
deferred in unrealized gains and losses in equity and recognized in earnings in
conjunction with the earnings recognition of the underlying hedged item. Default
swap contracts entered into for investment purposes are accounted for using the
fair value method, with changes in fair value, if any, reported in realized
investment gains and losses in earnings. Premium paid to the Company on default
swap contracts is reported in net investment income in earnings. Other swap
contracts entered into for investment purposes are accounted for using the fair
value method, with changes in fair value reported in realized investment gains
and losses in earnings. Any ineffective swaps or futures hedges are recognized
currently in realized investment gains and losses in earnings.
E. Cash and Cash Equivalents
Cash and cash equivalents includes cash on hand, amounts due from banks and
highly liquid debt instruments purchased with an original maturity of three
months or less.
35
F. Deferred Policy Acquisition Costs
Acquisition costs consist of commissions, underwriting costs and other costs,
which vary with, and are primarily related to, the production of revenues.
Property and casualty insurance business acquisition costs are deferred and
amortized over the terms of the insurance policies. Acquisition costs related to
universal life products, variable annuities and contractholder deposit funds are
deferred and amortized in proportion to total estimated gross profits from
investment yields, mortality, surrender charges and expense margins over the
expected life of the contracts. This amortization is reviewed annually and
adjusted retrospectively when the Company revises its estimate of current or
future gross profits to be realized from this group of products, including
realized and unrealized gains and losses from investments. Acquisition costs
related to fixed annuities and other life insurance products are deferred and
amortized, generally in proportion to the ratio of annual revenue to the
estimated total revenues over the contract periods based upon the same
assumptions used in estimating the liability for future policy benefits.
Deferred acquisition costs for each life product and property and casualty
line of business are reviewed to determine if they are recoverable from future
income, including investment income. If such costs are determined to be
unrecoverable, they are expensed at the time of determination. Although
realization of deferred policy acquisition costs is not assured, the Company
believes it is more likely than not that all of these costs will be realized.
The amount of deferred policy acquisition costs considered realizable, however,
could be reduced in the near term if the estimates of gross profits or total
revenues discussed above are reduced. The amount of amortization of deferred
policy acquisition costs could be revised in the near term if any of the
estimates discussed above are revised.
G. Property and Equipment
Property, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is provided using the
straight-line or accelerated method over the estimated useful lives of the
related assets which generally range from 3 to 30 years. Amortization of
leasehold improvements is provided using the straight-line method over the
lesser of the term of the leases or the estimated useful life of the
improvements.
H. Separate Accounts
Separate account assets and liabilities represent segregated funds administered
and invested by the Company for the benefit of certain pension, variable annuity
and variable life insurance contractholders. Assets consist principally of
bonds, common stocks, mutual funds, and short-term obligations at market value.
The investment income, gains and losses of these accounts generally accrue to
the contractholders and, therefore, are not included in the Company's net
income. Appreciation and depreciation of the Company's interest in the separate
accounts, including undistributed net investment income, is reflected in
shareholders' equity or net investment income.
I. Policy Liabilities and Accruals
Future policy benefits are liabilities for life, health and annuity products.
Such liabilities are established in amounts adequate to meet the estimated
future obligations of policies in force. The liabilities associated with
traditional life insurance products are computed using the net level premium
method for individual life and annuity policies, and are based upon estimates as
to future investment yield, mortality and withdrawals that include provisions
for adverse deviation. Future policy benefits for individual life insurance and
annuity policies are computed using interest rates ranging from 2 1/2% to 6.0%
for life insurance and 2 1/2% to 9 1/2% for annuities. Estimated liabilities are
established for group life and health policies that contain experience rating
provisions. Mortality, morbidity and withdrawal assumptions for all policies are
based on the Company's own experience and industry standards. Liabilities for
universal life, variable universal life and variable annuities include deposits
received from customers and investment earnings on their fund balances, less
administrative charges. Universal life fund balances are also assessed mortality
and surrender charges. Liabilities for variable annuities include a reserve for
benefit claims in excess of a guaranteed minimum fund value.
Liabilities for outstanding claims, losses and loss adjustment expenses
("LAE") are estimates of payments to be made on property and casualty and health
insurance for reported losses and LAE and estimates of losses and LAE incurred
but not reported. These liabilities are determined using case basis evaluations
and statistical analyses and represent estimates of the ultimate cost of all
losses incurred but not paid. These estimates are continually reviewed and
adjusted as necessary; such adjustments are reflected in current operations.
Estimated amounts of salvage and subrogation on unpaid property and casualty
losses are deducted from the liability for unpaid claims.
Premiums for property and casualty insurance are reported as earned on a
pro-rata basis over the contract period. The unexpired portion of these premiums
is recorded as unearned premiums.
Contractholder deposit funds and other policy liabilities include
investment-related products such as guaranteed investment contracts, deposit
administration funds and immediate participation guarantee funds and consist of
deposits received from customers and investment earnings on their fund balances.
All policy liabilities and accruals are based on the various estimates
discussed above. Although the adequacy of these amounts cannot be assured, the
Company believes that it is more likely than not that policy liabilities and
accruals will be sufficient to meet future obligations of policies in force. The
amount of liabilities and accruals, however, could be revised in the near term
if the estimates discussed above are revised.
36
J. Premium and Fee Revenue and Related Expenses
Premiums for individual life insurance and individual and group annuity
products, excluding universal life and investment-related products, are
considered revenue when due. Property and casualty insurance premiums are
recognized as revenue over the related contract periods. Benefits, losses and
related expenses are matched with premiums, resulting in their recognition over
the lives of the contracts. This matching is accomplished through the provision
for future benefits, estimated and unpaid losses and amortization of deferred
policy acquisition costs. Revenues for investment-related products consist of
net investment income and contract charges assessed against the fund values.
Related benefit expenses include annuity benefit claims in excess of a
guaranteed minimum fund value, and net investment income credited to the fund
values after deduction for investment and risk charges. Revenues for universal
life products consist of net investment income, with mortality, administration
and surrender charges assessed against the fund values. Related benefit expenses
include universal life benefit claims in excess of fund values and net
investment income credited to universal life fund values. Certain policy charges
that represent compensation for services to be provided in future periods are
deferred and amortized over the period benefited using the same assumptions used
to amortize capitalized acquisition costs.
K. Federal Income Taxes
AFC and its domestic subsidiaries (including certain non-insurance operations)
file a consolidated United States federal income tax return. Entities included
within the consolidated group are segregated into either a life insurance or a
non-life insurance company subgroup. The consolidation of these subgroups is
subject to certain statutory restrictions on the percentage of eligible non-life
tax losses that can be applied to offset life company taxable income. Prior to
the July 16, 1997 merger, Allmerica P&C and its subsidiaries filed a separate
United States federal income tax return.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes, and
for other temporary taxable and deductible differences as defined by Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes"
("Statement No. 109"). These differences result primarily from loss and LAE
reserves, policy reserves, policy acquisition expenses and unrealized
appreciation or depreciation on investments
L. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("Statement No. 133"), which establishes
accounting and reporting standards for derivative instruments. Statement No. 133
requires that an entity recognize all derivatives as either assets or
liabilities at fair value in the statement of financial position, and
establishes special accounting for the following three types of hedges: fair
value hedges, cash flow hedges, and hedges of foreign currency exposures of net
investments in foreign operations. This statement is effective for fiscal years
beginning after June 15, 2000. The Company is currently assessing the impact of
the adoption of Statement No. 133.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use" ("SoP No. 98-1"). SoP
No. 98-1 requires that certain costs incurred in developing internal-use
computer software be capitalized and provides guidance for determining whether
computer software is to be considered for internal use. This statement is
effective for fiscal years beginning after December 15, 1998. In the second
quarter of 1998, the Company adopted SoP No. 98-1 effective January 1, 1998,
resulting in an increase in pre-tax income of $12.4 million through December 31,
1998. The adoption of SoP No. 98-1 did not have a material effect on the results
of operations or financial position for the three months ended March 31, 1998.
In December 1997, the AICPA issued Statement of Position 97-3, "Accounting
by Insurance and Other Enterprises for Insurance-Related Assessments" ("SoP No.
97-3"). SoP No. 97-3 provides guidance on when a liability should be recognized
for guaranty fund and other assessments and how to measure the liability. This
statement allows for the discounting of the liability if the amount and timing
of the cash payments are fixed and determinable. In addition, it provides
criteria for when an asset may be recognized for a portion or all of the
assessment liability or paid assessment that can be recovered through premium
tax offsets or policy surcharges. This statement is effective for fiscal years
beginning after December 15, 1998. The adoption of SoP No. 97-3 did not have a
material effect on the results of operations or financial position of the
Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("Statement No. 131"). This statement establishes standards for the way that
public enterprises report information about operating segments in annual
financial statements and requires that selected information about those
operating segments be reported in interim financial statements. This statement
supersedes Statement No. 14, Financial Reporting for Segments of a Business
Enterprise. Statement No. 131 requires that all public enterprises report
financial and descriptive information about their reportable operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. This statement is effective for fiscal years beginning
after December 15, 1997. The Company adopted Statement No. 131 for the first
quarter of 1998, which resulted in certain segment re-definitions, and had no
impact on the consolidated results of operations (See Note 16).
37
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("Statement No. 130").
Statement No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. All items that are required to be recognized under
accounting standards as components of comprehensive income are to be reported in
a financial statement that is displayed with the same prominence as other
financial statements. This statement stipulates that comprehensive income
reflect the change in equity of an enterprise during a period from transactions
and other events and circumstances from non-owner sources. This statement is
effective for fiscal years beginning after December 15, 1997. The Company
adopted Statement No. 130 for the first quarter of 1998, which resulted
primarily in reporting unrealized gains and losses on investments in debt and
equity securities in comprehensive income.
M. Earnings Per Share
Earnings per share ("EPS") for the years ended December 31, 1999, 1998, and 1997
are based on a weighted average of the number of shares outstanding during each
year. The Company's EPS is based on net income for both basic and diluted
earnings per share. The weighted average shares outstanding which were utilized
in the calculation of basic earnings per share differ from the weighted average
shares outstanding used in the calculation of diluted earnings per share due to
the effect of dilutive employee stock options and nonvested stock grants.
Options to purchase shares of common stock whose exercise prices are
greater than the average market price of the common shares are not included in
the computation of diluted earnings per share because the effect would be
antidilutive.
N. Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2.
================================================================================
Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit its group
life and health insurance business, consisting of its Employee Benefit Services
("EBS") business, its Affinity Group Underwriters ("AGU") business and its
accident and health assumed reinsurance pool business ("reinsurance pool
business"). During the third quarter of 1998, the Company ceased writing new
premium in the reinsurance pool business, subject to certain contractual
obligations. Prior to 1999, these businesses comprised substantially all of the
former Corporate Risk Management Services segment. Accordingly, the operating
results of the discontinued segment, including its reinsurance pool business,
have been reported in the Consolidated Statements of Income as discontinued
operations in accordance with Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("APB Opinion No. 30"). In the third quarter of 1999,
the operating results from the discontinued segment were adjusted to reflect the
recording of additional reserves related to accident claims from prior years. On
October 6, 1999, the Company entered into an agreement with Great-West Life and
Annuity Insurance Company of Denver, which provides for the sale of the
Company's EBS business effective March 1, 2000. The Company has recorded a $30.5
million loss, net of taxes, on the disposal of its group life and health
business. Subsequent to the June 30, 1999 measurement date, operations from the
discontinued business generated losses of approximately $9.7 million, net of
taxes.
As permitted by APB Opinion No. 30, the Consolidated Balance Sheets have
not been segregated between continuing and discontinued operations. At December
31, 1999, the discontinued segment had assets of approximately $536.2 million
consisting primarily of invested assets, premiums and fees receivable, and
reinsurance recoverables, and liabilities of approximately $485.9 million
consisting primarily of policy liabilities. Revenues for the discontinued
operations were $367.0 million, $398.5 million, and $389.2 million for the years
ended December 31, 1999, 1998 and 1997, respectively.
3.
================================================================================
Acquisition of Minority Interest of Citizens Corporation
On December 3, 1998 Citizens Acquisition Corporation, a wholly owned subsidiary
of the Company, completed a cash tender offer to acquire the outstanding shares
of Citizens Corporation common stock at a price of $33.25 per share.
