Understanding what makes people secure is our business.
What is security?
1
a bank?
[PHOTO OF PIGGY BANK APPEARS HERE]
2
Most of us learned to save the same way. We put spare coins into a glass jar or
ceramic copy of a pink barnyard animal--a piggy bank. Eventually, when the
piggybank was full, we took what we had saved to a nearby savings institution.
That was where we first planted our money, expecting it to grow. And savings do
grow, but slowly. Very, very slowly. Over the years, savers have realized that
while a bank can keep funds secure, just opening an account may not maximize the
growth of their savings. Building financial security takes more. These days,
true security lies in building a solid base of diversified assets, with
promising growth potential. Variable annuity products give those who want their
savings to grow into a secure nest egg the ability to build security using fund
managers with years of experience in money management.
[PHOTO APPEARS HERE]
3
A strong knot is tied securely and stays tied as long as you want it to.
However, trying to untie the knot can be frustrating-- sometimes seeming
impossible if it has been tied too tightly, or if its ends become frayed. A
financial plan can also be tied too tightly. If it's not flexible, no amount of
tugging at it is going to help. A successful financial plan must easily allow
for changes and new options as market conditions or personal circumstances
dictate. Providing for the future means taking into consideration that times
change and that the unexpected often does occur. One of the many benefits of
variable life insurance is that in addition to estate value protection, it has
the flexibility to address many of the financial needs that arise from time to
time.
[PHOTO APPEARS HERE]
4
[PHOTO OF A ROPE TIED IN A KNOT APPEARS HERE]
a knot?
5
[PHOTO OF A HOUSE APPEARS HERE]
a house?
6
For many, a home represents basic security. Buying a home is very often the
single most significant investment we make in our lives. And we may depend on
that investment to provide comfort for today, and equity for retirement needs.
That may have once been a reasonable strategy, but times have changed. Owning a
home may not provide the financial assurance of satisfying as many concerns as
it once did. To gain more security, consumers have to invest more widely--beyond
their own backyard--in a well-diversified portfolio that is focused on growth.
Consumers also need to be sure that their home and families are protected from
risk of loss.
[PHOTO APPEARS HERE]
7
Few things are more comfortable than an old shoe. It's soft and cozy, and feels
secure on your foot. Nothing feels better. Or so it seems. But the most
comfortable shoe can't always take you where you need to go. Comfortable shoes
don't always work at the office, a nice restaurant or a fancy party.
Comfortable, traditional methods of saving are like old shoes. They no longer
meet the security needs they were once supposed to fulfill. In fact, just having
a savings nest egg may give people a false sense of security. What seems the
most comfortable ways to save may not take investors where they want to go. New
styles of investing, like a new pair of shoes, are a smart choice to reach the
important destinations of a secure retirement and financial well-being.
[PHOTO APPEARS HERE]
8
[PHOTO OF AN OLD SHOE APPEARS HERE]
an old shoe?
9
a paycheck?
[PHOTO OF A PAYROLL CHECK APPEARS HERE]
10
[PHOTO APPEARS HERE]
A paycheck is the ultimate foundation of financial security; it buys food,
shelter and comfort. But a paycheck is also often a key to the quality of
financial security after we stop working. Future financial security begins when
a part of each current paycheck is invested for the future. While millions of
Americans follow this philosophy, many don't. They need a partner to show them
the most effective way, providing them with convenient opportunities to make
choices at the worksite or through an agent or other financial advisor. A
paycheck by itself doesn't guarantee future financial security. If opportunities
aren't available or are limited, it can turn out to be just a piece of paper
with not enough numbers on it. But, for those who actively look for the best
ways to maximize their future, a paycheck can be stretched a long way toward
achieving financial goals.
11
To Our Shareholders
[PHOTO OF PRESIDENT AND CHIEF EXECUTIVE OFFICER APPEARS HERE]
John F. O'Brien
The merger of Allmerica Financial with its property and casualty subsidiary is
an important step which will make Allmerica Financial a larger and more powerful
financial services group, with greater financial flexibility to fund growth
plans.
Allmerica Financial achieved record earnings in 1996. We also substantially
advanced three major initiatives to significantly increase our capital base,
position the company for leadership in worksite marketing, and restructure
operations for greater efficiency. Progress made by Allmerica Financial on these
initiatives includes:
. Initiating the pending merger with Allmerica Property & Casualty, which will
increase Allmerica Financial's ownership to 100 percent and increase
shareholders' equity by more than 20 percent
. Signing agreements with banks and businesses to provide worksite-sold products
in order to establish a solid base for growth through this attractive
marketing channel
. Shifting all processing operations into a Service Company, which allows us to
consolidate process improvement and expense reduction efforts
Record Earnings
1996 operating earnings were $2.75 per share, up 18.5 percent from $2.32
per share in 1995. Growth was achieved largely from our Retirement and Asset
Management segment, which nearly doubled pre-tax income in 1996. This strong
result more than offset a difficult catastrophe year for our property and
casualty operations. Net income of $3.63 per share was up 36 percent over the
prior year. With the proceeds from realized gains on the sale of part of our
equity portfolio, we invested in higher-yielding, fixed income securities to
enhance current income.
Shareholders' equity grew 9.6 percent in 1996. Including proceeds from
Allmerica Financial's initial public offering in October of 1995, shareholders'
equity increased 40 percent, to $1.7 billion in just over a year. With the
equity from the merger with Allmerica Property & Casualty in 1997, Allmerica
Financial's five-year growth in shareholders' equity will exceed 230 percent--
from $900 million in 1992, to approximately $2.1 billion.
By any financial measure, our capital base is dramatically stronger than it
has ever been. Our capital position affords assurance to policyholders and
shareholders alike that we can continue to provide quality service and products,
backed by solid asset liability management strategies. The merger also gives
Allmerica Financial greater financial flexibility and a more diverse earnings
base. It also gives investors ownership in a larger organization, whose stock
has greater liquidity than ever before.
These accomplishments--record earnings, a pending merger, worksite
agreements, and service company
12
[BAR GRAPH APPEARS HERE]
Shareholders' Equity (In Millions)
96 - $1,725
95 - $1,574
94 - $992
93 - $1,051
initiatives--are the result of strategies developed several years ago to enhance
our product offerings, develop new distribution channels, and focus on
processing efficiencies required to compete in today's marketplace.
Merger With Allmerica P&C
Expense reduction and higher revenue growth are primary drivers of
acquisitions in any industry. With these goals in mind, in December of 1996, we
offered to buy all of the minority-held shares in Allmerica P&C. Terms were
reached in February and the transaction should close by the third quarter of
1997. This merger presents unique advantages. Allmerica Financial has managed
Allmerica P&C's operations for many years, as majority shareholder. The two
"home office" buildings are literally side-by-side. Because the operations of
both companies have been so close, the assimilation period typical to a merger
of unrelated parties simply does not exist for us. We gain a head start at
achieving advantages normally associated with combining business operations and
strategies.
Since we are so familiar with Allmerica P&C, we know that there are major
challenges ahead in the property and casualty industry. Competition in two of
our key states--Michigan and Massachusetts--eroded premium growth last year, and
rate pressures continue nationally as companies strive to maintain market share.
Investments in technology are absolutely necessary to give us the proper
information systems required to effectively service and maintain our market
share, and we must be diligent in identifying offsetting expense reductions.
We plan to address high expenses by sharpening our regional focus in order
to devote the most cost-effective resources to profitable markets. In 1997, we
will review our current markets to ensure that we can achieve required returns
in a reasonable time frame.
Key initiatives for our property and casualty segments are affinity group
and worksite marketing. Our Michigan-based company, Citizens Corporation, has
been a leader in affinity group marketing for a number of years. Currently,
nearly 50 percent of Citizens' premium comes from affinity groups such as the
Society of Automotive Engineers. During 1996, Citizens added several groups
including the University of Michigan Alumni Association, which has approximately
400,000 members. Hanover Insurance, which is regionally focused in the
Northeast, signed a group arrangement with BJ's Wholesale Club to market to its
347,000 Massachusetts members.
[BAR GRAPH APPEARS HERE]
Net Operating Income
Per Share*
96 - $2.75
95 - $2.32
94 - $1.80
93 - $2.38
* Per share data reflects outstanding shares of 50.1 million in all periods
presented.
Strong underwriting discipline and a regional focus have helped keep our
combined ratio below the industry average. Citizens leads this success,
with a combined ratio that has consecutively outperformed the industry average
for nearly two decades.
13
[BAR GRAPH APPEARS HERE]
Total Assets (In billions)
96 - $19.0
95 - $17.8
94 - $15.9
93 - $15.4
Worksite Marketing
Property and casualty products are the lead offerings for our worksite
program, but our asset accumulation products are also an excellent fit for this
market. There is a growing consumer demand for investment-type products,
including variable annuities and variable universal life insurance. The need is
especially great for millions of baby boomers who realize they are not
financially prepared for retirement. The time-pressured consumer also needs
convenient product delivery. Worksite marketing affords that convenience.
Employees are accustomed to purchasing benefits at work, and it is equally
convenient for them to address other financial needs at their place of
employment.
Our Retirement and Asset Management products have demonstrated value and
solid appeal through our retail sales channel. Our variable products business
has grown rapidly over the past five years. In 1996, total variable product
assets increased nearly 45 percent, to $6.2 billion. Retail sales alone were up
nearly 70 percent, to $1.3 billion. Worksite relationships established this year
are expected to substantially contribute to continued growth in these product
lines.
[BAR GRAPH APPEARS HERE]
Total Revenues (In millions)
96 - $3,275
95 - $3,241
94 - $3,195
93 - $3,239
In 1996, we refocused the efforts of our Institutional Services segment,
making it responsible for coordinating the worksite marketing and cross-selling
efforts for both property and casualty insurance and variable products. This
strategy is an outgrowth of our long history of marketing to small businesses.
Across our asset accumulation, Corporate Risk Management Services, and
commercial property and casualty lines, Allmerica Financial serves thousands of
businesses with at least one product. Each of these clients represents a
satisfied relationship on which we can build.
Key to worksite selling is our knowledge of this market, and our ability to
assist current customers by expanding the relationship to include new product
offerings and services. In 1996, Institutional Services hired more than a dozen
experienced marketing professionals to sell core products for worksite
distribution. This effort generated worksite relationships with more than 60
companies--including many clients we already serve who agreed to add additional
Allmerica Financial product offerings. We also forged new relationships with
several banks, including Chase Manhattan, Fleet Financial and First of America.
With each bank, we are developing strategies for worksite sales to their
employees and potentially to their commercial customers as well.
14
The investment we are making in our worksite distribution channel is a
viable remedy for a major problem facing our industry--cost-effective lead
generation. We have made substantial investments over the past five years in
sophisticated telephone marketing capabilities, policy automation, payroll
systems and claims management. As a result, we are confident that we will be
able to benefit from worksite sales as enrollments grow into a profitable
revenue stream.
The Service Company
In 1996, we significantly advanced our service strategies with the
expansion of Allmerica's Service Company. The concept of consolidating all
processing activities into a single service unit has been used successfully by
many leading companies in the banking, mutual fund and other service industries.
Allmerica Financial first implemented this concept in 1992, by combining all
corporate services, including human resources, legal, accounting and technology
into a single structure, and mandating process improvements. That effort proved
successful in improving service levels, leading us to enter the next phase. In
1996, we added to the Service Company all other processing activities, including
applications, endorsements, claims and many aspects of customer service.
The Service Company's role was expanded for two key reasons: to enable
distribution units to focus on sales, marketing and point-of-sale services; and
to consolidate all service improvement and expense control programs. The Service
Company will evaluate the cost and effectiveness of each core process impacting
a distribution unit, to ensure that we can satisfy operational needs at the
lowest possible cost.
Outlook
Allmerica Financial has enhanced its products, distribution strategies,
operating systems and corporate structure. Those efforts have produced
profitable results, and positioned Allmerica Financial to deliver even greater
returns. Our products are attractive, our worksite distribution strategy is off
and running, our earnings base is solid, and our Service Company is moving
rapidly to establish targets for cost-effective process improvement.
The transformation of Allmerica Financial into a competitive financial
services provider continues to be exciting and challenging. Both the pace and
scope of change in this industry continue to increase. We view change as a
positive and integral part of our commitment to deliver value to clients and
healthy growth to shareholders. Going forward, we intend to continue to achieve
profitable growth, and to ensure that shareholders' confidence in our strategies
is rewarded.
/s/ John F. O'Brien
John F. O'Brien
President and Chief Executive Officer
The mandate of our Service Company is to improve our business processes and
reduce operating costs.
[BAR GRAPH APPEARS HERE]
Net Income (In millions)
96 - $182
95 - $134
94 - $38
93 - $157
15
Allmerica Financial At A Glance
Retirement and Asset Management
Competitive Position
RETAIL . Strong growth achieved through diversified distribution using
agency, broker/dealer and financial planner channels.
. Excellent variable product offerings employing a diverse group of
quality funds and investment managers generate a marketing
advantage.
. Products developed in partnership with leading mutual fund
families.
. Emphasis on investment-oriented insurance products which offer a
strong growth outlook.
. Sourced in traditional insurance products from leading providers.
INSTITUTIONAL
. Full service provider of employee retirement plan services to a
solid base of institutional clients.
. Telemarketing expertise to reach retail customers.
. Coordination of direct worksite sales of Allmerica Financial
products through trained and licensed sales representatives.
. Variable products provide a broad array of quality funds and
investment managers to the group market.
. Providing education and personalized servicing to clients through
worksite marketing.
ASSET
MANAGEMENT
. Successful long-term record in fixed income portfolio management.
. Strong fundamental research orientation.
. Comprehensive client service and support capability.
1997 Outlook
RETAIL . Continue strong growth and market share gains in variable
annuities and variable universal life insurance products.
. Cost effectively grow agency system.
. Develop additional "wrapper" arrangements and broaden existing
relationships by expanding product offerings.
. Manage profitability through focus on cost control.
. Emphasis on customer needs through further enhancements to
existing products.
INSTITUTIONAL
. Continued focus on cross-selling initiatives and worksite
marketing sales of Allmerica Financial products.
. Focus on the corporate special benefits market with group variable
life and other products.
. Partnering with banks for expanded worksite distribution.
. Manage profitability in traditional spread based business.
ASSET
MANAGEMENT
. Continue targeting institutional clients, including other
insurance companies and pension funds for investment management
services.
[BAR GRAPH APPEARS HERE]
Retail - Life & Annuity Sales
By Channel (In millions)
96 - $1,350
95 - $813
94 - $790
93 - $710
92 - $406
[BAR GRAPH APPEARS HERE]
Institutional Variable
Product Assets (In millions)
96 - $1,429
95 - $1,190
94 - $991
93 - $845
92 - $606
[BAR GRAPH APPEARS HERE]
Asset Management
Assets Managed
(In millions)
96 - $1,557
95 - $1,232
94 - $1,024
93 - $942
92 - $537
16
Risk Management
Competitive Position
HANOVER . Regional property and casualty insurer with distribution through
a network of over 1,900 quality independent agencies.
. Strong local market expertise with Northeast concentration.
. Emerging employer-sponsored group business offers strong future
growth outlook and marketing advantage.
. Disciplined underwriter; small environmental exposure.
. Service capacity enhanced by on-line policy processing and
automated underwriting technology.
. Solid financial position; high degree of liquidity within well
managed investment portfolio.
CITIZENS . Leading Michigan property and casualty insurer, with nearly 10
percent market share.
. Disciplined underwriter; consistently outperforms industry.
. Regionally focused with Michigan concentration; expansion into
Indiana and Ohio.
. Company of choice through over 700 productive independent agencies.
. Successful affinity group marketing programs constitute nearly 50
percent of earned premiums.
. Solid reputation; ranked among top insurers in the nation for
claims service.
. Strong financial position; conservative investment and reserving
practices.
CORPORATE RISK MANAGEMENT
. Leading provider of Risk Sharing Employee Benefit programs to the
mid-sized employer.
. Managed Care plans offer one of the largest national Preferred
Provider organizations (PPO) serving over 200 markets.
. Products include a broad array of managed health and disability
plans along with all forms of non-medical insurance coverages.
. Capabilities include services for self-insured Workers'
Compensation programs which enable us to administer Workers'
Comp and Employee Benefit plans on a fully integrated "24-hour"
basis.
. Emerging leader in the Voluntary Employee Benefit marketplace with
group auto and homeowners as our lead product offerings.
1997 Outlook
HANOVER . Increase efficiencies by leveraging shared resources and new
technologies with Citizens and other Allmerica Financial marketing
units.
. Broaden distribution through expanding group business via
employer-sponsored worksite marketing.
. Maintain strong regional focus and disciplined underwriting
through local market knowledge and expertise.
. Growth in market share from continued worksite sales of personal
automobile and homeowners business.
. Technology enhancements to support further claims processing
automation.
CITIZENS . Maintain regional focus and disciplined underwriting.
. Increase efficiencies by leveraging shared resources and new
technologies with Hanover and other Allmerica Financial marketing
units.
. Develop new bank relationships and additional affinity and
employer group marketing programs, while increasing enrollment in
existing programs.
. Continue providing successful managed care solutions for medical
claims through Citizens Care program.
. Technology enhancements to support further claims processing
automation.
. Further penetration of Indiana and Ohio market share through strong
relationships with existing agents.
CORPORATE RISK MANAGEMENT
. Further develop our on-line information system to continue
providing employers' with administrative benefit plan processing
capabilities.
. Focus on expanding distribution through cross selling more
products to existing customers and building on existing third
party administrator relationships to sell non-medical products.
. Expand our sales growth of integrated Workers' Compensation and
Employee Benefit plans ("24-hour").
. Introduce Voluntary Life and Health products in conjunction with
group auto and homeowners business.
. Maintain our focus in the Alternative market for Workers' Comp
and Employee Benefit plans.
[BAR GRAPH APPEARS HERE]
Hanover
% of Agencies Using
Electronic Processing
---------------------
96 - 87%
95 - 80%
94 - 62%
93 - 30%
92 - 20%
[BAR GRAPH APPEARS HERE]
Citizens
Statutory Combined Ratio
------------------------
Citizens Industry
-------- --------
96 100.4 107.0
95 98.6 106.5
94 104.5 108.5
93 98.9 106.9
92 97.9 115.8
[BAR GRAPH APPEARS HERE]
Corporate Risk Management - Covered Lives (in thousands)
--------------------------------------------------------
96 - 620
95 - 547
94 - 497
93 - 387
92 - 325
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Retirement and Asset Management
The transformation of Allmerica Financial that began six years ago continues. We
are focused on two distinct business segments: Retirement and Asset Management,
and Risk Management. With a goal of improving growth and increasing profit
margins, we have altered our product mix, exited low-return businesses,
aggressively expanded our distribution channels and improved internal processing
systems and technology. Work on all of these strategies is ongoing, but we are
proceeding with great confidence in our mission of growth and increased
[PHOTO APPEARS HERE]
profitability. In the Retirement and Asset Management business, we are dedicated
to meeting the needs of baby boomers--to achieve financial security by managing
today's risks, and saving for tomorrow's retirement rewards. Many boomers
believe that Social Security will not be there for them come retirement, and
feel insecure because they don't quite know how to even begin saving enough to
be prepared. We have products that can help, which are broadly available through
convenient distribution channels.
It is good news that baby boomers have been improving their savings habits
in the last few years. That makes them more attuned than ever to our mix of
variable annuities and variable universal life products. Beginning six years
ago, we shifted our focus to these products, thereby emphasizing the areas of
our core competency. This has proven to be a sound decision from both a
marketing and financial perspective. While traditional insurance product sales
have essentially stagnated over this period, the variable product marketplace
has seen impressive growth.
In 1996, our Retirement and Asset Management segment produced a pre-tax
operating profit of $104.1 million, up from $54.6 million in 1995, and variable
assets under management exceed $6.2
Baby boomers are looking for ways to effectively save for retirement or to fund
their childrens' education. We offer smart choices with flexible, high-quality
variable annuities and variable life products--our fastest growing product
lines.
18
Our variable annuity sales continue to outpace that of the industry.
In 1996, Allmerica ranked 15th in annual variable annuity sales among U.S.
companies, up from 19th in 1995.
[PHOTO APPEARS HERE]
billion, compared with $800 million just five years ago.
Not only is this business growing, it is also fundamentally a better
business. Variable products require less capital support than traditional
insurance because they are fee-based businesses rather than "spread" products.
This corporate transformation required discipline, and a willingness to
stop doing the same old things the same old way. We have sold off marginal
operations such as a mutual-fund processing unit in 1995, and reinvested the
proceeds in the variable products business. We have exited slow-growth, low-
profit businesses and will continue to do so, redeploying the assets into core
businesses that are more promising.
In some aspects, we have been slower to transform the company than we would
have liked. Allmerica Financial is a fine, solid company, but it cannot be
considered a great one until it operates more efficiently and reduces its costs
of doing business. These issues will be addressed in several ways, through the
newly expanded scope of our Service Company.
For example, in the property and casualty operations, our Service Company
oversees client centers in Worcester and in Howell, Michigan. These two
locations now encompass many administrative functions previously handled within
branches. Although investments at this point are ongoing, process consolidation
should result in future cost savings, and should also free branch management to
concentrate fully on strategic field marketing and underwriting. During 1997,
[BAR CHART APPEARS HERE]
Retail Variable
Product Assets
(in millions)
--------------------
96 - $4,804
95 - $3,159
94 - $1,975
93 - $1,373
92 - $ 666
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RETIREMENT AND ASSET MANAGEMENT CONTINUED
[PHOTO APPEARS HERE]
Distribution, distribution, distribution--our focus on broadening distribution
for asset management and risk products is key for future growth.
RETAIL VARIABLE PRODUCT SALES
[PIE CHART APPEARS HERE]
Agency 53%
Broker/Dealers & Other 47%
the Service Company will focus on production support initiatives necessary to
run our day-to-day operations, such as policy processing systems used by
independent agents.
Success In Multi-Channel Distribution
In our business, good products at competitive prices are not enough.
Increasingly, success is determined by distribution.
In recent years, Allmerica Financial has been a leader in creating new
distribution opportunities on both the retail and institutional side. Our Retail
Financial Services division once depended primarily on career agents, but no
longer. Agents are still important to us, and their sales volumes have shown
impressive growth. At the same time, we have developed many new methods for
reaching the expanding market for our products and services.
We now market products through broker-dealers, financial planners and a
growing number of private labeling arrangements. Last fall, Kemper began selling
our variable annuities as a wrapper around its mutual funds and is expected to
make a strong contribution to sales in 1997. New avenues of distribution now
account for close to 50 percent of our retail variable sales and have helped us
grow variable product sales at a pace far greater than the industry. When 1996
began, Allmerica Financial was ranked 19th in variable annuity sales by the
Variable Annuity Research and Data Service (VARDS), a major tracking and
reporting service. Our strong performance in 1996 now puts us in the number 15
spot. Retail variable sales rose 66 percent last year, from $802 million to $1.3
20
billion. In 1997, we should approach $2 billion in variable sales. We expect
some of this growth to come from new third-party distribution agreements.
These marketing arrangements have two distinct advantages. First, they
allow us to reach a large number of potential clients without making major
marketing investments. Second, by partnering with these distributors, we
potentially gain access to their clients for additional product offerings.
Along with creating new distribution opportunities, career agents have been
more productive as well. In 1990, 1,400 agents generated $290 million in
variable sales. Today, our agent force consists of 700 agents who produced more
than $720 million in variable sales during 1996.
We continue to believe that an effectively managed agency force is a key to
successful growth. Accordingly, we completed a major revision of our general
agency structure, linking agents more closely to the company from both an
operational and compensation perspective. The revisions made to our agency
system enable us to grow that distribution channel on a basis that will
contribute significantly to the profitability of our company.
