FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from:___________ to ____________
Commission file number: 1-13754
ALLMERICA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3263626
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
440 Lincoln Street, Worcester, Massachusetts 01653
(Address of principal executive offices)
(Zip Code)
(508) 855-1000
(Registrant's telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the registrant's classes of
common stock as of the latest practicable date: 52,811,161 shares of common
stock outstanding, as of August 1, 2001.
38
Total Number of Pages Included in This Document
Exhibit Index is on Page 39
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Interim Consolidated Financial Statements 8 - 17
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18 - 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk 35
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 36
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------------------------
(In millions, except per share data) 2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------
Revenues
Premiums $ 562.0 $ 528.4 $1,125.5 $1,051.9
Universal life and investment product policy fees 99.2 102.7 199.6 205.2
Net investment income 165.7 160.4 331.5 315.9
Net realized investment losses (67.3) (23.7) (84.7) (70.8)
Other income 36.0 36.2 72.1 70.7
--------- --------- ---------- ---------
Total revenues 795.6 804.0 1,644.0 1,572.9
--------- --------- ---------- ---------
Benefits, losses and expenses
Policy benefits, claims, losses and loss adjustment expenses 521.4 480.1 1,078.1 969.3
Policy acquisition expenses 114.3 115.4 230.4 233.1
Other operating expenses 144.4 128.2 283.2 248.5
Restructuring costs - 20.3 - 20.3
--------- --------- ---------- ---------
Total benefits, losses and expenses 780.1 744.0 1,591.7 1,471.2
--------- --------- ---------- ---------
Income before federal income taxes 15.5 60.0 52.3 101.7
--------- --------- ---------- ---------
Federal income tax (benefit) expense
Current (22.8) 1.5 (28.2) (5.2)
Deferred 21.1 6.9 32.9 21.1
--------- --------- ---------- ---------
Total federal income tax (benefit) expense (1.7) 8.4 4.7 15.9
--------- --------- ---------- ---------
Income before minority interest and cumulative effect of
change in accounting principle 17.2 51.6 47.6 85.8
Minority interest:
Distributions on mandatorily redeemable preferred
securities of a subsidiary trust holding solely junior
subordinated debentures of the Company (4.0) (4.0) (8.0) (8.0)
--------- --------- ---------- ---------
Income before cumulative effect of change in accounting
principle 13.2 47.6 39.6 77.8
Cumulative effect of change in accounting principle (less
applicable income tax benefit of $1.7 for the six months
ended June 30, 2001) - - (3.2) -
--------- --------- ---------- ---------
Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8
========= ========= ========== =========
PER SHARE DATA
Basic
Income before cumulative effect of change in accounting
principle $ 0.25 $ 0.89 $ 0.75 $ 1.45
Cumulative effect of change in accounting principle
(less applicable income tax benefit of $0.03 for
the six months ended June 30, 2001) - - (0.06) -
--------- --------- ---------- ---------
Net income $ 0.25 $ 0.89 $ 0.69 $ 1.45
========= ========= ========== =========
Weighted average shares outstanding 52.6 53.4 52.6 53.7
========= ========= ========== =========
Diluted
Income before cumulative effect of change in accounting
principle $ 0.25 $ 0.88 $ 0.75 $ 1.43
Cumulative effect of change in accounting principle
(less applicable income tax benefit of $0.03 for
the six months ended June 30, 2001) - - (0.06) -
--------- --------- ---------- ---------
Net income $ 0.25 $ 0.88 $ 0.69 $ 1.43
========= ========= ========== =========
Weighted average shares outstanding 53.1 54.1 53.1 54.2
========= ========= ========== =========
The accompanying notes are an integral part of these consolidated financial statements.
3
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
(In millions, except per share data) 2001 2000
- -------------------------------------------------------------------------------- ---------- ----------
Assets
Investments:
Fixed maturities-at fair value (amortized cost of $8,910.8 and $8,153.7) $ 9,031.3 $ 8,118.0
Equity securities-at fair value (cost of $69.4 and $60.0) 75.1 85.5
Mortgage loans 568.8 617.6
Policy loans 384.6 381.3
Other long-term investments 162.3 193.2
---------- ----------
Total investments 10,222.1 9,395.6
---------- ----------
Cash and cash equivalents 482.7 281.1
Accrued investment income 156.7 155.4
Premiums, accounts and notes receivable, net 630.6 618.1
Reinsurance receivable on paid and unpaid losses,
benefits and unearned premiums 1,404.5 1,423.8
Deferred policy acquisition costs 1,684.9 1,608.2
Deferred federal income taxes 46.1 103.8
Other assets 714.8 564.6
Separate account assets 16,095.1 17,437.4
---------- ----------
Total assets $ 31,437.5 $ 31,588.0
========== ==========
Liabilities
Policy liabilities and accruals:
Future policy benefits $ 3,906.0 $ 3,617.4
Outstanding claims, losses and loss adjustment expenses 2,874.1 2,880.9
Unearned premiums 1,024.7 981.6
Contractholder deposit funds and other policy liabilities 2,170.8 2,193.1
---------- ----------
Total policy liabilities and accruals 9,975.6 9,673.0
---------- ----------
Expenses and taxes payable 747.3 768.6
Reinsurance premiums payable 102.4 122.3
Trust instruments supported by funding obligations 1,445.6 621.5
Short-term debt 69.3 56.6
Long-term debt 199.5 199.5
Separate account liabilities 16,095.1 17,437.4
---------- ----------
Total liabilities 28,634.8 28,878.9
---------- ----------
Minority interest:
Mandatorily redeemable preferred securities of a subsidiary trust holding
solely junior subordinated debentures of the Company 300.0 300.0
---------- ----------
Commitments and contingencies (Note 12)
Shareholders' equity
Preferred stock, $0.01 par value, 20.0 million shares authorized, none issued - -
Common stock, $0.01 par value, 300.0 million shares authorized, 60.4 million
shares issued 0.6 0.6
Additional paid-in capital 1,763.5 1,765.3
Accumulated other comprehensive income (loss) 45.6 (5.2)
Retained earnings 1,105.1 1,068.7
Treasury stock at cost (7.6 million and 7.7 million shares) (412.1) (420.3)
---------- ----------
Total shareholders' equity 2,502.7 2,409.1
---------- ----------
Total liabilities and shareholders' equity $ 31,437.5 $ 31,588.0
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
4
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
Six Months Ended
June 30,
-------------------------
(In millions) 2001 2000
- -----------------------------------------------------------------------------------------------------
Preferred Stock
Balance at beginning and end of period $ - $ -
-------- ----------
Common Stock
Balance at beginning and end of period 0.6 0.6
-------- ----------
Additional paid-in capital
Balance at beginning of period 1,765.3 1,770.5
Unearned compensation related to restricted stock and other (1.8) (8.2)
-------- ----------
Balance at end of period 1,763.5 1,762.3
-------- ----------
Accumulated Other Comprehensive Income
Net unrealized appreciation (deppreciation) on investments
Balance at beginning of period (5.2) (75.3)
Net appreciation on available-for-sale securities and derivative
instruments 78.1 17.6
Provision for deferred federal income taxes (27.3) (6.0)
-------- ----------
Other comprehensive income 50.8 11.6
-------- ----------
Balance at end of period 45.6 (63.7)
-------- ----------
Retained earnings
Balance at beginning of period 1,068.7 882.2
Net income 36.4 77.8
-------- ----------
Balance at end of period 1,105.1 960.0
-------- ----------
Treasury Stock
Balance at beginning of period (420.3) (337.8)
Shares purchased at cost - (46.8)
Shares reissued at cost 8.2 14.0
-------- ----------
Balance at end of period (412.1) (370.6)
-------- ----------
Total shareholders' equity $ 2,502.7 $ 2,288.6
======== ==========
The accompanying notes are an integral part of these consolidated financial statements.
5
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
----------------------------------------------------
(In millions) 2001 2000 2001 2000
- --------------------------------------------------- ---------------------------- -----------------------
Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8
Other comprehensive (loss) income:
Available-for-sale securities:
Net (depreciation) appreciation during the
period (42.4) (22.3) 72.6 17.6
Benefit (provision) for deferred federal
income taxes 14.8 8.0 (25.4) (6.0)
--------- --------- -------- --------
Total available-for-sale securities (27.6) (14.3) 47.2 11.6
--------- --------- -------- --------
Derivative instruments:
Net appreciation during the period 14.4 - 5.5 -
Provision for deferred federal income taxes (5.0) - (1.9) -
--------- --------- -------- --------
Total derivative instruments 9.4 - 3.6 -
--------- --------- -------- --------
Other comprehensive (loss) income (18.2) (14.3) 50.8 11.6
--------- --------- -------- --------
Comprehensive (loss) income $ (5.0) $ 33.3 $ 87.2 $ 89.4
========= ========= ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
6
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------------
(In millions) 2001 2000
- ----------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 36.4 $ 77.8
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net realized losses 84.7 70.8
Net amortization and depreciation 8.9 13.9
Deferred federal income taxes 32.9 21.1
Change in deferred acquisition costs (86.0) (116.7)
Change in premiums and notes receivable,
net of reinsurance payable (32.4) (28.2)
Change in accrued investment income (1.3) 2.7
Change in policy liabilities and accruals, net 409.9 (98.9)
Change in reinsurance receivable 19.3 (23.5)
Change in expenses and taxes payable (171.3) (39.7)
Separate account activity, net - (0.3)
Other, net (37.7) (7.3)
---------- -----------
Net cash provided by (used in) operating activities 263.4 (128.3)
---------- -----------
Cash flows from investing activities
Proceeds from disposals and maturities of available-for-sale fixed
maturities 870.9 1,504.9
Proceeds from disposals of equity securities 26.9 11.8
Proceeds from disposals of other investments 30.0 27.9
Proceeds from mortgages matured or collected 48.1 40.5
Purchase of available-for-sale fixed maturities 1,726.0) (2,001.8)
Purchase of equity securities (9.7) (0.8)
Purchase of other investments (11.9) (58.7)
Capital expenditures (14.6) (6.3)
Other, net 1.4 -
---------- -----------
Net cash used in investing activities (784.9) (482.5)
---------- -----------
Cash flows from financing activities
Deposits and interest credited to contractholder deposit funds 153.0 629.9
Withdrawals from contractholder deposit funds (270.7) (469.5)
Deposits to trust instruments supported by funding obligations 895.3 352.9
Withdrawals from trust instruments supported by funding obligations (71.2) -
Change in short-term debt 12.7 6.4
Treasury stock purchased at cost - (46.8)
Treasury stock reissued at cost 4.0 14.0
---------- -----------
Net cash provided by financing activities 723.1 486.9
---------- -----------
Net change in cash and cash equivalents 201.6 (123.9)
Cash and cash equivalents, beginning of period 281.1 464.8
---------- -----------
Cash and cash equivalents, end of period $ 482.7 $ 340.9
========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
7
ALLMERICA FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Principles of Consolidation
The accompanying unaudited consolidated financial statements of Allmerica
Financial Corporation ("AFC" or the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the requirements of Form 10-Q.