Approximately 99.8% of publicly held shares of Citizens Corporation common stock
were tendered. On December 14, 1998, the Company completed a short-form merger,
acquiring all shares of common stock of Citizens Corporation not purchased in
its tender offer, through the merger of its wholly owned subsidiary, Citizens
Acquisition Corporation with Citizens Corporation at a price of $33.25 per
share. Total consideration for the transactions amounted to $195.9 million. The
acquisition has been recognized as a purchase. The minority interest acquired
totaled $158.5 million. A total of $40.8 million representing the excess of the
purchase price over the fair values of the net assets acquired, net of deferred
taxes, has been allocated to goodwill and is being amortized over a 40-year
period.
The Company's consolidated results of operations include minority interest
in Citizens Corporation prior to December 3, 1998. The unaudited proforma
information below presents consolidated results of operation as if the
acquisition had occurred at the beginning of 1997.
The following unaudited pro forma information is not necessarily
indicative of the consolidated results of operations of the combined Company had
the acquisition occurred at the beginning of 1997, nor is it necessarily
indicative of future results.
38
(Unaudited)
For the Years Ended December 31 1998 1997
================================================================================
(In millions, except per share data)
Revenue $ 3,019.7 $ 2,988.5
- --------------------------------------------------------------------------------
Net realized capital gains included in revenue $ 56.4 $ 71.3
- --------------------------------------------------------------------------------
Income before taxes and minority interest $ 284.9 $ 321.1
Income taxes (51.1) (78.5)
Minority Interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary trust
holding solely junior subordinated
debentures of the Company (16.0) (14.5)
Equity in earnings -- (31.6)
- --------------------------------------------------------------------------------
Income from continuing operations 217.8 196.5
(Loss) income from operations of
discontinued business (13.5) 16.6
- --------------------------------------------------------------------------------
Net income $ 204.3 $ 213.1
- --------------------------------------------------------------------------------
PER SHARE DATA
Basic
Income from continuing operations $ 3.64 $ 3.59
Weighted average shares outstanding 59.9 54.7
Diluted
Income from continuing operations $ 3.61 $ 3.59
Weighted average shares outstanding 60.3 54.8
================================================================================
4.
================================================================================
Significant Transactions
During March 1999, the Company completed the repurchase of $200.0 million of its
issued common stock under its October, 1998 repurchase program authorized by the
Board of Directors of AFC. On March 23, 1999, the Board of Directors of AFC
authorized the repurchase of up to an additional $200.0 million of its issued
common stock. As of December 31, 1999, under this additional program, the
Company had repurchased 2.2 million shares of its common stock for an aggregate
cost of approximately $132.9 million.
Effective January 1, 1999, the Company entered into a whole account
aggregate excess of loss reinsurance agreement with a highly rated reinsurer.
The reinsurance agreement provides accident year coverage for the three years
1999 to 2001 for the Company's property and casualty business, and is subject to
cancellation or commutation annually at the Company's option. The program covers
losses and allocated loss adjustment expenses, including those incurred but not
yet reported, in excess of a specified whole account loss and allocated LAE
ratio. The annual and aggregate coverage limits for losses and allocated LAE are
$150.0 million and $300.0 million, respectively. The effect of this agreement on
results of operations in each reporting period is based on losses and allocated
LAE ceded, reduced by a sliding scale premium of 50.0-67.0% depending on the
size of the loss, and increased by a ceding commission of 20.0% of ceded
premium. In addition, net investment income is reduced for amounts credited to
the reinsurer. As a result of this agreement, the Company recognized a net
benefit of $15.9 million for the year ended December 31, 1999, based on annual
estimates of losses and allocated loss adjustment expenses for accident year
1999. In accordance with the provisions of this contract, the Company has
exercised its option to cancel this contract effective January 1, 2000.
On October 29, 1998, the Company announced that it had adopted a formal
restructuring plan for its Risk Management business. As part of this initiative,
the segment consolidated its property and casualty field support activities from
fourteen regional branches into three hub locations. As a result of the
Company's restructuring initiative, it recognized a pretax loss of $9.0 million
in the fourth quarter of 1998.
Approximately $4.8 million of this loss relates to severance and other
employee related costs resulting from the elimination of 306 positions, of which
207 and 106 employees had been terminated as of December 31, 1999 and 1998,
respectively. In addition, lease cancellations and contract terminations
resulted in losses of approximately $2.5 million and $1.7 million, respectively.
During 1999, this loss was reduced by $1.9 million, relating to severance and
other employee related costs, resulting from the reinstatement of 66 positions.
The Company made payments of approximately $4.7 million and $0.1 million in 1999
and 1998, respectively, related to this restructuring initiative.
Effective July 1, 1998, the Company entered into a reinsurance agreement
with a highly rated reinsurer that cedes current and future underwriting losses,
including unfavorable development of prior year reserves, up to a $40.0 million
maximum, relating to the Company's reinsurance pool business. These pools
consist primarily of the Company's assumed stop loss business, small group
managed care pools, long-term disability and long-term care pools, student
accident and special risk business. The agreement is consistent with
management's decision to exit this line of business, which the Company expects
to run-off over the next three years. As a result of this transaction, the
Company recognized a $25.3 million pre-tax loss in the third quarter of 1998.
This loss is reported in 1999 as part of the discontinued operations of the
Company.
Effective January 1, 1998, the Company entered into an agreement with a
highly rated reinsurer to reinsure the mortality risk on the universal life and
variable universal life blocks of business. The agreement did not have a
material effect on its results of operations or financial position.
The merger of Allmerica P&C and a wholly-owned subsidiary of the Company
was consummated on July 16, 1997. Through the merger, the Company acquired all
of the outstanding common stock of Allmerica P&C that it did not already own in
exchange for cash of $425.6 million and approximately 9.7 million shares of AFC
stock valued at $372.5 million. The merger has been recognized as a purchase.
Total consideration of approximately $798.1 million has been allocated to the
minority interest in the assets and liabilities based on estimates of their fair
values. The minority interest acquired totaled $703.5 million. A total of $90.6
million representing the excess
39
of the purchase price over the fair values of the net assets acquired, net of
deferred taxes, has been allocated to goodwill and is being amortized over a
40-year period.
On April 14, 1997, the Company entered into an agreement in principle to
cede substantially all of the Company's individual disability income line of
business under a 100% coinsurance agreement with a highly rated reinsurer. The
coinsurance agreement became effective October 1, 1997. The transaction has
resulted in the recognition of a $53.9 million pre-tax loss in the first quarter
of 1997.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary
business trust of AFC, issued $300.0 million of Series A Capital Securities
("Capital Securities"), which pay cumulative dividends at a rate of 8.207%
semiannually commencing August 15, 1997. The Trust exists for the sole purpose
of issuing the Capital Securities and investing the proceeds thereof in an
equivalent amount of 8.207% Junior Subordinated Deferrable Interest Debentures
due 2027 of AFC (the "Subordinated Debentures"). Through certain guarantees, the
Subordinated Debentures and the terms of related agreements, AFC has irrevocably
and unconditionally guaranteed the obligations of the Trust under the Capital
Securities. Net proceeds from the offering of approximately $296.3 million
funded a portion of the aforementioned July 16, 1997 acquisition. On August 7,
1997, AFC and the Trust exchanged the Series A Capital Securities for a like
amount of Series B Capital Securities and related guarantees which are
registered under the Securities Act of 1933 as required under the terms of the
initial transaction.
5.
================================================================================
Investments
A. Summary of Investments
The Company accounts for its investments, all of which are classified as
available-for-sale, in accordance with the provisions of Statement No. 115.
The amortized cost and fair value of available-for-sale fixed maturities
and equity securities were as follows:
December 31 1999
================================================================================
(In millions)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost(1) Gains Losses Value
U.S. Treasury securities
and U.S. government
and agency securities $ 185.0 $ 2.6 $ 2.0 $ 185.6
States and political
subdivisions 2,189.8 26.3 78.5 2,137.6
Foreign governments 89.0 3.1 0.2 91.9
Corporate fixed maturities 4,211.9 73.8 175.1 4,110.6
Mortgage-backed securities 419.3 1.8 13.0 408.1
- --------------------------------------------------------------------------------
Total fixed maturities $7,095.0 $ 107.6 $ 268.8 $6,933.8
================================================================================
Equity securities $ 49.5 $ 35.1 $ 1.4 $ 83.2
================================================================================
December 31 1998
================================================================================
(In millions)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost(1) Gains Losses Value
U.S. Treasury securities
and U.S. government and
agency securities $ 194.5 $ 12.1 $ 24.6 $ 182.0
States and political
subdivisions 2,408.9 83.0 5.2 2,486.7
Foreign governments 107.9 7.7 4.5 111.1
Corporate fixed maturities 4,340.5 168.4 83.4 4,425.5
Mortgage-backed securities 566.4 11.9 2.8 575.5
- --------------------------------------------------------------------------------
Total fixed maturities $7,618.2 $ 283.1 $ 120.5 $7,780.8
================================================================================
Equity securities $ 253.1 $ 151.1 $ 7.1 $ 397.1
================================================================================
(1) Amortized cost for fixed maturities and cost for equity securities.
In connection with AFLIAC's voluntary withdrawal of its license in New
York, AFLIAC agreed with the New York Department of Insurance to maintain,
through a custodial account in New York, a security deposit, the market value of
which will at all times equal 102% of all outstanding liabilities of AFLIAC for
New York policyholders, claimants and creditors. At December 31, 1999, the
amortized cost and market value of these assets on deposit in New York were
$196.4 million and $193.0 million, respectively. At December 31, 1998, the
amortized cost and market value of assets on deposit were $268.5 million and
$284.1 million, respectively. In addition, fixed maturities, excluding those
securities on deposit in New York, with an amortized cost of $112.7 million and
$105.4 million were on deposit with various state and governmental authorities
at December 31, 1999 and 1998, respectively.
There were no contractual fixed maturity investment commitments at
December 31, 1999.
The amortized cost and fair value by maturity periods for fixed maturities
are shown below. Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties, or the Company may have the right to put
or sell the obligations back to the issuers. Mortgage backed securities are
included in the category representing their ultimate maturity.
December 31 1999
================================================================================
(In millions)
Amortized Fair
Cost Value
Due in one year or less $ 424.3 $ 423.3
Due after one year through five years 2,238.1 2,213.9
Due after five years through ten years 2,036.5 1,950.4
Due after ten years 2,396.1 2,346.2
- --------------------------------------------------------------------------------
Total $7,095.0 $6,933.8
================================================================================
40
Unrealized gains and losses on available-for-sale and other securities,
are summarized as follows:
For the Years Ended December 31
================================================================================
(In millions)
Equity
Fixed Securities
1999 Maturities and Other(1) Total
Net appreciation, beginning of year $ 81.9 $ 98.6 $ 180.5
- --------------------------------------------------------------------------------
Net depreciation on
available-for-sale securities (352.7) (119.6) (472.3)
Net appreciation from the effect on
deferred policy acquisition costs
and on policy liabilities 78.5 -- 78.5
Benefits for deferred federal income taxes 95.3 42.7 138.0
- --------------------------------------------------------------------------------
(178.9) (76.9) (255.8)
- --------------------------------------------------------------------------------
Net (depreciation) appreciation,
end of year $ (97.0) $ 21.7 $ (75.3)
================================================================================
1998
Net appreciation, beginning of year $ 133.3 $ 84.6 $ 217.9
- --------------------------------------------------------------------------------
Net depreciation on
available-for-sale securities (108.8) (1.5) (110.3)
Purchased minority interest related
to the acquisition of minority
interest in Citizens 10.7 10.7 21.4
Net depreciation from the effect on
deferred policy acquisition costs
and on policy liabilities 6.2 -- 6.2
Benefit for deferred federal
income taxes and minority interest 40.5 4.8 45.3
- --------------------------------------------------------------------------------
(51.4) 14.0 (37.4)
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 81.9 $ 98.6 $ 180.5
================================================================================
1997
Net appreciation, beginning of year $ 71.1 $ 60.5 $ 131.6
- --------------------------------------------------------------------------------
Net appreciation (depreciation) on
available-for-sale securities 83.6 (5.8) 77.8
Purchased minority interest related
to the merger with Allmerica P&C 50.7 59.6 110.3
Net depreciation from the effect on
deferred policy acquisition costs
and on policy liabilities (16.8) -- (16.8)
Provision for deferred federal
income taxes and minority interest (55.3) (29.7) (85.0)
- --------------------------------------------------------------------------------
62.2 24.1 86.3
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 133.3 $ 84.6 $ 217.9
================================================================================
(1) Includes net (depreciation) appreciation on other investments of $(5.1)
million, $0.8 million, and $1.8 million in 1999, 1998 and 1997, respectively.
B. Mortgage Loans and Real Estate
AFC's mortgage loans and real estate are diversified by property type and
location. Real estate investments have been obtained primarily through
foreclosure. Mortgage loans are collateralized by the related properties and
generally are no more than 75% of the property's value at the time the original
loan is made.