Worksite Marketing
One of the most promising growth areas in our business is worksite
distribution. Several forces are converging to make it particularly attractive.
Busy employees are finding it convenient to do more of their financial shopping
at work, when such opportunities are presented by employers as a benefit option.
Employees appreciate insurance offered in partnership with their employer,
especially since it comes with a discount and the convenience of payments made
via payroll deduction--ensuring that each paycheck is used to buy a little extra
security.
Worksite marketing has similar appeal to employers as it does employees. At
a time when many companies must do more with less, employers are eager to
[PHOTO APPEARS HERE]
Whether a consumer wants to buy variable insurance products from an agent, a
broker, or directly from a mutual fund, Allmerica offers the choice. Today, half
of our variable annuity sales are made by agents, and the remainder are made
through a regional broker or mutual fund provider.
21
RETIREMENT AND ASSET MANAGEMENT CONTINUED
treat their employees well while keeping a tight rein on costs. This is one
reason the ability to offer a perceived benefit to employees--at no cost--is
very attractive to employers.
Allmerica Financial sells at the worksite in a variety of different ways.
In some cases, we will establish an on-site financial center for employees. It
would be similar to the full-service financial center we run for our employees
at our Worcester home office.
In a second format, we first make an institutional sale, for example, to
manage a company's 401(k) plan. Then we would begin a retail sales effort
directed at the companys' employees, with periodic on-site financial seminars,
but not necessarily a permanent presence.
A third format, which developed during 1996, also offers opportunity. We
have formed strategic partnerships with several banks to sell Allmerica
Financial, Hanover and Citizens products to their employees and to potentially
sell our insurance products to some of the banks' commercial customers.
We intend to collaborate with banks of all sizes, and those with which we
already have agreements represent a broad spectrum of U.S. banking. They include
community banks, such as Safety Fund National Bank of Fitchburg, MA, regional
banks, such as Fleet Financial, and the largest money center institution, Chase
Manhattan Bank. In 1997, we anticipate signing agreements with additional banks
and credit unions.
At Chase, we expect to begin selling our group P&C and group variable life
products. We will customize variable products so the investment choices include
funds Chase directly markets to its customers and employees. We have experience
in product customization to meet the needs of our marketing partners, and we
believe that our flexibility and speed in doing so are a
[PHOTO APPEARS HERE]
In today's fast-paced society, consumers are looking for convenience wherever
they can find it. We make our products available at the workplace, with easy
enrollment and time-saving payment options such as payroll deduction or
electronic funds transfer.
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[PHOTO APPEARS HERE]
Our experience and flexibility in product customization, to meet the needs of
our marketing partners, gives us a competitive advantage.
competitive strength. We believe this strength and our flexible approach are
qualities that help us win business when we go head-to-head with larger
competitors.
In all three worksite formats, our representatives can conduct seminars for
employees and offer financial counseling. Our products are highlighted in
communications with employees, via benefits communications, such as employee
newsletters, paycheck inserts and other similar means.
Worksite sales represent an enormous opportunity, and we expect it to
account for a substantial part of our business by the end of the decade.
Our Corporate Risk Management Services unit is also successfully using
third parties to broaden distribution. It has broadened alliances with plan
administrators and health maintenance organizations (HMO's) to help distribute
non-medical products, such as group life and disability, and dental insurance.
We are also using an old distribution approach in new ways. It is called
strategic cross-selling. Historically, it has often been true that when an
insurance company starts referring to cross-selling, or selling additional
products to existing clients, it is a sign that the company has run out of
meaningful things to say. At Allmerica Financial, we have something meaningful
to add on the subject. In 1996, we started an institutional sales committee to
focus on cross-selling--and it is delivering results.
Last year, the number of institutional accounts to which we sell multiple
products doubled, and we are looking for an increase of an additional 50 percent
in 1997. More importantly, the cross-sell effort has broadened our clients'
awareness of our capabilities, and has made it easier for the joint development
23
RETIREMENT AND ASSET MANAGEMENT CONTINUED
of one-stop solutions to a number of benefit issues.
Corporate Risk Management Services
This segment continues to undergo significant transformation. Not long ago,
Corporate Risk Management specialized in traditional indemnity health insurance.
Currently, most of its business falls within the realm of managed care, usually
provided to employers on a risk-sharing basis. We continue to offer indemnity
products, but growth lies elsewhere. Managed care solutions are a more
profitable and stable business. Since 1992, we have increased our covered lives
in health care by 91 percent, from 325,000 to 620,000 at the end of 1996, by
seeking to provide cost-effective alternatives to full-indemnity insurance.
Further enhancing profitability is the new marketing emphasis that has
accompanied our move into the managed care arena. In the past, our health care
business came primarily from small employers. Now the majority of our business
comes from mid-sized companies with up to 2,000 employees. That is where
Corporate Risk Management Services is putting its marketing effort.
Additionally, we are leveraging this group's expertise by having it manage
medical costs that arise from workers' compensation and auto insurance claims in
our P&C segment.
Financial Strength
Allmerica Financial has become a more aggressive marketer in recent years,
yet it remains conservative and prudent in its financial structure. As we look
toward completing the merger with Allmerica Property & Casualty, we are
constituted as an organization that has over $2.6 billion in total
capitalization, and we are in the position of achieving our greatest increase in
capital flexibility in our 153-year history. Since 1990, Allmerica Financial's
capital has grown by 500 percent. We are proud of that
[PHOTO APPEARS HERE]
Alliances with third parties to market non-medical products, including group
life and disability, and dental insurance, have generated solid sales growth and
increased market penetration.
24
Conservative underwriting and prudent investment policies add to our financial
strength, and position us to take advantage of new growth opportunities.
[PHOTO APPEARS HERE]
achievement and excited that Allmerica Financial can demonstrate the capital
strength and flexibility needed to fuel future growth.
Total assets now exceed $18 billion, a gain of more than 20 percent since
1993. The Company's $10 billion investment portfolio is weighted toward high-
quality bonds with very little real estate or mortgage loan exposure.
Over 85 percent of our bond holdings are rated investment grade. Our well-
diversified mortgage portfolio of $764.6 million represents less than five
percent of total assets, while real estate of less than $121 million continues
to demonstrate embedded gains at its current carrying value.
In addition to establishing a successful underwriting record, Allmerica
Financial has also earned a reputation for conservative reserving against
property and casualty exposures. Loss reserves in our P&C business have exceeded
actual losses in each of the last five years. Because the duration of our
liabilities is a relatively short average of about two years, we have been able
to validate our policy of conservatism as cases close and claims are settled.
[PIE CHART APPEARS HERE]
Investment Portfolio
$9.9 Billion
Includes closed block
--------------------------
Bonds -- 79%
Mortgage loans -- 8%
Equities -- 5%
Policy loans -- 4%
Real Estate -- 1%
Cash & other -- 3%
25
[PIE CHART APPEARS HERE]
Property and Casualty
Regional Focus
---------------------
Michigan -- 41%
New York/
New Jersey -- 15%
New England -- 19%
Other States -- 25%
Property & Casualty
Leveraging Strengths
The intense regional focus of our property and casualty segment gives us an
advantage in the marketplace. Most of our business is conducted in markets we
know very well, with independent agents with whom we have built strong ties, and
where our share is large enough to permit economies of scale.
Hanover, which has been in the business of helping make people secure since
1852, gets approximately two-thirds of its premiums from the Northeast, where it
holds market shares of six percent in Maine and nearly five percent in
Massachusetts. Hanover is also strong and growing in New Hampshire, New Jersey,
New York, Rhode Island and Vermont, meeting the needs of its customers through
1,900 independent agents.
Hanover owns 82.5 percent of Citizens Corporation, the third largest property
and casualty competitor in Michigan with a market share of nearly 10 percent.
Although Citizens has been a Michigan success story since 1915, its more recent
performance has been particularly noteworthy. Since 1980, Citizens' market share
has more than tripled.
Our regional focus yields rewards in many different ways. Knowing our markets
means that we have a thorough understanding of the regulatory and competitive
climate we face. This allows us to assess underwriting risks more accurately and
to price products appropriately. Over the last five years, our consolidated P&C
segments' combined ratio has outperformed the industry average. Citizens'
combined ratio has continued to trend at or below 100, outperforming the
industry average for 18 consecutive years.
Our regional focus also helps provide customers with a feeling of security. We
do most of our business in markets where we are very well known, where consumers
have experienced our quality service and have heard of our good reputation. We
believe we have
[PHOTO APPEARS HERE]
In 1996, Hanover partnered with BJ's Wholesale Club to market auto insurance to
BJ's 347,000 Massachusetts members, while Citizens added the University of
Michigan Alumni Association to its large affinity group base.
26
[PIE CHART APPEARS HERE]
Property and Casualty
Product Mix
-------------------------------
Personal Auto -- 47%
Homeowners -- 12%
Workers' Comp. -- 12%
Commercial Auto -- 9%
Commercial Multiple Peril -- 13%
All other -- 7%
established generations of goodwill in key markets.
This geographic focus also helps us target profitable niches, and we are adept
at acting quickly when circumstances warrant. We are disciplined underwriters,
prepared to walk away from business when pricing gets overly ambitious. And we
have done a good job of communicating this philosophy to our agents, giving them
appropriate incentives for bringing us preferred business.
We continually refine product features to meet our target market needs. For
example, Hanover is in the midst of a program designed to improve its
underwriting profitability in the homeowners market. It has offered renewals
with a higher deductible and more stable, yet lower rates--a welcomed prospect
to policyholders. By allowing policyholders the option of self-insuring small
potential losses, we can ensure that major claims receive the utmost service and
attention.
New Market Opportunities
Analysts estimate that, industry-wide, P&C premiums will rise only about two
percent a year for the next few years. Both Hanover and Citizens intend to grow
more rapidly in total over that time frame, primarily through even more focus on
our strongest regional markets.
Driving this growth will be selective regional expansion along with worksite
and other group marketing initiatives. We expect to increase market share by
operating more efficiently and delivering better products in a variety of ways.
We believe that worksite sales may ultimately represent a substantial portion
of the P&C business-based on our current aggressive pursuit of this market. In
worksite marketing, we offer our products to employees under the sponsorship of
their employer. Employers like the arrangement because there is no cost to
provide a valued benefit to their
New technology solutions will improve
our claims processing efficiency. In policy processing, Hanover and Citizens are
among the national leaders in on-line connectivity with agents.
[PHOTO APPEARS HERE]
27
RISK MANAGEMENT CONTINUED
workforce. Employees value it because they can purchase insurance conveniently
at work, at a discount, and pay via payroll deduction or electronic funds
transfer.
With worksite enrollment and product sales, we are able to offer financial
planning programs, and, in some instances, may establish a permanent on-site
presence to serve employees. In other cases, we will sell an institutional
product to a company with the right to market directly to employees.
In a third approach, we enter into marketing partnerships with banks to sell
products to their employees and, potentially, to their corporate customers. In
1996, Citizens signed three bank marketing partnerships, while Hanover signed
many new worksite clients, including state employee groups, large corporations
and professional associations.
Hanover is increasing its efforts to penetrate the group employee market.
This business is appealing because we can underwrite policies twice, the first
time based on the employee groups' overall risk profile and, secondly based on
each individual. Both Hanover and Citizens have found that the group market
offers better underwriting characteristics, lower acquisition costs and higher
retention.
Hanover has had recent success pursuing joint marketing arrangements with
large companies. In 1996, it won the right to market auto insurance to the
347,000 Massachusetts members of BJ's Wholesale Club, the largest warehouse club
in New England.
Hanover is actively seeking to increase its six percent market share of the
workers' compensation business in Maine during 1997. Regulatory reform has made
this business attractive in many states and Hanover is well positioned to gain a
sizable share of the market.
[PHOTO APPEARS HERE]
Citizens' affinity group marketing offers personal lines products to more than
one hundred affinity groups and professional associations, throughout Michigan,
Indiana, and Ohio. Affinity marketing accounts for nearly half of Citizens'
premiums.
28
[PHOTO APPEARS HERE]
Citizens has grown from expansion in Indiana and Ohio by partnering with
quality, independent agencies. Premiums written in Indiana grew 15 percent in
1996, while premiums in Ohio reached $10 million in its first full year of
operations.
Technological Enhancements
Among insurers, our P&C segment is one of the nation's leading users of
technology solutions to improve strong relationships with independent agents. We
rely on our strong network of independent agents and are aware that agents may
elect to sell a competitor's product rather than our own. Like many business
people, they often follow the easiest path to do business. Our objective is to
provide that pathway. We believe that the appropriate use of technology makes it
easier for agents to do business with us through systems that speed
transactions, eliminate guesswork, and reduce errors. We use technology strateg-
ically to increase information processing, reduce costs wherever possible, and
to improve our competitive position with independent insurance agents.
So far, the agents' response indicates that we are on the right track.
We are among the top insurers in the country in terms of on-line connectivity to
agencies. The system allows both the agent and the company to speed the exchange
of information. As a result, agents can serve their customers more promptly.
Currently, the majority of all personal line policies are approved and processed
directly through the agency-company on-line management system.
In 1996, we also made progress in our effort to handle more of our commercial
lines in the same manner, a process we'll complete in late 1997.
In addition to front-line technology enhancements for agents, we are focused
on administrative process reengineering. Client service centers in Worcester and
Howell, Michigan, now handle many
[BAR GRAPH APPEARS HERE]
Citizens affinity
Group Premium
In millions
-----------------
96 -- $414
95 -- $406
94 -- $383
93 -- $345
92 -- $317
29
RISK MANAGEMENT CONTINUED
Citizens Care case management program has received national praise for handling
policyholder injuries promptly and effectively. We help people get the care that
will allow them to return to a normal lifestyle as soon as possible.
[PHOTO APPEARS HERE]
administrative functions, which is changing how the Hanover and Citizens
branches do business. Branch management can now better focus on strategic,
field-based marketing and underwriting support to the independent agency sales
force which actually sells our products.
Financial Strength
Financially, our P&C segment is in excellent shape, a result of strong market
performance and conservative fiscal management. Assets total $5.7 billion, and
investments are largely in high-quality municipal government and corporate
bonds. Almost 85 percent of the bonds we hold are investment grade.
Our P&C business has been conservative in its management of loss reserves, and
that policy continues. Our financial strength is further enhanced by the nature
of our underwriting. Most business lines are short-tail, with limited exposure
to potential lingering losses. Similarly, we have low environmental exposures.
Our conservative reinsurance activity minimizes risk while allowing for solid
profitability.
30
Five Year Summary of Selected Financial Highlights
- -------------------------------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1993 1992
=======================================================================================================
STATEMENT OF INCOME
- -------------------
Revenues
Premiums $ 2,236.3 $ 2,222.8 $ 2,181.8 $ 2,079.3 $ 2,172.4
Universal life and investment product
policy fees 197.2 172.4 156.8 143.7 132.9
Net investment income 672.6 710.5 743.1 782.8 823.7
Net realized gains 65.9 39.8 1.1 159.6 9.6
Other income 102.7 95.4 112.3 73.8 37.1
- -------------------------------------------------------------------------------------------------------
Total revenues 3,274.7 3,240.9 3,195.1 3,239.2 3,175.7
- -------------------------------------------------------------------------------------------------------
Benefits, Losses and Expenses
Policy benefits, claims, losses and loss
adjustment expenses 1,957.0 2,010.3 2,047.0 1,987.2 2,163.8
Policy acquisition expenses 483.5 470.3 475.7 435.8 424.1
Other operating expenses 502.5 458.5 518.9 421.3 373.5
- -------------------------------------------------------------------------------------------------------
Total benefits, losses and expenses 2,943.0 2,939.1 3,041.6 2,844.3 2,961.4
- -------------------------------------------------------------------------------------------------------
Income before federal income taxes 331.7 301.8 153.5 394.9 214.3
Federal income tax expense 75.2 82.7 53.4 74.7 62.7
- -------------------------------------------------------------------------------------------------------
Income before minority interest,
extraordinary item and cumulative
effect of accounting changes 256.5 219.1 100.1 320.2 151.6
Minority interest (74.6) (73.1) (51.0) (122.8) (54.4)
- -------------------------------------------------------------------------------------------------------
Income before extraordinary item and
cumulative effect of accounting changes 181.9 146.0 49.1 197.4 97.2
Extraordinary item -
demutualization expenses -- (12.1) (9.2) (4.6) --
Cumulative effect of accounting changes -- -- (1.9) (35.4) --
- -------------------------------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0 $ 157.4 $ 97.2
=======================================================================================================
Adjusted Net Income (1) $ 137.9 $ 116.4 $ 90.4 $ 119.1 $ 109.9
==========================================================================================================
BALANCE SHEET (AT DECEMBER 31)
- ------------------------------
Total assets $18,997.7 $17,757.7 $15,921.5 $15,378.4 $14,083.1
Long-term debt 202.2 202.3 2.7 -- --
Total liabilities 16,489.0 15,425.0 14,299.4 13,711.7 12,764.1
Minority interest 784.0 758.5 629.7 615.8 422.4
Shareholders' equity 1,724.7 1,574.2 992.4 1,050.9 896.6
(1) 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 and
differential earnings tax adjustments.
- --------------------------------------------------------------------------------
31
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
Property & Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned non-
insurance holding company), The Hanover Insurance Company ("Hanover", a wholly
owned subsidiary of Allmerica P&C), Citizens Corporation ("Citizens", an 82.5%-
owned subsidiary of Hanover), Citizens Insurance Company of America (a wholly
owned subsidiary of Citizens) and certain other insurance and non-insurance
subsidiaries.
Closed Block
- ------------
On completion of its demutualization, FAFLIC established a Closed Block for the
payment of future benefits, policyholders' dividends and certain expenses and
taxes relating to certain classes of policies. FAFLIC allocated to the Closed
Block an amount of assets expected to produce cash flows which, together with
anticipated revenues from the Closed Block business, are reasonably expected to
be sufficient to support the Closed Block business. The Closed Block includes
only those revenues, benefit payments, dividends and premium taxes considered in
funding the Closed Block and excludes many costs and expenses associated with
operating the Closed Block and administering the policies included therein.
Since many expenses related to the Closed Block were excluded from the
calculation of the Closed Block contribution, the contribution from the Closed
Block does not represent the actual profitability of the Closed Block. As a
result of such exclusion, operating costs and expenses outside the Closed Block
are disproportionate to the business outside of the Closed Block.
The contribution from the Closed Block is included in 'Other income' in the
Consolidated Financial Statements. The pre-tax contribution from the Closed
Block was $8.6 million for the year ended December 31, 1996 and $2.9 million for
the period October 1, 1995 (date used to estimate financial information for the
date of establishment of October 16, 1995) through December 31, 1995.
FAFLIC's conversion to a stock life insurance company, which was completed
on October 16, 1995, and the establishment of the Closed Block have affected the
presentation of the Company's Consolidated Financial Statements. For
comparability with prior periods, the following table presents the results of
operations of the Closed Block for the year ended December 31, 1996 and the
period October 1, 1995 through December 31, 1995 combined with the results of
operations outside the Closed Block for the years then ended. Management's
discussion and analysis addresses the results of operations as combined unless
otherwise noted.
For the Years Ended December 31
(In millions) 1996 1995 1994
- -------------------------------------------------------------------------------
Revenues
Premiums $2,298.0 $2,234.3 $2,181.8
Universal life and investment
product policy fees 197.2 172.4 156.8
Net investment income 725.2 723.3 743.1
Net realized investment gains 65.2 19.1 1.1
Realized gain on sale of mutual
fund processing business -- 20.7 --
Other income 94.1 92.5 112.3
- -------------------------------------------------------------------------------
Total revenues 3,379.7 3,262.3 3,195.1
- -------------------------------------------------------------------------------
Benefits, Losses and Expenses
Policy benefits, claims, losses
and loss adjustment expenses 2,058.2 2,030.9 2,047.0
Policy acquisition expenses 486.7 471.1 475.7
Other operating expenses 503.1 458.5 518.9
- -------------------------------------------------------------------------------
Total benefits, losses
and expenses 3,048.0 2,960.5 3,041.6
- -------------------------------------------------------------------------------
Income before federal
income taxes 331.7 301.8 153.5
- -------------------------------------------------------------------------------
Federal income tax expense (benefit)
Current 90.9 119.7 45.4
Deferred (15.7) (37.0) 8.0
- -------------------------------------------------------------------------------
Total federal income
tax expense 75.2 82.7 53.4
- -------------------------------------------------------------------------------
Income before minority
interest, extraordinary item,
and cumulative effect of
accounting change 256.5 219.1 100.1
Minority interest (74.6) (73.1) (51.0)
- -------------------------------------------------------------------------------
Income before extraordinary
item and cumulative effect of
accounting change 181.9 146.0 49.1
Extraordinary item -
demutualization expenses -- (12.1) (9.2)
Cumulative effect of change in
accounting principle -- -- (1.9)
- -------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0
===============================================================================
32
Results of Operations
- ---------------------
Consolidated Overview
- ---------------------
1996 Compared to 1995
- ---------------------
The Company's consolidated net income increased $48.0 million to $181.9 million
in 1996. Net income includes certain items which management believes are not
indicative of overall operating trends.
The following table reflects consolidated net income adjusted for these
items, all net of taxes and minority interest as applicable.
For the Years Ended December 31
(In millions) 1996 1995
==============================================================================
Net income $181.9 $133.9
Adjustments:
Net realized investment gains (31.0) (8.5)
Net gain on sale of mutual
fund processing business -- (13.5)
Extraordinary item-
demutualization expense -- 12.1
Contingency payment from sale of mutual
fund processing business (3.1) --
Restructuring costs 0.3 --
Differential earnings tax adjustment (10.2) (7.6)
- -------------------------------------------------------------------------------
Adjusted net income $137.9 $116.4
===============================================================================
The increase in adjusted net income of $21.5 million is primarily
attributable to pre-tax increases of $39.6 million and $11.1 million in the
Retail Financial Services and Institutional Services segments, respectively,
partially offset by pre-tax decreases of $12.8 million and $43.2 million in the
Corporate and Regional Property and Casualty segments, respectively. The
increase in the Retail Financial Services segment resulted primarily from
increased fees from strong variable product growth, decreased losses in the
disability income line and income earned on proceeds from the Company's October,
1995 initial public offering. The increase in the Institutional Services segment
related principally to exiting certain unprofitable businesses in 1995. These
increases were partially offset by losses in the Corporate segment primarily due
to interest expense on the Company's 7 5/8% Senior Debentures issued in October
1995. Additionally, the Regional Property and Casualty segment's adjusted net
income decreased primarily due to severe weather-related claims during 1996,
partially offset by an increase in net investment income of $25.8 million, as
well as a $5.7 million arbitrated settlement from a voluntary pool.
Premium revenue increased $63.7 million, or 2.9%, to $2,298.0 million during
1996. Property and casualty premiums earned increased $35.1 million, or 1.9%, to
$1,898.3 million, reflecting the accounting effects of restructuring a
reinsurance contract at Hanover, increasing net premiums earned by approximately
$19.0 million. In addition, a 2.0% increase in policies in force in the
homeowners line as well as moderate price increases in this line contributed to
the increase in net premiums earned. The growth in Citizens' personal lines is
due to increases in net premiums earned in Ohio and Indiana resulting from
expansion in these states as well as price increases in the personal automobile
and homeowners lines. These increases were partially offset by decreases in the
commercial line due to rate decreases in workers' compensation, Hanover's
withdrawal from a large voluntary pool and continued competitive market
conditions. Premiums in the Corporate Risk Management Services segment increased
$30.2 million, or 11.1%, to $302.9 million due to increases in reinsurance,
fully insured group dental, group life, and stop loss product lines totaling
$33.1 million. These increases were partially offset by a $4.0 million decrease
in fully insured group medical premiums. Premiums in the Retail Financial
Services segment decreased $2.4 million, or 2.4%, to $95.7 million, primarily
reflecting the Company's continued shift in focus from traditional life
insurance products to variable life insurance and annuity products.