The interim consolidated financial statements of AFC include the accounts of
First Allmerica Financial Life Insurance Company ("FAFLIC"); Allmerica Financial
Life Insurance and Annuity Company ("AFLIAC"); The Hanover Insurance Company
("Hanover"); Citizens Insurance Company of America ("Citizens"), and other
insurance and non-insurance subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
The accompanying interim consolidated financial statements reflect, in the
opinion of the Company's management, all adjustments necessary for a fair
presentation of the financial position and results of operations. The results of
operations for the six months ended June 30, 2001, are not necessarily
indicative of the results to be expected for the full year. These financial
statements should be read in conjunction with the Company's 2000 Annual Report
to Shareholders, as filed on Form 10-K with the Securities and Exchange
Commission.
2. New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" ("Statement No. 142"), which requires that goodwill and intangible
assets that have indefinite useful lives no longer be amortized over their
useful lives, but instead be tested at least annually for impairment. Intangible
assets that have finite useful lives will continue to be amortized over their
useful lives. In addition, the statement provides specific guidance for testing
the impairment of intangible assets. Additional financial statement disclosures
about goodwill and other intangible assets, including changes in the carrying
amount of goodwill, carrying amounts by classification of amortized and
non-amortized assets, and estimated amortization expenses for the next five
years, are also required. This statement is effective for fiscal years beginning
after December 15, 2001 for all goodwill and other intangible assets held at the
date of adoption. Certain provisions of this statement are also applicable for
goodwill and other intangible assets acquired after June 30, 2001, but prior to
adoption of this statement. The Company is currently assessing the impact of the
adoption of Statement No. 142.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" ("Statement No. 141"), which requires that all
business combinations initiated after June 30, 2001 be accounted for using the
purchase method of accounting. It further specifies the criteria that intangible
assets must meet in order to be recognized and reported apart from goodwill. The
implementation of Statement No. 141 is not expected to have a material effect on
the Company's financial statements.
In December 2000, the American Institute of Certified Public Accountants issued
Statement of Position 00-3, "Accounting by Insurance Enterprises for
Demutualization and Formations of Mutual Insurance Holding Companies and For
Certain Long-Duration Participating Contracts" ("SoP No. 00-3"). SoP No. 00-3
requires that closed block assets, liabilities, revenues and expenses be
displayed together with all other assets, liabilities, revenues and expenses of
the insurance enterprise based on the nature of the particular item, with
appropriate disclosures relating to the closed block. In addition, the SoP
provides guidance on the accounting for participating contracts issued before
and after the date of demutualization, recording of closed block earnings and
related policyholder dividend liabilities, and the accounting treatment for
expenses and equity balances at the date of demutualization. This statement
became effective for fiscal years beginning after December 15, 2000. The
adoption of SoP No. 00-3 did not have a material impact on the Company's
financial position or results of operations. Certain prior year amounts have
been reclassified to conform to the required presentation in the current year.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement
No. 133"), which establishes accounting and reporting standards for derivative
instruments. Statement No. 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on the type of hedge transaction. For fair value hedge
transactions in which the Company is hedging changes in an asset's, liability's
or firm commitment's fair value, changes in the fair value of the derivative
instruments will generally be offset in the income statement by changes in the
hedged item's fair value. For cash flow hedge transactions, in which the Company
is hedging the variability of cash flows related to a variable rate asset,
liability, or a forecasted transaction, changes in the fair value of the
derivative instrument will be reported in other comprehensive income. The gains
and losses on the
8
derivative instrument that are reported in other comprehensive
income will be reclassified into earnings in the periods in which earnings are
impacted by the variability of the cash flows of the hedged item. To the extent
any hedges are determined to be ineffective, all or a portion of the change in
value of the derivative will be recognized currently in earnings. This statement
became effective for fiscal years beginning after June 15, 2000. The Company
adopted Statement No. 133 on January 1, 2001. In accordance with the transition
provisions of the statement, the Company recorded a $3.2 million charge,
net-of-taxes, in earnings to recognize all derivative instruments at their fair
values. This adjustment represents net losses that were previously deferred in
other comprehensive income on derivative instruments that do not qualify for
hedge accounting. The Company recorded an offsetting gain in other comprehensive
income of $3.3 million, net-of-tax, to recognize these derivative instruments.
3. Summary of New Significant Accounting Policies
Accounting for Derivatives and Hedging Activities
All derivatives are recognized on the balance sheet at their fair value. On the
date the derivative contract is entered into, the Company designates the
derivative as (1) a hedge of the fair value of a recognized asset or liability
("fair value" hedge); (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash flow" hedge); (3) a foreign-currency fair value or cash flow
hedge ("foreign currency" hedge); or (4) "held for trading". Changes in the fair
value of a derivative that is highly effective and that is designated and
qualifies as a fair value hedge, along with the gain or loss on the hedged asset
or liability that is attributable to the hedged risk, are recorded in current
period earnings. Changes in the fair value of a derivative that is highly
effective and that is designated and qualifies as a cash flow hedge are recorded
in other comprehensive income, until earnings are affected by the variability of
cash flows (e.g., when periodic settlements on a variable-rate asset or
liability are recorded in earnings). Changes in the fair value of derivatives
that are highly effective and that are designated and qualify as foreign
currency hedges are recorded in either current period earnings or other
comprehensive income, depending on whether the hedge transaction is a fair value
hedge or a cash flow hedge. Lastly, changes in the fair value of derivative
trading instruments are reported in current period earnings.
The Company may hold financial instruments that contain "embedded" derivative
instruments. The Company assesses whether the economic characteristics of the
embedded derivative are clearly and closely related to the economic
characteristics of the remaining component of the financial instrument, or host
contract, and whether a separate instrument with the same terms as the embedded
instrument would meet the definition of a derivative instrument. When it is
determined that (1) the embedded derivative possesses economic characteristics
that are not clearly and closely related to the economic characteristics of the
host contract, and (2) a separate instrument with the same terms would qualify
as a derivative instrument, the embedded derivative is separated from the host
contract, carried at fair value, and designated as a fair-value, cash-flow, or
foreign currency hedge, or as a trading derivative instrument.
The Company formally documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking various hedge transactions. This process includes linking all
derivatives that are designated as fair value, cash flow, or foreign currency
hedges to specific assets and liabilities on the balance sheet or to specific
forecasted transactions. The Company also formally assesses, both at the hedge's
inception and on an ongoing basis, whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. When it is determined that a derivative is not
highly effective as a hedge or that it has ceased to be a highly effective
hedge, the Company discontinues hedge accounting prospectively, as discussed
below.
The Company discontinues hedge accounting prospectively when (1) it is
determined that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of a hedged item, including forecasted
transactions; (2) the derivative expires or is sold, terminated, or exercised;
(3) the derivative is no longer designated as a hedge instrument, because it is
unlikely that a forecasted transaction will occur; or (4) management determines
that designation of the derivative as a hedge instrument is no longer
appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value hedge, the derivative
will continue to be carried on the balance sheet at its fair value, and the
hedged asset or liability will no longer be adjusted for changes in fair value.
When hedge accounting is discontinued because it is probable that a forecasted
transaction will not occur, the derivative will continue to be carried on the
balance sheet at its fair value, and gains and losses that were accumulated in
other comprehensive income will be recognized immediately in earnings. In all
other situations in which hedge accounting is discontinued, the derivative will
be carried at its fair value on the balance sheet, with changes in its fair
value recognized in current period earnings.
9
4. Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit its group
life and health insurance business, consisting of its Employee Benefit Services
("EBS") business, its Affinity Group Underwriters business and its accident and
health assumed reinsurance pool business ("reinsurance pool business"). During
the third quarter of 1998, the Company ceased writing new premiums in the
reinsurance pool business, subject to certain contractual obligations. Prior to
1999, these businesses comprised substantially all of the former Corporate Risk
Management Services segment. Accordingly, the operating results of the
discontinued segment, including its reinsurance pool business, have been
reported in the Consolidated Statements of Income as discontinued operations in
accordance with Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" ("APB Opinion No. 30"). In the third quarter of 1999, the
operating results from the discontinued segment were adjusted to reflect the
recording of additional reserves related to accident claims from prior years.
The Company also recorded a $30.5 million loss, net of taxes, on the disposal of
this segment, consisting of after-tax losses from the run-off of the group life
and health business of approximately $46.9 million, partially offset by net
proceeds from the sale of the EBS business of approximately $16.4 million.
Subsequent to a measurement date of June 30, 1999, approximately $17.1 million
of the aforementioned $46.9 million loss has been generated from the operations
of the discontinued business.
In March of 2000, the Company transferred its EBS business to Great-West Life
and Annuity Insurance Company of Denver and received consideration of
approximately $26 million, based on renewal rights for existing policies. The
Company retained policy liabilities estimated at $120.6 million at June 30, 2001
related to this business.
As permitted by APB Opinion No. 30, the Consolidated Balance Sheets have not
been segregated between continuing and discontinued operations. At June 30, 2001
and 2000, the discontinued segment had assets of approximately $435.8 million
and $534.4 million, respectively, consisting primarily of invested assets and
reinsurance recoverables, and liabilities of approximately $424.7 million and
$470.8 million, respectively, consisting primarily of policy liabilities.
Revenues for the discontinued operations were $10.8 million and $58.2 million
for the quarters ended June 30, 2001 and 2000, respectively, and $19.8 million
and $135.7 million for the six months ended June 30, 2001 and 2000,
respectively.
5. Significant Transactions
As of June 30, 2001, the Company has repurchased approximately $436.3 million,
or approximately 8 million shares, of its common stock under programs authorized
by the Board of Directors (the "Board"). As of June 30, 2001, the Board had
authorized total stock repurchases of $500.0 million, leaving approximately
$63.7 million available to the Company for future repurchases.