The carrying values of mortgage loans and real estate investments net of
applicable reserves were $533.8 million and $582.7 million at December 31, 1999
and 1998, respectively. Reserves for mortgage loans were $5.8 million and $11.5
million at December 31, 1999 and 1998, respectively.
During 1997, the Company committed to a plan to dispose of all real estate
assets. At December 31, 1999 there were 4 properties remaining in the Company's
real estate portfolio which are being actively marketed. Depreciation is not
recorded on these assets while they are held for disposal.
There were no non-cash investing activities, including real estate
acquired through foreclosure of mortgage loans, in 1999, 1998 and 1997.
There were no material contractual commitments to extend credit under
commercial mortgage loan agreements at December 31, 1999.
Mortgage loans and real estate investments comprised the following
property types and geographic regions:
December 31 1999 1998
================================================================================
(In millions)
Property type:
Office building $ 301.5 $ 304.4
Residential 50.5 52.8
Retail 92.2 108.5
Industrial / warehouse 83.6 110.0
Other 11.8 18.5
Valuation allowances (5.8) (11.5)
- --------------------------------------------------------------------------------
Total $ 533.8 $ 582.7
================================================================================
Geographic region:
South Atlantic $ 132.2 $ 136.1
Pacific 133.6 155.1
East North Central 62.7 80.5
Middle Atlantic 50.3 61.2
New England 90.8 60.7
West South Central 40.7 54.7
Other 29.3 45.9
Valuation allowances (5.8) (11.5)
- --------------------------------------------------------------------------------
Total $ 533.8 $ 582.7
================================================================================
41
At December 31, 1999, scheduled mortgage loan maturities were as follows:
2000 - $108.1 million; 2001 - $33.9 million; 2002 - $27.5 million; 2003 - $40.6
million; 2004 - $76.4 million and $234.7 million thereafter. Actual maturities
could differ from contractual maturities because borrowers may have the right to
prepay obligations with or without prepayment penalties and loans may be
refinanced. During 1999, the Company did not refinance any mortgage loans based
on terms which differed from those granted to new borrowers.
C. Investment Valuation Allowances
Investment valuation allowances which have been deducted in arriving at
investment carrying values as presented in the Consolidated Balance Sheets and
changes thereto are shown below.
For the Years Ended December 31
================================================================================
(In millions)
Balance at Balance at
January 1 Provisions Write-offs December 31
1999
Mortgage loans $ 11.5 $ (2.4) $ 3.3 $ 5.8
================================================================================
1998
Mortgage loans $ 20.7 $ (6.8) $ 2.4 $ 11.5
================================================================================
1997
Mortgage loans $ 19.6 $ 2.5 $ 1.4 $ 20.7
Real estate 14.9 6.0 20.9 --
- --------------------------------------------------------------------------------
Total $ 34.5 $ 8.5 $ 22.3 $ 20.7
================================================================================
Provisions on mortgages during 1999 and 1998 reflect the release of
redundant specific reserves. Write-offs of $20.9 million to the investment
valuation allowance related to real estate in 1997 primarily reflect write downs
to the estimated fair value less costs to sell pursuant to the aforementioned
1997 plan of disposal.
The carrying value of impaired loans was $18.0 million and $22.0 million,
with related reserves of $0.8 million and $6.0 million as of December 31, 1999
and 1998, respectively. All impaired loans were reserved for as of December 31,
1999 and 1998.
The average carrying value of impaired loans was $21.0 million, $26.1
million and $30.8 million, with related interest income while such loans were
impaired, of $2.1 million, $3.2 million and $3.2 million as of December 31,
1999, 1998 and 1997, respectively.
D. Futures Contracts
AFC purchases long futures contracts and sells short futures contracts on margin
to hedge against interest rate fluctuations associated with the sale of
Guaranteed Investment Contracts ("GICs") and other funding agreements. The
Company is exposed to interest rate risk from the time of sale of the GIC until
the receipt of the deposit and purchase of the underlying asset to back the
liability. The Company only trades futures contracts with nationally recognized
brokers, which the Company believes have adequate capital to ensure that there
is minimal danger of default. The Company does not require collateral or other
securities to support financial instruments with credit risk.
The notional amount of futures contracts outstanding was $37.1 million and
$92.7 million, at December 31, 1999 and 1998, respectively. The notional amounts
of the contracts represent the extent of the Company's investment but not future
cash requirements, as the Company generally settles open positions prior to
maturity. The maturity of all futures contracts outstanding are less than one
year. The fair value of futures contracts outstanding was $36.8 million and
$92.5 million at December 31, 1999 and 1998, respectively.
Gains and losses on hedge contracts related to interest rate fluctuations
are deferred and recognized in income over the period being hedged corresponding
to related guaranteed investment contracts. If instruments being hedged by
futures contracts are disposed, any unamortized gains or losses on such
contracts are included in the determination of the gain or loss from the
disposition. Deferred hedging losses were $0.9 million and $1.8 million in 1999
and 1998, respectively. Gains and losses on hedge contracts that are deemed
ineffective by the Company are realized immediately. There was $0.1 million of
gains realized on ineffective hedges in 1998. There were no gains or losses in
1999 and 1997.
A reconciliation of the notional amount of futures contracts is as
follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Contracts outstanding,
beginning of year $ 92.7 $ -- $ (40.0)
New contracts 947.0 1,117.5 (6.5)
Contracts expired (1,002.6) (1,024.8) 46.5
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 37.1 $ 92.7 $ --
================================================================================
E. Foreign Currency Swap Contracts
The Company enters into foreign currency swap contracts with swap counterparties
to hedge foreign currency exposure on specific fixed income securities.
Additionally, in 1999, the Company entered into a foreign currency swap contract
to hedge foreign currency exposure on specific fixed rate trust obligations
backed by funding agreements. Interest and principal related to foreign fixed
income securities and trust obligations payable in foreign currencies, at
current exchange rates, are exchanged for the equivalent payment in U.S. dollars
translated at a specific currency exchange rate. The primary risk associated
with these transactions is the inability of the counterparty to meet its
obligation. The Company regularly assesses the financial strength of its
counterparties and generally enters into forward or swap agreements with
counterparties rated "A" or better by nationally recognized rating agencies. The
42
Company's maximum exposure to counterparty credit risk is the difference between
the foreign currency exchange rate, as agreed upon in the swap contract, and the
foreign currency spot rate on the date of the exchange, as indicated by the fair
value of the contract. The fair values of the foreign currency swap contracts
outstanding were $(4.7) million and $1.2 million at December 31, 1999 and 1998,
respectively. Changes in the fair value of contracts hedging fixed income
securities are reported as an unrealized gain or loss, consistent with the
underlying hedged security. Changes in fair value of contracts hedging fixed
rate trust obligations backed by funding agreements are reported as other
operating income, consistent with the underlying hedged liability. The net
decrease in other operating income related to these contracts was $2.6 million
in 1999. The Company does not require collateral or other security to support
financial instruments with credit risk.
The difference between amounts paid and received on foreign currency swap
contracts is reflected in the net investment income related to the underlying
assets and is not material in 1999, 1998 and 1997. Any gain or loss on the
termination of swap contracts is deferred and recognized with any gain or loss
on the hedged transaction. The Company had no deferred gain or loss on foreign
currency swap contracts in 1999 or 1998.
A reconciliation of the notional amount of foreign currency swap contracts
is as follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Contracts outstanding,
beginning of year $ 42.6 $ 42.6 $ 47.6
New contracts 52.9 -- 5.0
Contracts expired (24.0) -- (10.0)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 71.5 $ 42.6 $ 42.6
================================================================================
Expected maturities of such foreign currency swap contracts outstanding at
December 31, 1999 are $8.3 million in 2000, $52.9 million in 2001, and $10.3
million thereafter. There are no expected maturities of such foreign currency
swap contracts in 2002, 2003 and 2004.
F. Interest Rate Swap Contracts
The Company enters into interest rate swap contracts to hedge exposure to
interest rate fluctuations. Specifically, for floating rate funding agreement
liabilities that are matched with fixed rate securities, the Company manages the
interest rate risk by hedging with interest rate swap contracts. Under these
swap contracts, the Company agrees to exchange, at specified intervals, the
difference between fixed and floating interest amounts calculated on an
agreed-upon notional principal amount. As with foreign currency swap contracts,
the primary risk associated with these transactions is the inability of the
counterparty to meet its obligation. The Company regularly assesses the
financial strength of its counterparties and generally enters into forward or
swap agreements with counterparties rated "A" or better by nationally recognized
rating agencies. Because the underlying principal of swap contracts is not
exchanged, the Company's maximum exposure to counterparty credit risk is the
difference in payments exchanged, which at December 31, 1999 and 1998 were net
payables of $4.2 million, and $3.9 million, respectively. The Company does not
require collateral or other security to support financial instruments with
credit risk.
The net amount receivable or payable is recognized over the life of the
swap contract as an adjustment to net investment income. The decrease in net
investment income related to interest rate swap contracts was $7.2 million, $2.8
million and $0.4 million for the years ended December 31, 1999, 1998 and 1997,
respectively. The fair value of interest rate swap contracts outstanding was
$33.2 million and $(28.3) million at December 31, 1999 and 1998, respectively.
Changes in the fair value of contracts are reported as an unrealized gain or
loss, consistent with the underlying hedged security. Any gain or loss on the
termination of interest rate swap contracts accounted for as hedges are deferred
and recognized with any gain or loss on the hedged transaction. The Company had
no deferred gain or loss on interest rate swap contracts in 1999 or 1998.
A reconciliation of the notional amount of interest rate swap contracts is
as follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Contracts outstanding,
beginning of year $1,112.6 $ 244.1 $ 5.0
New contracts 905.4 873.5 244.7
Contracts terminated (888.5) -- --
Contracts expired (80.0) (5.0) (5.6)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $1,049.5 $1,112.6 $ 244.1
================================================================================
Expected maturities of such interest rate swap contracts outstanding at
December 31, 1999 are $44.0 million in 2000, $43.1 million in 2001, $83.5
million in 2002, $536.0 million in 2003, $319.3 million in 2004 and $23.6
million thereafter.
G. Other Swap Contracts
The Company enters into insurance portfolio-linked and credit default swap
contracts for investment purposes. Under the insurance portfolio-linked swap
contracts, the Company agrees to exchange cash flows according to the
performance of a specified underwriter's portfolio of insurance business. As
with interest rate swap contracts, the primary risk associated with insurance
portfolio-linked swap contracts is the inability of the counterparty to meet its
obligation. Under the terms of the credit default swap contracts, the Company
assumes the default risk of a specific high credit quality issuer in exchange
for a
43
stated annual premium. In the case of default, the Company will pay the
counterparty par value for a pre-determined security of the issuer. The primary
risk associated with these transactions is the default risk of the underlying
companies. The Company regularly assesses the financial strength of its
counterparties and the underlying companies in default swap contracts, and
generally enters into forward or swap agreements with companies rated "A" or
better by nationally recognized rating agencies. Because the underlying
principal of swap contracts is not exchanged, the Company's maximum exposure to
counterparty credit risk is the difference in payments exchanged, which at
December 31, 1999, was not material to the Company. The Company does not require
collateral or other security to support financial instruments with credit risk.
The swap contracts are marked to market with any gain or loss recognized
currently. The fair values of swap contracts outstanding were $(0.3) million and
$(0.1) million at December 31, 1999 and 1998, respectively. The net amount
receivable or payable under insurance portfolio-linked swap contracts is
recognized when the contracts are marked to market. The net (decrease) increase
in realized investment gains related to these contracts was $(0.2) million, $1.0
million, and $(1.4) million for the years ended December 31, 1999, 1998 and
1997, respectively.
The stated annual premium under credit default swap contracts is
recognized currently in net investment income. The net increase to investment
income related to credit default swap contracts was $0.4 million and $0.2
million for the years ended December 31, 1999 and 1998, respectively. There was
no net investment income recognized in 1997.
A reconciliation of the notional amount of other swap contracts is as
follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Contracts outstanding,
beginning of year $ 255.0 $ 15.0 $ 58.6
New contracts 50.0 266.3 192.1
Contracts expired (115.0) (26.3) (211.6)
Contracts terminated -- -- (24.1)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 190.0 $ 255.0 $ 15.0
================================================================================
Expected maturities of such other swap contracts outstanding at December
31, 1999 are as follows: $140.0 million in 2000 and $50.0 million in 2001. There
are no expected maturities of other swap contracts in 2002, 2003, 2004 and
thereafter.