Universal life and investment product policy fees increased $24.8 million,
or 14.4%, to $197.2 million in 1996. This reflected additional deposits and
appreciation on variable products account balances.
Net investment income before taxes was relatively flat, increasing 0.3% to
$725.2 million during 1996. This increase primarily reflects approximately $20.0
million of incremental income in 1996 on proceeds from the Company's initial
public offering and from the issuance of Senior Debentures in October 1995, as
well as approximately $17.2 million in income from increases in short-term debt
used to finance additions to the investment portfolio. In addition, the Regional
Property and Casualty segment had $10.0 million of income from limited
partnerships in 1996. These increases were substantially offset by a reduction
in invested assets due to declining Guaranteed Investment Contracts ("GICs")
deposits resulting in a decline in investment income of $54.4 million. The
average gross yield of the portfolio was 7.2% in 1996 and 1995.
Net realized gains on investments were $65.2 million and $19.1 million,
before taxes, and $42.4 million and $12.4 million, after taxes, in 1996 and
1995, respectively. In 1996, the Regional Property and Casualty segment revised
its investment strategy, resulting in the sale of a portion of its equity
portfolio and the purchase of tax-exempt securities. Consequently, Regional
Property and Casualty segment realized gains increased $22.5 million, to $31.3
million on an after-tax basis in 1996. Additionally, Institutional Services
segment realized investment
33
gains increased $8.9 million on an after-tax basis in 1996, primarily reflecting
additional real estate sales in favorable market conditions.
Results in 1995 included a $20.7 million pre-tax gain from the March 1995
sale of the Company's mutual fund processing business.
Other income increased $1.6 million, or 1.7%, to $94.1 million in 1996.
Other income from the Retail Financial Services segment increased $6.8 million,
primarily attributable to increased investment management income. Additionally,
other income in the Allmerica Asset Management and Regional Property and
Casualty segments increased $4.4 million and $3.1 million, respectively. These
increases were partially offset by decreases in the Institutional Services
segment resulting primarily from the sale of the mutual fund processing business
in March of 1995, which had contributed revenues of approximately $13.7 million
in that year. Also, 1996 results included a non-recurring $4.8 million pre-tax
contingent payment related to the aforementioned sale. Other income attributable
to the Corporate Risk Management Services segment decreased $2.1 million,
primarily due to an $11.1 million litigation settlement recognized in the fourth
quarter of 1995, partially offset by growth in Administrative Services Only
("ASO") and contract fees totaling $7.9 million.
Policy benefits, claims, losses and loss adjustment expenses ("LAE")
increased $27.3 million, or 1.3%, to $2,058.2 million during 1996. This increase
is primarily attributable to an $83.1 million, or 6.4%, increase in losses and
LAE in the Company's Regional Property and Casualty segment as a result of
catastrophe losses and severe weather in 1996. Additionally, policy benefits,
claims, losses and LAE increased $14.1 million, or 7.2%, in the Corporate Risk
Management Services segment resulting primarily from product growth. These
increases were partially offset by decreased policy benefits of $57.7 million,
or 26.5%, in the Institutional Services segment primarily resulting from the
continuing decline of GICs during 1996 and decreases in the Retail Financial
Services segment of $12.2 million, or 3.9%, due primarily to reserve
strengthening in the disability income line in 1995.
Policy acquisition expenses consist primarily of commissions, premium taxes
and other policy issuance costs. Policy acquisition expenses increased $15.6
million, or 3.3%, to $486.7 million during 1996. This was primarily due to an
increase of $13.5 million, or 3.3%, to $422.6 million in the Regional Property
and Casualty segment primarily reflecting growth in net premiums earned.
Other operating expenses increased $44.6 million, or 9.7%, to $503.1 million
in 1996 across all major segments, except the Institutional Services segment.
Other operating expenses in the Retail Financial Services segment increased
$17.0 million, or 16.8%, to $118.2 million in 1996, primarily from an $8.3
million increase in short-term borrowing costs used to finance additions to the
investment portfolio. Other operating expenses in the Corporate Risk Management
Services segment increased $16.1 million, or 14.6%, to $126.4 million in 1996 as
a result of increased commissions, claims processing expenses and field office
expenses, resulting from the increased volume of both premiums and claims. The
Corporate segment's other operating expenses increased $15.1 million in 1996,
principally related to interest expense on the Company's Senior Debentures for a
full year in 1996 versus one quarter in 1995. Additionally, the Regional
Property and Casualty segment's other operating expenses increased $10.6 million
due primarily to technology and other administrative expenses. These increases
were partially offset by a decrease of $19.8 million in the Institutional
Services segment related to the sale of the mutual fund processing business in
March 1995.
Federal income tax expense decreased $7.5 million in 1996, while the
effective tax rate decreased from 27.4% to 22.7% in the same period. For the
life insurance subsidiaries, the effective rate decreased slightly from 32.0% to
28.9%, primarily due to additional reserves provided for revisions of estimated
prior year tax liabilities in 1995, as well as an increase of $2.6 million in
the differential earnings benefit from 1995 to 1996. For the property and
casualty subsidiaries, a decrease in the effective rate from 25.3% to 18.4%
resulted from a higher underwriting loss and a greater proportion of pre-tax
income from tax-exempt bonds in 1996, and to reserves provided for revisions of
estimated prior year tax liabilities in 1995.
1995 Compared to 1994
- ---------------------
The Company's consolidated net income increased $95.9 million to $133.9 million
in 1995. Net income includes certain items which management believes are not
indicative of overall operating trends.
The following table reflects consolidated net income adjusted for these
items, all net of taxes and minority interest.
FOR THE YEARS ENDED DECMEBER 31
(IN MILLIONS) 1995 1994
===============================================================================
Net income $133.9 $38.0
Adjustments:
Net realized investment (gains) losses (8.5) 0.1
Net (gain) loss on disposal of businesses (13.5) 6.2
Extraordinary item - demutualization expenses 12.1 9.2
Cumulative effect of accounting change -- 1.9
Differential earnings tax adjustment (7.6) 35.0
- -------------------------------------------------------------------------------
Adjusted net income $116.4 $90.4
===============================================================================
The increase in adjusted net income of $26.0 million is primarily
attributable to a pre-tax increase of $83.2 million in the Regional Property and
Casualty segment due to improved underwriting results primarily attributable to
favorable 1995 claims experience resulting from a return to more normal
34
- --------------------------------------------------------------------------------
weather conditions in the Northeast and in Michigan. Additionally, adjusted net
income increased $17.3 million in the Retail Financial Services segment,
resulting primarily from an increase in fee revenue from variable products and a
decrease in policy acquisition expenses for all major products. These increases
were partially offset by an increase in disability income policy benefits and
decreased interest margins. Also, adjusted net income in the Institutional
Services segment increased $13.8 million, primarily attributable to the sale of
the Company's mutual fund processing business in March 1995, which decreased
1995 revenue from this business by $38.3 million and expenses by $49.3 million,
contributing $11.0 million to adjusted net income before taxes for this period.
Premium revenue increased $52.5 million, or 2.4%, to $2,234.3 million during
1995 as a result of increased property and casualty premiums earned, partially
offset by a decrease in premiums from traditional life products. Regional
Property and Casualty premiums earned increased $71.9 million, or 4.0%, to
$1,863.2 million, as a result of growth in the personal lines. Premiums in the
Retail Financial Services segment decreased $23.5 million, or 19.3%, to $98.1
million, reflecting the cession in January of 1995 of substantially all yearly
renewable term ("term") insurance.
Universal life and investment-type product policy fees increased $15.6
million, or 9.9%, to $172.4 million during 1995. This resulted from additional
deposits and appreciation on variable products account balances.
Net investment income before taxes decreased $19.8 million, or 2.7%, to
$723.3 million during 1995. Although overall invested assets have remained at
approximately the same level in 1995 versus 1994, net investment income has
decreased due to decreases in the average portfolio yields. The average gross
yield of the fixed maturity investment portfolio decreased from 7.5% during
1994, to 7.2% during 1995.
Net realized gains on investments before taxes were $19.1 million during
1995, versus $1.1 million during 1994. After taxes, net realized gains on
investments were $12.4 million during 1995, versus $0.7 million during 1994.
This change is primarily attributable to gains taken on sales of equity
securities and real estate, partially offset by losses on sales of fixed
maturities.
Results in 1995 include a $20.7 million pre-tax gain from the March 1995
sale of the Company's mutual fund processing business.
Policy benefits, claims, losses and LAE decreased $16.1 million, or 0.8%, to
$2,030.9 million during 1995. Property and casualty losses and LAE decreased
$15.2 million, or 1.2%, to $1,300.3 million during 1995, primarily due to a
return to more normal weather conditions during the first half of 1995 in the
Northeast and in Michigan. Institutional Services policy benefits decreased
$30.3 million, or 12.2%, to $217.8 million in 1995 as a result of the decrease
in interest credited during 1995, due to declining GIC deposits. These decreases
were partially offset by increases in Retail Financial Services policy benefits
of $14.8 million, or 4.9%, to $315.6 million during 1995, reflecting increased
policy benefits of $21.6 million due to adverse morbidity and reserve
strengthening in the disability line in 1995, partially offset by a decline in
traditional life benefits resulting from the cession of term insurance. Policy
benefits in the Corporate Risk Management Services segment also increased by
$14.6 million, or 8.0%, to $197.2 million during 1995, primarily due to a
deterioration in claims experience in all major lines.
Policy acquisition expenses decreased $4.6 million, or 1.0%, to $471.1
million during 1995. This was due primarily to a decrease of $23.4 million, or
29.4%, to $56.1 million in the Retail Financial Services segment due to reduced
profit margins resulting from increased mortality and reduced investment
margins, which resulted in a corresponding reduction in amortization, and due to
the cession of term insurance, for which the amortization of deferred
acquisition costs totaled $12.1 million in 1994. This decrease was mostly offset
by an increase in policy acquisition expenses in the Regional Property and
Casualty segment of $18.8 million, or 4.8%, to $409.1 million during 1995,
primarily related to the increase in net premiums earned.
Other operating expenses decreased $60.4 million, or 11.6%, to $458.5
million during 1995, resulting primarily from a decrease of $58.1 million in
operating expenses in the Institutional Services segment, caused by the sale of
the mutual fund processing business in March, 1995 and by reduced expenses
resulting from exiting certain other product lines and businesses, primarily
various processing services for defined contribution plans.
Federal income tax expense increased $29.3 million in 1995, while the
effective tax rate decreased from 34.8% in 1994 to 27.4% in 1995. The decrease
in the effective tax rate resulted from a lower expected differential earnings
charge for the life insurance subsidiaries in 1995, which was partially offset
by an increase in the property and casualty effective tax rate due to improved
underwriting results, a decrease in the proportion of pre-tax income
attributable to tax-exempt interest, and to reserves provided for revisions in
estimated prior year tax liabilities.
SEGMENT RESULTS
- ---------------
The following is management's discussion and analysis of the Company's results
of operations by business segment. The Company offers financial products and
services in two major areas: Risk Management and Retirement and Asset
Management. Within these broad areas, the Company conducts business principally
in five operating segments. These segments are Regional Property and Casualty;
Corporate Risk Management Services; Retail Financial Services; Institutional
Services; and Allmerica Asset Management. The Regional Property and Casualty
segment consists of the Company's
35
- --------------------------------------------------------------------------------
59.5% ownership of Allmerica P&C; however, all property and casualty results
presented include 100% of Allmerica P&C's pre-tax results of operations,
consistent with the presentation in the Company's consolidated financial
statements. The other segments are all owned and operated by FAFLIC and its
wholly owned subsidiaries.
In addition to the five operating segments, the Company also has a Corporate
segment, which consists primarily of Senior Debentures and a portion of the net
proceeds from the Company's initial public offering. These proceeds are invested
primarily in fixed maturities at December 31, 1996.
RISK MANAGEMENT
- ---------------
Regional Property and Casualty
- ------------------------------
The following table summarizes the results of operations for the Regional
Property and Casualty segment.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==============================================================================
Revenues
Net premiums earned $1,898.3 $1,863.2 $1,791.3
Net investment income 235.4 209.6 202.4
Net realized gains 48.1 13.5 3.5
Other income 11.9 8.8 7.6
- ------------------------------------------------------------------------------
Total revenues 2,193.7 2,095.1 2,004.8
Losses and LAE (1) 1,383.4 1,300.3 1,315.5
Policy acquisition expenses 422.6 409.1 390.3
Other operating expenses 190.0 179.4 185.9
- ------------------------------------------------------------------------------
Income before taxes $ 197.7 $ 206.3 $ 113.1
==============================================================================
(1) Includes policyholders' dividends of $11.5 million, $10.6 million and $8.8
million in 1996, 1995 and 1994, respectively.
INCOME BEFORE TAXES
- -------------------
1996 Compared to 1995
- ---------------------
Income before taxes decreased $8.6 million, or 4.2%, to $197.7 million in 1996.
This decrease resulted from catastrophes and other severe weather related losses
which contributed to an $83.1 million increase in losses and LAE to $1,383.4
million. Catastrophe losses increased $27.3 million, to $62.9 million in 1996
from $35.6 million during the previous year. The increase in losses and LAE was
partially offset by an increase in net investment income of $25.8 million, or
12.3%, to $235.4 million, attributable to an increase in higher-yielding debt
securities in the portfolio and earnings from a limited partnership. The
decrease in income before tax was also offset by a $33.5 million increase in
realized gains, primarily related to the sale of equity securities, reflecting
the Regional Property and Casualty segment's decision during the first quarter
of 1996 to increase the proportion of debt securities in the portfolio. Income
was also favorably impacted by a $5.7 million arbitrated settlement from a
voluntary pool during the third quarter.
1995 Compared to 1994
- ---------------------
Income before taxes increased $93.2 million, or 82.4%, to $206.3 million in
1995. This increase resulted primarily from improved underwriting results
attributable to favorable current year claims experience resulting from a return
to more normal weather conditions in the Northeast and in Michigan. Catastrophe
losses decreased $10.5 million, to $35.6 million in 1995, from $46.1 million
during the previous year.
LINES OF BUSINESS RESULTS
- -------------------------
Personal Lines of Business
- --------------------------
The personal lines represented 61.2%, 59.8% and 58.3% of total net premiums
earned in 1996, 1995 and 1994, respectively.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1996 1995 1994 1996 1995 1994
==============================================================================================================================
Total Regional Property
Hanover Citizens and Casualty
Net premiums earned $ 607.3 $ 577.1 $ 548.2 $ 554.6 $ 536.2 $ 496.1 $ 1,161.9 $ 1,113.3 $ 1,044.3
Losses and loss adjustment
expenses incurred 452.0 368.6 366.0 404.1 413.6 391.0 856.1 782.2 757.0
Policy acquisition expenses 150.8 135.2 125.9 112.5 108.1 99.5 263.3 243.3 225.4
Other underwriting expenses 51.7 49.7 50.0 39.3 41.1 37.9 91.0 90.8 87.9
- ------------------------------------------------------------------------------------------------------------------------------
Underwriting (loss) profit $ (47.2) $ 23.6 $ 6.3 $ (1.3) $ (26.6) $ (32.3) $ (48.5) $ (3.0) $ (26.0)
==============================================================================================================================
36
1996 Compared to 1995
- ---------------------
Revenues
Net premiums earned by the personal lines increased $48.6 million, or 4.4%, to
$1,161.9 million in 1996, compared to $1,113.3 million in 1995. Hanover's
personal lines net premiums earned increased $30.2 million, or 5.2%, to $607.3
million during 1996. This increase is primarily attributable to an increase in
the personal automobile line associated with the accounting effects of
restructuring a reinsurance contract, increasing net premiums earned by $19.0
million. A 2.0% increase in policies in force in Hanover's homeowners line as
well as moderate price increases in this line also contributed to the increase
in net premiums earned. These increases were partially offset by a mandated 4.5%
decrease in Massachusetts personal automobile rates which became effective
January 1, 1996. Effective January 1, 1997, Massachusetts personal automobile
rates were decreased an additional 6.2% as mandated by the Massachusetts
Insurance Commissioner. In addition, in response to increasing price competition
in Massachusetts, Hanover, in February 1997, requested the Massachusetts
Division of Insurance to approve a plan to offer a safe driver's discount of 10%
on automobile insurance premiums. Management believes these actions may
unfavorably impact premium growth in Massachusetts. Approximately 39% of
Hanover's personal automobile business is currently written in Massachusetts.
[LINE GRAPH APPEARS HERE]
Personal Lines
Net Premiums Earned (In millions)
96 - $1,162
95 - $1,113
94 - $1,044
Citizens' personal lines' net premiums earned increased $18.4 million, or
3.4%, to $554.6 million in 1996. This growth is attributable to price increases
in the personal automobile and homeowners lines. The growth is partially offset
by a 3.0% decrease in policies in force in the personal automobile line,
attributable to the segment's selective reduction of writings in Michigan when
rates were viewed as inadequate, and to continued strong competition in
Michigan. While management has taken steps to increase penetration in affinity
groups and has initiated other marketing programs, heightened competition may
continue to result in reduced growth in the personal lines.
Underwriting results
The personal lines' underwriting loss in 1996 increased $45.5 million, to a loss
of $48.5 million. Hanover's underwriting results deteriorated $70.8 million to a
loss of $47.2 million, while Citizens' underwriting loss improved $25.3 million
to a loss of $1.3 million.
Hanover's personal lines' losses and LAE increased $83.4 million, or 22.6%,
to $452.0 million in 1996. This increase is partially attributable to a $28.8
million increase in losses and LAE in the homeowners line, resulting from
increased catastrophes and severe weather. Catastrophe losses in Hanover's
personal lines increased $17.2 million, to $30.6 million in 1996 from $13.4
million in 1995. Losses and LAE in the personal automobile line increased $49.6
million, or 17.8%, to $328.0 million, primarily reflecting the accounting
effects of restructuring a reinsurance contract, increasing losses by $19.0
million, in addition to a moderate increase in claims frequency and a $4.7
million reduction in favorable reserve development.
The improvement in Citizens' underwriting results reflects favorable claims
activity in both current and prior accident years in the personal automobile
line attributable to continued improvements in severity. This was partially
offset by an increase in catastrophe losses of $6.2 million to $13.4 million,
primarily in the homeowners line.
Policy acquisition expenses in the personal lines increased $20.0 million,
or 8.2%, to $263.3 million and other underwriting expenses increased $0.2
million to $91.0 million in 1996. This increase in policy acquisition expenses
is primarily attributable to an increase of $15.6 million, or 11.5%, to $150.8
million at Hanover resulting from a reapportionment of certain acquisition
expenses to the personal lines from the commercial lines, as well as an increase
in net premiums earned. The $2.0 million increase in Hanover's other
underwriting expenses resulted from an increase of approximately $4.0 million in
expenses associated with the policy administration technology project, offset by
a decrease in assessment expenses associated with the reapportionment of an
involuntary pool. Policy acquisition expenses in the personal lines at Citizens
increased $4.4 million, or 4.1%, to $112.5 million in 1996, reflecting growth in
net premiums earned. The $1.8 million decline in Citizens' other underwriting
expenses is primarily attributable to reductions in employee related expenses
and commissions, partially offset by expenses associated with a policy
administration technology project. Management anticipates an increase in this
segment's expense levels due to further planned investments in technology.
1995 Compared to 1994
- ---------------------
Revenues
Net premiums earned by the personal lines increased $69.0 million, or 6.6%, to
$1,113.3 million in 1995. Hanover's net premiums earned increased $28.9 million,
or 5.3%, to $577.1 million in 1995. The increase is primarily attributable to a
2.0% and 1.3% increase in policies in force in the personal automobile and
homeowners lines, respectively, and a 2.5% rate increase in the homeowners line.
Hanover's premium growth in the personal lines in 1995 was partially offset by a
mandated 6.5% decrease in Massachusetts automobile insurance rates, which was
effective January 1, 1995.
37
Citizens' personal lines net premiums earned increased $40.1 million, or
8.1%, to $536.2 million in 1995. This increase reflects price increases in the
personal automobile and homeowners lines, and was partially offset by a 5.8%
decrease in personal automobile policies in force. This decrease is attributable
to the Company's selective reduction of writings in Michigan when rates were
viewed as inadequate, and to increased competition in affinity group franchise
sales as a result of the January 1995 order by the Michigan Insurance
Commissioner which has permitted competitors to offer similar products.
Underwriting Results
The personal lines underwriting loss decreased $23.0 million, from $26.0 million
in 1994, to $3.0 million in 1995. Hanover's underwriting results improved $17.3
million, from a profit of $6.3 million in 1994, to a profit of $23.6 million in
1995. Citizens' underwriting loss improved $5.7 million, or 17.6%, from $32.3
million in 1994, to $26.6 million in 1995.
The improvement in Hanover's underwriting results is primarily attributable
to favorable claims experience on current years claims in the homeowners line
resulting from a decrease in catastrophe losses from $27.2 million in 1994, to
$13.4 million during 1995, and to a return to more normal weather conditions
during the first half of 1995. This resulted in a decrease in losses and LAE in
the homeowners line of $17.8 million, or 17.9%, from $99.2 million in 1994, to
$81.4 million in 1995.
The change in Citizens' underwriting results reflects a return to more
normal weather conditions in Michigan as well as favorable claims activity in
both current and prior accident years in the personal automobile line
attributable to improvements in severity. Citizens' underwriting results
improved despite a $3.4 million increase in catastrophe losses in the personal
lines, primarily in the homeowners line. Catastrophe losses were $7.2 million
and $3.8 million in Citizens' personal lines in 1995 and 1994, respectively.
The increase in policy acquisition expenses in the personal lines of $17.9
million, or 7.9%, to $243.3 million in 1995, reflects the growth in net earned
premiums at both Hanover and Citizens. Other underwriting expenses at Hanover
remained relatively unchanged at $49.7 million in 1995, compared to $50.0
million in 1994. Other underwriting expenses at Citizens increased by $3.2
million, or 8.4%, to $41.1 million in 1995, reflecting the growth in net
premiums earned in 1995.
Commercial Lines of Business
- ----------------------------
The commercial lines represented 38.8%, 40.2% and 41.7% of net premiums earned
in 1996, 1995 and 1994, respectively.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994 1996 1995 1994 1996 1995 1994
====================================================================================================================================
Total Regional Property
Hanover Citizens and Casualty
Net premiums earned $455.5 $468.3 $480.4 $280.9 $281.6 $266.6 $736.4 $749.9 $747.0
Losses and loss adjustment
expenses incurred 315.5 342.8 361.2 200.3 164.7 188.5 515.8 507.5 549.7
Policy acquisition expenses 107.7 114.3 117.6 51.6 51.5 47.3 159.3 165.8 164.9
Other underwriting expenses (1) 74.0 73.8 77.6 27.0 25.4 29.2 101.0 99.2 106.8
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting (loss) profit $(41.7) $(62.6) $(76.0) $ 2.0 $ 40.0 $ 1.6 $(39.7) $(22.6) $(74.4)
====================================================================================================================================
(1) Includes policyholders' dividends.
1996 Compared to 1995
- ---------------------
Revenues
Commercial lines' net premiums earned in 1996 decreased $13.5 million, or 1.8%,
to $736.4 million. Hanover's commercial lines net premiums earned decreased
$12.8 million, or 2.7%, to $455.5 million. This decrease is primarily
attributable to Hanover's withdrawal from a large voluntary pool on December 1,
1995, and to aggregate rate decreases of 14.6% since January 1, 1995, in the
workers' compensation line. Citizens' commercial lines' net premiums earned
decreased $0.7 million, or 0.2%, to $280.9 million in 1996. This decrease
primarily reflects rate reductions and a 1.4% decrease in policies in force in
the workers' compensation line due to continuing competition in this line in
Michigan. Rates in the workers' compensation line at Citizens were decreased
8.5%, 7.0% and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996,
respectively. This decrease is partially offset by an increase in policies in
force in the commercial multiple peril and commercial automobile lines of 13.2%
and 3.7%, respectively. Management believes competitive conditions in the
workers' compensation line may impact future growth in net premiums earned.