During the second quarter of 2000, the Company adopted a formal company-wide
restructuring plan. This plan is the result of a corporate initiative that began
in the fall of 1999, intended to reduce expenses and enhance revenues. This plan
consists of various initiatives including a series of internal reorganizations,
consolidations in home office operations, consolidations in field offices,
changes in distribution channels and product changes. As a result of the
Company's restructuring plan, it recognized a pre-tax charge of $21.4 million
during 2000. Approximately $5.7 million of this charge relates to severance and
other employee related costs resulting from the elimination of approximately 360
positions, of which 235 employees have been terminated as of June 30, 2001. All
levels of employees, from staff to senior management, were affected by the
restructuring. In addition, approximately $15.7 million of this charge relates
to other restructuring costs, consisting of one-time project costs, lease
cancellations and the present value of idle leased space. As of June 30, 2001,
the Company has made payments of approximately $20.6 million related to this
restructuring plan, of which approximately $5.4 million relates to severance and
other employee related costs.
10
6. Investments
A. Derivative Instruments
The Company maintains an overall risk management strategy that incorporates the
use of derivative instruments to minimize significant unplanned fluctuations in
earnings that are caused by interest rate or foreign currency volatility. The
operations of the Company are subject to risk resulting from interest rate
fluctuations to the extent that there is a difference between the amount of the
Company's interest-earning assets and the amount of interest-bearing liabilities
that are paid, withdrawn, mature or re-price in specified periods. The principal
objective of the Company's asset/liability management activities is to provide
maximum levels of net investment income while maintaining acceptable levels of
interest rate and liquidity risk and facilitating the funding needs of the
Company. The Company has developed an asset/liability management approach
tailored to specific insurance or investment product objectives. The investment
assets of the Company are managed in over 20 portfolio segments consistent with
specific products or groups of products having similar liability
characteristics. As part of this approach, management develops investment
guidelines for each portfolio consistent with the return objectives, risk
tolerance, liquidity, time horizon, tax and regulatory requirements of the
related product or business segment. Management has a general policy of
diversifying investments both within and across all portfolios. The Company
monitors the credit quality of its investments and its exposure to individual
markets, borrowers, industries, and sectors.
The Company uses derivative financial instruments, primarily interest rate swaps
and futures contracts, with indices that correlate to balance sheet instruments
to modify its indicated net interest sensitivity to levels deemed to be
appropriate. Specifically, for floating rate funding agreements that are matched
with fixed rate securities, the Company manages the risk of cash flow
variability by hedging with interest rate swap contracts designed to pay fixed
and receive floating interest. Under interest rate 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. Additionally, the Company uses exchange traded financial futures
contracts to hedge against interest rate risk on anticipated guaranteed
investment contract ("GIC") sales and other funding agreements, as well as the
reinvestment of fixed maturities. The Company is exposed to interest rate risk
from the time of sale of the GIC until the receipt of the deposit and purchase
of the underlying asset to back the liability. Similarly, the Company is exposed
to interest rate risk on fixed maturities reinvestments from the time of
maturity until the purchase of new fixed maturities. The Company only trades
futures contracts with nationally recognized brokers, which the Company believes
have adequate capital to ensure that there is minimal danger of default.
As a result of the Company's issuance of trust instruments supported by funding
obligations denominated in foreign currencies, as well as the Company's
investment in securities denominated in foreign currencies, the Company's
operating results are exposed to changes in exchange rates between the U.S.
dollar and the Swiss Franc, Japanese Yen, British Pound and Euro. From time to
time, the Company may also have exposure to other foreign currencies. To
mitigate the short-term effect of changes in currency exchange rates, the
Company regularly hedges by entering into foreign exchange swap contracts to
hedge its net foreign currency exposure. Additionally, the Company enters into
compound currency/interest rate swap contracts to hedge foreign currency and
interest rate exposure on specific trust instruments supported by funding
obligations. Under these swap contracts, the Company agrees to exchange interest
and principal related to foreign fixed income securities and trust obligations
payable in foreign currencies, at current exchange rates, for the equivalent
payment in U.S. dollars translated at a specific currency exchange rate.
By using derivative instruments, the Company is exposed to credit risk. If the
counterparty fails to perform, credit risk is equal to the extent of the fair
value gain (including any accrued receivable) in a derivative. The Company
regularly assesses the financial strength of its counterparties and generally
enters into forward or swap agreements with counterparties rated "A" or better
by nationally recognized rating agencies. Depending on the nature of the
derivative transaction, bilateral collateral arrangements may be required.
The Company's derivative activities are monitored by management, who review
portfolio activities and risk levels. Management also oversees all derivative
transactions to ensure that the types of transactions entered into and the
results obtained from those transactions are consistent with the Company's risk
management strategy and with Company policies and procedures.
Fair Value Hedges
The Company enters into compound foreign currency/interest rate swaps to convert
its foreign denominated fixed rate trust instruments supported by funding
obligations to U.S. dollar floating rate instruments. For the six months ended
June 30, 2001, the Company recognized a net gain of $1.3 million (reported as
other income in the Consolidated Statements of Income), which represented the
ineffective portion of all fair value hedges. All components of each
derivative's gain or loss are included in the assessment of hedge effectiveness,
unless otherwise noted.
11
Cash Flow Hedges
The Company enters into various types of interest rate swap contracts to hedge
exposure to interest rate fluctuations. Specifically, for floating rate funding
agreement liabilities that are matched with fixed rate securities, the Company
manages the risk of cash flow variability by hedging with interest rate swap
contracts. Under these swap contracts, the Company agrees to exchange, at
specified intervals, the difference between fixed and floating interest amounts
calculated on an agreed-upon notional principal amount. The Company also
purchases long futures contracts and sells short futures contracts on margin to
hedge against interest rate fluctuations associated with the sale of GICs and
other funding agreements, as well as the reinvestment of fixed maturities. The
Company is exposed to interest rate risk from the time of sale of the GIC until
the receipt of the deposit and purchase of the underlying asset to back the
liability. Similarly, the Company is exposed to interest rate risk on
reinvestments of fixed maturities from the time of maturity until the purchase
of new fixed maturities. The Company uses U.S. Treasury Note Futures to hedge
this risk.
The Company also enters into foreign currency swap contracts to hedge foreign
currency exposure on specific fixed income securities, as well as compound
foreign currency/interest rate swap contracts to hedge foreign currency and
interest rate exposure on specific trust instruments supported by funding
obligations. Under these swap contracts, the Company agrees to exchange interest
and principal related to foreign fixed maturities and trust obligations payable
in foreign currencies, at current exchange rates, for the equivalent payment in
U.S. dollars translated at a specific currency exchange rate.
For the six months ended June 30, 2001, the Company recognized a net gain of
$1.6 million, (reported as other income in the Consolidated Statements of
Income), which represented the total ineffectiveness of all cash flow hedges.
All components of each derivative's gain or loss are included in the assessment
of hedge effectiveness, unless otherwise noted.
Gains and losses on derivative contracts that are reclassified from accumulated
other comprehensive income to current period earnings are included in the line
item in which the hedged item is recorded. As of June 30, 2001, $98.5 million of
the deferred net losses on derivative instruments accumulated in other
comprehensive income could be recognized in earnings during the next twelve
months depending on the forward interest rate and currency rate environment.
Transactions and events that (1) are expected to occur over the next twelve
months and (2) will necessitate reclassifying to earnings these derivatives
gains (losses) include (a) the re-pricing of variable rate trust instruments
supported by funding obligations, (b) the interest payments (receipts) on
foreign denominated trust instruments supported by funding obligations and
foreign securities, (c) the anticipated sale of GICs and other funding
agreements, and (d) the anticipated reinvestment of fixed maturities. The
maximum term over which the Company is hedging its exposure to the variability
of future cash flows (for all forecasted transactions, excluding interest
payments on variable-rate debt) is 12 months.
Trading Activities
The Company enters into insurance portfolio-linked and credit default swap
contracts for investment purposes. Under the insurance portfolio-linked swap
contracts, the Company agrees to exchange cash flows according to the
performance of a specified underwriter's portfolio of insurance business. As
with interest rate swap contracts, the primary risk associated with insurance
portfolio-linked swap contracts is the inability of the counterparty to meet its
obligation. Under the terms of the credit default swap contracts, the Company
assumes the default risk of a specific high credit quality issuer in exchange
for a stated annual premium. In the case of default, the Company will pay the
counterparty par value for a pre-determined security of the issuer. The primary
risk associated with these transactions is the default risk of the underlying
companies. The Company regularly assesses the financial strength of its
counterparties and the underlying companies in default swap contracts, and
generally enters into forward or swap agreements with companies rated "A" or
better by nationally recognized rating agencies. Because the underlying
principal of swap contracts is not exchanged, the Company's maximum exposure to
counterparty credit risk is the difference in payments exchanged, which at June
30, 2001, was $0.2 million. The Company does not require collateral or other
security to support financial instruments with credit risk. These products are
not linked to specific assets and liabilities on the balance sheet or to a
forecasted transaction, and therefore do not qualify for hedge accounting.
The swap contracts are marked to market with any gain or loss recognized
currently. The fair values of swap contracts outstanding were $(0.3) million at
June 30, 2001 and December 31, 2000. The net amount receivable or payable under
insurance portfolio-linked swap contracts is recognized when the contracts are
marked to market. The net increase (decrease) in realized investment gains
related to these contracts was $0.1 million, $(0.7) million and $(0.2) million
for the six months ended June 30, 2001 and the years ended December 31, 2000 and
1999, respectively.
12
The stated annual premium under credit default swap contracts is recognized
currently in net investment income. There was no net increase to investment
income related to credit default swap contracts for the six months ended June
30, 2001; however, there was a net increase of $0.2 million and $0.4 million for
the years ended December 31, 2000 and 1999, respectively.
B. Impact of Defaults on Net Investment Income
The Company had fixed maturity securities with a carrying value of $19.6
million, $7.5 million and $3.7 million on non-accrual status at June 30, 2001,
December 31, 2000 and June 30, 2000, respectively. The effect of non-accruals,
compared with amounts that would have been recognized in accordance with the
original terms of the investments, was a reduction in net investment income of
$6.8 million and $1.7 million for the six months ended June 30, 2001 and 2000,
respectively.
7. Federal Income Taxes
Federal income tax expense for the six months ended June 30, 2001 and 2000, has
been computed using estimated effective tax rates. These rates are revised, if
necessary, at the end of each successive interim period to reflect the current
estimates of the annual effective tax rates.