H. Other
At December 31, 1999 and 1998, AFC had no concentration of investments in
a single investee exceeding 10% of shareholders' equity.
6.
================================================================================
Investment Income and Gains and Losses
A. Net Investment Income
The components of net investment income were as follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Fixed maturities $ 524.8 $ 517.9 $ 525.8
Mortgage loans 45.5 57.6 57.1
Equity securities 2.4 7.2 10.5
Policy loans 12.7 11.9 10.9
Real estate and other long-term investments 12.9 7.1 31.5
Short-term investments 33.1 17.7 19.0
- --------------------------------------------------------------------------------
Gross investment income 631.4 619.4 654.8
Less investment expenses (15.7) (15.0) (23.7)
- --------------------------------------------------------------------------------
Net investment income $ 615.7 $ 604.4 $ 631.1
================================================================================
At December 31, 1999, the Company had fixed maturities with a carrying
value of $1.4 million on non-accrual status. There were no mortgage loans on
non-accrual status at December 31, 1999. At December 31, 1998, there was one
mortgage loan on non-accrual status which had an outstanding principal balance
of $4.3 million. This loan was restructured and fully impaired. There were no
fixed maturities on non-accrual status at December 31, 1998. The effect of
non-accruals, compared with amounts that would have been recognized in
accordance with the original terms of the investments, was a reduction in net
income of $2.0 million in 1999, and had no impact in 1998 and 1997.
The payment terms of mortgage loans may from time to time be restructured
or modified. The investment in restructured mortgage loans, based on amortized
cost, amounted to $18.8 million, $28.7 million and $40.3 million at December 31,
1999, 1998 and 1997, respectively. Interest income on restructured mortgage
loans that would have been recorded in accordance with the original terms of
such loans amounted to $2.5 million, $3.3 million and $3.9 million and in 1999,
1998 and 1997, respectively. Actual interest income on these loans included in
net investment income aggregated $1.8 million, $3.3 million and $4.2 million in
1999, 1998 and 1997, respectively.
There were no mortgage loans which were non-income producing for the year
ended December 31, 1999. There were, however, fixed maturities with a carrying
value of $2.0 million which were non-income producing for the year ended
December 31, 1999.
Included in other long-term investments is income from limited
partnerships of $7.2 million in 1999, losses of $6.3 million in 1998, and income
of $7.6 million in 1997.
44
B. Net Realized Investment Gains and Losses
Realized gains (losses) on investments were as follows:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Fixed maturities $ (62.6) $ (13.3) $ 13.5
Mortgage loans 2.5 8.8 (1.2)
Equity securities 141.8 63.7 53.1
Real estate 2.3 13.9 13.0
Other 7.0 (13.9) (2.4)
- --------------------------------------------------------------------------------
Net realized investment gains $ 91.0 $ 59.2 $ 76.0
================================================================================
The proceeds from voluntary sales of available-for-sale securities and the gross
realized gains and gross realized losses on those sales were as follows:
For the Years Ended December 31
================================================================================
(In millions)
Proceeds from Gross Gross
1999 Voluntary Sales Gains Losses
Fixed maturities $1,884.3 $ 20.4 $37.5
Equity securities $ 420.1 $149.4 $ 7.6
================================================================================
1998
Fixed maturities $ 899.5 $ 13.5 $11.1
Equity securities $ 258.7 $ 72.8 $ 9.0
================================================================================
1997
Fixed maturities $1,948.3 $ 27.3 $15.9
Equity securities $ 144.9 $ 55.5 $ 1.2
================================================================================
C. Other Comprehensive Income Reconciliation
The following table provides a reconciliation of gross unrealized gains to the
net balance shown in the Consolidated Statements of Comprehensive Income:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Unrealized gains (losses) on securities:
Unrealized holding (losses) gains arising
during period, (net of taxes (benefit) and
minority interest of $(108.0) million,
$(20.7) million and $122.0 million in
1999, 1998 and 1997, respectively) $(200.0) $ (1.1) $125.5
Less: reclassification adjustment for gains
included in net income (net of taxes and
minority interest of $30.0 million,
$24.6 million and $37.0 million in 1999,
1998 and 1997, respectively) 55.8 36.3 39.2
- --------------------------------------------------------------------------------
Other comprehensive (loss) income $(255.8) $(37.4) $ 86.3
================================================================================
7.
================================================================================
Fair Value Disclosures of Financial Instruments
Statement No. 107, "Disclosures about Fair Value of Financial Instruments",
requires disclosure of fair value information about certain financial
instruments (insurance contracts, real estate, goodwill and taxes are excluded)
for which it is practicable to estimate such values, whether or not these
instruments are included in the balance sheet. The fair values presented for
certain financial instruments are estimates which, in many cases, may differ
significantly from the amounts which could be realized upon immediate
liquidation. In cases where market prices are not available, estimates of fair
value are based on discounted cash flow analyses which utilize current interest
rates for similar financial instruments which have comparable terms and credit
quality. Included in the fair value of fixed maturities are swap contracts used
to hedge fixed maturities with a fair value of $31.1 million and $(27.1) million
at December 31, 1999 and 1998, respectively. In addition, the Company held
futures contracts with a carrying value of $(0.9) million and $(1.8) million at
December 31, 1999 and 1998, respectively. The fair value of these contracts was
$36.8 million and $92.5 million at December 31, 1999 and 1998, respectively.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Cash and Cash Equivalents
For these short-term investments, the carrying amount approximates fair value.
Fixed Maturities
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models using discounted cash flow
analyses.
Equity Securities
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models.
Mortgage Loans
Fair values are estimated by discounting the future contractual cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings. The fair value of below investment grade mortgage loans are
limited to the lesser of the present value of the cash flows or book value.
Policy Loans
The carrying amount reported in the consolidated balance sheets approximates
fair value since policy loans have no defined maturity dates and are inseparable
from the insurance contracts.
45
Investment Contracts (Without Mortality Features)
Fair values for the Company's liabilities under guaranteed investment type
contracts are estimated using discounted cash flow calculations using current
interest rates for similar contracts with maturities consistent with those
remaining for the contracts being valued. Other liabilities are based on
surrender values.
Trust Instruments Supported by Funding Obligations
Fair values are estimated using discounted cash flow calculations using current
interest rates for similar contracts with maturities consistent with those
remaining for the contracts being valued.
Debt
The carrying value of short-term debt reported in the balance sheet approximates
fair value. The fair value of long-term debt was estimated using market quotes,
when available, and when not available, discounted cash flow analyses.
Mandatorily Redeemable Preferred Securities of a Subsidiary Trust Holding Solely
Junior Subordinated Debentures of the Company
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources.
The estimated fair values of the financial instruments were as follows:
December 31 1999 1998
=======================================================================================================================
(In millions)
Carrying Fair Carrying Fair
Value Value Value Value
Financial Assets
Cash and cash equivalents $ 442.2 $ 442.2 $ 550.3 $ 550.3
Fixed maturities 6,933.8 6,933.8 7,780.8 7,780.8
Equity securities 83.2 83.2 397.1 397.1
Mortgage loans 521.2 521.9 562.3 587.1
Policy loans 170.5 170.5 154.3 154.3
- -----------------------------------------------------------------------------------------------------------------------
$8,150.9 $8,151.6 $9,444.8 $9,469.6
=======================================================================================================================
Financial Liabilities
Guaranteed investment contracts $1,316.0 $1,341.4 $1,791.8 $1,830.8
Supplemental contracts without life contingencies 48.8 48.8 37.3 37.3
Dividend accumulations 88.1 88.1 88.4 88.4
Other individual contract deposit funds 48.4 48.2 61.6 61.1
Other group contract deposit funds 602.9 583.5 700.4 704.0
Individual fixed annuity contracts 1,092.5 1,057.1 1,110.6 1,073.6
Trust instruments supported by funding obligations 50.6 49.6 -- --
Short-term debt 45.0 45.0 221.3 221.3
Long-term debt 199.5 187.4 199.5 213.4
Mandatorily redeemable preferred securities of a subsidiary trust holding
soley junior subordinated debentures of the Company 300.0 292.5 300.0 334.7
- -----------------------------------------------------------------------------------------------------------------------
$3,791.8 $3,741.6 $4,510.9 $4,564.6
=======================================================================================================================
46
8.
================================================================================
Closed Block
Included in other income in the Consolidated Statements of Income in 1999, 1998
and 1997 is a net pre-tax contribution from the Closed Block of $13.8 million,
$10.4 million and $9.1 million, respectively. Summarized financial information
of the Closed Block as of December 31, 1999 and 1998 and for the periods ended
December 31, 1999, 1998 and 1997 is as follows:
December 31 1999 1998
================================================================================
(In millions)
Assets
Fixed maturities, at fair value (amortized
cost of $387.4 and $399.1, respectively) $ 372.9 $ 414.2
Mortgage loans 136.3 136.0
Policy loans 201.1 210.9
Cash and cash equivalents 22.6 9.4
Accrued investment income 14.0 14.1
Deferred policy acquisition costs 13.1 15.6
Other assets 12.3 2.9
- --------------------------------------------------------------------------------
Total assets $ 772.3 $ 803.1
================================================================================
Liabilities
Policy liabilities and accruals $ 835.2 $ 862.9
Other liabilities 6.9 9.1
- --------------------------------------------------------------------------------
Total liabilities $ 842.1 $ 872.0
================================================================================
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Revenues
Premiums and other income $ 52.1 $ 55.4 $ 58.3
Net investment income 53.8 53.3 53.4
Realized investment (loss) gain (0.6) 0.1 1.3
- -------------------------------------------------------------------------------
Total revenues 105.3 108.8 113.0
===============================================================================
Benefits and expenses
Policy benefits 88.9 95.0 100.5
Policy acquisition expenses 2.5 2.7 3.0
Other operating expenses 0.1 0.7 0.4
- -------------------------------------------------------------------------------
Total benefits and expenses 91.5 98.4 103.9
- -------------------------------------------------------------------------------
Contribution from the Closed Block $ 13.8 $ 10.4 $ 9.1
===============================================================================
Cash flows
Cash flows from operating activities:
Contribution from the Closed Block $ 13.8 $ 10.4 $ 9.1
Change in:
Deferred policy acquisition costs, net 2.5 2.6 2.9
Premiums and other receivables -- 0.3 --
Policy liabilities and accruals (13.1) (13.5) (11.6)
Accrued investment income 0.1 -- 0.2
Deferred taxes -- 0.1 (5.1)
Other assets (8.3) 2.4 (2.9)
Expenses and taxes payable (2.9) (2.9) (2.0)
Other, net 0.8 (0.1) (1.2)
- -------------------------------------------------------------------------------
Net cash used in operating activities (7.1) (0.7) (10.6)
- -------------------------------------------------------------------------------
Cash flows from investing activities:
Sales, maturities and
repayments of investments 139.0 83.6 161.6
Purchases of investments (128.5) (106.5) (161.4)
Other, net 9.8 7.9 11.4
- -------------------------------------------------------------------------------
Net cash provided by (used in)
investing activities 20.3 (15.0) 11.6
- -------------------------------------------------------------------------------
Net increase (decrease) in cash and
cash equivalents 13.2 (15.7) 1.0
Cash and cash equivalents,
beginning of year 9.4 25.1 24.1
- -------------------------------------------------------------------------------
Cash and cash equivalents,
end of year $ 22.6 $ 9.4 $ 25.1
===============================================================================
There were no valuation allowances on mortgage loans at December 31, 1999,
1998 and 1997, respectively.
Many expenses related to Closed Block operations are charged to operations
outside the Closed Block; accordingly, the contribution from the Closed Block
does not represent the actual profitability of the Closed Block operations.
Operating costs and expenses outside of the Closed Block are, therefore,
disproportionate to the business outside the Closed Block.
47
9.
================================================================================
Debt
Short and long-term debt consisted of the following:
December 31 1999 1998
================================================================================
(In millions)
Short-term
Commercial paper $ 45.0 $ 41.3
Borrowings under bank credit facility -- 150.0
Repurchase agreements -- 30.0
- --------------------------------------------------------------------------------
Total short-term debt $ 45.0 $ 221.3
================================================================================
Long-term
Senior Debentures (unsecured) $ 199.5 $ 199.5
================================================================================
AFC issues commercial paper primarily to manage imbalances between
operating cash flows and existing commitments. Commercial paper borrowing
arrangements are supported by a credit agreement. At December 31, 1999, the
weighted average interest rate for outstanding commercial paper was
approximately 5.27%.