Underwriting results
The commercial lines' underwriting loss for 1996 increased $17.1 million, or
75.7% to a loss of $39.7 million. Hanover's underwriting loss improved $20.9
million, or 33.4%, to a loss of $41.7 million and Citizens' underwriting profit
decreased $38.0 million, to a profit of $2.0 million in 1996.
Hanover's commercial lines losses and LAE decreased $27.3 million, or 8.0%,
to $315.5 million in 1996. This improvement is primarily attributable to a $41.5
million decrease in losses and LAE resulting from the withdrawal from a large
voluntary pool.
38
However, this decrease was partially offset by increased losses in the workers'
compensation line of $17.9 million, primarily due to a $19.8 million decrease in
favorable reserve development during 1996.
Citizens' underwriting profit decreased primarily due to an increase in
loss severity and frequency in the commercial multiple peril line. Commercial
multiple peril losses and LAE increased $16.9 million, or 42.4%, to $56.8
million in 1996, partially offset by a $5.1 million, or 9.4% increase to $59.1
million in net premiums earned. Workers' compensation net premiums earned
decreased $17.6 million, or 11.9%, to $130.7 million in 1996, while losses and
LAE increased $9.6 million, or 15.0%, to $73.4 million in this line, primarily
due to reduced favorable development of prior year reserves. Catastrophe losses
in the commercial lines were $1.9 million in 1996 compared to $0.8 million
during 1995.
[LINE GRAPH APPEARS HERE]
Commercial Lines
Underwriting Loss ( In millions)
96 - $39.7
95 - $22.6
94 - $74.4
Policy acquisition expenses in the commercial lines decreased $6.5 million,
or 3.9%, to $159.3 million in 1996 and other underwriting expenses increased
$1.8 million, or 1.8%, to $101.0 million. Hanover's policy acquisition expenses
decreased $6.6 million, or 5.8%, to $107.7 million, primarily attributable to a
reapportionment of certain acquisition expenses from the commercial lines to the
personal lines, as well as the decrease in net earned premium. Other
underwriting expenses at Hanover increased $0.2 million, to $74.0 million as a
result of an increase of approximately $3.0 million in expenses associated with
the policy administration technology project, which were partially offset by a
net decrease in assessment expenses associated with voluntary and involuntary
pools. Citizens' policy acquisition expenses in the commercial lines remained
consistent between years, primarily as a result of flat net earned premiums.
Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million in
1996, due to investments in technology and increased policyholders' dividends,
partially offset by reductions in employee related expenses and commissions.
Management anticipates an increase in its expense levels due to further planned
investments in technology.
1995 Compared to 1994
- ---------------------
Revenues
Commercial lines' net premiums earned increased $2.9 million, to $749.9 million
in 1995. Hanover's commercial lines net premiums earned decreased $12.1 million,
or 2.5%, to $468.3 million in 1995, reflecting decreases in policies in force in
all major commercial lines, particularly a $10.7 million, or 9.4%, decrease in
commercial automobile net premiums earned to $103.1 million, resulting from
continued competitive market conditions affecting Hanover. Workers' compensation
net premiums earned at Hanover decreased $6.4 million, or 5.8%, to $104.4
million in 1995, primarily as a result of rate decreases and an increasing level
of large deductible policies.
Citizens' commercial lines' net premiums earned increased $15.0 million, or
5.6%, to $281.6 million in 1995. This increase primarily reflects growth of 8.1%
in total commercial policies in force. The overall growth includes increases in
policies in force in the commercial automobile and commercial multiple peril
lines of 12.5% and 11.6%, respectively, along with a decrease in workers'
compensation policies in force of 4.6% and rate decreases of 15.5% in the
workers' compensation line in 1995. These decreases in workers' compensation
premiums were more than offset by increased workforce coverage due to full
employment in Michigan. Price increases in the commercial automobile line also
contributed to the increase in net premiums earned.
Underwriting Results
The commercial lines' underwriting loss improved $51.8 million to $22.6 million
in 1995. Hanover's underwriting loss improved to a loss of $62.6 million, from
$76.0 million, and Citizens' underwriting profit increased from $1.6 million in
1994, to $40.0 million in 1995.
Hanover's commercial lines' losses and LAE decreased by $18.4 million, or
5.1%, to $342.8 million in 1995. This improvement is primarily attributable to
decreased losses and LAE in the workers' compensation and commercial automobile
lines. Losses and LAE in the workers' compensation line decreased $34.7 million,
or 47.6%, from $72.9 million in 1994 to $38.2 million in 1995. This decrease
resulted from continued favorable claims experience for both the current and
prior years. Commercial automobile losses and LAE decreased $14.9 million, or
17.0%, from $87.7 million in 1994 to $72.8 million in 1995. This decrease
results from favorable claims experience in this line for both the current and
prior years, and a decrease in premiums earned. Losses and LAE in Hanover's
other commercial lines, which consist primarily of voluntary pools, general
liability and inland marine, increased $28.9 million, or 55.0%, from $52.5
million in 1994, to $81.4 million in 1995. Commercial lines were also
unfavorably impacted by a $25.9 million loss in an industrial voluntary pool,
including a $12.0 million charge during the fourth quarter of 1995.
The improvement in Citizens' underwriting results in 1995 reflects
favorable claims activity in both current and prior accident years in the
workers' compensation line attributable to improvements in severity and
frequency, and to severe weather and large claims in the first half of 1994
which had an adverse impact on the commercial multiple peril and commercial
automobile lines.
39
Policy acquisition expenses in the commercial lines decreased $0.9 million,
or 0.5%, to $165.8 million in 1995. Policy acquisition expenses in the
commercial lines at Citizens increased $4.2 million, or 8.9%, from $47.3 million
in 1994, to $51.5 million in 1995, reflecting the growth in net premiums earned.
Hanover's policy acquisition expenses decreased $3.3 million, or 2.8%, from
$117.6 million in 1994, to $114.3 million in 1995, reflecting the decrease in
net earned premiums. Other underwriting expenses at Hanover decreased $3.8
million, or 4.9%, from $77.6 million in 1994, to $73.8 million in 1995,
reflecting the decrease in net premiums written. Other underwriting expenses at
Citizens decreased $3.8 million, or 13.0%, from $29.2 million in 1994, to $25.4
million in 1995. This decrease reflects the unusually high level of expenses
incurred during 1994 resulting from the expansion into Ohio including the cost
of preparing to write multi-state and cross-state commercial line policies, as
well as a reduction in 1995 administrative expenses resulting from process
improvements in the commercial lines.
INVESTMENT RESULTS
- ------------------
Net investment income before tax was $235.4 million, $209.6 million and $202.4
million in 1996, 1995 and 1994, respectively. The increase from 1995 to 1996
represents an increase in average invested assets, $10.0 million of income from
limited partnerships, and the Regional Property and Casualty segment's portfolio
shift to higher yielding debt securities, including longer duration and non-
investment grade securities. Also, the average pre-tax yield on debt securities
increased from 6.1% in 1995 to 6.4% in 1996. Net investment income increased
from 1994 to 1995 as a result of increased average invested assets partially
offset by a decrease in the portfolio's average pre-tax yield from 6.2% in 1994
to 6.0% in 1995. This decrease resulted primarily from lower yields available on
new investments relative to the yields on maturing investments. Net realized
gains on investments before taxes were $48.1 million, $14.6 million and $3.5
million in 1996, 1995 and 1994, respectively. The high level of realized gains
in 1996 was primarily the result of sales of appreciated equity securities due
to the strategy of shifting to a higher level of debt securities. The $10.0
million increase in net realized gains in 1995 was due to increased gains on the
sale of equity securities.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
- -----------------------------------------------
The Regional Property and Casualty segment maintains reserves to provide for its
estimated 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 Regional Property and Casualty segment 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
(IN MILLIONS) 1996 1995 1994
================================================================================
Reserve for losses and LAE,
beginning of year $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events
of current year 1,513.3 1,427.3 1,434.8
Decrease in provision for
insured events of prior years (141.4) (137.6) (128.1)
- --------------------------------------------------------------------------------
Total incurred losses and LAE 1,371.9 1,289.7 1,306.7
- --------------------------------------------------------------------------------
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 759.6 652.2 650.2
Losses and LAE attributable to
insured events of prior years 627.6 614.3 566.9
- --------------------------------------------------------------------------------
Total payments 1,387.2 1,266.5 1,217.1
- --------------------------------------------------------------------------------
Change in reinsurance recoverable
on unpaid losses (136.6) 51.1 14.8
- --------------------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,744.1 $2,896.0 $2,821.7
================================================================================
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $141.4 million, $137.6 million and
$128.1 million in 1996, 1995, and 1994, respectively. The increase in favorable
development on prior years' reserves of $3.8 million in 1996 results primarily
from an $11.4 million increase in favorable development at Citizens. The
increase in Citizens' favorable development of $11.4 million in 1996 reflects
improved severity in the personal automobile line, where favorable development
increased $28.6 million to $33.0 million in 1996, partially offset by less
favorable development in the workers' compensation
40
line. In 1995, the workers' compensation line had favorable development of $32.7
million, primarily as a result of Citizens re-estimating reserves to reflect the
new claims cost management programs and the Michigan Supreme Court ruling, which
decreases the maximum to be paid for indemnity cases on all existing and future
claims. In 1996, the favorable development in the workers' compensation line of
$21.8 million also reflected these developments. Hanover's favorable
development, including voluntary and involuntary pools, decreased $7.7 million
in 1996 to $82.9 million, primarily attributable to a decrease in favorable
development in the workers' compensation line of $19.8 million. This decrease is
primarily attributable to a re-estimate of reserves with respect to certain
types of workers' compensation policies including large deductibles and excess
of loss policies. In addition, during 1995 the Regional Property and Casualty
segment refined its estimation of unallocated loss adjustment expenses which
increased favorable development in that year. Favorable development in the
personal automobile line also decreased $4.7 million, to $42.4 million in 1996.
These decreases were offset by increases in favorable development of $1.9
million and $5.6 million, to $12.6 million and $5.7 million, in the commercial
automobile and commercial multiple peril lines, respectively. Favorable
development in other lines increased by $8.8 million, primarily as a result of
environmental reserve strengthening in 1995. Favorable development in Hanover's
voluntary and involuntary pools increased $3.7 million to $4.1 million during
1996. The Regional Property and Casualty segment expects reduced favorable
development at Hanover to continue to impact future earnings.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal automobile
and workers' compensation lines increased $16.6 million and $15.5 million, to
favorable development of $4.4 million and $32.7 million, respectively, due to
the aforementioned change in claims cost management and the Michigan Supreme
Court ruling. Hanover's favorable development, not including the effect of
voluntary and involuntary pools, was relatively unchanged at $90.2 million in
1995 compared to $91.7 million in 1994. Favorable development in Hanover's
workers' compensation line increased $27.7 million to $31.0 million during 1995.
This was offset by decreases of $14.6 million and $12.6 million, to $45.5
million and $0.1 million, in the personal automobile and commercial multiple
peril lines, respectively. Favorable development in Hanover's voluntary and
involuntary pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Regional Property and Casualty
segment'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 Regional Property and
Casualty 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 $50.8 million
and $43.2 million, net of reinsurance of $20.2 million and $8.4 million in 1996
and 1995, respectively. During 1995, the Regional Property and Casualty segment
redefined its environmental liabilities in conformity with new guidelines issued
by the NAIC. This had no impact on results of operations. The Regional Property
and Casualty segment does not specifically underwrite policies that include this
coverage, but as case law expands policy provisions and insurers' liability
beyond the intended coverage, the Regional Property and Casualty segment may be
required to defend such claims. During 1995, Hanover performed an actuarial
review of its environmental reserves. This resulted in Hanover's providing
additional reserves for "IBNR" (incurred but not reported) claims, in addition
to existing reserves for reported claims. Although these claims are not
material, their existence gives rise to uncertainty and is discussed because of
the possibility, however remote, that they may become material. The Regional
Property and Casualty segment believes that, notwithstanding the evolution of
case law expanding liability in environmental claims, recorded reserves related
to these claims are adequate. In addition, the Regional Property and Casualty
segment 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 Regional Property and Casualty segment
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 Regional Property and
Casualty segment 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 Regional Property and Casualty segment 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 Regional Property and Casualty segment
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,
41
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.
Corporate Risk Management Services
- ----------------------------------
The following table summarizes the results of operations for the Corporate Risk
Management Services ("CRMS") segment.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================
Premiums and premium equivalents
Premiums $302.9 $272.7 $268.0
Premium equivalents 581.4 513.4 459.7
- ----------------------------------------------------------------
Total premiums and
premium equivalents $884.3 $786.1 $727.7
================================================================
Revenues
Premiums $302.9 $272.7 $268.0
Net investment income 21.7 17.6 14.0
Net realized gains (losses) 0.3 (0.5) 0.1
Other income 36.6 38.7 20.3
- ----------------------------------------------------------------
Total revenues 361.5 328.5 302.4
Policy benefits, claims and losses 211.3 197.2 182.6
Policy acquisition expenses 3.1 2.7 2.5
Other operating expenses 126.4 110.3 97.4
- ----------------------------------------------------------------
Income before taxes $ 20.7 $ 18.3 $ 19.9
================================================================
1996 Compared to 1995
- ---------------------
Income before taxes increased $2.4 million, or 13.1%, to $20.7 million in 1996.
In 1995, CRMS received a one time litigation settlement of $11.1 million.
Excluding this item, income before taxes increased $13.5 million, or 187.5%.
This increase is primarily attributable to premium growth in the Company's
reinsurance, fully insured group dental and group life product lines, and to
improved overall loss trends.
Premiums increased $30.2 million, or 11.1%, to $302.9 million in 1996,
primarily due to increases in reinsurance, fully insured group dental, group
life and stop loss product lines totaling $33.1 million. These increases were
partially offset by a decrease of $4.0 million in fully insured medical
premiums.
Net investment income increased $4.1 million, or 23.3%, to $21.7 million in
1996, due primarily to a $1.6 million increase in income earned on proceeds from
the Company's October, 1995 initial public offerings and approximately $1.4
million from increases in short-term debt used to finance additions to the
investment portfolio. In addition, net investment income increased approximately
$1.2 million from growth in invested assets.
Other income decreased $2.1 million, or 5.4%, to $36.6 million in 1996, due
primarily to the absence in 1996 of the aforementioned $11.1 million litigation
settlement. This decrease was partially offset by growth in ASO and contract
fees of $7.9 million in 1996.
Policy benefits, claims and losses increased $14.1 million, or 7.2%, to
$211.3 million in 1996. This increase is principally related to the growth in
premiums, partially offset by favorable claims experience overall.
Other operating expenses increased $16.1 million, or 14.6%, to $126.4
million in 1996, due primarily to increases in commissions, claims processing
expenses and field office expenses, resulting from the increased volume of both
premiums and claims. In addition, other operating expenses includes
approximately $1.0 million of short-term borrowing costs related to the short-
term debt used to finance additions to the investment portfolio.
1995 Compared to 1994
- ---------------------
Income before taxes decreased $1.6 million, or 8.0%, to $18.3 million in 1995.
This decrease was primarily attributable to adverse claims experience in all
major lines, partially offset by an $11.1 million fourth quarter litigation
settlement representing the recovery of claims paid in prior years.
Premiums increased $4.7 million, or 1.8%, in 1995 as a result of increases
in risk sharing and stop loss products and other products such as group life,
long term disability, and reinsurance, totaling $20.4 million. These increases
were partially offset by decreases of $15.7 million in full indemnity medical
products. The decrease in full indemnity health business is consistent with the
Company's plan to de-emphasize these products in favor of the more profitable
risk sharing arrangements.
Net investment income increased $3.6 million, or 25.7%, to $17.6 million in
1995 due to growth in invested assets.
Other income increased $18.3 million, or 89.7%, to $38.7 million in 1995.
This change is primarily due to an $11.1 million litigation settlement,
recognized in the fourth quarter of 1995, which represents the recovery of prior
years' claims paid. In addition, fees from the administrative services only
business increased $4.0 million, or 27.2%, to $18.7 million in 1995.
Policy benefits, claims and losses increased $14.6 million, or 8.0% in
1995. This increase is principally due to a deterioration in long term
disability, medical, and dental loss experience as well as to growth in
substantially all products except full indemnity medical.
Other operating expenses increased $12.8 million, or 13.1%, in 1995,
primarily due to increases in commissions, increased employee costs, and
increased expenses associated with the Company's client center in Atlanta,
Georgia.
42
- --------------------------------------------------------------------------------
Retail Financial Services
- -------------------------
The following table summarizes the results of operations for the Retail
Financial Services segment.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==============================================================
Revenues
Premiums $ 95.7 $ 98.1 $121.6
Fees 181.2 157.9 143.9
Net investment income 251.3 229.1 223.9
Net realized (losses) gains (1.5) 0.6 (3.1)
Other income 29.2 22.4 21.6
- --------------------------------------------------------------
Total revenues 555.9 508.1 507.9
Policy benefits, claims and losses 303.4 315.6 300.8
Policy acquisition expenses 58.1 56.1 79.5
Other operating expenses 118.2 101.2 113.4
- --------------------------------------------------------------
Income before taxes $ 76.2 $ 35.2 $ 14.2
==============================================================
1996 Compared to 1995
- ---------------------
Income before taxes increased $41.0 million, or 116.5%, to $76.2 million in 1996
compared to 1995. This increase was primarily attributable to growth in variable
products' fee revenue, decreased losses in the disability income line and income
earned on the proceeds from the October, 1995 initial public offerings.
[GRAPH APPEARS HERE]
Policy Fees
(In millions)
96 - $181
95 - $158
94 - $144
The decrease in premiums of $2.4 million, or 2.4%, to $95.7 million in 1996
is primarily due to the Company's shift in focus from traditional life insurance
products to variable life insurance and annuity products. Premiums from
traditional life products decreased $3.4 million, or 5.1%, to $62.8 million in
1996.
The increase in fee revenue of $23.3 million, or 14.8%, to $181.2 million in
1996 is due to additional deposits and appreciation on variable products account
balances. Fees from annuities increased $20.1 million, or 54.5%, to $57.0
million in 1996. Fees from variable universal life policies increased $8.0
million, or 22.7%, to $43.3 million in 1996. These increases were partially
offset by a continued decline in fees from non-variable universal life of $4.8
million, to $80.9 million, in 1996. The Company expects fees on this product to
decrease as policies in force and related contract values decline.
Net investment income increased $22.2 million, or 9.7%, to $251.3 million in
1996 primarily from $15.4 million in additional income on proceeds from the
October, 1995 initial public offerings. Also, increases in short-term debt used
to finance additions to the investment portfolio resulted in approximately $10.9
million in additional investment income. Partially offsetting these increases
was a slightly lower portfolio yield in 1996.
Other income increased $6.8 million, or 30.4%, to $29.2 million in 1996.
This increase was primarily attributable to increased investment management
income.
Policy benefits, claims, and losses decreased $12.2 million, or 3.9%, to
$303.4 million in 1996. Losses in the disability income line decreased $16.3
million due primarily to reserve strengthening of $14.5 million in 1995.
Additionally, non-variable universal life benefits decreased $2.5 million
principally due to improved mortality experience in 1996. These decreases were
partially offset by an increase in variable products' policy benefits of $6.2
million, which related primarily to growth in these product lines.
Other operating expenses include insurance taxes, licenses, fees, and
administrative expenses incurred to support sales and marketing of products sold
in this segment. The increase of $17.0 million, or 16.8%, to $118.2 million in
1996 was primarily attributable to $8.3 million of additional interest expense
in 1996 relating to the short-term debt used to finance additions to the
investment portfolio. Additionally, other operating expenses in 1995 included a
$7.5 million decrease due to the cession of substantially all term life
insurance business.
1995 Compared to 1994
- ---------------------
Income before taxes increased $21.0 million, or 147.9%, to $35.2 million in
1995. This increase was primarily attributable to an increase in fee revenue
from variable products and a decrease in policy acquisition expenses for all
major products. These increases were partially offset by an increase in
disability income policy benefits and decreased interest margins.
The decrease in premiums of $23.5 million during 1995 is primarily due to
the Company's ceding substantially all of its term life insurance business,
which contributed $18.7 million in premiums in 1994.
The increase in fee revenue of $14.0 million in 1995 is due to additional
deposits and appreciation on variable products account balances. Fees from
variable universal life increased from $28.9 million during 1994 to $35.3
million in 1995. Fees from annuities increased from $24.1 million for 1994 to
$36.9 million for 1995. Fees from non-variable universal life decreased $5.2
million in 1995 as a result of a decline in policies in force and related
contract values. The Company expects fees on this product to decrease as
policies in force and related contract values continue to decline.
The increase in policy benefits, claims and losses of $14.8 million in 1995
is primarily a result of increases in disability income policy benefits, non-
variable universal life policy benefits, annuity benefits and variable life
benefits, partially offset by a decrease in traditional life benefits due to
cession of substantially all of the term life insurance business. Disability
43
- --------------------------------------------------------------------------------
income policy benefits increased $21.6 million, reflecting reserve strengthening
and adverse morbidity in 1995, including fourth quarter reserve strengthening of
$11.7 million. Non-variable universal life policy benefits increased $1.8
million due to adverse mortality. Annuity benefits and variable universal life
benefits increased by $3.7 million in total, due primarily to growth in business
and higher crediting rates for annuities. Total traditional policy benefits,
claims and losses decreased from $116.7 million during 1994 to $104.4 million
during 1995. The largest component of this $12.3 million decrease is a $12.5
million decrease in term life insurance benefits due to the cession of
substantially all of this block of business in 1995.
The decrease in policy acquisition expenses of $23.4 million, or 29.4%, to
$56.1 million in 1995 is primarily due to reduced profit margins resulting from
increased mortality and reduced investment margins, which resulted in a
corresponding reduction in amortization. In addition, the 1994 amortization
includes an increase of $9.6 million for the term life insurance product due to
revised estimates of future profits.
Other operating expenses decreased $12.2 million, or 10.8%, to $101.2
million in 1995, resulting primarily from a $7.5 million decrease due to the
cession of substantially all term life insurance business and to significant
non-recurring 1994 expenses.
Interest Margins
- ----------------
The results of the Retail Financial Services segment depend, in part, on the
maintenance of profitable margins between investment results from investment
assets supporting universal life and general account annuity products and the
interest credited on those products. The following table sets forth interest
earned, interest credited and the related interest margin.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=======================================================================
Net investment income $145.9 $152.7 $157.5
Less: Interest credited 101.3 107.7 102.0
- -----------------------------------------------------------------------
Interest margins (1) $ 44.6 $ 45.0 $ 55.5
=======================================================================
(1) Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal life and
general account annuity policies.
Interest margins were relatively consistent in 1996, as compared to 1995.
The decrease in interest margins from 1994 to 1995 is a result of a decline in
policies in force and higher crediting rates resulting from the competetive
environment.