8. Other Comprehensive (Loss) Income
The following table provides a reconciliation of gross unrealized (losses) gains
to the net balance shown in the Statements of Comprehensive Income:
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
--------------------- -------------------
(In millions) 2001 2000 2001 2000
- ------------------------------------------------------------------ ---------- ---------- ---------- --------
Unrealized (losses) gains on available-for-sale securities:
Unrealized holding losses arising during period (net of
income tax (benefit) of $(29.3) million and $(17.9)
million for the quarters ended June 30, 2001 and 2000 and
$8.1 million and $(16.9) million for the six months
ended June 30, 2001 and 2000) $ (78.3) $ (35.7) $ (14.5) $ (46.9)
Less: reclassification adjustment for losses included in
net income (net of income tax benefit of $14.5 million
and $9.9 million for the quarters ended June 30, 2001 and
2000 and $17.3 million and $22.9 million for the six
months months ended June 30, 2001 and 2000) (50.7) (21.4) (61.7) (58.5)
-------- -------- -------- -------
Total available-for-sale securities (27.6) (14.3) 47.2 11.6
-------- -------- -------- -------
Unrealized gains on derivative instruments:
Unrealized holding gains arising during period (net of
income tax of $5.1 million and $0.9 million for the quarter
and six months ended June 30, 2001) 9.1 - 1.6 -
Less: reclassification adjustment for losses included in net
income (net of income tax (benefit) of $0.1 million and
$(1.0) million for the quarter and six months ended
June 30, 2001) (0.3) - (2.0) -
-------- -------- -------- -------
Total derivative instruments 9.4 - 3.6 -
-------- -------- -------- -------
Other comprehensive (loss) income $ (18.2) $ (14.3) $ 50.8 $ 11.6
======== ======== ======== =======
13
9. Closed Block
Included in the Consolidated Statements of Income is a net pre-tax contribution
from the Closed Block of $5.6 million and $10.9 million for the quarter and six
months ended June 30, 2001, respectively, compared to $1.6 million and $4.8
million for the quarter and six months ended June 30, 2000, respectively.
Summarized financial information of the Closed Block is as follows:
(Unaudited)
June 30, December 31,
(In millions) 2001 2000
-------------------------------------------------------------------------------------
Assets
Fixed maturities-at fair value (amortized cost
of $410.2 and $400.3) $ 413.8 $ 397.5
Mortgage loans 142.8 144.9
Policy loans 189.5 191.7
Cash and cash equivalents 0.9 1.9
Accrued investment income 14.8 14.6
Deferred policy acquisition costs 10.6 11.0
Other assets 5.9 6.4
--------- -------
Total assets $ 778.3 $ 768.0
========= =======
Liabilities
Policy liabilities and accruals $ 810.4 $ 808.9
Policyholder dividends 16.3 20.0
Other liabilities 3.5 0.8
--------- -------
Total liabilities $ 830.2 $ 829.7
========= =======
Excess of Closed Block liabilities over assets
designated to the Closed Block $ 51.9 $ 61.7
Amounts included in accumulated other comprehensive
income:
Net unrealized investment losses, net of
deferred federal income tax benefit of $1.5
million and $1.3 million (2.8) (2.5)
--------- -------
Maximum future earnings to be recognized from Closed
Block assets and liabilities $ 49.7 $ 59.2
========= =======
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
(In millions) 2001 2000 2001 2000
- ------------------------------------------------------------ -------- ---- ------- ---- ------- ----- -------
Revenues
Premiums $ 7.3 $ 8.3 $ 32.4 $ 34.3
Net investment income 13.6 13.8 27.6 27.0
Net realized investment losses (1.2) (3.3) (1.2) (3.6)
-------- ------- ------- -------
Total revenues 19.7 18.8 58.8 57.7
-------- ------- ------- -------
Benefits and expenses
Policy benefits 14.0 16.9 47.5 51.7
Policy acquisition expenses 0.1 0.4 0.1 1.0
Other operating expenses - (0.1) 0.3 0.2
-------- ------- ------- -------
Total benefits and expenses 14.1 17.2 47.9 52.9
-------- ------- ------- -------
Contribution from the Closed Block $ 5.6 $ 1.6 $ 10.9 $ 4.8
======== ======= ======= =======
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.
14
10. Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management, Allmerica Financial Services and Allmerica Asset Management.
The separate financial information of each segment is presented consistent with
the way results are regularly evaluated by the chief operating decision maker in
deciding how to allocate resources and in assessing performance. A summary of
the Company's reportable segments is included below.
The Risk Management Segment manages its products through three distribution
channels identified as Standard Markets, Sponsored Markets, and Specialty
Markets. Standard Markets sells property and casualty insurance products through
independent agents and brokers primarily in the Northeast, Midwest and Southeast
United States. Sponsored Markets offers property and casualty products to
members of affinity groups and other organizations. This distribution channel
also focuses on worksite distribution, which offers discounted property and
casualty (automobile and homeowners) insurance through employer sponsored
programs. Specialty Markets offers specialty or program property and casualty
business nationwide. This channel focuses on niche classes of risks and
leverages specific underwriting processes.
The Asset Accumulation group includes two segments: Allmerica Financial Services
and Allmerica Asset Management. The Allmerica Financial Services segment
includes variable annuities, variable universal life and traditional life
insurance products and to a lesser extent, certain group retirement products.
Through its Allmerica Asset Management segment, the Company offers its customers
the option of investing in GICs, such as short-term and long-term funding
agreements. Short-term funding agreements are investment contracts issued to
institutional buyers, such as money market funds, corporate cash management
programs and securities lending collateral programs, which typically have short
maturities and periodic interest rate resets based on an index such as LIBOR.
Long-term funding agreements are investment contracts issued to various
businesses or charitable trusts, which are used to support debt issued by the
trust to foreign and domestic institutional buyers, such as banks, insurance
companies, and pension plans. These funding agreements have long maturities and
may be issued with a fixed or variable interest rate based on an index such as
LIBOR. This segment is also a Registered Investment Advisor providing investment
advisory services, primarily to affiliates and to third parties, such as money
market and other fixed income clients.
In addition to the three operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt, Capital
Securities and corporate overhead expenses. Corporate overhead expenses reflect
costs not attributable to a particular segment, such as those generated by
certain officers and directors, technology, finance, human resources and legal.
Management evaluates the results of the aforementioned segments based on a
pre-tax and pre-minority interest basis. Segment income is determined by
adjusting net income for net realized investment gains and losses, net gains and
losses on disposals of businesses, discontinued operations, extraordinary items,
the cumulative effect of accounting changes and certain other items which
management believes are not indicative of overall operating trends. While these
items may be significant components in understanding and assessing the Company's
financial performance, management believes that the presentation of segment
income enhances understanding of the Company's results of operations by
highlighting net income attributable to the normal, recurring operations of the
business. However, segment income should not be construed as a substitute for
net income determined in accordance with generally accepted accounting
principles.
15
Summarized below is financial information with respect to business segments for
the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
(In millions) 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Segment revenues:
Risk Management $ 617.0 $ 579.4 $ 1,218.3 $ 1,136.9
-------- -------- -------- --------
Asset Accumulation:
Allmerica Financial Services 204.3 213.2 427.5 442.5
Allmerica Asset Management 41.6 34.9 81.3 64.2
-------- -------- -------- --------
Subtotal 245.9 248.1 508.8 506.7
-------- -------- -------- --------
Corporate 1.5 1.7 2.5 2.7
Intersegment revenues (1.9) (1.5) (3.8) (2.6)
-------- -------- -------- --------
Total segment revenues 862.5 827.7 1,725.8 1,643.7
Adjustments to segment revenues:
Net realized losses (67.3) (23.7) (84.7) (70.8)
Gains on derivatives 0.4 - 2.9 -
-------- -------- -------- --------
Total revenues $ 795.6 $ 804.0 $ 1,644.0 $ 1,572.9
======== ======== ======== ========
Segment income (loss) before federal income taxes, minority
interest and cumulative effect of change in accounting
principle:
Risk Management $ 41.5 $ 53.9 $ 57.7 $ 97.0
-------- -------- -------- --------
Asset Accumulation:
Allmerica Financial Services 42.6 55.5 86.9 109.9
Allmerica Asset Management 4.4 4.6 10.4 9.7
-------- -------- -------- --------
Subtotal 47.0 60.1 97.3 119.6
-------- -------- -------- --------
Corporate (15.6) (12.2) (31.8) (26.7)
-------- -------- -------- --------
Segment income before federal income taxes and
minority interest 72.9 101.8 123.2 189.9
Adjustments to segment income:
Net realized investment losses, net of amortization (65.5) (21.5) (81.5) (67.9)
Gains on derivatives 0.4 - 2.9 -
Sales practice litigation 7.7 - 7.7 -
Restructuring costs - (20.3) - (20.3)
-------- -------- -------- --------
Income before federal income taxes, minority interest
and cumulative effect of change in accounting
principle $ 15.5 $ 60.0 $ 52.3 $ 101.7
======== ======== ======== ========
Identifiable Assets Deferred Acquisition Costs
- ------------------------------------------ -----------------------------------------------------------------
(Unaudited) (Unaudited)
June 30, December 31, June 30, December 31,
(In millions) 2001 2000 2001 2000
- ------------------------------------------ ----------------- ---------------- ------------- -------------
Risk Management $ 6,065.6 $ 6,186.6 $ 198.3 $ 187.2
------------ ------------ ------------ -----------
Asset Accumulation
Allmerica Financial Services 22,088.7 23,082.5 1,486.5 1,420.8
Allmerica Asset Management 3,122.7 2,238.4 0.1 0.2
------------ ------------ ------------ -----------
Subtotal 25,211.4 25,320.9 1,486.6 1,421.0
Corporate 160.5 80.5 - -
------------ ------------ ------------ -----------
Total $ 31,437.5 $ 31,588.0 $ 1,684.9 $ 1,608.2
============ ============ ============ ===========
16
11. Earnings Per Share
The following table provides share information used in the calculation of the
Company's basic and diluted earnings per share:
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
---------------------------------------------
(In millions, except per share data) 2001 2000 2001 2000
- ----------------------------------------------------------------- --------------------- -----------------------
Basic shares used in the calculation of earnings per share 52.6 53.4 52.6 53.7
Dilutive effect of securities:
Employee stock options 0.3 0.4 0.3 0.3
Non-vested stock grants 0.2 0.3 0.2 0.2
-------- -------- -------- --------
Diluted shares used in the calculation of earnings per share 53.1 54.1 53.1 54.2
======== ======== ======== ========
Per share effect of dilutive securities on income from
continuing operations before cumulative effect of
change in accounting principle $ - $ 0.01 $ - $ 0.02
======== ======== ======== ========
Per share effect of dilutive securities on net income $ - $ 0.01 $ - $ 0.02
======== ======== ======== ========
12. Commitments and Contingencies
Litigation
In 1997, a lawsuit on behalf of a putative class was instituted against the
Company alleging fraud, unfair or deceptive acts, breach of contract,
misrepresentation, and related claims in the sale of life insurance policies. In
November 1998, the Company and the plaintiffs entered into a settlement
agreement and in May 1999, the Federal District Court in Worcester,
Massachusetts approved the settlement agreement and certified the class for this
purpose. AFC recognized a $31.0 million pre-tax expense in 1998 related to this
litigation. In the second quarter of 2001, the Company recognized a pre-tax
benefit of $7.7 million resulting from the refinement of cost estimates.