Effective May 28, 1999, the Company renewed a credit agreement entered
into on May 28, 1998, which replaces lines of credit previously held by FAFLIC
and Allmerica P&C, and provides for a $150.0 million credit facility, which
expires on May 28, 2000. Borrowings under this agreement are unsecured and incur
interest at a rate per annum equal to, at the Company's option, a designated
base rate or the eurodollar rate plus applicable margin. At December 31, 1999,
the Company had approximately $150.0 million in committed lines of credit, all
of which was available for borrowing. These lines of credit generally have terms
of less than one year, and require the Company to pay annual commitment fees
limited to 0.08% of the available credit.
Effective December 4, 1998, AFC entered into a credit agreement that
expired on February 5, 1999. Borrowings under this agreement were unsecured and
incurred interest at a rate per annum equal to the eurodollar rate plus
applicable margin. Borrowings outstanding under this credit facility at December
31, 1998 were $150.0 million. These borrowings were repaid in February 1999.
The Company utilizes repurchase agreements to finance certain transactions
and had approximately $30.0 million in such agreements outstanding at December
31, 1998. There were no repurchase agreements outstanding at December 31, 1999.
Senior Debentures of the Company have a $200.0 million face value, pay
interest semiannually at a rate of 7 5/8%, and mature on October 16, 2025. The
Senior Debentures are subject to certain restrictive covenants, including
limitations on issuance of or disposition of stock of restricted subsidiaries
and limitations on liens. The Company is in compliance with all covenants.
Interest expense was $22.0 million, $23.4 million and $21.7 million in
1999, 1998 and 1997, respectively. Interest expense included $15.3 million
related to the Company's Senior Debentures for each year. Interest expense
related to borrowings under the credit agreements were approximately $1.0
million, $0.7 million and $2.8 million in 1999, 1998, and 1997, respectively.
All interest expense is recorded in other operating expenses.
10.
================================================================================
Federal Income Taxes
Provisions for federal income taxes have been calculated in accordance with the
provisions of Statement No. 109. A summary of the federal income tax expense
(benefit) in the Consolidated Statements of Income is shown below:
For the Years Ended December 31 1999 1998 1997
================================================================================
(In millions)
Federal income tax expense (benefit)
Current $ 88.1 $ 72.5 $ 70.8
Deferred 18.8 (16.4) 13.9
- --------------------------------------------------------------------------------
Total $ 106.9 $ 56.1 $ 84.7
================================================================================
The federal income taxes attributable to the consolidated results of
operations are different from the amounts determined by multiplying income
before federal income taxes by the statutory federal income tax rate. The
sources of the difference and the tax effects of each were as follows:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Expected federal income tax
expense $ 163.8 $ 104.9 $ 119.0
Tax-exempt interest (37.4) (38.9) (37.9)
Dividend received deduction (3.8) (5.1) (3.2)
Changes in tax reserve estimates (8.7) 2.3 7.8
Tax credits (8.5) (8.5) (2.7)
Other, net 1.5 1.4 1.7
- -------------------------------------------------------------------------------
Federal income tax expense $ 106.9 $ 56.1 $ 84.7
===============================================================================
48
The deferred income tax (asset) liability represents the tax effects of
temporary differences attributable to the Company's consolidated federal tax
return group. Its components were as follows:
December 31 1999 1998
===============================================================================
(In millions)
Deferred tax (assets) liabilities
AMT carryforwards $ (17.1) $ (16.8)
Loss reserve discounting (439.9) (406.6)
Deferred acquisition costs 414.2 345.8
Employee benefit plans (47.4) (45.3)
Investments, net (30.1) 121.6
Discontinued operations (11.7) --
Bad debt reserve (2.1) (1.8)
Litigation reserves (6.0) (10.9)
Other, net (1.6) (5.8)
- -------------------------------------------------------------------------------
Deferred tax asset, net $(141.7) $ (19.8)
===============================================================================
Gross deferred income tax assets totaled $716.6 million and $538.2 million
at December 31, 1999 and 1998, respectively. Gross deferred income tax
liabilities totaled $574.9 million and $518.4 million at December 31, 1999 and
1998, respectively.
The Company believes, based on its recent earnings history and its future
expectations, that the Company's taxable income in future years will be
sufficient to realize all deferred tax assets. In determining the adequacy of
future income, the Company considered the future reversal of its existing
temporary differences and available tax planning strategies that could be
implemented, if necessary. At December 31, 1999, there are available alternative
minimum tax credit carryforwards of $17.1 million.
The Company's federal income tax returns are routinely audited by the IRS,
and provisions are routinely made in the financial statements in anticipation of
the results of these audits. The IRS has examined the FAFLIC/AFLIAC consolidated
group's federal income tax returns through 1994. The IRS has also examined the
former Allmerica P&C consolidated group's federal income tax returns through
1994. The Company has appealed certain adjustments proposed by the IRS with
respect to the federal income tax returns for 1992, 1993 and 1994 for the
FAFLIC/AFLIAC consolidated group. Also, certain adjustments proposed by the IRS
with respect to FAFLIC/AFLIAC's federal income tax returns for 1982 and 1983
remain unresolved. If upheld, these adjustments would result in additional
payments; however, the Company will vigorously defend its position with respect
to these adjustments. In the Company's opinion, adequate tax liabilities have
been established for all years. However, the amount of these tax liabilities
could be revised in the near term if estimates of the Company's ultimate
liability are revised.
11.
================================================================================
Pension Plans
AFC provides retirement benefits to substantially all of its employees under a
defined benefit pension plan. This plan is based on a defined benefit cash
balance formula, whereby the Company annually provides an allocation to each
eligible employee based on a percentage of that employee's salary, similar to a
defined contribution plan arrangement. The 1999, 1998 and 1997 allocations were
based on 7.0% of each eligible employee's salary. In addition to the cash
balance allocation, certain transition group employees, who have met specified
age and service requirements as of December 31, 1994, are eligible for a
grandfathered benefit based primarily on the employees' years of service and
compensation during their highest five consecutive plan years of employment. The
Company's policy for the plans is to fund at least the minimum amount required
by the Employee Retirement Income Security Act of 1974.
Components of net periodic pension cost were as follows:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Service cost - benefits earned during the year $ 19.3 $ 19.0 $ 19.9
Interest cost 26.5 25.5 23.5
Expected return on plan assets (38.9) (34.9) (31.2)
Recognized net actuarial loss 0.4 0.4 0.1
Amortization of transition asset (1.4) (1.8) (1.9)
Amortization of prior service cost (2.2) (1.7) (2.0)
- -------------------------------------------------------------------------------
Net periodic pension cost $ 3.7 $ 6.5 $ 8.4
===============================================================================
The following table summarizes the status of the plan. At December 31,
1999 and 1998, the plans' assets exceeded their projected benefit obligations.
December 31 1999 1998
===============================================================================
(In millions)
Change in benefit obligations:
Projected benefit obligation at beginning of year $ 414.2 $ 370.4
Service cost - benefits earned during the year 19.3 19.0
Interest cost 26.5 25.5
Actuarial (gains) losses (44.4) 20.4
Benefits paid (22.9) (21.1)
- -------------------------------------------------------------------------------
Projected benefit obligation at end of year 392.7 414.2
- -------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of year 441.6 395.5
Actual return on plan assets 51.9 67.2
Benefits paid (22.9) (21.1)
- -------------------------------------------------------------------------------
Fair value of plan assets at end of year 470.6 441.6
- -------------------------------------------------------------------------------
Funded status of the plan 77.9 27.4
Unrecognized transition obligation (21.6) (23.9)
Unamortized prior service cost (12.0) (11.0)
Unrecognized net actuarial gains (101.6) (54.9)
- -------------------------------------------------------------------------------
Net pension liability $ (57.3) $ (62.4)
===============================================================================
49
As a result of the Company's merger with Allmerica P&C, certain pension
liabilities were reduced to reflect their fair value as of the merger date.
These pension liabilities were reduced by $8.9 million and $10.3 million in 1999
and 1998, respectively, which reflects fair value, net of applicable
amortization.
Determination of the projected benefit obligations was based on a weighted
average discount rate of 7.75% and 6.5% in 1999 and 1998, respectively, and the
assumed long-term rate of return on plan assets was 9.0% in both 1999 and 1998.
The actuarial present value of the projected benefit obligations was determined
using assumed rates of increase in future compensation levels ranging from 5.0%
to 5.5%. Plan assets are invested primarily in various separate accounts and the
general account of FAFLIC. Plan assets also include 796,462 shares and 973,262
shares of AFC Common Stock at December 31, 1999 and 1998, respectively, with a
market value of $44.3 million and $56.3 million at December 31, 1999 and 1998,
respectively.
The Company has a defined contribution 401(k) plan for its employees,
whereby the Company matches employee elective 401(k) contributions, up to a
maximum percentage determined annually by the Board of Directors. During 1999,
1998 and 1997, the Company matched 50% of employees' contributions up to 6.0% of
eligible compensation. The total expense related to this plan was $5.9 million,
$5.6 million and $3.3 million in 1999, 1998 and 1997, respectively. In addition
to this plan, the Company has a defined contribution plan for substantially all
of its agents. The Plan expense in 1999, 1998 and 1997 was $3.1 million, $3.0
million and $2.8 million, respectively.
12.
================================================================================
Other Postretirement Benefit Plans
In addition to the Company's pension plans, the Company currently provides
postretirement medical and death benefits to certain full-time employees and
dependents, under a plan sponsored by FAFLIC. Generally, employees become
eligible at age 55 with at least 15 years of service. Spousal coverage is
generally provided for up to two years after death of the retiree. Benefits
include hospital, major medical and a payment at death equal to retirees' final
compensation up to certain limits. Effective January 1, 1996, the Company
revised these benefits so as to establish limits on future benefit payments and
to restrict eligibility to current employees. The medical plans have varying
copayments and deductibles, depending on the plan. These plans are unfunded.
The plans' funded status reconciled with amounts recognized in the
Company's Consolidated Balance Sheets were as follows:
December 31 1999 1998
===============================================================================
(In millions)
Change in benefit obligations:
Accumulated postretirement benefit obligation
at beginning of year $ 84.0 $ 71.8
Service cost 2.9 3.1
Interest cost 4.6 5.1
Actuarial (gains) losses (21.2) 7.6
Benefits paid (3.5) (3.6)
- -------------------------------------------------------------------------------
Accumulated postretirement benefit obligation
at end of year 66.8 84.0
- -------------------------------------------------------------------------------
Fair value of plan assets at end of year -- --
===============================================================================
Funded status of the plan (66.8) (84.0)
Unamortized prior service cost (9.8) (12.9)
Unrecognized net actuarial (gains) losses (13.8) 7.5
- -------------------------------------------------------------------------------
Accumulated postretirement benefit costs $ (90.4) $ (89.4)
===============================================================================
The components of net periodic postretirement benefit cost were as
follows:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Service cost $ 2.9 $ 3.1 $ 3.0
Interest cost 4.6 5.1 4.6
Recognized net actuarial loss (gain) 0.1 0.1 (0.1)
Amortization of prior service cost (2.3) (2.4) (2.7)
- -------------------------------------------------------------------------------
Net periodic postretirement benefit cost $ 5.3 $ 5.9 $ 4.8
===============================================================================
As a result of the Company's merger with Allmerica P&C, certain
postretirement liabilities were reduced to reflect their fair value as of the
merger date. These postretirement liabilities were reduced by $4.6 million and
$5.4 million in 1999 and 1998, respectively, which reflects fair value, net of
applicable amortization.
For purposes of measuring the accumulated postretirement benefit
obligation at December 31, 1999, health care costs were assumed to increase 6.0%
in 2000, declining thereafter until the ultimate rate of 5.5% is reached in 2001
and remains at that level thereafter. The health care cost trend rate assumption
has a significant effect on the amounts reported. For example, increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation at December 31, 1999
by $4.1 million, and the aggregate of the service and interest cost com-
50
ponents of net periodic postretirement benefit expense for 1999 by $0.6 million.
Conversely, decreasing the assumed health care cost trend rates by one
percentage point in each year would decrease the accumulated postretirement
benefit obligation at December 31, 1999 by $3.6 million, and the aggregate of
the service and interest cost components of net periodic postretirement benefit
expense for 1999 by $0.5 million.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7.75% and 6.5% at December 31, 1999 and
1998, respectively. In addition, the actuarial present value of the accumulated
postretirement benefit obligation was determined using an assumed rate of
increase in future compensation levels of 5.5% for FAFLIC agents.
13.