Institutional Services
- ----------------------
The following table summarizes the results of operations for the Institutional
Services segment.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
============================================================
Revenues
Fees, premiums and
non-insurance income (1) $ 33.5 $ 37.6 $ 72.6
Net investment income
GICs 98.5 152.9 188.2
Other 115.5 113.5 114.6
Net realized gains 19.2 5.5 0.6
Gain on sale of mutual fund
processing business -- 20.7 --
- ------------------------------------------------------------
Total revenues 266.7 330.2 376.0
- ------------------------------------------------------------
Policy benefits, claims and losses
Interest credited to GICs 89.2 137.2 166.6
Other 70.9 80.6 81.5
- ------------------------------------------------------------
Total policy benefits, claims
and losses 160.1 217.8 248.1
Policy acquisition expenses 2.9 3.2 3.4
Other operating expenses 50.9 66.4 120.1
- ------------------------------------------------------------
Income before taxes $ 52.8 $ 42.8 $ 4.4
============================================================
(1) Fees, premiums and non-insurance income includes fees from retirement
services, mutual fund services, institutional 401(k) recordkeeping services
and other miscellaneous non-insurance related fees. In March 1995, the
Company sold its mutual fund processing business.
1996 Compared to 1995
- ---------------------
Income before taxes increased $10.0 million, or 23.4%, to $52.8 million in 1996.
This change was primarily attributable to increased realized gains of $13.7
million and to decreased other policy benefits, claims and losses of $9.7
million resulting from defined benefit and defined contribution plan
cancellations. These items were partially offset by a net decline of $9.8
million related to the sale of the mutual fund processing business in 1995 and a
decline in the interest margins on GICs of $6.4 million.
Fees, premiums, non-insurance and other income decreased $4.1 million, or
10.9%, to $33.5 million in 1996. This decrease was primarily attributable to a
$13.7 million decrease in revenues due to the absence of the mutual fund
processing business in 1996, partially offset by the 1996 receipt of a non-
recurring $4.8 million contingent payment related to the aforementioned sale and
to $3.0 million from growth in retail telemarketing revenues. Additionally, fee
income increased $1.5 million from the appreciation of separate account balances
in related defined benefit and defined contribution plans.
44
- --------------------------------------------------------------------------------
Net investment income related to GICs and interest credited to GIC
contractholders have declined in 1996 as a result of declining GIC deposits due
to the downgrading in March 1995 of FAFLIC's S&P Rating to A+ (Good). As a
result, sales of traditional GICs have substantially ceased. Management expects
GIC deposits and related income to continue to decline.
Net realized gains increased $13.7 million, to $19.2 million in 1996. This
change resulted primarily from increased gains from sales of real estate
properties totaling $12.2 million.
Other policy benefits, claims and losses consist primarily of benefits
provided by the Company's defined contribution and defined benefit plans,
including annuity benefits for certain defined benefit plan participants
electing that option. Other policy benefits, claims and losses declined from
$80.6 million in 1995 to $70.9 million in 1996. This was primarily due to
reductions in the interest credited to participants resulting from the
aforementioned cancellations in defined benefit and defined contribution plans.
Other operating expenses decreased $15.5 million, or 23.3%, to $50.9 million
in 1996. This decrease was primarily attributable to the sale of the mutual fund
processing business, which incurred $19.8 million of operating expenses in 1995.
1995 Compared to 1994
- ---------------------
Income before taxes increased $38.4 million to $42.8 million in 1995. This
increase was primarily attributable to the sale of the Company's mutual fund
processing business in March 1995, resulting in a pre-tax gain of $20.7 million,
and to a $4.9 million increase in realized investment gains. Additionally, in
1995 revenue from the mutual fund processing business decreased $38.3 million
and expenses decreased $49.3 million, contributing another $11.0 million to the
increase in net income before taxes for this period.
Fees, premiums and non-insurance income decreased $35.0 million, or 48.2% in
1995. As noted above, this decrease was primarily attributable to the $38.3
million decrease in revenues from the mutual fund processing business, which was
sold in March 1995.
Net investment income related to GICs and interest credited to GIC
contractholders have declined as a result of declining GIC deposits due to the
downgrading in March 1995 of FAFLIC's S&P Rating to A+ (Good). Management
expects GIC deposits and related income to continue to decline.
Net realized gains increased $4.9 million, to $5.5 million in 1995 due to
decreased mortgage loan impairments.
Other operating expenses decreased $53.7 million, or 44.7% in 1995. This
decrease was primarily attributable to the $49.3 million decrease in expenses
for the mutual fund processing business. The remainder of the decrease was due
primarily to decreases in consulting fees, system development costs, and
employee costs as a result of exiting certain other product lines and
businesses, primarily various processing services for defined contribution
plans.
Allmerica Asset Management
- --------------------------
The following table summarizes the results of operations for the Allmerica Asset
Management segment.
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=================================================================
Fees and other income:
External $ 1.1 $ 1.0 $ 0.7
Internal 7.7 3.4 3.3
- -----------------------------------------------------------------
Total revenues 8.8 4.4 4.0
Other operating expenses 7.7 2.1 2.1
- -----------------------------------------------------------------
Income before taxes $ 1.1 $ 2.3 $ 1.9
=================================================================
Since 1994, the Company has provided investment advisory and sub-advisory
services, primarily to affiliates, through its registered investment advisor,
Allmerica Asset Management ("AAM"). In the second quarter of 1996, AAM finalized
contracts with two related parties, FAFLIC and AFLIAC, to provide investment
advisory services at cost. The internal fees and corresponding operating
expenses related to these contracts totaled $4.3 million for the year ended
December 31, 1996.
Corporate
- ---------
The following table summarizes the results of operations for the Corporate
segment.
Period from
October 1
through
December 31 December 31
(IN MILLIONS) 1996 1995
==============================================================================
Revenues
Investment and other income $ 2.7 $ 0.4
Realized loss (0.9) --
- ------------------------------------------------------------------------------
Total revenues 1.8 0.4
Other operating expenses 18.6 3.5
- ------------------------------------------------------------------------------
Loss before taxes $(16.8) $(3.1)
==============================================================================
This segment consists primarily of $32.9 million of cash, investments and
other assets remaining from the $52.9 million in net proceeds retained by the
holding company in the Company's initial public offerings. These investments
earned $2.7 million in net investment income in 1996 and $0.4 million for the
period from October 1, 1995 to December 31, 1995. The segment incurred $18.6
million and $3.5 million of other operating expenses in 1996 and for the period
from October 1, 1995 to December 31, 1995, respectively, primarily $15.3 million
and $3.2 million, respectively, in interest expense on the Company's 7 5/8%
Senior Debentures issued in October 1995.
45
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
- --------------------
The Company had investment assets diversified across several asset classes, as
follows:
December 31
(Dollars in millions) 1996(1) 1995(1)
================================================================================
% of Total % of Total
Carrying Carrying Carrying Carrying
Value Value Value Value
Fixed maturities (2) $7,891.7 79.4% $ 8,197.3 78.1%
Equity securities (2) 473.6 4.8 517.2 4.9
Mortgages 764.6 7.7 856.5 8.2
Policy loans 362.6 3.6 365.7 3.5
Real estate 120.7 1.2 179.6 1.7
Cash and cash equivalents 202.6 2.0 307.1 2.9
Other invested assets 128.8 1.3 71.9 0.7
- --------------------------------------------------------------------------------
Total $9,944.6 100.0% $10,495.3 100.0%
================================================================================
(1) Includes Closed Block invested assets with a carrying value of $772.7
million and $775.1 million at December 31, 1996 and 1995, respectively.
(2) The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
Total investment assets decreased $550.7 million, or 5.2%, to $9.9 billion
during 1996. This decrease is primarily attributable to a decline in invested
assets resulting from the settlement of GIC contracts and to market value
depreciation in the fixed maturities portfolio. Equity securities decreased
$43.6 million, or 8.4%, to $473.6 million, as a result of the Regional Property
and Casualty segment's shift in portfolio holdings from equity securities to
tax-exempt fixed maturity securities. Despite this portfolio shift, fixed
maturities decreased $305.6 million, or 3.7%, due primarily to financing of net
GIC withdrawals and to market value depreciation of $93.0 million. Additionally,
mortgage loans decreased $91.9 million, or 10.7%, to $764.6 million caused
primarily by loan repayments. The real estate portfolio decreased $58.9 million,
or 32.8%, to $120.7 million during 1996 due to sales of investment properties.
The increase in other invested assets of $56.9 million, or 79.1% to $128.8
million primarily relates to third and fourth quarter purchases of limited
partnerships by FAFLIC. Cash and cash equivalents decreased $104.5 million, or
34.0%, to $202.6 million.
[PIE CHART APPEARS HERE]
Bond Portfolio
Credit Quality
Aaa/Aa/A -- 54%
Baa -- 31%
Ba & Below -- 15%
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 84.8% and 88.7% of the Company's total fixed maturity portfolio at
December 31, 1996 and December 31, 1995, respectively. In 1996, there was a
modest shift to higher yielding debt securities, including longer duration and
non-investment grade securities. The average yield on debt securities was 7.3%
and 7.2% for 1996 and 1995, respectively. Although management expects that a
substantial portion of new funds will be invested in investment grade fixed
maturities, the Company may invest a portion of new funds in below investment
grade fixed maturities or equity interests.
46
The following table illustrates asset valuation allowances and additions to or
deductions from such allowances for the periods indicated.
For the Years Ended December 31
(Dollars in millions)
================================================================================
Other
Real Invested
1995 Mortgages Estate Assets Total
- ----
Beginning balance $ 47.2 $22.9 $ 3.7 $ 73.8
Provision (benefits) 1.5 (0.6) -- 0.9
Write-offs (1) (14.9) (2.7) -- (17.6)
- --------------------------------------------------------------------------------
Ending balance $ 33.8 $19.6 $ 3.7 $ 57.1
Valuation allowance as a percentage
of carrying value before reserves 3.8% 9.8% 4.9% 4.9%
1996
- ----
Provision 5.5 -- -- 5.5
Write-offs (1) (19.7) (4.7) (3.7) (28.1)
- --------------------------------------------------------------------------------
Ending balance $ 19.6 $14.9 $ -- $ 34.5
Valuation allowance as a percentage
of carrying value before reserves 2.5% 11.0% --% 3.8%
(1) Write-offs reflect asset sales, foreclosures and forgiveness of debt upon
restructuring.
The increase in write-offs of mortgages during 1996 as compared to 1995
reflects an increase in the disposal of modified loans which were previously
impaired.
Income Taxes
- ------------
AFC and its life insurance 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. Allmerica P&C and its subsidiaries file a separate United States
federal income tax return.
For the years ended December 31, 1995 and 1994, FAFLIC, as a mutual
insurance company until October 1995, was required to adjust its deduction for
policyholder dividends by the differential earnings amount under Section 809 of
the Internal Revenue Code. This amount was computed, for each tax year, by
multiplying the average equity base of the FAFLIC/AFLIAC consolidated group, as
determined for tax purposes, by the estimate of an excess of an imputed earnings
rate over the average mutual life insurance companies' earnings rate.
The differential earnings amount for each tax year was subsequently
recomputed when actual earnings rates were published by the IRS. As a stock
company, AFC, including its life insurance subsidiaries, is no longer required
to reduce its policyholder dividend deduction by the differential earnings
amount. The differential earnings amount in the current period related to an
adjustment for the 1994 tax year based on the actual average mutual life
insurance companies' earnings rate issued by the IRS in 1996.
Provision for federal income taxes before minority interest was $75.2
million during 1996 compared to $82.7 million during 1995. These provisions
resulted in consolidated effective federal tax rates of 22.7% and 27.4%,
respectively. The effective tax rates for AFLIAC and FAFLIC and its non-
insurance subsidiaries were 28.9% and 32.0% during 1996 and 1995, respectively.
The effective tax rates for the Regional Property and Casualty subsidiaries were
18.4% and 25.3% during 1996 and 1995, respectively. The reduction in the rate
for FAFLIC in 1996 resulted primarily from additional reserves provided for
revisions of estimated prior year tax liabilities in 1995, as well as an
increase of $2.6 million in the differential earnings benefit from 1995 to 1996.
The decrease in the rate for Regional Property and Casualty subsidiaries
reflects a higher underwriting loss and greater proportion of pre-tax income
from tax-exempt bonds in 1996, and to reserves provided for revisions in
estimated prior year tax liabilities in 1995.
Provision for federal income taxes before minority interest was $82.7
million during 1995 compared to $53.4 million during 1994. These provisions
resulted in consolidated effective federal tax rates of 27.4% and 34.8% in 1995
and 1994, respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 32.0% and 122.4% during 1995 and 1994,
respectively. The effective tax rates for the Regional Property and Casualty
subsidiaries were 25.3% and 3.5% during 1995 and 1994, respectively. The
significant reduction in the rate for FAFLIC primarily resulted from a
47
- --------------------------------------------------------------------------------
differential earnings benefit of $7.6 million, or 7.9% of taxable income, during
1995, including a benefit of $15.2 million recognized during the fourth quarter,
versus a charge of $35.0 million, or 86.5% of taxable income, during 1994. The
increase in the rate for the Regional Property and Casualty subsidiaries is
attributable to improved underwriting results, a decrease in the proportion of
pre-tax income attributable to tax-exempt interest, and to reserves provided for
revisions in estimated prior year tax liabilities, including $7.2 million
provided during the fourth quarter of 1995.
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.
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, claim losses and loss 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 $156.0 million, $131.2 million
and $331.7 million in 1996, 1995 and 1994, respectively. The increase in 1996
was primarily attributable to an increase in cash provided by the operations of
the life insurance subsidiaries. This increase was partially offset by increased
underwriting losses in the Regional Property and Casualty Insurance subsidiaries
which resulted in an increase in claims payments. The decrease during 1995 was
due primarily to the timing of payments of losses and LAE in the Regional
Property and Casualty Insurance subsidiaries; the timing of cash receipts and
payments relating to reinsurance due primarily to the cession of the yearly
renewable term product in 1995; the decrease in investment income due to the
decrease in GIC assets; and the decrease in other income resulting from the sale
of the mutual fund processing business.
Net cash provided by investing activities was $424.6 in 1996 and $327.2
million in 1994. Net cash used in investing activities was $128.1 million in
1995. The increase from 1995 to 1996 was primarily attributable to increased
sales of investments used to finance net withdrawals from GICs partially offset
by additional purchases of fixed maturities and other long-term investments
financed through an increase in investable cash generated by operations. During
1996, cash flows from investing activities were impacted by delayed sales of
investments financed instead with repurchase agreements. Although the repurchase
agreements were entirely settled by year end, management may utilize this policy
again in future periods.
In 1995, the net cash used resulted from net purchases of fixed maturities
and equity securities which were partially offset by mortgage loan repayments
and proceeds from the sale of the mutual fund processing business. In 1994, a
larger amount of mortgage loan repayments and net sales and maturities of fixed
maturities resulted in the net cash provided.
Net cash used for financing activities was $685.1 million, $235.7 million,
and $410.6 million in 1996, 1995, and 1994 respectively. The Company made cash
payments on withdrawals from GICs that exceeded cash received from deposits on
these contracts by $636.3 million, $624.1 million and $400.7 million in 1996,
1995 and 1994, respectively. Although the Company expects this trend in negative
financing cash flows from GIC withdrawals to continue, the Company does not
expect GIC withdrawals to have a material impact on liquidity. Also, cash used
to purchase subsidiary common stock increased $21.1 million, to $42.0 million
during the year ended December 31, 1996.
In 1995, the cash used for financing activities was positively impacted by
the Company's receipt of proceeds of $248.0 million and $197.2 million from its
initial public offering of stock and debt, respectively.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300 million Series A 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 are intended to fund a portion of the
acquisition of the 24.2 million publicly held shares of Allmerica P&C pursuant
to an Agreement and Plan of Merger dated February 19, 1997.
On October 16, 1995, FAFLIC converted from a policyholder owned to
stockholder owned insurance company and AFC became the holding company for
FAFLIC. AFC also raised net proceeds of $248.0 million from the sale of Common
Stock and issued $200.0 million principal amount 7 5/8% Senior
48
- --------------------------------------------------------------------------------
Debentures due 2025 with net proceeds to the Company of $197.2 million. The
Company will also pay approximately $15.3 million per year in interest payments
on the Senior Debentures.
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC to meet its obligations to pay interest on the Senior
Debentures, Subordinated Debentures 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. FAFLIC and Allmerica P&C have $100.0 million and $40.0 million
respectively, under various committed short-term lines of credit. At December
31, 1996, no amounts were outstanding and $90.2 million and $12.0 million were
available for borrowing by FAFLIC and Allmerica P&C, respectively. FAFLIC and
Allmerica P&C had $9.8 million and $28.0 million, respectively, of commercial
paper borrowings outstanding at December 31, 1996.
RECENT DEVELOPMENTS
- -------------------
On February 19, 1997, the Company and Allmerica P&C entered into an Agreement
and Plan of Merger (the "Merger Agreement") pursuant to which the Company will
acquire all of the outstanding Common Stock, $1.00 par value per share, of
Allmerica P&C that it does not already own for consideration consisting of
$33.00 per share of Common Stock, subject to adjustment, payable in cash and
shares of common stock, par value $0.01 per share, of the Company (the "AFC
Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive
the consideration in cash, without interest, or in shares of AFC Common Stock,
subject to proration as set forth in the Merger Agreement. The maximum number of
shares of AFC Common Stock to be issued in the Merger is approximately 9.67
million shares. The acquisition will be accomplished by merging a newly created,
wholly-owned subsidiary of the Company with and into Allmerica P&C ( the
"Merger") resulting in Allmerica P&C becoming a wholly-owned subsidiary of the
Company. Also, immediately prior to the Merger, Allmerica P&C's Certificate of
Incorporation will be amended to authorize a new class of Common Stock, one
share of which will be exchanged for each share of Common Stock currently held
by SMA Financial Corp., a wholly-owned subsidiary of the Company. The
consummation of the Merger is subject to the satisfaction of various conditions,
including the approval of regulatory authorities.
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 1996
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," "anticipated," "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, 1996.
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 products; (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 renegotiation 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 Poors, 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; and (xv)
possible claims relating to sales practices for insurance products.
49
Report of Independent Accountants
- --------------------------------------------------------------------------------
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, of shareholders' equity, and of cash flows
present fairly, in all material respects, the financial position of Allmerica
Financial Corporation and its subsidiaries at December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996, in conformity with generally accepted
accounting principles. 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 generally accepted auditing standards 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.
As discussed in the accompanying notes to the consolidated financial
statements, the Company changed its method of accounting for investments (Note
1) and postemployment benefits (Note 11) in 1994.