Although the Company believes that the remaining expense reflects appropriate
recognition of its obligation under the settlement, this estimate may be revised
based on the amount of reimbursement actually tendered by AFC's insurance
carriers, and based on changes in the Company's estimate of the ultimate cost of
the benefits to be provided to members of the class.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the Company's opinion, based on the
advice of legal counsel, the ultimate resolution of these proceedings will not
have a material effect on the Company's consolidated financial statements.
However, liabilities related to these proceedings could be established in the
near term if estimates of the ultimate resolution of these proceedings are
revised.
17
PART I - FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations and
financial condition of the Company should be read in conjunction with the
interim Consolidated Financial Statements and related footnotes included
elsewhere herein and the Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the 2000 Annual Report to
Shareholders, as filed on Form 10-K with the Securities and Exchange Commission.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and subsidiaries
("AFC" or "the Company") include the accounts of First Allmerica Financial Life
Insurance Company ("FAFLIC") and Allmerica Financial Life Insurance and Annuity
Company ("AFLIAC"), AFC's principal life insurance and annuity companies; The
Hanover Insurance Company ("Hanover") and Citizens Insurance Company of America
("Citizens"), AFC's principal property and casualty companies; and certain other
insurance and non-insurance subsidiaries.
Description of Operating Segments
The Company offers financial products and services in two major areas: Risk
Management and Asset Accumulation. Within these broad areas, the Company
conducts business principally in three operating segments. These segments are
Risk Management, Allmerica Financial Services, and Allmerica Asset Management.
The separate financial information of each segment is presented consistent with
the way results are regularly evaluated by the chief operating decision maker in
deciding how to allocate resources and in assessing performance.
Results of Operations
Consolidated Overview
Consolidated net income includes the results of each segment of the Company,
which management evaluates on a pre-tax and pre-minority interest basis. In
addition, net income also includes certain items which management believes are
not indicative of overall operating trends, such as net realized investment
gains and losses, net gains and losses on disposals of businesses, discontinued
operations, extraordinary items, the cumulative effect of accounting changes and
certain other items. While these items may be significant components in
understanding and assessing the Company's financial performance, management
believes that the presentation of "Adjusted Net Income", which excludes these
items, enhances understanding of the Company's results of operations by
highlighting net income attributable to the normal, recurring operations of the
business. However, adjusted net income should not be construed as a substitute
for net income determined in accordance with generally accepted accounting
principles.
The Company's consolidated net income for the second quarter of 2001 decreased
$34.4 million, or 72.3%, to $13.2 million, compared to the same period in 2000.
The reduction in net income in the second quarter resulted primarily from an
increase in net realized investment losses of $37.3 million and a decrease in
adjusted net income of $15.6 million. Consolidated net income for the first six
months of 2001 decreased $41.4 million, or 53.2%, to $36.4 million, compared to
the first six months of 2000. The reduction in net income resulted primarily
from a decrease in adjusted net income of $44.8 million and an increase in net
realized investment losses of $13.5 million. Net income in 2000 also included a
restructuring charge of $13.2 million.
The following table reflects adjusted net income and a reconciliation to
consolidated net income. Adjusted net income consists of segment income (loss),
federal income taxes on segment income and minority interest on preferred
dividends.
18
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
---------------------------------------
(In millions) 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------
Segment income (loss) before federal income taxes and
minority interest:
Risk Management $ 41.5 $ 53.9 $ 57.7 $ 97.0
-------- -------- -------- --------
Asset Accumulation:
Allmerica Financial Services 42.6 55.5 86.9 109.9
Allmerica Asset Management 4.4 4.6 10.4 9.7
-------- -------- -------- --------
Subtotal 47.0 60.1 97.3 119.6
Corporate (15.6) (12.2) (31.8) (26.7)
-------- -------- -------- --------
Segment income before federal income taxes and
minority interest 72.9 101.8 123.2 189.9
Federal income taxes on segment income (10.0) (23.3) (19.1) (41.0)
Minority interest on preferred dividends (4.0) (4.0) (8.0) (8.0)
-------- -------- -------- --------
Adjusted net income 58.9 74.5 96.1 140.9
Adjustments (net of taxes and amortization, as applicable):
Net realized investment losses (51.0) (13.7) (63.4) (49.9)
Gains on derivatives 0.3 - 1.9 -
Sales practice litigation 5.0 - 5.0 -
Restructuring costs - (13.2) - (13.2)
-------- -------- -------- --------
Income before cumulative effect of change in
accounting principle 13.2 47.6 39.6 77.8
Cumulative effect of change in accounting principle,
net of applicable taxes - - (3.2) -
-------- -------- -------- --------
Net income $ 13.2 $ 47.6 $ 36.4 $ 77.8
======== ======== ======== ========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
The Company's segment income before federal income taxes and minority interest
decreased $28.9 million, or 28.4%, to $72.9 million in the second quarter of
2001. This decrease is primarily attributable to lower income from the Allmerica
Financial Services and Risk Management segments of $12.9 million and $12.4
million, respectively. The decrease in Allmerica Financial Services' segment
income was primarily due to declines in asset-based fees, principally resulting
from a decrease in the market value of assets under management in the variable
product lines, and to lower brokerage income. The decrease is also attributable
to an increase in policy benefits and other operating expenses, net of lower
deferred acquisition costs. Risk Management's segment income decreased $12.4
million primarily due to an approximate increase of $28 million in current
accident year losses and a reduction in favorable loss and loss adjustment
expense ("LAE")reserve development of $22.0 million, partially offset by rate
increases of approximately $34 million.
The effective tax rate for segment income was 13.7% for the second quarter of
2001 compared to 22.9% for the second quarter of 2000. The decrease in the tax
rate is primarily due to lower underwriting income resulting in an increase in
the proportion of tax-exempt investment income to pre-tax income, as well as the
dividends received deduction associated with the Company's variable products.
Net realized losses on investments, after taxes, were $51.0 million in the
second quarter of 2001, resulting primarily from impairments of fixed
maturities, partially offset by gains from sales of equity securities. Most of
these impairments occurred in the Company's portfolio of high-yield bonds.
During the second quarter of 2000, the Company recognized net realized losses on
investments, after taxes, of $13.7 million, primarily due to impairments of
fixed maturities and to the sale of securities pursuant to the Company's tax
strategy to increase portfolio yields.
The Company recognized a benefit of $5.0 million, net of taxes, in the second
quarter of 2001 as a result of refining cost estimates related to a class action
lawsuit.
During the second quarter of 2000, the Company recognized a one-time after-tax
restructuring charge of $13.2 million. This charge is the result of a formal
company-wide restructuring plan, intended to reduce expenses and enhance
revenues.
19
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
The Company's segment income before federal income taxes and minority interest
decreased $66.7 million, or 35.1%, to $123.2 million in the first six months of
2001. This decrease is primarily attributable to lower income from the Risk
Management and Allmerica Financial Services segments of $39.3 million and $23.0
million, respectively. The decrease in Risk Management segment income was
primarily attributable to decreased favorable loss and LAE reserve development
of $85.2 million and to an increase in current year claims severity. These
decreases were partially offset by premium rate increases of approximately $54
million and decreased catastrophe losses of $10.9 million. Allmerica Financial
Services' segment income decreased $23.0 million principally due to lower
asset-based fees, primarily resulting from a decrease in the market value of
assets under management in the variable product lines, and to lower brokerage
income. The decrease is also attributable to higher policy benefits and other
operating expenses, partially offset by lower deferred policy acquisition costs.
The effective tax rate for segment income was 15.5% for the first six months of
2001 compared to 21.6% for the first six months of 2000. The decrease in the tax
rate is primarily due to lower underwriting income resulting in an increase in
the proportion of tax-exempt investment income to pre-tax income, as well as the
dividends received deduction associated with the Company's variable products.
Net realized losses on investments after taxes were $63.4 million in the first
six months of 2001 resulting primarily from impairments of fixed maturities.
During the first six months of 2000, net realized losses on investments after
taxes of $49.9 million resulted primarily from after tax realized losses of
$38.1 million due to the sale of $1.1 billion of fixed income securities in
order to reinvest the proceeds in higher yielding securities. In addition, the
Company recognized $14.7 million in after tax realized losses from impairments
of fixed maturities in 2000.
During the first quarter of 2001, the Company recognized a $3.2 million loss,
net of taxes, upon adoption of Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities".
Segment Results
The following is management's discussion and analysis of the Company's
results of operations by business segment. The segment results are presented
before taxes and minority interest and other items which management believes are
not indicative of overall operating trends, including realized gains and losses.
Risk Management
The following table summarizes the results of operations for the Risk Management
segment for the periods indicated:
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
---------------------------------------------
(In millions) 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------
Segment revenues
Net premiums written $ 581.4 $ 562.2 $ 1,148.1 $ 1,089.8
======== ======= ========= ==========
Net premiums earned $ 554.4 $ 519.6 $ 1,092.4 $ 1,016.6
Net investment income 53.0 54.4 109.8 109.6
Other income 9.6 5.4 16.1 10.7
-------- ------- --------- ----------
Total segment revenues 617.0 579.4 1,218.3 1,136.9
Losses and operating expenses
Losses and LAE (1) 426.1 383.6 864.0 759.3
Policy acquisition expenses 99.1 93.9 195.5 186.0
Other operating expenses 50.3 48.0 101.1 94.6
-------- ------- --------- ----------
Total losses and operating expenses 575.5 525.5 1,160.6 1,039.9
-------- ------- --------- ----------
Segment income $ 41.5 $ 53.9 $ 57.7 $ 97.0
======== ======= ========= ==========
(1) Includes policyholders' dividends of $1.9 million and $3.7 million for the quarters ended
June 30, 2001 and 2000, respectively, and $4.0 million and $6.4 million for the six months
ended June 30, 2001 and 2000, respectively.