================================================================================
Stock-Based Compensation Plans
The Company has elected to apply the provisions of APB No. 25 (Accounting
Principles Board Opinion No. 25) in accounting for its stock-based compensation
plans, and thus no compensation cost has been recognized for stock options in
the financial statements. The pro forma effect of recognizing compensation cost
based on an instrument's fair value at the date of grant, consistent with
Statement No. 123, "Accounting for Stock-Based Compensation", results in net
income and earnings per share of $286.5 million and $5.17 per share-diluted
($5.21 per share-basic) in 1999, $194.4 million and $3.23 per share-diluted
($3.25 per share-basic) in 1998, and $206.0 million and $3.76 per share ($3.77
per share-basic) in 1997. Since options vest over several years and additional
awards generally are made each year, the aforementioned pro forma effects are
not likely to be representative of the effects on reported net income for future
years.
Effective June 17, 1996, the Company adopted a Long Term Stock Incentive
Plan for employees of the Company (the "Employees' Plan"). Key employees of the
Company and its subsidiaries are eligible for awards pursuant to the Plan
administered by the Compensation Committee of the Board of Directors (the
"Committee") of the Company. Under the terms of the Employees' Plan, the maximum
number of shares available for award in any given year is equal to 2.25% of the
outstanding common stock of the Company at the beginning of the year, plus any
awards authorized but unused from prior years. In addition, the maximum number
of shares authorized for grants over the life of the plan is equal to 5,166,597
shares as of December 31, 1999, increasing annually by 1.25% of the Company's
outstanding stock.
Options may be granted to eligible employees at a price not less than the
market price of the Company's common stock on the date of grant. Option shares
may be exercised subject to the terms prescribed by the Committee at the time of
grant, otherwise options vest at the rate of 20% annually for five consecutive
years and must be exercised not later than ten years from the date of grant.
Stock grants may be awarded to eligible employees at a price established
by the Committee (which may be zero). Under the Employees' Plan, stock grants
may vest based upon performance criteria or continued employment. Stock grants
which vest based on performance vest over a minimum one year period. Stock
grants which vest based on continued employment vest at the end of a minimum of
three consecutive years.
Information on the Company's stock option plan is summarized below:
1999 1998 1997
==========================================================================================================================
(In whole shares and dollars)
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
Outstanding at beginning of year 1,746,239 $42.39 1,075,044 $33.45 209,500 $27.50
Granted 1,286,917 52.39 807,511 54.06 849,500 35.64
Converted from Allmerica P&C merger -- -- -- -- 114,509 27.40
Converted from Citizens acquisition -- -- 38,976 28.27 -- --
Exercised 63,150 37.09 61,693 31.34 16,021 27.23
Forfeited 176,227 29.03 113,599 41.85 82,444 33.74
- --------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 2,793,779 $46.76 1,746,239 $42.39 1,075,044 $33.45
==========================================================================================================================
Options exercisable at end of year 546,521 $38.41 240,384 $32.61 57,116 $27.38
==========================================================================================================================
51
No options expired during 1999, 1998, or 1997. The fair value of each
option is estimated on the date of grant or date of conversion using the
Black-Scholes option-pricing model. For options granted through 1999, the
exercise price equaled the market price of the stock on the grant date. The
weighted average fair value of options granted in 1999, 1998 and 1997 was $20.97
per share, $23.68 per share, and $15.02 per share, respectively. For options
converted pursuant to the acquisition of the minority interest in Citizens
Corporation and Allmerica P&C, the exercise price was less than the fair value
of the stock on the conversion date. The weighted average fair values of these
options were $27.87 and $28.24 per share, respectively.
The following significant assumptions were used to determine fair value
for 1999 options granted and converted:
Weighted Average Assumptions for
Options Awarded during 1999 1998 1997
================================================================================
Dividend yield 0.6% 0.4% 0.5%
Expected volatility 40.69% 47.49% 31.52%
Risk-free interest rate 5.70% 4.84% 5.66% to 6.19%
Expected lives range (in years) 2.5 to 7 2.5 to 7 2.5 to 7
The following table summarizes information about employee options
outstanding and exercisable at December 31, 1999.
Options Outstanding Options Currently Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Lives Exercise Price Number Exercise Price
=============================================================================================================
Range of Exercise Prices
$24.50 to $30.66 252,929 6.23 $27.56 152,127 $27.39
$35.375 to $50.00 656,786 7.43 $35.98 245,806 $35.74
$51.00 to $52.50 1,157,585 9.09 $52.07 250 $52.06
$52.625 to $68.25 726,479 8.28 $54.73 148,338 $54.12
During 1999, 1998 and 1997 the Company granted shares of nonvested stock
to eligible employees, which vest after three years of continuous employment.
During 1999, the Company also granted shares of nonvested stock to certain
agents, which vest 60% after three years, and 20% per year thereafter. The
following table summarizes information about employee and agent nonvested stock.
Stock Awards 1999 1998 1997
================================================================================
Common stock granted 66,710 237,394 68,127
Weighted average fair value per share
at the date of grant $ 52.06 $ 37.21 $ 34.13
The Company recognizes compensation expense related to nonvested shares
over the vesting period on a pro rata basis. As a result, the Company recognized
$4.3 million, $3.3 million and $0.7 million of compensation cost in 1999, 1998
and 1997 respectively.
14.
================================================================================
Earnings Per Share
The following table provides share information used in the calculation of
the Company's basic and diluted earnings per share:
December 31 1999 1998 1997
================================================================================
(In millions, except per share data)
Basic shares used in the
calculation of earnings per share 55.0 59.9 54.7
Dilutive effect of securities:
Employee stock options 0.3 0.3 0.1
Non-vested stock grants 0.2 0.1 --
- --------------------------------------------------------------------------------
Diluted shares used in the
calculation of earnings per share 55.5 60.3 54.8
================================================================================
Per share effect of dilutive
securities on income from
continuing operations $0.06 $0.03 $0.01
================================================================================
Per share effect of dilutive
securities on net income $0.05 $0.03 $0.01
================================================================================
Options to purchase 729,363 shares, 97,500 shares and 7,742 shares of
common stock were outstanding during 1999, 1998 and 1997, respectively, but were
not included in the computation of diluted earnings because the option's
exercise prices were greater than the average market price of the common shares
and, therefore, the effect would be antidilutive.
52
15.
================================================================================
Dividend Restrictions
Massachusetts, Delaware, New Hampshire and Michigan have enacted laws governing
the payment of dividends to stockholders by insurers. These laws affect the
dividend paying ability of FAFLIC, AFLIAC, Hanover and Citizens, respectively.
Massachusetts' statute limits the dividends an insurer may pay in any
twelve month period, without the prior permission of the Commonwealth of
Massachusetts Insurance Commissioner, to the greater of (i) 10% of its statutory
policyholder surplus as of the preceding December 31 or (ii) the individual
company's statutory net gain from operations for the preceding calendar year (if
such insurer is a life company), or its net income for the preceding calendar
year (if such insurer is not a life company). In addition, under Massachusetts
law, no domestic insurer shall pay a dividend or make any distribution to its
shareholders from other than unassigned funds unless the Commissioner shall have
approved such dividend or distribution. During 1999 and 1997, no dividends were
declared by FAFLIC to AFC. During 1998, FAFLIC paid dividends of $50.0 million
to AFC. As of July 1, 1999, FAFLIC's ownership of Allmerica P&C, as well as
several non-insurance subsidiaries, was transferred from FAFLIC to AFC. Under an
agreement with the Commonwealth of Massachusetts Insurance Commissioner any
dividend from FAFLIC to AFC for years 2000 and 2001 would require the prior
approval of the Commissioner and may require AFC to make additional capital
contributions to FAFLIC.
Pursuant to Delaware's statute, the maximum amount of dividends and other
distributions that an insurer may pay in any twelve month period, without the
prior approval of the Delaware Commissioner of Insurance, is limited to the
greater of (i) 10% of its policyholders' surplus as of the preceding December 31
or (ii) the individual company's statutory net gain from operations for the
preceding calendar year (if such insurer is a life company) or its net income
(not including realized capital gains) for the preceding calendar year (if such
insurer is not a life company). Any dividends to be paid by an insurer, whether
or not in excess of the aforementioned threshold, from a source other than
statutory earned surplus would also require the prior approval of the Delaware
Commissioner of Insurance. No dividends were declared by AFLIAC to FAFLIC during
1999, 1998 or 1997. During 2000, AFLIAC could pay dividends of $34.3 million to
FAFLIC without prior approval.
Pursuant to New Hampshire's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without prior
approval of the New Hampshire Insurance Commissioner, is limited to 10% of such
insurer's statutory policyholder surplus as of the preceding December 31.
Hanover declared dividends to Allmerica P&C totaling $350.0 million, $125.0
million and $120.0 million during 1999, 1998 and 1997, respectively. Included in
these amounts were extraordinary dividends totaling $225.0 million and $125.0
million in 1999 and 1998, respectively, which were approved by the Commissioner.
Prior to April 2000, Hanover can declare no dividends to Allmerica P&C without
prior approval of the New Hampshire Insurance Commissioner. The allowable
dividend without prior approval will increase to approximately $108.6 million on
April 1, 2000.
Pursuant to Michigan's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without prior
approval of the Michigan Insurance Commissioner, is limited to the greater of
10% of policyholders' surplus as of December 31 of the immediately preceding
year or the statutory net income less realized gains, for the immediately
preceding calendar year. Citizens declared dividends to Citizens Corporation
totaling $200.0 million during both 1999 and 1998. Included in these amounts
were extraordinary dividends totaling $200.0 million and $180.0 million in 1999
and 1998, respectively, which were approved by the Commissioner. No dividends
were declared by Citizens in 1997. Prior to April 2000, Citizens can declare no
dividends to Citizens Corporation without prior approval of the Michigan
Insurance Commissioner. The allowable dividend without prior approval will
increase to approximately $120.8 million on April 1, 2000.
16.
================================================================================
Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management, Allmerica Financial Services, and Allmerica Asset Management.
In accordance with Statement No. 131, the separate financial information of each
segment is presented consistent with the way results are regularly evaluated by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. A summary of the Company's reportable segments is
included below.
In 1999, the Company reorganized its Property and Casualty business and
Corporate Risk Management Services operations within the Risk Management
segment. Under the new structure, the Risk Management segment manages its
business through five distribution channels identified as Hanover North, Hanover
South, Citizens Midwest, Allmerica Voluntary Benefits and Allmerica Specialty.
During the second quarter of 1999, the Company approved a plan to exit its group
life and health business, consisting of its EBS business, its AGU business and
its reinsurance pool business. Results of operations from this business,
relating to both the current and the prior periods, have been segregated and
reported as a component of discontinued operations in the Consolidated
Statements of Income. Operating results from this business were previously
reported in the
53
Allmerica Voluntary Benefits and Allmerica Specialty distribution channels.
Prior to 1999, results of the group life and health business were included in
the Corporate Risk Management Services segment, while all other Risk Management
business was reflected in the Property and Casualty segment.
The Risk Management segment's property and casualty business is offered
primarily through the Hanover North, Hanover South and Citizens Midwest
distribution channels utilizing the Company's independent agent network
primarily in the Northeast, Midwest and Southeast United States, maintaining a
strong regional focus. Allmerica Voluntary Benefits focuses on worksite
distribution, which offers discounted property and casualty products through
employer sponsored programs, and affinity group property and casualty business.
Allmerica Specialty offers special niche property and casualty products in
selected markets.
The Asset Accumulation group includes two segments: Allmerica Financial
Services and Allmerica Asset Management. The Allmerica Financial Services
segment includes variable annuities, variable universal life and traditional
life insurance products distributed via retail channels as well as group
retirement products, such as defined benefit and 401(k) plans and tax-sheltered
annuities distributed to institutions. Through its Allmerica Asset Management
segment, the Company offers its customers the option of investing in GICs such
as the traditional GIC, synthetic GIC and other funding agreements. Funding
agreements are investment contracts issued to institutional buyers, such as
money market funds, corporate cash management programs and securities lending
collateral programs, which typically have short maturities and periodic interest
rate resets based on an index such as LIBOR. This segment is also a Registered
Investment Advisor providing investment advisory services, primarily to
affiliates, and to other institutions, such as insurance companies and pension
plans.
In addition to the three operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt, Capital
Securities and corporate overhead expenses. Corporate overhead expenses reflect
costs not attributable to a particular segment, such as those generated by
certain officers and directors, Corporate Technology, Corporate Finance, Human
Resources and the Legal department.