/s/ Price Waterhouse LLP
Boston, Massachusetts
February 3, 1997, except as to Notes 1 and 2,
which are as of February 19, 1997
Management 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 Price Waterhouse 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, Price Waterhouse LLP. Both our
internal auditors and Price Waterhouse 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, Chief Financial
Executive Officer Officer, Principal Accounting Officer
50
Consolidated Statements of Income
- ------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS, EXCEPT PER SHARE DATA) 1996 1995 1994
==============================================================================
REVENUES
- --------
Premiums $2,236.3 $2,222.8 $2,181.8
Universal life and investment
product policy fees 197.2 172.4 156.8
Net investment income 672.6 710.5 743.1
Net realized investment gains 65.9 19.1 1.1
Realized gain on sale of
mutual fund processing
business -- 20.7 --
Other income 102.7 95.4 112.3
- ------------------------------------------------------------------------------
Total revenues 3,274.7 3,240.9 3,195.1
- ------------------------------------------------------------------------------
BENEFITS, LOSSES AND EXPENSES
- -----------------------------
Policy benefits, claims,
losses and loss adjustment
expenses 1,957.0 2,010.3 2,047.0
Policy acquisition expenses 483.5 470.3 475.7
Other operating expenses 502.5 458.5 518.9
- ------------------------------------------------------------------------------
Total benefits, losses and
expenses 2,943.0 2,939.1 3,041.6
- ------------------------------------------------------------------------------
Income before federal income taxes 331.7 301.8 153.5
- ------------------------------------------------------------------------------
Federal income tax expense (benefit)
Current 90.9 119.7 45.4
Deferred (15.7) (37.0) 8.0
- ------------------------------------------------------------------------------
Total federal income tax
expense 75.2 82.7 53.4
- ------------------------------------------------------------------------------
Income before minority interest,
extraordinary item and cumulative
effect of accounting change 256.5 219.1 100.1
Minority interest (74.6) (73.1) (51.0)
- ------------------------------------------------------------------------------
Income before extraordinary item
and cumulative effect
of accounting change 181.9 146.0 49.1
Extraordinary item -
demutualization expenses -- (12.1) (9.2)
Cumulative effect of change in
accounting principle -- -- (1.9)
- ------------------------------------------------------------------------------
Net income $ 181.9 $ 133.9 $ 38.0
==============================================================================
For the Period Year Ended
October 1 December 31,
Year Ended through 1995
December 31, December 31, Pro Forma*
1996 1995 (Unaudited)
Net income after demutualization $ 181.9 $ 40.7 $ 130.6
===============================================================================
Net income after demutualization
per share $ 3.63 $ 0.82 $ 2.61
===============================================================================
Weighted average shares outstanding 50.1 49.4 50.1
===============================================================================
*The pro forma information gives effect to the transactions referred to in
Note 1N.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
51
Consolidated Balance Sheets
- ------------------------------------------------------------------------------------
DECEMBER 31
(IN MILLIONS, EXCEPT PER SHARE DATA) 1996 1995
====================================================================================
ASSETS
Investments:
Fixed maturities-at fair value (amortized cost of
$7,305.5 and $7,467.9) $ 7,487.8 $ 7,739.3
Equity securities-at fair value (cost of $328.2 and
$410.6) 473.6 517.2
Mortgage loans 650.1 799.5
Real estate 120.7 179.6
Policy loans 132.4 123.2
Other long-term investments 128.8 71.9
- ------------------------------------------------------------------------------------
Total investments 8,993.4 9,430.7
- ------------------------------------------------------------------------------------
Cash and cash equivalents 178.5 289.5
Accrued investment income 149.0 163.2
Deferred policy acquisition costs 822.7 735.7
- ------------------------------------------------------------------------------------
Reinsurance receivables:
Future policy benefits 102.8 97.1
Outstanding claims, losses and loss adjustment
expenses 663.8 799.6
Unearned premiums 46.2 43.8
Other 62.8 58.9
- ------------------------------------------------------------------------------------
Total reinsurance receivables 875.6 999.4
- ------------------------------------------------------------------------------------
Deferred federal income taxes 93.2 81.2
Premiums, accounts and notes receivable 533.0 526.7
Other assets 307.5 363.6
Closed Block assets 811.8 818.9
Separate account assets 6,233.0 4,348.8
- ------------------------------------------------------------------------------------
Total assets $18,997.7 $17,757.7
====================================================================================
LIABILITIES
- -----------
Policy liabilities and accruals:
Future policy benefits $ 2,613.7 $ 2,639.3
Outstanding claims, losses and loss adjustment
expenses 2,944.1 3,081.3
Unearned premiums 822.5 800.9
Contractholder deposit funds and other policy
liabilities 2,060.4 2,737.4
- ------------------------------------------------------------------------------------
Total policy liabilities and accruals 8,440.7 9,258.9
====================================================================================
Expenses and taxes payable 622.3 603.0
Reinsurance premiums payable 31.4 42.0
Short-term debt 38.4 31.2
Deferred federal income taxes 34.7 47.8
Long-term debt 202.2 202.3
Closed Block liabilities 892.1 902.0
Separate account liabilities 6,227.2 4,337.8
- ------------------------------------------------------------------------------------
Total liabilities 16,489.0 15,425.0
- ------------------------------------------------------------------------------------
Minority interest 784.0 758.5
- ------------------------------------------------------------------------------------
Commitments and contingencies (Notes 15 and 20)
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, 50.1 million
shares issued and outstanding 0.5 0.5
Additional paid-in capital 1,382.5 1,382.5
Unrealized appreciation on investments, net 131.6 153.0
Retained earnings 210.1 38.2
- ------------------------------------------------------------------------------------
Total shareholders' equity 1,724.7 1,574.2
- ------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $18,997.7 $17,757.7
====================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
52
Consolidated Statements of Shareholders' Equity
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
COMMON STOCK
- ------------
Balance at beginning of year $ 0.5 $ -- $ --
Demutualization transaction -- 0.4 --
Initial public offering -- 0.1 --
- --------------------------------------------------------------------------------
Balance at end of year 0.5 0.5 --
- --------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
- --------------------------
Balance at beginning of year 1,382.5 -- --
Demutualization transaction -- 1,134.6 --
Initial public offering -- 247.9 --
- --------------------------------------------------------------------------------
Balance at end of year 1,382.5 1,382.5 --
- --------------------------------------------------------------------------------
RETAINED EARNINGS
- -----------------
Balance at beginning of year 38.2 1,071.4 1,033.4
Net income prior to
demutualization -- 93.2 38.0
- --------------------------------------------------------------------------------
38.2 1,164.6 1,071.4
Demutualization transaction -- (1,164.6) --
Net income subsequent to
demutualization 181.9 40.7 --
Dividends to shareholders (10.0) (2.5) --
- --------------------------------------------------------------------------------
Balance at end of year 210.1 38.2 1,071.4
- --------------------------------------------------------------------------------
NET UNREALIZED APPRECIATION
- ---------------------------
(DEPRECIATION) ON INVESTMENTS
- -----------------------------
Balance at beginning of year 153.0 (79.0) 17.5
- --------------------------------------------------------------------------------
Cumulative effect of accounting
change:
Net appreciation on
available-for-sale debt
securities -- -- 296.1
Provision for deferred federal
income taxes and minority
interest -- -- (149.1)
- --------------------------------------------------------------------------------
-- -- 147.0
- --------------------------------------------------------------------------------
Effect of transfer of
securities from
held-to-maturity
to available-for-sale:
Net appreciation on
available-for-sale debt
securities -- 22.4 --
Provision for deferred federal
income taxes and minority
interest -- (9.6) --
- --------------------------------------------------------------------------------
-- 12.8 --
- --------------------------------------------------------------------------------
(Depreciation) appreciation
during the period:
Net (depreciation) appreciation
on available-for-sale
securities (35.1) 466.0 (492.1)
Benefit (provision) for
deferred federal income taxes 12.3 (163.1) 171.9
Minority interest 1.4 (83.7) 76.7
- --------------------------------------------------------------------------------
(21.4) 219.2 (243.5)
- --------------------------------------------------------------------------------
Balance at end of year 131.6 153.0 (79.0)
- --------------------------------------------------------------------------------
Total shareholders' equity $1,724.7 $ 1,574.2 $ 992.4
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
53
Consolidated Statements of Cash Flows
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 199
================================================================================
CASH FLOWS FROM OPERATING
- -------------------------
ACTIVITIES
- ----------
Net income $ 181.9 $ 133.9 $ 38.0
Adjustments to reconcile net
income to net cash provided
by operating activities:
Minority interest 74.6 73.1 50.1
Net realized gains (65.2) (39.8) (1.1)
Net amortization and
depreciation 44.7 57.7 45.9
Deferred federal income taxes (15.7) (37.0) 8.0
Change in deferred acquisition
costs (73.9) (38.4) (34.6)
Change in premiums and notes
receivable, net of
reinsurance payable (16.7) (42.0) (25.6)
Change in accrued investment
income 16.5 6.8 4.6
Change in policy liabilities
and accruals, net (184.3) 116.2 175.9
Change in reinsurance receivable 123.7 (75.6) (31.9)
Change in expenses and taxes
payable 27.1 7.7 88.0
Separate account activity, net 5.2 (0.1) 0.4
Other, net 38.1 (31.3) 14.0
- --------------------------------------------------------------------------------
Net cash provided by operating
activities 156.0 131.2 331.7
- --------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
------------------------------------
Proceeds from disposals and
maturities of
available-for-sale fixed
maturities 4,018.5 2,738.4 2,097.8
Proceeds from disposals of
held-to-maturity fixed
maturities -- 271.3 304.4
Proceeds from disposals of
equity securities 228.7 120.0 143.9
Proceeds from disposals of
other investments 99.3 40.5 25.9
Proceeds from mortgages matured
or collected 176.9 230.3 256.4
Purchase of available-for-sale
fixed maturities (3,830.7) (3,273.3) (2,150.1)
Purchase of held-to-maturity
fixed maturities -- -- (111.6)
Purchase of equity securities (91.6) (254.0) (172.2)
Purchase of other investments (168.0) (24.8) (26.6)
Proceeds from sale of mutual
fund processing business -- 32.9 --
Capital expenditures (12.8) (14.1) (43.1)
Other investing activities, net 4.3 4.7 2.4
- --------------------------------------------------------------------------------
Net cash provided by (used in)
investing activities 424.6 (128.1) 327.2
- --------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Deposits and interest credited
to contractholder deposit funds 268.7 445.8 786.3
Withdrawals from contractholder
deposit funds (905.0) (1,069.9) (1,187.0)
Change in short-term debt 7.2 (1.6) (6.0)
Change in long-term debt (0.1) 0.2 0.3
Dividends paid to shareholders (13.9) (6.6) (4.2)
Net proceeds from issuance of
common stock -- 248.0 --
Payments for policyholders'
membership interests -- (27.9) --
Net proceeds from issuance of
long-term debt -- 197.2 --
Subsidiary treasury stock
purchased, at cost (42.0) (20.9) --
- --------------------------------------------------------------------------------
Net cash used in financing
activities (685.1) (235.7) (410.6)
- --------------------------------------------------------------------------------
Net change in cash and cash
equivalents (104.5) (232.6) 248.3
Net change in cash held in the
Closed Block (6.5) (17.6) --
Cash and cash equivalents,
beginning of year 289.5 539.7 291.4
- --------------------------------------------------------------------------------
Cash and cash equivalents, end
of year $ 178.5 $ 289.5 $ 539.7
================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION
- ----------------------------------
Interest paid $ 33.8 $ 4.1 $ 4.3
Income taxes paid $ 68.1 $ 90.6 $ 46.1
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
54
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Significant Accounting Policies
------------------------------------------
A. Basis of Presentation and Principles of Consolidation
- --------------------------------------------------------
First Allmerica Financial Life Insurance Company ("FAFLIC") was organized as a
mutual life insurance company until October 16, 1995. FAFLIC converted to a
stock life insurance company pursuant to a plan of reorganization effective
October 16, 1995 and became a wholly owned subsidiary of Allmerica Financial
Corporation ("AFC" or the "Company"). The consolidated financial statements have
been prepared as if FAFLIC were organized as a stock life insurance company for
all periods presented. Thus, generally accepted accounting principles for stock
life insurance companies have been applied retroactively for all periods
presented.
The consolidated financial statements of AFC include the accounts of
FAFLIC, its wholly owned life insurance subsidiary, Allmerica Financial Life
Insurance and Annuity Company ("AFLIAC"), non-insurance subsidiaries
(principally brokerage and investment advisory subsidiaries), and Allmerica
Property and Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned non-
insurance holding company). The Closed Block assets and liabilities at December
31, 1996 and 1995 and its results of operations subsequent to demutualization
are presented in the consolidated financial statements as single line items.
Prior to demutualization such amounts are presented line by line in the
consolidated financial statements (see Note 6). Unless specifically stated, all
disclosures contained herein supporting the consolidated financial statements at
December 31, 1996 and 1995 and the years then ended exclude the Closed Block
related amounts. All significant intercompany accounts and transactions have
been eliminated.
Minority interest relates to the Company's investment in Allmerica P&C and
its only significant subsidiary, The Hanover Insurance Company ("Hanover").
Hanover's 82.5%-owned subsidiary is Citizens Corporation, the holding company
for Citizens Insurance Company of America ("Citizens"). Minority interest also
includes an amount related to the minority interest in Citizens Corporation.
On February 19, 1997, the Company announced a definitive merger agreement
under which it would acquire, at consideration of $33.00 per share, all of the
shares of Allmerica P&C currently held by the minority stockholders. Additional
information pertaining to the merger agreement is included in Note 2,
Significant Transactions.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
B. Closed Block
- ---------------
As of October 16, 1995, 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 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 after the demutualization. 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 is in force. On October 16, 1995, 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 at October 16, 1995
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 October 16, 1995,
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 as of October 16, 1995.
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 dividends scales are inadequate to
55
- --------------------------------------------------------------------------------
offset the negative performance in relation to the expected performance, 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
- ---------------------------
Effective January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain
Investments in Debt and Equity Securities", which requires investments be
classified into one of three categories: held-to-maturity, available-for-sale or
trading. The effect of implementing SFAS No. 115, as of January 1, 1994, was an
increase in the carrying value of fixed maturity investments of $335.3 million,
a decrease in deferred policy acquisition costs of $20.8 million, an increase in
policyholder liabilities of $18.4 million, a net increase in deferred income tax
liabilities of $103.7 million, an increase in minority interest of $45.4 million
and an increase in shareholders' equity of $147.0 million, which resulted from
changing the carrying value of certain fixed maturities from amortized cost to
fair value and related adjustments. The implementation had no effect on net
income.
In November 1995, the Financial Accounting Standards Board issued a Special
Report, A Guide to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities, which permitted companies to
reclassify securities, where appropriate, based on the new guidance. As a
result, the Company transferred securities with amortized cost and fair value of
$696.4 million and $725.6 million, respectively, from the held-to-maturity
category to the available-for-sale category, which resulted in a net increase in
shareholders' equity of $12.8 million.
Realized gains and losses on sales of fixed maturities and equity
securities are determined on the specific-identification basis using amortized
cost for fixed maturities and cost for equity securities. Fixed maturities and
equity securities with other than temporary declines in fair value are written
down to estimated fair value resulting in the recognition of realized losses.
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 management 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 management believes may not be collectible in
full. In establishing reserves, management 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.
Real estate that has been acquired through the foreclosure of mortgage
loans is valued at the estimated fair value at the time of foreclosure. The
Company considers several methods in determining fair value at foreclosure,
using primarily third-party appraisals and discounted cash flow analyses. After
foreclosure, the Company makes a determination as to whether the asset should be
held for production of income or held for sale.
Real estate investments held for the production of income and held for
sale are carried at depreciated cost less valuation allowances, if necessary, to
reduce the carrying value to fair value. Depreciation is generally calculated
using the straight-line method.
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 and real
estate 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.
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.
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, group life and group health insurance business
acquisition costs are deferred and amortized over the terms of the insurance
policies. Acquisition costs related to universal life products and
contractholder deposit funds are deferred and amortized in proportion to total
estimated gross profits over the expected life of the contracts using a revised
interest rate applied to the remaining benefit period. Acquisition costs related
to annuity and other life insurance businesses are deferred and amortized,
56
- --------------------------------------------------------------------------------
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 product 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,
management 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% for
life insurance and 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 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 outstanding claims, losses and loss adjustment expenses are
estimates of payments to be made on property and casualty and health insurance
for reported losses and estimates of losses 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, group life, and accident and health
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,
management 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.
J. Premium and Fee Revenue and Related Expenses
- -----------------------------------------------
Premiums for individual life and health insurance and individual and group
annuity products, excluding universal life and investment-related products, are
considered revenue when due. Property and casualty and group life, accident and
health 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 primarily
consist of 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, and 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.
57
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K. Policyholder Dividends
- -------------------------
Prior to demutualization, certain life, health and annuity insurance policies
contained dividend payment provisions that enabled the policyholder to
participate in the earnings of the Company. The amount of policyholders'
dividends was determined annually by the Board of Directors. The aggregate
amount of policyholders' dividends was related to the actual interest,
mortality, morbidity and expense experience for the year and the Company's
judgment as to the appropriate level of statutory surplus to be retained. Upon
demutualization, certain participating individual life insurance policies and
individual annuity and supplemental contracts were transferred to the Closed
Block. The Closed Block was funded to protect the dividend expectations of such
policies and contracts. Accordingly, these policies no longer participate in the
earnings and surplus of the Open Block. Subsequent to demutualization, the
Company ceased issuance of participating policies.
Prior to demutualization, the participating life insurance in force was
16.2% of the face value of total life insurance in force at December 31, 1994.
The premiums on participating life, health and annuity policies were 11.3% and
6.4% of total life, health and annuity statutory premiums prior to
demutualization in 1995 and 1994, respectively. Total policyholders' dividends
were $23.3 million and $32.8 million prior to demutualization in 1995 and 1994,
respectively.
L. Federal Income Taxes
- -----------------------
AFC, FAFLIC, AFLIAC and FAFLIC's non-insurance domestic subsidiaries file a
consolidated United States federal income tax return. Entities included within
the consolidated group are segregated into either a life insurance or 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. Allmerica P&C and its
subsidiaries file 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" (SFAS
No. 109). These differences result primarily from loss reserves, policy
acquisition expenses, and unrealized appreciation/depreciation on investments.
M. New Accounting Pronouncements
- --------------------------------
In March 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of" was issued. This statement requires
companies to write down to fair value long-lived assets whose carrying value is
greater than the undiscounted cash flows of those assets. The statement also
requires that long-lived assets of which management is committed to dispose,
either by sale or abandonment, be valued at the lower of their carrying amount
or fair value less costs to sell. This statement is effective for fiscal years
beginning after December 15, 1995. The adoption of this statement has not had a
material effect on the financial statements.
N. Earnings Per Share
- ---------------------
Earnings per share for the year ended December 31, 1996 is based on a weighted
average of the number of shares outstanding during 1996. Earnings per share for
the period October 1, 1995 (date used to estimate financial information for the
effective date of the demutualization transaction of October 16, 1995) through
December 31, 1995 is based on a weighted average of the number of shares
outstanding between October 16, 1995 and December 31, 1995.
The unaudited pro forma earnings per share for the year ended December 31,
1995 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 as of January 1, 1995.
The unaudited pro forma earnings and earnings per share information give
effect to the demutualization transaction and the Senior Debentures transaction
as if these transactions had occurred as of January 1, 1995. The effect on
earnings is to eliminate demutualization expenses of $12.1 million, to eliminate
a differential earnings adjustment tax credit of $7.6 million and to increase
interest and amortization expense related to the Senior Debentures by $7.8
million, for a net decrease in pro forma earnings of $3.3 million.
The unaudited pro forma 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 transactions been consummated on January 1, 1995,
and does not represent a projection or forecast of the Company's consolidated
results of operations for any future period.
O. Reclassifications
- --------------------
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. SIGNIFICANT TRANSACTIONS
------------------------
On February 19, 1997, the Company and Allmerica P&C entered into an Agreement
and Plan of Merger (the "Merger Agreement") pursuant to which the Company will
acquire all of the outstanding Common Stock, $1.00 par value per share, of
Allmerica P&C that it does not already own for consideration consisting of
$33.00 per share of Common Stock, subject to adjustment, payable in cash and
shares of common stock, par value $0.01 per share, of the Company (the "AFC
Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive
the consideration in cash, without interest, or in shares of AFC Common Stock,
subject to proration as set forth in the Merger Agreement. The maximum number of
shares of AFC Common Stock to be issued in the Merger is approximately 9.67
million shares. The acquisition will be accomplished by merging a newly created,
wholly-owned subsidiary of the Company with and into Allmerica P&C ( the
"Merger")
58
- --------------------------------------------------------------------------------
resulting in Allmerica P&C becoming a wholly-owned subsidiary of the Company.
Also, immediately prior to the Merger, Allmerica P&C's Certificate of
Incorporation will be amended to authorize a new class of Common Stock, one
share of which will be exchanged for each share of Common Stock currently held
by SMA Financial Corp., a wholly-owned subsidiary of the Company. The
consummation of the Merger is subject to the satisfaction of various conditions,
including the approval of regulatory authorities.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300 million Series A 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 are intended to fund a portion of the
acquisition of the 24.2 million publicly held shares of Allmerica P&C pursuant
to an Agreement and Plan of Merger dated February 19, 1997.
Pursuant to the plan of reorganization effective October 16, 1995, the
Company issued 37.5 million shares of its common stock to eligible
policyholders. The Company also issued 12.6 million shares of its common stock
at a price of $21.00 per share in a public offering, resulting in net proceeds
of $248.0 million, and issued Senior Debentures in the principal amount of
$200.0 million which resulted in net proceeds of $197.2 million.
Effective March 31, 1995, the Company entered into an agreement with TSSG,
a division of First Data Corporation, pursuant to which the Company sold its
mutual fund processing business and agreed not to engage in this business for
four years after that date. In accordance with this agreement, the Company
received proceeds of $32.1 million. A gain of $13.5 million, net of taxes of
$7.2 million, was recorded in March 1995. Additionally, the Company received a
non-recurring $3.1 million contingent payment, net of taxes of $1.7 million, in
1996 related to the aforementioned sale.
3. 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 SFAS No. 115.
The amortized cost and fair value of available-for-sale fixed maturities
and equity securities were as follows:
DECEMBER 31
(IN MILLIONS) 1996
- --------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost (1) Gains Losses Value
U.S. Treasury securities and
U.S. government and agency
securities $ 279.1 $ 9.3 $ 1.6 $ 286.8
States and political
subdivisions 2,236.9 48.5 7.7 2,277.7
Foreign governments 108.8 7.4 -- 116.2
Corporate fixed maturities 4,297.6 140.4 16.0 4,422.0
Mortgage-backed securities 383.1 4.7 2.7 385.1
- --------------------------------------------------------------------------------
Total fixed maturities $ 7,305.5 $ 210.3 $ 28.0 $ 7,487.8
================================================================================
Equity securities $ 328.2 $ 149.1 $ 3.7 $ 473.6
================================================================================
DECEMBER 31
(IN MILLIONS) 1995
- --------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost (1) Gains Losses Value
U.S. Treasury securities and
U.S. government and agency
securities $ 377.0 $ 21.0 $ -- $ 398.0
States and political
subdivisions 2,110.6 60.7 4.0 2,167.3
Foreign governments 60.6 3.4 0.6 63.4
Corporate fixed maturities 4,582.1 200.8 16.4 4,766.5
Mortgage-backed securities 337.6 8.6 2.1 344.1
- --------------------------------------------------------------------------------
Total fixed maturities $ 7,467.9 $ 294.5 $ 23.1 $ 7,739.3
================================================================================
Equity securities $ 410.6 $111.7 $ 5.1 $ 517.2
================================================================================
(1) Amortized cost for fixed maturities and cost for equity securities.
59
- --------------------------------------------------------------------------------
In March 1994, AFLIAC voluntarily withdrew its license in New York in order to
provide for certain commission arrangements prohibited by New York comparable to
AFLIAC's competitors. In connection with the withdrawal, FAFLIC, which is
licensed in New York, became qualified to sell the products previously sold by
AFLIAC 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 general
account liabilities of AFLIAC for New York policyholders, claimants and
creditors. At December 31, 1996, the amortized cost and market value of assets
on deposit were $284.9 million and $292.2 million, respectively. At December 31,
1995, the amortized cost and market value of assets on deposit were $295.0
million and $303.6 million, respectively. In addition, fixed maturities,
excluding those securities on deposit in New York, with an amortized cost of
$98.0 million and $82.2 million were on deposit with various state and
governmental authorities at December 31, 1996 and 1995, respectively.
There were no contractual fixed maturity investment commitments at December
31, 1996 and 1995, respectively.
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
(In millions) 1996
================================================================================
AMORTIZED FAIR
COST VALUE
Due in one year or less $ 567.6 $ 571.2
Due after one year through five years 2,216.4 2,297.2
Due after five years through ten years 2,398.2 2,456.9
Due after ten years 2,123.3 2,162.5
- --------------------------------------------------------------------------------
Total $7,305.5 $7,487.8
================================================================================
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
1996 Voluntary Sales Gains Losses
- ----
Fixed maturities $2,463.3 $ 19.3 $ 31.0
================================================================================
Equity securities $ 228.7 $ 56.3 $ 1.3
================================================================================
1995
- ----
Fixed maturities $1,612.3 $ 23.7 $ 33.0
================================================================================
Equity securities $ 122.2 $ 23.1 $ 6.9
================================================================================
1994
- ----
Fixed maturities $1,026.2 $ 12.6 $ 21.6
================================================================================
Equity securities $ 124.3 $ 17.4 $ 4.5
================================================================================
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
1996 Maturities and Other(1) Total
- ----
Net appreciation, beginning
of year $ 108.7 $ 44.3 $153.0
- --------------------------------------------------------------------------------
Net (depreciation) appreciation
on available-for-sale securities (94.3) 36.1 (58.2)
Net appreciation from the
effect on deferred policy
acquisition costs and on
policy liabilities 23.1 -- 23.1
Benefit (provision) for deferred
federal income taxes
and minority interest 33.6 (19.9) 13.7
- --------------------------------------------------------------------------------
(37.6) 16.2 (21.4)
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 71.1 $ 60.5 $131.6
================================================================================
60
- --------------------------------------------------------------------------------
Equity
Fixed Securities
1995 Maturities and Other(1) Total
- ----
Net (depreciation) appreciation,
beginning of year $ (89.4) $ 10.4 $ (79.0)
- --------------------------------------------------------------------------------
Effect of transfer of securities
between classifications:
Net appreciation on available-
for-sale fixed maturities 29.2 -- 29.2
Effect of transfer on
deferred policy acquisition
costs and on policy liabilities (6.8) -- (6.8)
Provision for deferred
federal income taxes
and minority interest (9.6) -- (9.6)
- --------------------------------------------------------------------------------
12.8 -- 12.8
- --------------------------------------------------------------------------------
Net appreciation on
available-for-sale securities 465.4 87.5 552.9
Net depreciation from the
effect on deferred policy
acquisition costs and
on policy liabilities (86.9) -- (86.9)
Provision for deferred
federal income taxes
and minority interest (193.2) (53.6) (246.8)
- --------------------------------------------------------------------------------
185.3 33.9 219.2
- --------------------------------------------------------------------------------
Net appreciation, end of year $ 108.7 $ 44.3 $ 153.0
================================================================================
1994
- ----
Net appreciation, beginning of year $ -- $ 17.5 $ 17.5
- --------------------------------------------------------------------------------
Cumulative effect of accounting
change:
Net appreciation on available-
for-sale fixed maturities 335.3 -- 335.3
Net depreciation from the
effect of accounting change
on deferred policy acquisition
costs and on policy liabilities (39.2) -- (39.2)
Provision for deferred federal
income taxes and minority
interest (149.1) -- (149.1)
- --------------------------------------------------------------------------------
147.0 17.5 164.5
- --------------------------------------------------------------------------------
Net depreciation on
available-for-sale securities (547.9) (17.4) (565.3)
Net appreciation from the effect
on deferred policy acquisition
costs and on policy liabilities 73.2 -- 73.2
Benefit for deferred federal income
taxes and minority interest 238.3 10.3 248.6
- --------------------------------------------------------------------------------
(236.4) (7.1) (243.5)
- --------------------------------------------------------------------------------
Net (depreciation) appreciation,
end of year $ (89.4) $ 10.4 $ (79.0)
================================================================================
(1) Includes net appreciation on other investments of $0.6 million, $2.2
million, and $0.6 million in 1996, 1995, and 1994 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 as follows:
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Mortgage loans $650.1 $799.5
- --------------------------------------------------------------------------------
Real estate:
Held for sale 110.4 168.9
Held for production of income 10.3 10.7
- --------------------------------------------------------------------------------
Total real estate 120.7 179.6
- --------------------------------------------------------------------------------
Total mortgage loans and real estate $770.8 $979.1
================================================================================
Reserves for mortgage loans were $19.6 million and $33.8 million at December
31, 1996 and 1995, respectively.
During 1996, 1995 and 1994, non-cash investing activities included real estate
acquired through foreclosure of mortgage loans, which had a fair value of $0.9
million, $26.1 million and $39.2 million, respectively.
At December 31, 1996, contractual commitments to extend credit under
commercial mortgage loan agreements amounted to approximately $22.1 million, of
which $3.1 million related to the Closed Block. These commitments generally
expire within one year.