20
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
Risk Management's segment income declined $12.4 million, or 23.0%, to $41.5
million for the quarter ended June 30, 2001. The decrease in segment income is
primarily attributable to a $42.5 million increase in losses and loss adjustment
expenses. This is primarily the result of approximately a $28 million increase
in current accident year losses in the second quarter, primarily in the
commercial multiple peril and homeowners lines as a result of increased claims
severity in both lines. In addition, losses and loss adjustment expenses
increased as a result of a $22.0 million decrease in favorable development on
prior years' reserves, to $3.9 million of favorable development in the second
quarter of 2001. Partially offsetting these items are approximately $34 million
of rate increases, primarily in the commercial lines. Improved current year
claims severity in the commercial automobile line also favorably impacted
results. In addition, catastrophe losses decreased $2.5 million, to $15.3
million for the second quarter of 2001, compared to $17.8 million for the same
period in 2000. Policy acquisition and other operating expenses have increased
consistent with the growth in earned premium.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Risk Management's segment income decreased $39.3 million, or 40.5%, to $57.7
million for the six months ended June 30, 2001. The decrease in segment income
is primarily attributable to increased losses and loss adjustment expenses
resulting from an $85.2 million decrease in favorable development on prior
years' reserves, to $15.6 million of adverse development for the six months
ended June 30, 2001 from $69.6 million of favorable development for the same
period in 2000. The decrease in favorable development is primarily related to
the Company's having captured, in prior periods, the accumulated benefits of its
claim processing redesign efforts. These efforts resulted in reduced reserves
related to prior accident years, primarily in the personal automobile line in
the Northeast, and lower claims settlement costs. Increased current year claims
severity in the commercial multiple peril line also contributed to the decline
in results. Partially offsetting these items are approximately $54 million of
rate increases, primarily in commercial lines. Improved current year claims
severity in the commercial automobile and workers' compensation lines also
favorably impacted results. In addition, catastrophe losses decreased $10.9
million, to $22.1 million for the six months ended June 30, 2001, compared to
$33.0 million for the same period in 2000.
Distribution Channel Results
Distribution channel results are reported using statutory accounting principles,
which are prescribed by state insurance regulators. The primary difference
between statutory and generally accepted accounting principles ("GAAP") is the
deferral of certain underwriting costs under GAAP that are amortized over the
life of the policy. Under statutory accounting principles, these costs are
recognized when incurred or paid. Management reviews the operations of this
business based upon statutory results.
Quarter Ended June 30, 2001 Compared to Quarter Ended Ended June 30, 2000
The following table summarizes the results of operations for the distribution
channels of the Risk Management segment:
21
(Unaudited)
Quarter Ended June 30, 2001
-----------------------------------------------------------
Standard Sponsored Specialty
(In millions, except ratios) Markets Markets Markets Other(2) Total
- ---------------------------------------------------------------------------------------------------
Statutory net premiums written $ 394.7 $ 161.4 $ 23.5 $ 0.3 $ 579.9
-----------------------------------------------------------
Statutory combined ratio(1) 106.0 96.3 95.0 N/M 103.3
-----------------------------------------------------------
Statutory underwriting (loss) profit $ (26.2) $ 4.6 $ (2.8) $ (1.0) $ (25.4)
-----------------------------------------------------------
Reconciliation to segment income:
Net investment income 53.0
Other income and expenses, net 6.2
Other Statutory to GAAP adjustments 7.7
-------
Segment income $ 41.5
=======
- ---------------------------------------------------------------------------------------------------
(Unaudited)
Quarter Ended June 30, 2000
-----------------------------------------------------------
Standard Sponsored Specialty
(In millions, except ratios) Markets Markets Markets Other (2) Total
- ---------------------------------------------------------------------------------------------------
Statutory net premiums written $ 393.0 $ 151.1 $ 11.9 $ 2.4 $ 558.4
-----------------------------------------------------------
Statutory combined ratio (1) 101.5 98.5 79.5 N/M 100.4
-----------------------------------------------------------
Statutory underwriting (loss) profit $ (14.5) $ 0.4 $ 1.5 $ (0.8) $ (13.4)
-----------------------------------------------------------
Reconciliation to segment income:
Net investment income 54.4
Other income and expenses, net 2.8
Other Statutory to GAAP adjustments 10.1
-------
Segment income $ 53.9
=======
- ----------------------------------------------------------------------------------------------------
(1) Statutory combined ratio is a common industry measurement of the results of property and
casualty insurance underwriting. This ratio is the sum of the ratio of incurred claims and claim
expenses to premiums earned and the ratio of underwriting expenses incurred to premiums written.
Federal income taxes, net investment income and other non-underwriting expenses are not reflected
in the statutory combined ratio.
(2) Includes results from certain property and casualty business which the Company has exited. The
decline in underwriting results is primarily attributable to unprofitable business in California.
N/M - Not meaningful
Standard Markets Standard Markets' net premiums written increased $1.7 million
to $394.7 million for the quarter ended June 30, 2001. This improvement is
primarily attributable to increases of $3.4 million, or 4.3% and $2.7 million,
or 4.6%, in the commercial multiple peril and commercial automobile lines,
respectively. The increase in the commercial multiple peril line is primarily
the result of a 4.5% increase in policies in force since June 30, 2000 and 8.7%
and 6.0% rate increases in Michigan and New York, respectively. Commercial
automobile's net premiums written increased primarily as a result of 5.9%, 4.9%,
and 6.7% rate increases in Michigan, Massachusetts, and New York, respectively,
partially offset by a 6.9% decrease in policies in force since June 30, 2000.
Partially offsetting these favorable items is a $3.6 million, or 6.7%, decrease
in workers' compensation's net premiums written due to the non-renewal of
several large unprofitable commercial accounts in 2001. In addition, personal
automobile net premiums written decreased $0.5 million, as a result of net rate
decreases of 5.4% and 1.4% in Massachusetts and Michigan, respectively,
partially offset by a 5.7% increase in policies in force since June 30, 2000.
Management believes that net rate reductions may continue to unfavorably impact
future premiums in Massachusetts.
22
Standard Markets' underwriting results declined $11.7 million to an underwriting
loss of $26.2 million for the quarter ended June 30, 2001 compared to the same
period in 2000. This is primarily attributable to the aforementioned decrease in
favorable development on prior years' loss reserves. An increase in current year
claims activity in the commercial multiple peril and workers compensation lines
also contributed to the decline in underwriting results. Catastrophe losses
increased $2.4 million to $10.5 million for the second quarter of 2001, compared
to $8.1 million for the same period in 2000. Partially offsetting these
unfavorable items are approximately $24 million of rate increases, primarily in
the commercial lines. A decrease in current year claims severity in the
commercial automobile line also favorably impacted results in the second quarter
of 2001. In addition, excluding the impact of growth in earned premium, policy
acquisition and other underwriting expenses and loss adjustment expenses
decreased as a result of expense management initiatives.
Sponsored Markets
Sponsored Markets' net premiums written increased $10.3 million, or 6.8%, to
$161.4 million for the quarter ended June 30, 2001. This improvement is
primarily due to increases of $5.3 million, or 16.1%, and $4.8 million, or 4.2%,
in the homeowners and personal automobile lines, respectively. Homeowners' net
premiums written increased primarily due to a 4.7% growth in policies in force
and an 8.0% Michigan rate increase compared to the same period in 2000. Personal
automobile's net premiums written increased as a result of a 4.9% growth in
policies in force, partially offset by the aforementioned Massachusetts and
Michigan net rate reductions.
Sponsored Markets' underwriting results improved $4.2 million to an underwriting
profit of $4.6 million for the quarter ended June 30, 2001. The improvement in
underwriting results is primarily attributable to approximately $10 million of
rate increases and an improvement in current year claims severity in the
personal automobile line. In addition, catastrophe losses decreased $4.9 million
to $4.8 million in the second quarter of 2001. Partially offsetting these
favorable items is approximately a $15 million decrease in favorable development
on prior years' reserves. In addition, increased current year claim activity in
the homeowners line unfavorably impacted second quarter 2001 results.
Specialty Markets
Specialty Markets' net premiums written increased $11.6 million to $23.5 million
for the quarter ended June 30, 2001. This improvement is primarily attributable
to increases of $8.5 million and $3.8 million in the commercial automobile and
commercial multiple peril lines, respectively. Commercial automobile's net
premiums written increased primarily as a result of significant growth in
policies in force since June 30, 2000 and a decrease in the utilization of
reinsurance. The increase in commercial multiple peril's net premiums written is
primarily the result of a decrease in the utilization of reinsurance and a 6.3%
growth in policies in force since June 30, 2000.
Specialty Markets' underwriting results declined $4.3 million to an underwriting
loss of $2.8 million for the quarter ended June 30, 2001. The decline in
underwriting results is primarily the result of an increase in current accident
year claims severity in the commercial multiple peril line. In addition, an
absence of ceding commission income from business that has not been renewed
unfavorably impacted results.
23
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
The following table summarizes the results of operations for the distribution
channels of the Risk Management segment:
(Unaudited)
Six Months Ended June 30, 2001
- ----------------------------------------------------------------------------------------------------
Standard Sponsored Specialty
(In millions, except ratios) Markets Markets Markets Other (2) Total
- ----------------------------------------------------------------------------------------------------
Statutory net premiums written $ 787.5 $ 322.9 $ 34.2 $ 0.6 $ 1,145.2
----------------------------------------------------------
Statutory combined ratio (1) 105.1 104.2 107.3 N/M 105.4
----------------------------------------------------------
Statutory underwriting loss $ (47.2) $ (15.9) $ (5.9) $ (6.2) $ (75.2)
----------------------------------------------------------
Reconciliation to segment income:
Net investment income 109.8
Other income and expenses, net 9.7
Other Statutory to GAAP adjustments 13.4
--------
Segment income $ 57.7
========
- ----------------------------------------------------------------------------------------------------
(Unaudited)
Six Months Ended June 30, 2000
------------------------------------------------------------
Standard Sponsored Specialty
(In millions, except ratios) Markets Markets Markets Other(2) Total
- ----------------------------------------------------------------------------------------------------
Statutory net premiums written $ 762.2 $ 302.7 $ 18.3 $ 2.7 $ 1,085.9
----------------------------------------------------------
Statutory combined ratio (1) 102.6 97.7 95.6 N/M 101.4
----------------------------------------------------------
Statutory underwriting (loss) profit $ (32.8) $ 2.4 $ 0.2 $ (3.2) $ (33.4)
----------------------------------------------------------
Reconciliation to segment income:
Net investment income 109.6
Other income and expenses, net 5.4
Other Statutory to GAAP adjustments 15.4
--------
Segment income $ 97.0
========
- ----------------------------------------------------------------------------------------------------
(1) Statutory combined ratio is a common industry measurement of the results of property and
casualty insurance underwriting. This ratio is the sum of the ratio of incurred claims and claim
expenses to premiums earned and the ratio of underwriting expenses incurred to premiums written.