Management evaluates the results of the aforementioned segments based on a
pre-tax and minority interest basis. Segment income is determined by adjusting
net income for net realized investment gains and losses, net gains and losses on
disposals of businesses, discontinued operations, extraordinary items, the
cumulative effect of accounting changes and certain other items which management
believes are not indicative of overall operating trends. While these items may
be significant components in understanding and assessing the Company's financial
performance, management believes that the presentation of segment income
enhances understanding of the Company's results of operations by highlighting
net income attributable to the normal, recurring operations of the business.
However, segment income should not be construed as a substitute for net income
determined in accordance with generally accepted accounting principles.
Summarized below is financial information with respect to business
segments:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Segment revenues:
Risk Management $2,189.4 $2,222.1 $2,227.6
Asset Accumulation
Allmerica Financial Services 806.3 724.0 713.9
Allmerica Asset Management 150.5 121.7 91.1
- -------------------------------------------------------------------------------
Subtotal 956.8 845.7 805.0
- -------------------------------------------------------------------------------
Corporate 6.0 12.9 16.1
Intersegment revenues (5.9) (7.6) (11.5)
- -------------------------------------------------------------------------------
Total segment revenues including
Closed Block 3,146.3 3,073.1 3,037.2
- -------------------------------------------------------------------------------
Adjustments to segment revenues:
Adjustment for Closed Block (92.1) (98.3) (102.6)
Change in mortality assumptions -- -- (4.2)
Net realized gains 91.0 59.2 76.0
- -------------------------------------------------------------------------------
Total revenues $3,145.2 $3,034.0 $3,006.4
===============================================================================
Segment income (loss) before income
taxes and minority interest:
Risk Management $ 199.6 $ 149.6 $ 174.2
Asset Accumulation
Allmerica Financial Services 205.5 169.0 134.6
Allmerica Asset Management 23.5 23.7 18.4
- -------------------------------------------------------------------------------
Subtotal 229.0 192.7 153.0
- -------------------------------------------------------------------------------
Corporate (59.3) (50.9) (48.0)
- -------------------------------------------------------------------------------
Segment income before income
taxes and minority interest 369.3 291.4 279.2
- -------------------------------------------------------------------------------
Adjustments to segment income:
Net realized investment gains,
net of amortization 96.8 49.5 75.9
Sales practice litigation expense -- (31.0) --
Gain from change in mortality
assumptions -- -- 47.0
Loss on cession of disability
income business -- -- (53.9)
Restructuring costs 1.9 (9.0) --
Other items -- (0.8) (8.2)
- -------------------------------------------------------------------------------
Income from continuing operations
before federal income taxes
and minority interest $ 468.0 $ 300.1 $ 340.0
===============================================================================
54
December 31 1999 1998 1999 1998
================================================================================
(In millions)
Identifiable Assets Deferred Acquisition Costs
Risk Management $ 5,869.0 $ 6,219.0 $ 173.3 $ 167.5
Asset Accumulation
Allmerica Financial
Services 23,435.7 19,461.8 1,213.1 993.1
Allmerica Asset
Management 1,387.6 1,810.9 0.4 0.6
- --------------------------------------------------------------------------------
Subtotal 24,823.3 21,272.7 1,213.5 993.7
Corporate 77.3 161.4 -- --
- --------------------------------------------------------------------------------
Total $30,769.6 $27,653.1 $ 1,386.8 $ 1,161.2
================================================================================
17.
================================================================================
Lease Commitments
Rental expenses for operating leases, including those related to the
discontinued operations of the Company, amounted to $33.2 million, $34.9 million
and $33.6 million in 1999, 1998 and 1997, respectively. These expenses relate
primarily to building leases of the Company. At December 31, 1999, future
minimum rental payments under non-cancelable operating leases were approximately
$70.1 million, payable as follows: 2000 - $27.0 million; 2001 - $20.7 million;
2002 - $12.9 million; 2003 - $6.5 million; and $3.0 million thereafter. It is
expected that, in the normal course of business, leases that expire may be
renewed or replaced by leases on other property and equipment; thus, it is
anticipated that future minimum lease commitments may not be less than the
amounts shown for 2000.
18.
================================================================================
Reinsurance
In the normal course of business, the Company seeks to reduce the losses that
may arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers. Reinsurance transactions are
accounted for in accordance with the provisions of Statement No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts."
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy. Reinsurance
contracts do not relieve the Company from its obligations to policyholders.
Failure of reinsurers to honor their obligations could result in losses to the
Company; consequently, allowances are established for amounts deemed
uncollectible. The Company determines the appropriate amount of reinsurance
based on evaluation of the risks accepted and analyses prepared by consultants
and reinsurers and on market conditions (including the availability and pricing
of reinsurance). The Company also believes that the terms of its reinsurance
contracts are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limit and retention,
arbitration and occurrence. Based on its review of its reinsurers' financial
statements and reputations in the reinsurance marketplace, the Company believes
that its reinsurers are financially sound.
Effective January 1, 1999, the Company entered into a whole account
aggregate excess of loss reinsurance agreement with a highly rated insurer (See
Note 4). The Company is subject to concentration of risk with respect to this
reinsurance agreement, which represented 10% or more of the Company's
reinsurance business at December 31, 1999. Net premiums earned and losses and
loss adjustment expenses ceded under this agreement in 1999 were $21.9 million
and $35.0 million, respectively. In addition, the Company is subject to
concentration of risk with respect to reinsurance ceded to various residual
market mechanisms. As a condition to the ability to conduct certain business in
various states, the Company is required to participate in various residual
market mechanisms and pooling arrangements which provide various insurance
coverages to individuals or other entities that are otherwise unable to purchase
such coverage voluntarily provided by private insurers. These market mechanisms
and pooling arrangements include the Massachusetts Commonwealth Automobile
Reinsurers ("CAR"), the Maine Workers' Compensation Residual Market Pool
("MWCRP") and the Michigan Catastrophic Claims Association ("MCCA"). At December
31, 1999, CAR and MCCA represented 10% or more of the Company's reinsurance
business. As a servicing carrier in Massachusetts, the Company cedes a
significant portion of its private passenger and commercial automobile premiums
to CAR. Net premiums earned and losses and loss adjustment expenses ceded to CAR
in 1999, 1998 and 1997 were $42.8 million and $42.6 million, $34.3 million and
$38.1 million, and $32.3 million and $28.2 million, respectively. The Company
ceded to MCCA premiums earned and losses and loss adjustment expenses in 1999,
1998 and 1997 of $3.7 million and $75.3 million, $3.7 million and $18.0 million,
and $9.8 million and $(0.8) million, respectively.
On June 2, 1998, the Company recorded a $124.2 million one-time reduction
of its direct and ceded written premiums as a result of a return of excess
surplus from MCCA. This transaction had no impact on the total net premiums
recorded by the Company in 1998.
Because the MCCA is supported by assessments permitted by statute, and all
amounts billed by the Company to CAR, MWCRP and MCCA have been paid when due,
the Company believes that it has no significant exposure to uncollectible
reinsurance balances.
55
The effects of reinsurance were as follows:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Life and accident and health insurance premiums:
Direct $ 53.5 $ 51.4 $ 55.9
Assumed 0.7 0.7 0.6
Ceded (50.0) (47.8) (29.1)
- -------------------------------------------------------------------------------
Net premiums $ 4.2 $ 4.3 $ 27.4
===============================================================================
Property and casualty premiums written:
Direct $2,179.0 $1,970.4 $2,068.5
Assumed 67.3 58.8 103.1
Ceded (270.9) (74.1) (179.8)
- -------------------------------------------------------------------------------
Net premiums $1,975.4 $1,955.1 $1,991.8
===============================================================================
Property and casualty premiums earned:
Direct $2,135.0 $1,967.9 $2,046.2
Assumed 73.0 64.5 102.0
Ceded (261.7) (66.1) (195.1)
- -------------------------------------------------------------------------------
Net premiums $1,946.3 $1,966.3 $1,953.1
===============================================================================
Life and accident and health
insurance and other individual
policy benefits, claims, losses
and loss adjustment expenses:
Direct $ 391.9 $ 359.5 $ 401.1
Assumed 0.1 0.3 0.4
Ceded (39.2) (49.5) (79.4)
- -------------------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $ 352.8 $ 310.3 $ 322.1
===============================================================================
Property and casualty benefits,
claims, losses and loss
adjustment expenses:
Direct $1,603.8 $1,589.2 $1,464.9
Assumed 61.7 62.7 101.2
Ceded (247.6) (158.2) (120.6)
- -------------------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $1,417.9 $1,493.7 $1,445.5
===============================================================================
19.
================================================================================
Deferred Policy Acquisition Costs
The following reflects the changes to the deferred policy acquisition asset:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Balance at beginning of year $1,161.2 $ 965.5 $ 822.7
Acquisition expenses deferred 612.8 638.2 601.0
Amortized to expense during
the year (429.9) (449.6) (459.3)
Adjustment for discontinued
operations 3.4 (0.2) --
Adjustment to equity during
the year 39.3 7.3 (11.1)
Adjustment for cession of disability
income insurance -- -- (38.6)
Adjustment for revision of universal
life and variable universal life
insurance mortality assumptions -- -- 50.8
- -------------------------------------------------------------------------------
Balance at end of year $1,386.8 $1,161.2 $ 965.5
===============================================================================
At October 1, 1997, the Company revised the mortality assumptions for
universal life and variable universal life product lines. These revisions
resulted in a $50.8 million recapitalization of deferred policy acquisition
costs.
20.
================================================================================
Liabilities for Outstanding Claims, Losses and Loss Adjustment Expenses
The Company regularly updates its estimates of liabilities for outstanding
claims, losses and loss adjustment expenses as new information becomes available
and further events occur which may impact the resolution of unsettled claims for
its property and casualty and its accident and health lines of business. Changes
in prior estimates are recorded in results of operations in the year such
changes are determined to be needed.
The liability for future policy benefits and outstanding claims, losses
and loss adjustment expenses related to the Company's accident and health
business was $601.3 million and $568.0 million at December 31, 1999 and 1998,
respectively. Accident and health claim liabilities were re-estimated for all
prior years and were increased by $51.2 million and $14.6 million in 1999 and
1998, respectively. The increase in 1999 resulted from the Company's reserve
strengthening primarily in the EBS and reinsurance pool business. The 1998
increase also resulted from the Company's reserve strengthening primarily in the
assumed reinsurance and stop loss only business.
56
The following table provides a reconciliation of the beginning and ending
property and casualty reserve for unpaid losses and loss adjustment expenses:
For the Years Ended December 31 1999 1998 1997
===============================================================================
(In millions)
Reserve for losses and LAE,
beginning of year $2,597.3 $2,615.4 $2,744.1
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events
of current year 1,601.4 1,609.0 1,564.1
Decrease in provision for
insured events of prior years (183.4) (127.2) (127.9)
- -------------------------------------------------------------------------------
Total incurred losses and LAE 1,418.0 1,481.8 1,436.2
===============================================================================
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 861.1 871.9 775.1
Losses and LAE attributable to
insured events of prior years 638.0 643.0 732.1
- -------------------------------------------------------------------------------
Total payments 1,499.1 1,514.9 1,507.2
===============================================================================
Change in reinsurance recoverable
on unpaid losses 102.5 15.0 (50.2)
Other(1) -- -- (7.5)
- -------------------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,618.7 $2,597.3 $2,615.4
===============================================================================
(1) Includes purchase accounting adjustments.
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $183.4 million, $127.2 million and
$127.9 million in 1999, 1998 and 1997, respectively, reflecting increased
favorable development on reserves for both losses and loss adjustment expenses.
Favorable development on prior years' loss reserves was $93.1 million,
$58.9 million, and $87.2 million for the years ended December 31, 1999, 1998,
and 1997, respectively. The increase of $34.2 million in 1999 is primarily due
to improved personal automobile results in the Northeast and increased
reinsurance recoverables in the commercial multiple peril line. Favorable
development on prior year's loss adjustment expense reserves was $90.3 million,
$68.3 million, and $40.7 million for the years ended December 31, 1999, 1998,
and 1997, respectively. The increase in favorable development in both 1999 and
1998 is primarily attributable to claims process improvement initiatives taken
by the Company over the past two years. The Company has lowered claim settlement
costs through increased utilization of in-house attorneys and consolidation of
claim offices.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the loss and LAE reserves in the past may not
necessarily occur in the future.