Mortgage loans and real estate investments comprised the following property
types and geographic regions:
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Property type:
Office building $317.1 $435.9
Residential 95.4 145.3
Retail 177.0 205.6
Industrial / warehouse 124.8 93.8
Other 91.0 151.9
Valuation allowances (34.5) (53.4)
- --------------------------------------------------------------------------------
Total $770.8 $979.1
================================================================================
Geographic region:
South Atlantic $227.0 $281.4
Pacific 154.4 191.9
East North Central 119.2 118.2
Middle Atlantic 112.6 148.9
West South Central 41.6 79.7
New England 50.9 94.9
Other 99.6 117.5
Valuation allowances (34.5) (53.4)
- --------------------------------------------------------------------------------
Total $770.8 $979.1
================================================================================
61
- --------------------------------------------------------------------------------
At December 31, 1996, scheduled mortgage loan maturities were as follows: 1997 -
$131.9 million; 1998 - $161.7 million; 1999 - $99.9 million; 2000 - $138.0
million; 2001 - $34.4 million; and $84.2 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 1996, the Company refinanced $7.8 million of 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
1996 January 1 Additions Deductions December 31
- ----
Mortgage loans $33.8 $ 5.5 $19.7 $19.6
Real estate 19.6 - 4.7 14.9
- --------------------------------------------------------------------------------
Total $53.4 $ 5.5 $24.4 $34.5
================================================================================
1995
- ----
Mortgage loans $47.2 $ 1.5 $14.9 $33.8
Real estate 22.9 (0.6) 2.7 19.6
- --------------------------------------------------------------------------------
Total $70.1 $ 0.9 $17.6 $53.4
================================================================================
1994
- ----
Mortgage loans $73.8 $14.6 $41.2 $47.2
Real estate 21.0 3.2 1.3 22.9
- --------------------------------------------------------------------------------
Total $94.8 $17.8 $42.5 $70.1
================================================================================
The carrying value of impaired loans was $33.6 million and $55.7 million,
with related reserves of $11.9 million and $22.3 million as of December 31, 1996
and 1995, respectively. All impaired loans were reserved as of December 31, 1996
and 1995.
The average carrying value of impaired loans was $50.4 million, $117.9
million and $155.5 million, with related interest income while such loans were
impaired, of $5.8 million, $9.3 million and $12.4 million as of December 31,
1996, 1995 and 1994 respectively.
D. Futures Contracts
- --------------------
AFC purchases long futures contracts and sells short futures contracts on margin
to hedge against interest rate fluctuations and their effect on the net cash
flows from the sales of guaranteed investment contracts. The notional amount of
such futures contracts outstanding were $(40.0) million net short contracts and
$74.7 million long contracts at December 31, 1996 and 1995, respectively.
Because the Company purchases and sells futures contracts through brokers
who assume the risk of loss, the Company's exposure to credit risk under futures
contracts is limited to the margin deposited with the broker. The maturity of
all futures contracts outstanding are less than one year. The fair value of
futures contracts outstanding were $(39.4) million and $75.7 million at December
31, 1996 and 1995, 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. Deferred hedging gains (losses) were
$0.6 million, $5.6 million and $(7.7) million in 1996, 1995 and 1994,
respectively. Gains and losses on hedge contracts that are deemed ineffective by
management are realized immediately.
A reconciliation of the notional amount of futures contracts is as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
Contracts outstanding,
beginning of year $ 74.7 $ 126.6 $ 141.7
New contracts (44.0) 349.2 816.0
Contracts terminated (70.7) (401.1) (831.1)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $(40.0) $ 74.7 $ 126.6
================================================================================
62
- --------------------------------------------------------------------------------
E. Foreign Currency Swap Contracts
- ----------------------------------
The Company enters into foreign currency swap contracts to hedge exposure to
currency risk on foreign fixed maturity investments. Interest and principal
related to foreign fixed maturity investments payable in foreign currencies, at
current exchange rates, are exchanged for the equivalent payment translated at a
specific currency exchange rate. The 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. The fair values of the foreign currency swap contracts
outstanding were $(9.2) million and $(1.8) million at December 31, 1996 and
1995, respectively.
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 1996, 1995 and 1994. The Company had no deferred
gains or losses on foreign currency swap contracts.
A reconciliation of the notional amount of swap contracts is as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
Contracts outstanding,
beginning of year $104.6 $118.7 $128.8
New contracts -- -- 10.1
Contracts expired (36.0) -- (15.1)
Contracts terminated -- (14.1) (5.1)
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 68.6 $104.6 $118.7
================================================================================
Expected maturities of foreign currency swap contracts are $18.2 million in
1997 and $50.4 million in 1999 and thereafter. There are no expected maturities
of foreign currency swap contracts in 1998.
F. Interest Rate and Other Swap Contracts
- -----------------------------------------
The Company enters into interest rate swap contracts to hedge exposure to
interest rate fluctuations. 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. In
addition, the Company has entered into two new types of swap contracts in 1996:
security return-linked swap contracts and insurance portfolio-linked swap
contracts for investment purposes. Under the security return-linked contracts,
the Company agrees to exchange cash flows according to the performance of a
specified security or portfolio of securities. 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.
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.
The net amount receivable or payable is recognized over the life of the
swap contract as an adjustment to net investment income. The increase or
(decrease) in net investment income related to interest rate and other swap
contracts was $0.6 million, $0.7 million and $(1.3) million for the years ended
December 31, 1996, 1995, and 1994, respectively. The Company had no deferred
gains or losses relating to interest rate and other swap contracts. The fair
values of interest rate and other swap contracts outstanding were $0.1 million,
$0.4 million and $0.6 million at December 31, 1996, 1995 and 1994, respectively.
A reconciliation of the notional amount of interest rate and other swap
contracts is as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
Contracts outstanding,
beginning of year $ 17.5 $22.8 $22.8
New contracts 63.6 -- --
Contracts expired (17.5) (5.3) --
- --------------------------------------------------------------------------------
Contracts outstanding, end of year $ 63.6 $17.5 $22.8
================================================================================
Expected maturities of interest rate and other swap contracts outstanding
at December 31 are as follows: $43.6 million in 1997, $5.0 million in 1998, and
$15.0 million in 1999 and thereafter.
G. Other
- --------
At December 31, 1996, AFC had no concentration of investments in a single
investee exceeding 10% of shareholders' equity, except for investments with the
U.S. Treasury with a carrying value of $268.3 million.
4. 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
(IN MILLIONS) 1996 1995 1994
================================================================================
Fixed maturities $555.8 $555.1 $578.3
Mortgage loans 69.5 97.0 119.9
Equity securities 11.1 13.2 9.9
Policy loans 10.3 20.3 23.3
Real estate 40.8 48.7 44.6
Other long-term investments 19.0 7.1 5.7
Short-term investments 11.3 21.6 10.3
- --------------------------------------------------------------------------------
Gross investment income 717.8 763.0 792.0
Less investment expenses (45.2) (52.5) (48.9)
- --------------------------------------------------------------------------------
Net investment income $672.6 $710.5 $743.1
================================================================================
At December 31, 1996, fixed maturities and mortgage loans on non-accrual
status were $2.0 million and $6.8 million, including restructured loans of $4.4
million. The effect of non-
63
- --------------------------------------------------------------------------------
accruals, compared with amounts that would have been recognized in accordance
with the original terms of the investments, was to reduce net income by $0.5
million, $0.6 million and $5.1 million in 1996, 1995 and 1994, respectively.
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 $51.3 million, $98.9 million and $126.8 million at December
31, 1996, 1995 and 1994, respectively. Interest income on restructured mortgage
loans that would have been recorded in accordance with the original terms of
such loans amounted to $7.7 million, $11.1 million and $14.4 million in 1996,
1995 and 1994, respectively. Actual interest income on these loans included in
net investment income aggregated $4.5 million, $7.1 million and $8.2 million in
1996, 1995 and 1994, respectively.
At December 31, 1996, fixed maturities with a carrying value of $2.0
million were non-income producing for the twelve months ended December 31, 1996.
There were no mortgage loans which were non-income producing for the twelve
months ended December 31, 1996.
Included in other long-term investments is income from limited partnerships
of $13.7 million, $0.1 million and $0.6 million in 1996, 1995 and 1994
respectively.
B. Realized Investment Gains and Losses
- ---------------------------------------
Realized gains (losses) on investments were as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
==========================================================================
Fixed maturities $(10.1) $(7.0) $ 2.4
Mortgage loans (2.4) 1.4 (12.1)
Equity securities 55.0 16.2 12.4
Real estate 21.1 5.3 1.4
Other 2.3 3.2 (3.0)
- --------------------------------------------------------------------------
Net realized investment gains $ 65.9 $19.1 $ 1.1
==========================================================================
Proceeds from voluntary sales of investments in fixed maturities were
$2,463.3 million, $1,612.3 million and $1,036.5 million in 1996, 1995 and 1994,
respectively. Realized gains on such sales were $19.3 million, $23.7 million and
$12.9 million; and realized losses were $31.0 million, $33.0 million and $21.6
million for 1996, 1995 and 1994, respectively.
5. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
-----------------------------------------------
SFAS 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. Fair values of
interest rate futures were not material at December 31, 1996 and 1995.
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.
Reinsurance Receivables
The carrying amount reported in the consolidated balance sheets approximates
fair 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.
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.
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.
64
- --------------------------------------------------------------------------------
The estimated fair values of the financial instruments were as follows:
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Carrying Fair Carrying Fair
FINANCIAL ASSETS Value Value Value Value
- ----------------
Cash and cash equivalents $ 178.5 $ 178.5 $ 289.5 $ 289.5
Fixed maturities 7,487.8 7,487.8 7,739.3 7,739.3
Equity securities 473.6 473.6 517.2 517.2
Mortgage loans 650.1 675.7 799.5 845.4
Policy loans 132.4 132.4 123.2 123.2
- --------------------------------------------------------------------------------
$8,922.4 $8,948.0 $9,468.7 $9,514.6
================================================================================
FINANCIAL LIABILITIES
- ---------------------
Guaranteed investment contracts $1,101.3 $1,119.2 $1,632.8 $1,677.0
Supplemental contracts without
life contingencies 23.1 23.1 24.4 24.4
Dividend accumulations 87.3 87.3 86.2 86.2
Other individual contract
deposit funds 76.9 74.3 95.7 92.8
Other group contract deposit
funds 789.1 788.3 894.0 902.8
Individual annuity contracts 935.6 719.0 966.3 810.0
Short-term debt 38.4 38.4 31.2 31.2
Long-term debt 202.2 199.1 202.3 212.4
- --------------------------------------------------------------------------------
$3,253.9 $3,048.7 $3,932.9 $3,836.8
================================================================================
6. CLOSED BLOCK
------------
Included in other income in the Consolidated Statements of Income in 1996 and
1995 is a net pre-tax contribution from the Closed Block of $8.6 million and
$2.9 million, respectively. Summarized financial information of the Closed Block
as of December 31, 1996 and 1995 and for the period ended December 31, 1996 and
the period from October 1, 1995 through December 31, 1995 is as follows:
DECEMBER 31
(IN MILLIONS) 1996 1995
==================================================================
Assets
Fixed maturities, at fair value (amortized
cost of $397.2 and $447.4, respectively) $403.9 $458.0
Mortgage loans 114.5 57.1
Policy loans 230.2 242.4
Cash and cash equivalents 24.1 17.6
Accrued investment income 14.3 16.6
Deferred policy acquisition costs 21.1 24.5
Other assets 3.7 2.7
- -----------------------------------------------------------------
Total assets $811.8 $818.9
=================================================================
Liabilities
Policy liabilities and accruals $883.4 $899.2
Other liabilities 8.7 2.8
- -----------------------------------------------------------------
Total liabilities $892.1 $902.0
=================================================================
65
- --------------------------------------------------------------------------------
Period from
October 1
through
December 31 December 31
(In millions) 1996 1995
================================================================================
Revenues
Premiums $ 61.7 $ 11.5
Net investment income 52.6 12.8
Realized investment loss (0.7) --
- --------------------------------------------------------------------------------
Total revenues 113.6 24.3
- --------------------------------------------------------------------------------
Benefits and expenses
Policy benefits 101.2 20.6
Policy acquisition expenses 3.2 0.8
Other operating expenses 0.6 --
- --------------------------------------------------------------------------------
Total benefits and expenses 105.0 21.4
- --------------------------------------------------------------------------------
Contribution from the Closed Block $ 8.6 $ 2.9
================================================================================
Cash flows
Cash flows from operating activities:
Contribution from the Closed Block $ 8.6 $ 2.9
Initial cash transferred to the Closed Block -- 139.7
Change in deferred policy acquisition
costs, net 3.4 0.4
Change in premiums and other receivables 0.2 (0.1)
Change in policy liabilities and accruals (13.9) 2.0
Change in accrued investment income 2.3 (1.3)
Other, net 2.5 0.8
- --------------------------------------------------------------------------------
Net cash provided by operating activities 3.1 144.4
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Sales, maturities and repayments of
investments 188.1 29.0
Purchases of investments (196.9) (158.8)
Other, net 12.2 3.0
- --------------------------------------------------------------------------------
Net cash provided by
(used in) investing activities 3.4 (126.8)
- --------------------------------------------------------------------------------
Net increase in cash and cash equivalents 6.5 17.6
Cash and cash equivalents, beginning
of the year 17.6 --
- --------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 24.1 $ 17.6
================================================================================
On October 16, 1995, there were no valuation allowances transferred to the
Closed Block on mortgage loans. There were no valuation allowances on mortgage
loans at December 31, 1996 and 1995, 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.
7. DEBT
----
Short- and long-term debt consisted of the following:
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Short-term
Commercial paper $ 37.8 $ 27.7
Other 0.6 3.5
- --------------------------------------------------------------------------------
Total short-term debt $ 38.4 $ 31.2
================================================================================
Long-term
Senior Debentures (unsecured) $199.5 $199.5
Other 2.7 2.8
- --------------------------------------------------------------------------------
Total long-term debt $202.2 $202.3
================================================================================
AFC issues commercial paper primarily to manage imbalances between
operating cash flows and existing commitments. Commercial paper borrowing
arrangements are supported by various lines of credit. At December 31, 1996, the
weighted average interest rate for outstanding commercial paper was
approximately 5.5%.
At December 31, 1996, AFC had approximately $140.0 million in committed
lines of credit provided by U.S. banks, of which $102.2 million 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 of 0.07% of the available
credit. Interest that would be charged for usage of these lines of credit is
based upon negotiated arrangements.
During 1996, the Company utilized repurchase agreements to finance certain
investments. Although the repurchase agreements were entirely settled by year
end, management may utilize this policy again in future periods.
In October, 1995, AFC issued $200.0 million face amount of Senior
Debentures for proceeds of $197.2 million net of discounts and issuance costs.
These securities have an effective interest rate of 7.65%, and mature on October
16, 2025. Interest is payable semiannually on October 15 and April 15 of each
year. 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.
66
- --------------------------------------------------------------------------------
Interest expense was $32.1 million, $7.3 million and $4.3 million in 1996,
1995 and 1994, respectively. Interest expense in 1996 included $15.3 million
related to the Company's Senior Debentures and $11.0 million related to interest
payments on repurchase agreements. Interest expense in 1995 included $3.2
million related to the Company's Senior Debentures. All interest expense is
recorded in other operating expenses.
8. Federal Income Taxes
--------------------
Provisions for federal income taxes have been calculated in accordance with the
provisions of SFAS 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
(In millions) 1996 1995 1994
================================================================================
Federal income tax expense (benefit)
Current $ 90.9 $119.7 $45.4
Deferred (15.7) (37.0) 8.0
- --------------------------------------------------------------------------------
Total $ 75.2 $ 82.7 $53.4
================================================================================
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 expected federal income tax rate. The sources
of the difference and the tax effects of each were as follows:
For the Years Ended December 31
(In millions) 1996 1995 1994
================================================================================
Expected federal income tax expense $116.1 $105.6 $ 53.7
Tax-exempt interest (35.3) (32.2) (35.9)
Differential earnings amount (10.2) (7.6) 35.0
Dividend received deduction (1.6) (4.0) (2.5)
Changes in tax reserve estimates 4.7 19.3 4.0
Other, net 1.5 1.6 (0.9)
- --------------------------------------------------------------------------------
Federal income tax expense $ 75.2 $ 82.7 $ 53.4
================================================================================
Until conversion to a stock life insurance company, FAFLIC, as a mutual
company, reduced its deduction for policyholder dividends by the differential
earnings amount. This amount was computed, for each tax year, by multiplying the
average equity base of the FAFLIC/AFLIAC consolidated group, as determined for
tax purposes, by the estimate of an excess of an imputed earnings rate over the
average mutual life insurance companies' earnings rate. The differential
earnings amount for each tax year was subsequently recomputed when actual
earnings rates were published by the Internal Revenue Service (IRS). The
differential earnings amount included in 1996 related to an adjustment for the
1994 tax year based on the actual average mutual life insurance companies'
earnings rate issued by the IRS in 1996. As a stock life company, FAFLIC is no
longer required to reduce its policyholder dividend deduction by the
differential earnings amount.
The deferred income tax asset represents the tax effects of temporary
differences attributable to Allmerica P&C, a separate consolidated group for
federal tax return purposes. Its components were as follows:
December 31
(In millions) 1996 1995
================================================================================
Deferred tax (assets) liabilities
AMT carryforwards $ (16.3) $ (9.8)
Loss reserve discounting (182.1) (178.3)
Deferred acquisition costs 57.5 55.1
Employee benefit plans (25.1) (25.5)
Investments, net 73.4 77.4
Bad debt reserve (1.7) (1.8)
Other, net 1.1 1.7
- --------------------------------------------------------------------------------
Deferred tax asset, net $ (93.2) $ (81.2)
================================================================================
The deferred income tax liability represents the tax effects of temporary
differences attributable to the FAFLIC/AFLIAC consolidated federal tax return
group. Its components were as follows:
December 31
(In millions) 1996 1995
================================================================================
Deferred tax (assets) liabilities
Loss reserve discounting $(153.7) $(129.1)
Deferred acquisition costs 189.6 169.7
Employee benefit plans (16.3) (14.6)
Investments, net 55.2 67.0
Bad debt reserve (24.5) (26.3)
Other, net (15.6) (18.9)
- --------------------------------------------------------------------------------
Deferred tax liability, net $ 34.7 $ 47.8
================================================================================
Gross deferred income tax assets totaled $435.3 million and $405.1 million
at December 31, 1996 and 1995, respectively. Gross deferred income tax
liabilities totaled $376.8 million and $371.7 million at December 31, 1996 and
1995, respectively.
67
Management believes, based on the Company's 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, management considered the future reversal of its existing
temporary differences and available tax planning strategies that could be
implemented, if necessary. At December 31, 1996, there are available non-life
net operating loss carryforwards of $0.8 million, and alternative minimum tax
credit carryforwards of $16.3 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 1991. The IRS has also examined the
Allmerica P&C consolidated group's federal income tax returns through 1991. The
Company is currently considering its response to certain adjustments proposed by
the IRS with respect to the federal income tax returns for 1989, 1990, and 1991
for both the FAFLIC/AFLIAC consolidated group as well as the Allmerica P&C
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 management'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.
9. PENSION PLANS
-------------
AFC provides retirement benefits to substantially all of its employees under
three separate defined benefit pension plans. Through December 31, 1994,
retirement benefits were based primarily on employees' years of service and
compensation during the highest five consecutive plan years of employment.
Benefits under this defined benefit formula were frozen for most employees (but
not for eligible agents) effective December 31, 1994. In their place, the
Company adopted a defined benefit cash balance formula, under which the Company
annually provides an allocation to each eligible employee as a percentage of
that employee's salary, similar to a defined contribution plan arrangement. The
1996 and 1995 allocations were based on 7.0% of each eligible employee's salary.
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 pension expense were as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
Service cost - benefits
earned during the year $ 19.0 $ 19.7 $ 13.0
Interest accrued on projected
benefit obligations 21.9 21.1 20.0
Actual return on assets (42.2) (89.3) (2.6)
Net amortization and deferral 9.3 66.1 (16.3)
- --------------------------------------------------------------------------------
Net pension expense $ 8.0 $ 17.6 $ 14.1
================================================================================
The following table summarizes the combined status of the three pension
plans. At December 31, 1996 the plans' assets exceeded their projected benefit
obligations and in 1995 the plans' projected benefit obligation exceeded their
assets.
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Actuarial present value of benefit obligations:
Vested benefit obligation $308.9 $325.6
Unvested benefit obligation 6.6 5.0
- --------------------------------------------------------------------------------
Accumulated benefit obligation $315.5 $330.6
================================================================================
Pension liability included in
Consolidated Balance Sheets:
Projected benefit obligation $344.2 $367.1
Plan assets at fair value 347.8 321.2
- --------------------------------------------------------------------------------
Plan assets greater (less) than
projected benefit obligation 3.6 (45.9)
Unrecognized net (gain) loss from
past experience (9.1) 48.8
Unrecognized prior service benefit (11.5) (13.8)
Unamortized transition asset (24.7) (26.5)
- --------------------------------------------------------------------------------
Net pension liability $(41.7) $(37.4)
================================================================================
Determination of the projected benefit obligations was based on a weighted
average discount rate of 7.0% in 1996 and 1995, and the assumed long-term rate
of return on plan assets was 9.0%. The actuarial present value of the projected
benefit obligations was determined using assumed rates of increase in future
compensation levels ranging from 5.5% to 6.5%. Plan assets are invested
primarily in various separate accounts and the general account of FAFLIC. The
plans also hold stock of AFC.
The Company has a profit sharing and 401(k) plan for its employees.
Effective for plan years beginning after 1994, the profit sharing formula for
employees has been discontinued and a 401(k) match feature has been added to the
continuing 401(k)
68
- --------------------------------------------------------------------------------
plan for the employees. Total plan expense in 1996, 1995 and 1994 was $5.5
million, $5.2 million and $12.6 million, respectively. In addition to this Plan,
the Company has a defined contribution plan for substantially all of its agents.
The Plan expense in 1996, 1995 and 1994 was $2.0 million, $3.5 million and $2.7
million, respectively.
10. 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 several plans sponsored by FAFLIC, Hanover and Citizens.
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 plan changes effective January 1, 1996 resulted in a negative plan
amendment (change in eligibility and medical benefits) of $26.8 million and
curtailment (no future increases in life insurance) of $5.3 million. The
negative plan amendment will be amortized as prior service cost over the average
number of years to full eligibility (approximately 9 years or $3.0 million per
year). Of the $5.3 million curtailment gain, $3.3 million has been deducted from
unrecognized loss and $2.0 million has been recorded as a reduction of the net
periodic postretirement benefit expense.
The plans' funded status reconciled with amounts recognized in the
Company's consolidated balance sheet were as follows:
DECEMBER 31
(IN MILLIONS) 1996 1995
================================================================================
Accumulated postretirement benefit obligation:
Retirees $40.4 $ 44.9
Fully eligible active plan participants 7.5 14.0
Other active plan participants 24.4 45.9
- --------------------------------------------------------------------------------
72.3 104.8
Plan assets at fair value -- --
- --------------------------------------------------------------------------------
Accumulated postretirement benefit
obligation in excess of plan assets 72.3 104.8
Unrecognized prior service benefit 23.8 --
Unrecognized loss (5.0) (13.4)
- --------------------------------------------------------------------------------
Accrued postretirement benefit costs $91.1 $ 91.4
================================================================================
The components of net periodic postretirement benefit expense were as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================================
Service cost $ 3.2 $ 4.2 $ 6.6
Interest cost 4.6 6.9 6.9
Amortization of (gain) loss (2.8) (0.5) 1.4
- --------------------------------------------------------------------------------
Net periodic postretirement
benefit expense $ 5.0 $10.6 $14.9
================================================================================
For purposes of measuring the accumulated postretirement benefit obligation
at December 31, 1996, health care costs were assumed to increase 9.0% in 1997,
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, 1996
by $5.3 million, and the aggregate of the service and interest cost components
of net periodic postretirement benefit expense for 1996 by $0.7 million.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0% at December 31, 1996 and 1995.