Federal income taxes, net investment income and other non-underwriting expenses are not reflected
in the statutory combined ratio.
(2) Includes results from certain property and casualty business which the Company has exited. The
decline in underwriting results is primarily attributable to unprofitable business in California.
N/M - Not meaningful
Standard Markets
Standard Markets' net premiums written increased $25.3 million, or 3.3%, to
$787.5 million for the six months ended June 30, 2001. This improvement is
primarily attributable to increases of $13.8 million, or 8.9%, $8.5 million, or
7.6%, and $3.3 million, or 1.3%, in the commercial multiple peril, commercial
automobile and personal automobile lines, respectively. The increase in the
commercial multiple peril line is primarily the result of a 4.5% increase in
policies in force since June 30, 2000 and 8.7% and 6.0% rate increases in
Michigan and New York, respectively. Commercial automobile's net premiums
written increased primarily as a result of 5.9%, 4.9%, and 6.7% rate increases
in Michigan, Massachusetts, and New York, respectively. These favorable items
are partially offset by a 6.9% decrease in policies in force since June 30, 2000
in the commercial automobile line. Personal automobile's net premiums written
increased as a result of an 8.5% growth in policies in force in the Northeast,
partially offset by net rate decreases of 5.4% and 1.4% in Massachusetts and
Michigan, respectively, and a 5.1% decrease in policies in force in the Midwest
since June 30, 2000. Partially offsetting these favorable
24
items is a $1.1 million, or 1.0%, decrease in workers' compensation's net
premiums written due to the non-renewal of several unprofitable large commercial
accounts in 2001.
Standard Markets' underwriting losses increased $14.4 million, or 43.9%, to an
underwriting loss of $47.2 million for the six months ended June 30, 2001. This
is primarily attributable to the aforementioned decrease in favorable
development on prior years' reserves. An increase in current year claims
activity in the commercial multiple peril line also contributed to the decline
in underwriting results. In addition, increased current accident year claims
frequency in the homeowners line unfavorably impacted results. Partially
offsetting these unfavorable items are approximately $48 million of rate
increases, primarily in the commercial lines. A decrease in current year claims
severity in the workers' compensation, personal automobile, and commercial
automobile lines also favorably impacted results for the six months ended June
30, 2001. Catastrophe losses decreased $11.2 million to $11.6 million for the
six months ended June 30, 2001, compared to $22.8 million for the same period in
2000. In addition, policy acquisition and other underwriting expenses and loss
adjustment expenses decreased as a result of expense management initiatives.
Sponsored Markets
Sponsored Markets' net premiums written increased $20.2 million, or 6.7%, to
$322.9 million for the six months ended June 30, 2001. This improvement is
primarily due to increases of $11.2 million, or 4.6%, and $8.6 million, or
15.9%, in the personal automobile and homeowners lines, respectively. Personal
automobile's net premiums written increased as a result of a 4.9% growth in
policies in force, partially offset by the aforementioned Massachusetts and
Michigan net rate reductions. Homeowners' net premiums written increased
primarily due to a 4.7% growth in policies in force and an 8.0% Michigan rate
increase compared to the same period in 2000.
Sponsored Markets' underwriting results declined $18.3 million, to an
underwriting loss of $15.9 million, for the six months ended June 30, 2001. The
decline in underwriting results is primarily attributable to approximately a $25
million decrease in favorable development on prior years' reserves. This is
partially offset by approximately $6 million of rate increases and improvement
in current year claims severity in the homeowners and personal automobile lines.
Specialty Markets
Specialty Markets' net premiums written increased $15.9 million, or 86.9%, to
$34.2 million for the six months ended June 30, 2001. This improvement is
primarily attributable to increases of $10.2 million and $4.9 million in the
commercial automobile and commercial multiple peril lines, respectively.
Commercial automobile's net premiums written increased primarily as a result of
a significant growth in policies in force since June 30, 2000 and a decrease in
the utilization of reinsurance. The increase in commercial multiple peril's net
premiums written is primarily the result of a decrease in the utilization of
reinsurance and a 6.3% growth in policies in force over the prior year.
Specialty Markets' underwriting results declined $6.1 million, to an
underwriting loss of $5.9 million, for the six months ended June 30, 2001. The
decline in underwriting results is primarily the result of an increase in
current accident year claims severity in the commercial multiple peril line as a
result of large losses. In addition, an absence of ceding commission income from
business that has not been renewed also unfavorably impacted results.
Investment Results
Net investment income before tax was $53.0 million and $54.4 million for the
quarters ended June 30, 2001 and 2000, respectively. The decline of $1.4
million, or 2.6%, is primarily due to the impact of defaulted bonds.
Net investment income before tax was $109.8 million and $109.6 million for the
six months ended June 30, 2001 and 2000, respectively. The increase in net
investment income in 2001, compared to 2000, primarily reflects higher yields,
offset by a reduction in average invested assets.
Reserve for Losses and Loss Adjustment Expenses
The Risk Management segment maintains reserves for its property and casualty
products to provide for the Company's ultimate liability for losses and loss
adjustment expenses with respect to reported and unreported claims incurred as
of the end of each accounting period. These reserves are estimates, involving
actuarial projections at a given point in time, of what management expects the
ultimate settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claim severity and judicial theories of liability and other factors.
The inherent uncertainty of estimating insurance reserves is greater for certain
types of property and casualty insurance lines, particularly workers'
compensation and other liability lines, where a longer period of time may elapse
before a definitive determination of ultimate liability may be made, and where
the technological, judicial and political climates involving these types of
claims are changing.
25
The Company regularly updates its reserve estimates as new information becomes
available and further events occur which may impact the resolution of unsettled
claims. Changes in prior reserve estimates are reflected in results of
operations in the period 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:
(Unaudited)
Six Months Ended
June 30,
------------------------
(In millions) 2001 2000
- ------------------------------------------------------------------ ------------- ------------
Reserve for losses and LAE, beginning of period $ 2,719.1 $ 2,615.9
Incurred losses and LAE, net of reinsurance recoverable:
Provision for insured events of current year 844.4 821.5
Increase (decrease) in provision for insured events of
prior years 15.6 (69.6)
----------- -----------
Total incurred losses and LAE 860.0 751.9
----------- -----------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events of current year 342.6 341.8
Losses and LAE attributable to insured events of prior years 486.8 421.8
----------- -----------
Total payments 829.4 763.6
----------- -----------
Change in reinsurance recoverable on unpaid losses 1.8 18.0
----------- -----------
Reserve for losses and LAE, end of period $ 2,751.5 $ 2,622.2
=========== ===========
As part of an ongoing process, the reserves have been re-estimated for all prior
accident years and were increased by $15.6 million and decreased $69.6 million
for the six months ended June 30, 2001 and 2000, respectively.
During the first six months of 2001, estimated loss reserves for claims
occurring in prior years increased $43.9 million. During the first six months of
2000, favorable development on prior years' loss reserves was $38.2 million.
This $82.1 million change is primarily the result of an increase in commercial
lines loss cost, and the Company having captured, in 1999 and 2000, the
accumulated benefits of its claims redesign efforts. These efforts resulted in
reduced reserves related to prior accident years, primarily in the personal
automobile line in the Northeast. The adverse development in 2001 also reflects
additional losses related to fourth quarter 2000 non-catastrophe weather related
claims in Michigan. These claims primarily impacted the personal automobile,
workers' compensation, and commercial multiple peril lines. Favorable
development on prior year's loss adjustment expense reserves was $28.3 million
and $31.4 million for the six months ended June 30, 2001 and 2000, respectively.
The favorable development in both periods is primarily attributable to claims
process improvement initiatives taken by the Company over the past three years.
Since 1997, the Company has lowered claim settlement costs through increased
utilization of in-house attorneys and consolidation of claims offices. These
measures are substantially complete.
Reserves established for current year losses and LAE consider the factors that
resulted in the favorable development of prior years' loss and LAE reserves
during 2000 and earlier years. Accordingly, current year reserves are modestly
lower, relative to those initially established for similar exposures in years
prior to 2000, and the Company currently expects no significant adverse or
favorable development for the remainder of the year.
Due to the nature of the business written by the Risk Management segment, the
exposure to environmental liabilities is relatively small and therefore its
reserves are relatively small compared to other types of liabilities. Loss and
LAE reserves related to environmental damage and toxic tort liability, included
in the reserve for losses and LAE, were $33.9 million and $39.5 million, net of
reinsurance of $9.5 million and $11.0 million in the first six months of 2001
and 2000, respectively. The Company does not specifically underwrite policies
that include this coverage, but as case law expands policy provisions and
insurers' liability beyond the intended coverage, the Company may be required to
defend such claims. The Company estimated its ultimate liability for these
claims based upon currently known facts, reasonable assumptions where the facts
are not known, current law and methodologies currently available. Although these
outstanding claims are not significant, their existence gives rise to
uncertainty and are discussed because of the possibility that they may become
significant. The Company currently believes that recorded reserves related to
these claims are adequate. The environmental liability could be revised in the
near term if the estimates used in determining the liability are revised.
26
Inflation generally increases the cost of losses covered by insurance contracts.
The effect of inflation on the Company varies by product. Property and casualty
insurance premiums are established before the amount of losses and LAE, and the
extent to which inflation may affect such expenses are known. Consequently, the
Company attempts, in establishing rates and reserves, to anticipate the
potential impact of inflation in the projection of ultimate costs. The impact of
inflation has been relatively insignificant in recent years. However, inflation
could contribute to increased losses and LAE in the future.
The Company regularly reviews its reserving techniques, its overall reserving
position and its reinsurance. Based on (i) review of historical data,
legislative enactments, judicial decisions, legal developments in impositions of
damages, changes in political attitudes and trends in general economic
conditions, (ii) review of per claim information, (iii) historical loss
experience of the Company and the industry, (iv) the relatively short-term
nature of most policies and (v) internal estimates of required reserves,
management believes that adequate provision has been made for loss reserves.