Due to the nature of the business written by the Risk Management segment,
the exposure to environmental liabilities is relatively small and therefore its
reserves are relatively small compared to other types of liabilities. Loss and
LAE reserves related to environmental damage and toxic tort liability, included
in the reserve for losses and LAE, were $47.3 million, $49.9 million and $53.1
million, net of reinsurance of $11.2 million, $14.2 million and $15.7 million in
1999, 1998 and 1997, respectively. The Company does not specifically underwrite
policies that include this coverage, but as case law expands policy provisions
and insurers' liability beyond the intended coverage, the Company may be
required to defend such claims. The Company estimated its ultimate liability for
these claims based upon currently known facts, reasonable assumptions where the
facts are not known, current law and methodologies currently available. Although
these claims are not significant, their existence gives rise to uncertainty and
is discussed because of the possibility, however remote, that they may become
significant. The Company believes that, notwithstanding the evolution of case
law expanding liability in environmental claims, recorded reserves related to
these claims are adequate. In addition, the Company is not aware of any
litigation or pending claims that may result in additional material liabilities
in excess of recorded reserves. The environmental liability could be revised in
the near term if the estimates used in determining the liability are revised.
21.
================================================================================
Minority Interest
The Company's interest in Allmerica P&C is represented by ownership of 59.5% of
the outstanding common stock prior to its merger with AFC on July 16, 1997.
Allmerica P&C's interest in Citizens Corporation prior to the acquisition of
minority interest completed on or about December 3, 1998, whereby Citizens
Corporation became a wholly-owned subsidiary, and at December 31, 1997 was 83.2%
and 82.5%, respectively.
Minority interest at December 31, 1999 and 1998 also reflects the
Company's issuance of Capital Securities (See Note 4).
57
22.
================================================================================
Contingencies
Regulatory and Industry Developments
Unfavorable economic conditions may contribute to an increase in the number of
insurance companies that are under regulatory supervision. This may result in an
increase in mandatory assessments by state guaranty funds, or voluntary payments
by solvent insurance companies to cover losses to policyholders of insolvent or
rehabilitated companies. Mandatory assessments, which are subject to statutory
limits, can be partially recovered through a reduction in future premium taxes
in some states. The Company is not able to reasonably estimate the potential
effect on it of any such future assessments or voluntary payments.
Litigation
In July 1997, a lawsuit on behalf of a putative class was instituted in
Louisiana against AFC and certain of its subsidiaries by individual plaintiffs
alleging fraud, unfair or deceptive acts, breach of contract, misrepresentation,
and related claims in the sale of life insurance policies. In October 1997, the
plaintiffs voluntarily dismissed the Louisiana suit and filed a substantially
similar action in Federal District Court in Worcester, Massachusetts. In early
November 1998, the Company and the plaintiffs entered into a settlement
agreement. The court granted preliminary approval of the settlement on December
4, 1998. On May 19, 1999, the court issued an order certifying the class for
settlement purposes and granting final approval of the settlement agreement. AFC
recognized a $31.0 million pre-tax expense during the third quarter of 1998
related to this litigation. Although the Company believes that this expense
reflects appropriate recognition of its obligation under the settlement, this
estimate assumes the availability of insurance coverage for certain claims, and
the estimate may be revised based on the amount of reimbursement actually
tendered by AFC's insurance carriers, and based on changes in the Company's
estimate of the ultimate cost of the benefits to be provided to members of the
class.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the Company's opinion, based on the
advice of legal counsel, the ultimate resolution of these proceedings will not
have a material effect on the Company's consolidated financial statements.
However, liabilities related to these proceedings could be established in the
near term if estimates of the ultimate resolution of these proceedings are
revised.
Residual Markets
The Company is required to participate in residual markets in various states.
The results of the residual markets are not subject to the predictability
associated with the Company's own managed business, and are significant to the
workers' compensation line of business and both the private passenger and
commercial automobile lines of business.
Year 2000
The Year 2000 issue resulted from computer programs being written using two
digits rather than four to define the applicable year. Computer programs that
have date-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
Although the Company does not believe that there is a material contingency
associated with the Year 2000 issue, there can be no assurance that exposure for
material contingencies will not arise.
58
23.
================================================================================
Statutory Financial Information
The Company's insurance subsidiaries are required to file annual statements with
state regulatory authorities prepared on an accounting basis prescribed or
permitted by such authorities (statutory basis). Statutory surplus differs from
shareholders' equity reported in accordance with generally accepted accounting
principles primarily because policy acquisition costs are expensed when
incurred, investment reserves are based on different assumptions, postretirement
benefit costs are based on different assumptions and reflect a different method
of adoption, life insurance reserves are based on different assumptions and
income tax expense reflects only taxes paid or currently payable. In 1999, 49
out of 50 states have adopted the National Association of Insurance
Commissioners proposed Codification, which provides for uniform statutory
accounting principles. These principles are effective January 1, 2001. The
Company is currently assessing the impact that the adoption of Codification will
have on its insurance subsidiaries.
Statutory net income and surplus are as follows:
1999 1998 1997
================================================================================
(In millions)
Statutory Net Income (Combined)
Property and Casualty Companies $ 511.6 $ 180.7 $ 190.3
Life and Health Companies 239.0 86.4 191.2
- --------------------------------------------------------------------------------
Statutory Shareholders'
Surplus (Combined)
Property and Casualty Companies $1,089.1 $1,269.3 $1,279.6
Life and Health Companies 590.1 1,164.1 1,221.3
================================================================================
As of July 1, 1999, FAFLIC transferred its remaining ownership in
Allmerica P&C to AFC. At December 31, 1998 and 1997, the life and health
companies' statutory surplus reflected interest in Allmerica P&C of
approximately 70.0% and 66.0%, respectively.
24.
================================================================================
Quarterly Results of Operations (Unaudited)
The quarterly results of operations for 1999 and 1998 are summarized below:
For the Three Months Ended March 31 June 30 Sept. 30 Dec. 31
================================================================================
(In millions, except per share data))
1999
Total revenues $856.2 $764.8 $761.7 $762.5
Net income $154.1 $ 60.2 $ 13.1 $ 68.4
Net income per share:
Basic $ 2.69 $ 1.10 $ 0.24 $ 1.26
Diluted $ 2.67 $ 1.09 $ 0.24 $ 1.25
Dividends declared per share $ -- $ -- $ 0.25 $ --
================================================================================
1998
Total revenues $762.7 $757.4 $745.0 $768.9
Net income $ 66.8 $ 60.3 $ 8.2 $ 65.9
Net income per share:
Basic $ 1.11 $ 1.00 $ 0.14 $ 1.11
Diluted $ 1.11 $ 1.00 $ 0.13 $ 1.10
Dividends declared per share $ 0.05 $ 0.05 $ 0.05 $ --
================================================================================
Note: Due to the use of weighted average shares outstanding when calculating
earnings per common share, the sum of the quarterly per common share data may
not equal the per common share data for the year.
59
Allmerica Financial Corporation
BOARD OF DIRECTORS
Michael P. Angelini (a)
Chairman and Partner, Bowditch & Dewey, LLP
E. Gordon Gee (d)
Chancellor-elect, Vanderbilt University
Samuel J. Gerson (d)
Chairman and Chief Executive Officer,
Filene's Basement, Inc.
Gail L. Harrison (a)
Founding Principal, The Wexler Group
Robert P. Henderson (c)
General Partner,
Greylock Management Corporation
M Howard Jacobson (c)
Senior Advisor and Consultant,
Bankers Trust Private Bank
Wendell J. Knox (a)
President and Chief Executive Officer,
Abt Associates
Robert J. Murray (a)
Chairman, President and Chief Executive Officer,
New England Business Service, Inc.
J. Terrence Murray (d)
Chairman and Chief Executive Officer,
FleetBoston Financial Corporation
John F. O'Brien
President and Chief Executive Officer,
Allmerica Financial Corporation
John L. Sprague (a)
President, John L. Sprague Associates, Inc.
Robert G. Stachler (c)
Partner, Taft, Stettinius & Hollister, LLP
Herbert M. Varnum (c)
Former Chairman and Chief Executive Officer,
Quabaug Corporation
(a) Audit Committee
(c) Compensation Committee
(d) Directors Committee
OPERATING COMMITTEE
Bruce C. Anderson
Vice President, Corporate Services
Mark R. Colborn
Vice President, Operations Services
J. Kendall Huber
Vice President, General Counsel
and Assistant Secretary
John P. Kavanaugh
Vice President, Chief Investment Officer
John F. O'Brien
President and Chief Executive Officer
Edward J. Parry, III
Vice President, Chief Financial Officer
and Treasurer
Richard M. Reilly
President and Chief Executive Officer,
Allmerica Financial Life Insurance and
Annuity Company
Robert P. Restrepo, Jr.
President and Chief Executive Officer,
Allmerica Property and Casualty Companies, Inc.
Eric A. Simonsen
President, Allmerica Services Corporation
60
SHAREHOLDER INFORMATION
ANNUAL MEETING OF SHAREHOLDERS
The management and Board of Directors of Allmerica Financial Corporation invite
you to attend the Company's Annual Meeting of Shareholders. The meeting will be
held on May 16, 2000, at 9:00 a.m. at Allmerica Financial, 440 Lincoln Street,
Worcester, Massachusetts.
COMMON STOCK AND SHAREHOLDER OWNERSHIP PROFILE
The common stock of Allmerica Financial Corporation is traded on the New York
Stock Exchange under the symbol "AFC." As of the end of business on
February 29, 2000, the Company had 48,075 shareholders of record. On the same
date, the trading price of the Company's common stock closed at $41.75 per
share.
COMMON STOCK PRICES AND DIVIDENDS
1999 High Low Dividends
- ---------------------------------------------------------------------
First Quarter $57.88 $50.19 --
Second Quarter $62.25 $54.50 --
Third Quarter $64.44 $47.56 $0.25
Fourth Quarter $59.69 $46.50 --
1998 High Low Dividends
- ---------------------------------------------------------------------
First Quarter $66.38 $42.31 $0.05
Second Quarter $72.13 $61.31 $0.05
Third Quarter $72.13 $57.31 $0.05
Fourth Quarter $57.88 $39.25 --
DIVIDENDS
Allmerica Financial Corporation currently pays an annual cash dividend of $0.25
per share.
IMSA
Allmerica Financial is proud to be a charter member of the Insurance Marketplace
Standards Association. The Association promotes high standards of conduct in the
sale and servicing of individual life insurance and annuity products. Our
membership demonstrates Allmerica's commitment to the high ethical standards and
practices set forth in IMSA's Principles of Ethical Conduct and accompanying
Code of Life Insurance Ethical Market Conduct. Membership in the association
requires the successful completion of rigorous internal and independent, third
party assessments, designed to determine whether Allmerica's policies and
procedures satisfy IMSA's principles and codes.
REGISTRAR AND STOCK TRANSFER AGENT
First Chicago Trust Company of New York,
A division of Equiserve, LP
525 Washington Boulevard
Jersey City, NJ 07303-2512
(800) 317-4454
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
160 Federal Street
Boston, MA 02110
INDUSTRY RATINGS
A.M. Standard Duff &
Claims Paying Ability Best & Poors Moody's Phelps
- -----------------------------------------------------------------------
First Allmerica Financial
Life Insurance Company A AA- A1 AA
Allmerica Financial Life
Insurance and Annuity Company A AA- A1 AA
The Hanover Insurance Company A AA- A1 --
Citizens Insurance Company of
America A -- -- --
Standard Duff &
Debt Ratings & Poors Moody's Phelps
- -----------------------------------------------------------------------
Allmerica Financial
Corporation Senior Debt A- A2 A+
Allmerica Financial
Corporation Capital Securities BBB A2 --
Allmerica Financial Corporation
Short Term Debt A1+ P1 --
First Allmerica Financial Life
Insurance Company Short Term Debt A1+ P1 --
First Allmerica Financial Life
Insurance Company Short Term
Insurance Financial Strength Rating -- P1 --
TOLL-FREE INVESTOR INFORMATION LINE
Call our toll-free investor information line, (800) 407-5222, to receive
additional printed information, including Form 10-Ks or quarterly reports on
Form 10-Q filed with the Securities and Exchange Commission, fax-on-demand
services, access to shareholder services, prerecorded messages, and other
services.
Alternatively, investors may address questions to:
Henry P. St. Cyr, CFA, Vice President, Investor Relations
Allmerica Financial Corporation
440 Lincoln Street, Worcester, MA 01653
tel: (508) 855-2959 fax: (508) 853-4481
William J. Steglitz, CPA, Manager, Investor Relations
tel: (508) 855-3883 fax: (508) 855-3675
CORPORATE OFFICES AND PRINCIPAL SUBSIDIARIES
Allmerica Financial Corporation
440 Lincoln Street
Worcester, MA 01653
The Hanover Insurance Company
100 North Parkway
Worcester, MA 01605
Citizens Insurance Company of America
645 West Grand River
Howell, MI 48843
WEB SITE
Please visit our Internet site at http://www.allmerica.com