11. POSTEMPLOYMENT BENEFITS
-----------------------
Effective January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 112, (SFAS No. 112), "Employers' Accounting
for Postemployment Benefits", which requires employers to recognize the costs
and obligations of severance, disability and related life insurance and health
care benefits to be paid to inactive or former employees after employment but
before retirement. Prior to adoption, the Company had recognized the cost of
these benefits on an accrual or paid basis, depending on the plan.
Implementation of SFAS No. 112 resulted in a transition obligation of $1.9
million, net of federal income taxes and minority interest, and is reported as a
cumulative effect of a change in accounting principle in the consolidated
statement of income. The impact of this accounting change, after recognition of
the cumulative effect, was not significant.
69
- --------------------------------------------------------------------------------
12. STOCK-BASED COMPENSATION PLANS
In October 1995 the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation"("SFAS 123"). The Standard is
effective for fiscal years beginning after December 15, 1995, and requires the
Company either to apply a fair value measure to any stock-based compensation
granted by the Company, or continue to apply the valuation provisions of
existing accounting standards, but with pro-forma net income and earnings per
share disclosures using a fair value methodology to value the stock-based
compensation. Beginning for the year ended December 31, 1996, the Company has
elected to continue to apply the valuation provisions of existing accounting
standards (APB 25). The pro forma effect of applying SFAS 123 is not material.
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, 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. At June 17, 1996,
231,500 option shares were granted at an option price of $27.50. During 1996,
22,000 option shares were forfeited leaving 209,500 option shares outstanding at
December 31, 1996. There were no options exercised during 1996. At December 31,
1996, there were no options exercisable and 2,140,500 option shares were
available for future grant.
13. 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. At January 1, 1997, FAFLIC could pay
dividends of $151.8 million to AFC without prior approval of the Commissioner.
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. At January 1, 1997, AFLIAC could pay dividends of
$11.9 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 the
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.
At January 1, 1997, the maximum dividend and other distributions that could be
paid to Allmerica P&C by Hanover, without prior approval of the Insurance
Commissioner, was approximately $15.4 million, which considers dividends
declared to Allmerica P&C of $105.0 million during 1996, including $80.0 million
which was declared in December. On January 2, 1997, Hanover declared an
extraordinary dividend in the amount of $120.0 million, payable on or after
January 21, 1997 to Allmerica P&C. The dividend which was approved by the New
Hampshire Insurance Department on January 9, 1997 is to be paid in a lump sum or
in such installments as Allmerica P&C, in its discretion, may determine.
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. At January 1, 1997, Citizens Insurance could pay
dividends of $39.9 million to Citizens Corporation without prior approval.
70
- -------------------------------------------------------------------------------
14. SEGMENT INFORMATION
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Management. Within these broad areas, the
Company conducts business principally in five operating segments.
The Risk Management group includes two segments: Regional Property and
Casualty and Corporate Risk Management Services.
The Regional Property and Casualty segment includes property and casualty
insurance products, such as automobile insurance, homeowners insurance,
commercial multiple-peril insurance, and workers' compensation insurance. These
products are offered by Allmerica P&C through its operating subsidiaries,
Hanover and Citizens. Substantially all of the Regional Property and Casualty
segment's earnings are generated in Michigan and the Northeast (Connecticut,
Massachusetts, New York, New Jersey, New Hampshire, Rhode Island, Vermont and
Maine). The Corporate Risk Management Services segment includes group life and
health insurance products and services which assist employers in administering
employee benefit programs and in managing the related risks.
The Retirement and Asset Management group includes three segments: Retail
Financial Services, Institutional Services and Allmerica Asset Management. The
Retail Financial Services segment includes variable annuities, variable
universal life-type, traditional and health insurance products distributed via
retail channels to individuals across the country. The Institutional Services
segment includes primarily group retirement products such as 401(k) plans, tax-
sheltered annuities and GIC contracts which are distributed to institutions
across the country via work-site marketing and other arrangements. Allmerica
Asset Management is a Registered Investment Advisor which provides investment
advisory services, primarily to affiliates, and to other institutions, such as
insurance companies and pension plans.
In addition to the five operating segments, the Company also has a
Corporate segment, which consists primarily of Senior Debentures and a portion
of the net proceeds from the Company's initial public offering.
Summarized below is financial information with respect to business segments for
the years ended and as of December 31.
(IN MILLIONS) 1996 1995 1994
- ---------------------------------------------------------------------
Revenues:
Risk Management
Regional Property and
Casualty $ 2,193.7 $ 2,095.1 $ 2,004.8
Corporate Risk Management 361.5 328.5 302.4
- ---------------------------------------------------------------------
Subtotal 2,555.2 2,423.6 2,307.2
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 450.9 486.7 507.9
Institutional Services 266.7 330.2 397.9
Allmerica Asset Management 8.8 4.4 4.0
- ---------------------------------------------------------------------
Subtotal 726.4 821.3 909.8
- ---------------------------------------------------------------------
Corporate 1.8 0.4 --
Eliminations (8.7) (4.4) (21.9)
- ---------------------------------------------------------------------
Total $ 3,274.7 $ 3,240.9 $ 3,195.1
=====================================================================
Income from continuing
operations before income taxes:
Risk Management
Regional Property and
Casualty $ 197.7 $ 206.3 $ 113.1
Corporate Risk Management 20.7 18.3 19.9
- ---------------------------------------------------------------------
Subtotal 218.4 224.6 133.0
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 76.2 35.2 14.2
Institutional Services 52.8 42.8 4.4
Allmerica Asset Management 1.1 2.3 1.9
- ---------------------------------------------------------------------
Subtotal 130.1 80.3 20.5
- ---------------------------------------------------------------------
Corporate (16.8) (3.1) --
- ---------------------------------------------------------------------
Total $ 331.7 $ 301.8 $ 153.5
=====================================================================
Identifiable assets:
Risk Management
Regional Property and
Casualty $ 5,703.9 $ 5,741.8 $ 5,408.7
Corporate Risk Management 506.0 458.9 386.3
- ---------------------------------------------------------------------
Subtotal 6,209.9 6,200.7 5,795.0
- ---------------------------------------------------------------------
Retirement and Asset
Management
Retail Financial Services 8,873.5 7,218.6 5,639.8
Institutional Services 3,879.0 4,280.9 4,484.5
Allmerica Asset Management 2.4 2.1 2.2
- ---------------------------------------------------------------------
Subtotal 12,754.9 11,501.6 10,126.5
- ---------------------------------------------------------------------
Corporate 32.9 55.4 --
- ---------------------------------------------------------------------
Total $18,997.7 $17,757.7 $15,921.5
=====================================================================
71
- --------------------------------------------------------------------------------
15. LEASE COMMITMENTS
-----------------
Rental expenses for operating leases, principally with respect to buildings,
amounted to $33.6 million, $36.4 million and $35.2 million in 1996, 1995 and
1994, respectively. At December 31, 1996, future minimum rental payments under
non-cancellable operating leases were approximately $71.7 million, payable as
follows: 1997 - $26.4 million; 1998 - $19.6 million; 1999 - $12.8 million; 2000
- - $8.0 million; and $5.0 million thereafter. It is expected that, in the normal
course of business, leases that expire will be renewed or replaced by leases on
other property and equipment; thus, it is anticipated that future minimum lease
commitments will not be less than the amounts shown for 1997.
16. REINSURANCE
-----------
In the normal course of business, the Company seeks to reduce the loss 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 SFAS No. 113.
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.
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, 1996, the MCCA and CAR were the only two
reinsurers which 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 1996, 1995 and
1994 were $38.0 million and $21.8 million, $49.1 million and $33.7 million, and
$50.0 million and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool, which is administered by The
National Council on Compensation Insurance ("NCCI"). The Company is currently
involved in legal proceedings regarding the MWCRP's deficit which through a
legislated settlement issued on June 23, 1995 provided for an initial funding of
$220.0 million, of which the insurance carriers were responsible for $65.0
million. Hanover paid its allocation of $4.2 million in December 1995. Some of
the small carriers appealed this decision. The Company's right to recover
reinsurance balances for claims properly paid is not at issue in any such
proceedings. The Company expects to collect its reinsurance balance; however,
funding of the cash flow needs of the MWCRP may in the future be affected by
issues related to certain litigation, the outcome of which the Company cannot
predict. The Company ceded to MCCA premiums earned and losses and loss
adjustment expenses in 1996, 1995 and 1994 of $50.5 million and $(52.9) million,
$66.8 million and $62.9 million, and $80.0 million and $24.2 million,
respectively. 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.
72
- --------------------------------------------------------------------------------
The effects of reinsurance were as follows:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
======================================================================
Life insurance premiums:
Direct $ 389.1 $ 438.9 $ 447.2
Assumed 87.8 71.0 54.3
Ceded (138.9) (150.3) (111.0)
- ----------------------------------------------------------------------
Net premiums $ 338.0 $ 359.6 $ 390.5
======================================================================
Property and casualty premiums
written:
Direct $2,039.7 $2,039.4 $1,992.4
Assumed 108.7 125.0 128.6
Ceded (234.0) (279.1) (298.1)
- ----------------------------------------------------------------------
Net premiums $1,914.4 $1,885.3 $1,822.9
======================================================================
Property and casualty premiums
earned:
Direct $2,018.5 $2,021.7 $1,967.1
Assumed 112.4 137.7 116.1
Ceded (232.6) (296.2) (291.9)
- ----------------------------------------------------------------------
Net premiums $1,898.3 $1,863.2 $1,791.3
======================================================================
Life insurance and other individual
policy benefits, claims, losses
and loss adjustment expenses:
Direct $ 618.0 $ 749.6 $ 773.0
Assumed 44.9 38.5 28.9
Ceded (77.8) (69.5) (61.6)
- ----------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $ 585.1 $ 718.6 $ 740.3
======================================================================
Property and casualty benefits,
claims,losses and loss
adjustment expenses:
Direct $1,288.3 $1,372.7 $1,364.4
Assumed 85.8 146.1 102.7
Ceded (2.2) (229.1) (160.4)
- ----------------------------------------------------------------------
Net policy benefits, claims, losses
and loss adjustment expenses $1,371.9 $1,289.7 $1,306.7
======================================================================
17. DEFERRED POLICY ACQUISITION COSTS
---------------------------------
The following reflects the changes to the deferred policy acquisition asset:
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
================================================================
Balance at beginning of year $ 735.7 $ 802.8 $ 746.9
Acquisition expenses deferred 560.8 504.8 510.3
Amortized to expense during
the year (483.5) (470.3) (475.7)
Adjustment to equity during
the year 9.7 (50.4) 21.3
Transferred to the Closed Block -- (24.8) --
Adjustment for cession of term
life insurance -- (26.4) --
- ----------------------------------------------------------------
Balance at end of year $ 822.7 $ 735.7 $ 802.8
================================================================
18. 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 reflected in results of operations in the year such
changes are determined to be needed and recorded.
The liability for future policy benefits and outstanding claims, losses and
loss adjustment expenses related to the Company's accident and health business
was $471.7 million, $446.9 million and $371.4 million at December 31, 1996, 1995
and 1994, respectively. Accident and health claim liabilities have been re-
estimated for all prior years and were decreased by $0.6 million and $2.2
million in 1996 and 1994, respectively, and increased by $17.6 million in 1995.
Unfavorable development in the accident and health business during 1995 was
primarily due to reserve strengthening and adverse experience in the Company's
individual disability line of business.
73
- --------------------------------------------------------------------------------
The following table provides a reconciliation of the beginning and ending
property and casualty reserve for unpaid losses and loss adjustment expenses
(LAE):
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
=======================================================================
Reserve for losses and LAE,
beginning of year $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net
of reinsurance recoverable:
Provision for insured events
of current year 1,513.3 1,427.3 1,434.8
Decrease in provision for
insured events of prior years (141.4) (137.6) (128.1)
- -----------------------------------------------------------------------
Total incurred losses and LAE 1,371.9 1,289.7 1,306.7
- -----------------------------------------------------------------------
Payments, net of reinsurance
recoverable:
Losses and LAE attributable to
insured events of current year 759.6 652.2 650.2
Losses and LAE attributable to
insured events of prior years 627.6 614.3 566.9
- -----------------------------------------------------------------------
Total payments 1,387.2 1,266.5 1,217.1
- -----------------------------------------------------------------------
Change in reinsurance
recoverable on unpaid losses (136.6) 51.1 14.8
- -----------------------------------------------------------------------
Reserve for losses and LAE,
end of year $2,744.1 $2,896.0 $2,821.7
=======================================================================
As part of an ongoing process, the property and casualty reserves have been
re-estimated for all prior accident years and were decreased by $141.4 million,
$137.6 million and $128.1 million in 1996, 1995 and 1994, respectively. The
increase in favorable development on prior years' reserves of $3.8 million in
1996 results primarily from an $11.4 million increase in favorable development
at Citizens.
The increase in Citizens' favorable development of $11.4 million in 1996
reflects improved severity in the personal automobile line, where favorable
development increased $28.6 million to $33.0 million in 1996, partially offset
by less favorable development in the workers' compensation line. In 1995, the
workers' compensation line had favorable development of $32.7 million, primarily
as a result of Citizens re-estimating reserves to reflect the new claims cost
management programs and the Michigan Supreme Court ruling, which decreases the
maximum to be paid for indemnity cases on all existing and future claims. In
1996, the favorable development in the workers' compensation line of $21.8
million also reflected these developments. Hanover's favorable development,
including voluntary and involuntary pools, decreased $7.7 million in 1996 to
$82.9 million, primarily attributable to a decrease in favorable development in
the workers' compensation line of $19.8 million. This decrease is primarily
attributable to a re-estimate of reserves with respect to certain types of
workers' compensation policies including large deductibles and excess of loss
policies. In addition, during 1995 the Regional Property and Casualty
subsidiaries refined their estimation of unallocated loss adjustment expenses
which increased favorable development in that year. Favorable development in the
personal automobile line also decreased $4.7 million, to $42.4 million in 1996.
These decreases were offset by increases in favorable development of $1.9
million and $5.6 million, to $12.6 million and $5.7 million, in the commercial
automobile and commercial multiple peril lines, respectively. Favorable
development in other lines increased by $8.8 million, primarily as a result of
environmental reserve strengthening in 1995. Favorable development in Hanover's
voluntary and involuntary pools increased $3.7 million to $4.1 million during
1996.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal automobile
and workers' compensation lines increased $16.6 million and $15.5 million, to
favorable development of $4.4 million and $32.7 million, respectively, due to
the aforementioned change in claims cost management and the Michigan Supreme
Court ruling. Hanover's favorable development, not including the effect of
voluntary and involuntary pools, was relatively unchanged at $90.2 million in
1995 compared to $91.7 million in 1994. Favorable development in Hanover's
workers' compensation line increased $27.7 million to $31.0 million during 1995.
This was offset by decreases of $14.6 million and $12.6 million, to $45.5
million and $0.1 million, in the personal automobile and commercial multiple
peril lines, respectively. Favorable development in Hanover's voluntary and
involuntary pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Regional Property and Casualty
subsidiaries' 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 business written by the Regional Property and Casualty
subsidiaries, the exposure to environmental liabilities is relatively small and
therefore their reserves are relatively small compared to other types of
74
- --------------------------------------------------------------------------------
liabilities. Losses and LAE reserves related to environmental damage and toxic
tort liability, included in the total reserve for losses and LAE, were $50.8
million and $43.2 million, net of reinsurance of $20.2 million and $8.4 million,
at the end of 1996 and 1995, respectively. During 1995, the Regional Property
and Casualty subsidiaries redefined their environmental liabilities in
conformity with new guidelines issued by the NAIC. This had no impact on results
of operations. The Regional Property and Casualty subsidiaries do not
specifically underwrite policies that include this coverage, but as case law
expands policy provisions and insurers' liability beyond the intended coverage,
the Regional Property and Casualty subsidiaries may be required to defend such
claims. During 1995, Hanover performed an actuarial review of its environmental
reserves. This resulted in Hanover's providing additional reserves for "IBNR"
(incurred but not reported) claims in addition to existing reserves for reported
claims. Although these claims are not material, their existence gives rise to
uncertainty and is discussed because of the possibility, however remote, that
they may become material. Management believes that, notwithstanding the
evolution of case law expanding liability in environmental claims, recorded
reserves related to these claims for environmental liability are adequate. In
addition, management 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.
19. MINORITY INTEREST
-----------------
The Company's interest in Allmerica P&C, through its wholly-owned subsidiary
FAFLIC, is represented by ownership of 59.5%, 58.3% and 57.4% of the outstanding
shares of common stock at December 31, 1996, 1995 and 1994, respectively.
Earnings and shareholders' equity attributable to minority shareholders are
included in minority interest in the consolidated financial statements.
20. 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
On June 23, 1995, the governor of Maine approved a legislative settlement for
the Maine Workers' Compensation Residual Market Pool deficit for the years 1988
through 1992. The settlement provides for an initial funding of $220.0 million
toward the deficit. The insurance carriers were liable for $65.0 million and
employers would contribute $110.0 million payable through surcharges on premiums
over the course of the next ten years. The major insurers are responsible for
90% of the $65.0 million. Hanover's allocated share of the settlement is
approximately $4.2 million, which was paid in December 1995. The remainder of
the deficit of $45.0 million will be paid by the Maine Guaranty Fund, payable in
quarterly contributions over ten years. A group of smaller carriers filed
litigation to appeal the settlement. The Company believes that adequate reserves
have been established for any additional liability.
The Company has been named a defendant in various other legal
proceedings arising in the normal course of business. In the opinion of
management, 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.
75
- --------------------------------------------------------------------------------
21. Statutory Financial Information
-------------------------------
The 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 for stock life insurance companies 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.
Statutory net income and surplus are as follows:
(In millions) 1996 1995 1994
===========================================================
Statutory net income
- --------------------
(combined)
----------
Property and Casualty
Companies $ 155.3 $ 155.3 $ 79.9
Life and Health Companies 133.3 134.3 40.7
- -----------------------------------------------------------
Statutory Shareholders'
- -----------------------
Surplus (combined)
------------------
Property and Casualty
Companies $1,201.6 $1,128.4 $974.3
Life and Health Companies 1,120.1 965.6 465.3
- -----------------------------------------------------------
22. Quarterly Results of Operations (unaudited)
-------------------------------------------
The quarterly results of operations for 1996 and 1995 are summarized below:
For the Three Months Ended
(In millions)
================================================================================
1996 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ----
Total revenues $828.4 $800.3 $806.3 $839.7
================================================================================
Net income $ 47.3 $ 42.6 $ 46.7 $ 45.3
================================================================================
Net income per share $ 0.94 $ 0.85 $ 0.93 $ 0.91
================================================================================
Dividends declared per share $ 0.05 $ 0.05 $ 0.05 $ 0.05
================================================================================
1995
- ----
Total revenues $841.4 $791.9 $822.8 $784.8
================================================================================
Income before extraordinary
item $ 39.2 $ 29.9 $ 34.8 $ 42.1
Extraordinary item -
demutualization expense (2.5) (3.5) (4.7) (1.4)
- --------------------------------------------------------------------------------
Net income $ 36.7 $ 26.4 $ 30.1 $ 40.7
================================================================================
Net income after
demutualization per share $ -- $ -- $ -- $ 0.82
================================================================================
Dividends declared per share $ -- $ -- $ -- $ 0.05
================================================================================
76
Allmerica Financial Corporation
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BOARD OF DIRECTORS
Michael P. Angelini (A)
Partner, Bowditch & Dewey
DAVID A. BARRETT (A)
Consultant, Memorial Health Care
(MCCM, Inc.)
GAIL L. HARRISON (D)
Founding Principal,
The Wexler Group
ROBERT P. HENDERSON
Chairman, Greylock
Management Corporation
ROBERT J. MURRAY (D)
Chairman, President and
Chief Executive Officer, New England
Business Service, Inc.
TERRENCE MURRAY (D)
Chairman, President and Chief Executive Officer,
Fleet Financial Group, Inc.
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
HERBERT M. VARNUM (A,C)
Former Chairman and Chief Executive Officer,
Quabaug Corporation
RICHARD MANNING WALL (C)
General Counsel and Assistant to the Chairman,
Flexcon Company, Inc.
(A) Audit Committee
(C) Compensation Committee
(D) Directors Committee
OPERATING COMMITTEE
BRUCE C. ANDERSON
Vice President, Corporate Services
JOHN P. KAVANAUGH
Vice President and Chief Investment Officer
JOHN F. KELLY
Vice President, General Counsel
and Assistant Secretary
J. BARRY MAY
President, The Hanover Insurance
Company
JAMES R. MCAULIFFE
President, Citizens Insurance
Company of America
JOHN F. O'BRIEN
President and Chief Executive Officer
EDWARD J. PARRY III
Vice President, Chief Financial Officer
and Treasurer
RICHARD M. REILLY
Vice President, Retail Financial Services
LARRY C. RENFRO
Vice President, Institutional Services
ERIC A. SIMONSEN
President, Allmerica Services Corporation
PHILLIP E. SOULE
Vice President, Corporate Risk
Management Services
77
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 20, 1997, at 9:00 a.m. at Allmerica Financial, 440 Lincoln Street,
Worcester, MA.
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." On February 28, 1997, the Company had
65,397 shareholders of record. On the same date, the trading price of the
Company's common stock was $37 3/8 per share.
DIVIDENDS
Allmerica Financial Corporation declared a cash dividend of $0.05 on February
24, 1997, payable on May 15, 1997 for shareholders of record on May 1, 1997.
COMMON STOCK PRICES AND DIVIDENDS
1996 HIGH LOW DIVIDENDS
FIRST QUARTER $28 $24 3/4 $0.05
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SECOND QUARTER $30 1/8 $25 1/4 $0.05
- -------------------------------------------------------------------
THIRD QUARTER $32 7/8 $27 1/2 $0.05
- -------------------------------------------------------------------
FOURTH QUARTER $33 3/4 $30 1/8 $0.05
- -------------------------------------------------------------------
REGISTRAR AND STOCK TRANSFER AGENT
First Chicago Trust Company of New York
525 Washington Boulevard
Jersey City, NJ 07303-2512
1-800-317-4454
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
160 Federal Street
Boston, MA 02110
TOLL-FREE INVESTOR INFORMATION LINE
Call our toll-free investor information line, 1-800-407-5222, to receive
additional printed information, including the 1996 Form 10-K or quarterly
reports on Form 10-Q filed with the Securities and Exchange Commission, fax-on-
demand services, access to shareholder services, pre-recorded messages and other
services.
Alternatively, investors may address questions to:
Jean Peters, Vice President - Investor Relations
Allmerica Financial Corporation
440 Lincoln Street, Worcester, MA 01653
tel. (508) 855-1000 fax (508) 852-7588
MacArthur Starks, Jr., Director - Investor Relations
tel. (508) 855-1000 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
INDUSTRY RATINGS
A.M. Standard Duff &
Claims Paying Ability Best & Poors Moody's Phelps
- --------------------------------------------------------------------------------
First Allmerica Financial
Life Insurance Company A A+ A1 AA
- --------------------------------------------------------------------------------
Allmerica Financial
Life Insurance and
Annuity Company A A+ A1 -
- --------------------------------------------------------------------------------
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+
- --------------------------------------------------------------------------------
PRINTED ENTIRELY ON RECYCLED PAPER
DESIGN
The Graphic Expression Inc., New York
78