However, establishment of appropriate reserves is an inherently uncertain
process and there can be no certainty that current established reserves will
prove adequate in light of subsequent actual experience. A significant change to
the estimated reserves could have a material impact on the results of
operations.
Asset Accumulation
Allmerica Financial Services
The following table summarizes the results of operations for the Allmerica
Financial Services segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
(In millions) 2001 2000 2001 2000
- --------------------------------------------------------------------- ------------------
Segment revenues
Premiums $ 7.6 $ 8.8 $ 33.1 $ 35.3
Fees 99.2 102.7 199.6 205.2
Net investment income 72.0 72.4 143.2 145.4
Other income 25.5 29.3 51.6 56.6
-------- -------- ------- --------
Total segment revenues 204.3 213.2 427.5 442.5
Policy benefits, claims and losses 78.5 71.0 172.2 162.7
Policy acquisition and other operating expenses 83.2 86.7 168.4 169.9
-------- -------- ------- --------
Segment income $ 42.6 $ 55.5 $ 86.9 $ 109.9
======== ======== ======= ========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
Segment income decreased $12.9 million, or 23.2%, to $42.6 million during the
second quarter of 2001. This decrease reflects lower asset-based fee and other
income, as well as an increase in policy benefits and other operating expenses,
net of lower deferred acquisition costs. The decline in asset-based fees and
other income is principally attributable to a decrease in the market value of
assets under management in the variable product lines, and to lower brokerage
income.
Segment revenues decreased $8.9 million, or 4.2%, in the second quarter of
2001, primarily due to lower asset-based fees and other income. Oher income
decreased $3.8 million, or 13.0%, to $25.5 million. This decline was primarily
due to lower brokerage income resulting from a decrease in mutual fund and
general securities transaction volumes as well as decreased investment
management fees due to depreciation in variable product assets under management.
Fee income decreased $3.5 million, or 3.4%, to $99.2 million primarily as a
result of variable annuity fees which decreased $4.4 million, or 7.5%. A decline
in the market value of average variable annuity assets under management resulted
in decreased fee income of $6.7 million. This was partially offset by fees of
$2.3 million from additional variable annuity deposits. This decrease in fee
income was partially offset by a $1.3 million increase in individual variable
universal life policy fees, primarily due to additional deposits. A decline in
net investment income, which primarily resulted from the impact of defaulted
bonds, was substantially offset by additional income from the investment of
higher general account deposits, including approximately $300 million of
deposits from the introduction of a promotional annuity program. This program
offered an enhanced crediting rate of 7% for new general account deposits, for
up to one year. The Company completed this program in the second quarter of
2001. (See "Investment Portfolio")
27
Policy benefits, claims and losses increased $7.5 million, or 10.6%, to
$78.5 million, primarily due to an increase in general account deposits,
including the introduction of the aforementioned promotional annuity program.
This increase is also attributable to less favorable mortality experience in the
individual variable universal life product line.
Policy acquisition and other operating expenses decreased $3.5 million, or 4.0%,
to $83.2 million in the second quarter of 2001. Policy acquisition expenses
decreased $7.8 million due to a refinement in the methodology used by the
Company's deferred policy acquisition cost valuation system, as well as lower
annuity profits. Partially offsetting this decrease was a $4.3 million increase
in other operating expenses resulting primarily from increased distribution and
technology costs.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Segment income decreased $23.0 million, or 20.9%, to $86.9 million during the
first six months of 2001. This decrease primarily reflects lower asset-based fee
and other income, as well as an increase in policy benefits and other operating
expenses, net of lower deferred acquisition costs. The decline in asset-based
fees and other income is principally attributable to a decrease in the market
value of assets under management in the variable product lines, and to lower
brokerage income.
Segment revenues decreased $15.0 million, or 3.4%, in the first six months of
2001, primarily due to lower asset-based fees and other income. Fee income
decreased $5.6 million, or 2.7%, to $199.6 million, primarily due to variable
annuity fees which decreased $6.9 million, or 5.9%. A decline in the market
value of average variable annuity assets under management resulted in a $10.8
million decrease in fee income, partially offset by an increase of $3.9 million
from additional deposits. In addition, non-variable universal life policy fees
decreased $1.5 million in the first six months of 2001, primarily due to a
decline in average invested assets resulting from the continued shift in focus
to variable life insurance and annuity products. These decreases in fee income
were partially offset by a $3.1 million increase in fees from variable universal
life policies, primarily due to additional deposits. Other income decreased $5.0
million, or 8.8%, to $51.6 million. This decline was primarily due to lower
brokerage income resulting from a decrease in mutual fund and general securities
transaction volumes, as well as decreased investment management fees resulting
from depreciation in variable product assets under management. Net investment
income declined $2.2 million primarily due to the impact of defaulted bonds and
to lower average mortgage investments and yields. This decline was partially
offset by additional income from the investment of higher general account
deposits, including deposits from the aforementioned promotional annuity
program.
Policy benefits, claims and losses increased $9.5 million, or 5.8%, to $172.2
million in the first six months of 2001, primarily due to an increase in general
account deposits, including the introduction of the aforementioned promotional
annuity program, and to less favorable mortality experience in the individual
variable universal life product line. These increases were partially offset by
more favorable mortality experience in the traditional life line of business.
Policy acquisition and other operating expenses decreased $1.5 million, or
0.9%, to $168.4 million in the first six months of 2001. Policy acquisition
expenses decreased $13.0 million due to the aforementioned refinement in the
methodology used by the Company's deferred policy acquisition cost valuation
system, as well as lower annuity profits. Partially offsetting this decrease was
an $11.5 million increase in other operating expenses primarily from increased
distribution and technology costs.
28
Statutory Premiums and Deposits
The following table sets forth statutory premiums and deposits by product for
the Allmerica Financial Services segment.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
----------------------------------------------
(In millions) 2001 2000 2001 2000
------------------------------------------ -----------------------------------------------
Insurance:
Traditional life $ 7.8 $ 9.0 $ 24.0 $ 25.6
Universal life 4.8 4.7 9.4 10.5
Variable universal life 43.0 51.5 101.3 102.7
Individual health 0.1 - 0.2 0.1
Group variable universal life 20.9 18.6 59.3 30.1
-------- -------- --------- ---------
Total insurance 76.6 83.8 194.2 169.0
-------- -------- --------- ---------
Annuities:
Separate account annuities 480.9 676.5 979.3 1,355.4
General account annuities 326.0 125.4 556.4 264.1
Retirement investment accounts 1.6 2.6 3.9 6.1
-------- -------- --------- ---------
Total individual annuities 808.5 804.5 1,539.6 1,625.6
Group annuities 70.3 90.7 165.2 259.3
-------- -------- --------- ---------
Total annuities 878.8 895.2 1,704.8 1,884.9
-------- -------- --------- ---------
Total premiums and deposits $ 955.4 $ 979.0 $ 1,899.0 $ 2,053.9
======== ======== ========= =========
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
Total premiums and deposits decreased $23.6 million, or 2.4%, to $955.4 million.
These decreases are primarily due to lower separate account, group annuity and
variable universal life deposits, partially offset by higher general account
deposits. The Company believes that the lower separate account, group annuity,
and variable universal life deposits reflect an industry-wide trend resulting
from a general decline in the equity markets. In addition, group annuity
deposits decreased due to the Company's decision to cease marketing activities
for new group retirement business. Partially offsetting these decreases were
higher annuity deposits into the Company's general account, resulting in part,
from the aforementioned promotional annuity program.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
For the six months ended June 30, 2001, total premiums and deposits decreased
$154.9 million, or 7.5%, to $1,899.0 million. These decreases are primarily due
to lower separate account and group annuity deposits resulting from the
aforementioned general decline in the equity markets and to the Company's
decision to cease marketing activities for new group retirement business.
Partially offsetting these decreases were higher annuity deposits into the
Company's general account resulting, in part, from the aforementioned
promotional annuity program.
Annuity products are distributed primarily through three distribution channels:
(1) "Agency", which consists of the Company's career agency force; (2) "Select",
which consists of a network of third party broker-dealers; and (3) "Partners",
which includes distributors of the mutual funds advised by Zurich Scudder
Investments ("Zurich-Scudder"), Pioneer Investment Management, Inc. and Delaware
Management Company ("Delaware"). Select, Partners, and Agency represented,
respectively, approximately 40%, 35%, and 25% of individual annuity deposits in
the second quarter and first six months of 2001, and Zurich-Scudder represented
25% of all individual annuity deposits. During the second quarter and first six
months of 2000, Select, Partners, and Agency represented, respectively,
approximately 25%, 45%, and 30% of individual annuity deposits. The increase in
deposits within the Select channel resulted primarily from the aforementioned
promotional annuity program which was only available in the Select channel.
29
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica Asset
Management segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
-----------------------------------------------
(In millions) 2001 2000 2001 2000
- ---------------------------------------------------------------------------------
Interest margins on GICs
Net investment income $ 39.5 $ 32.1 $ 76.4 $ 58.5
Interest credited 35.6 28.5 67.6 50.9
-------- -------- --------- -------
Net interest margin 3.9 3.6 8.8 7.6
-------- -------- --------- -------
Fees and other income
External 1.1 1.5 2.8 3.1
Internal 1.3 1.3 2.7 2.6
Other operating expenses (1.9) (1.8) (3.9) (3.6)
-------- -------- --------- -------
Segment income $ 4.4 $ 4.6 $ 10.4 $ 9.7
======== ======== ========= =======
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
Segment income decreased $0.2 million, or 4.3%, to $4.4 million during the
second quarter of 2001. This decline is primarily due to a decrease in fee and
other income related to external clients, partially offset by increased earnings
on guaranteed investment contracts ("GICs"). Lower investment management fees
related to external clients resulted from decreased fees from the management of
a securitized investment portfolio, partially offset by an increase in other
external fixed income assets under management. Other external assets under
management grew in the second quarter of 2001 due to increased business from new
and existing money market and fixed income fund clients. Earnings from GICs
increased in the second quarter primarily due to additional long-term funding
agreement deposits of approximately $300.0 million, partially offset by lower
investment income due to defaults of certain bonds supporting GIC obligations.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Segment income increased $0.7 million, or 7.2%, to $10.4 million in the first
six months of 2001. This increase is primarily due to increased earnings on
GICs, partially offset by a decrease in fees and other income related to
external clients. Earnings on GICs increased in 2001 primarily due to additional
long-term funding agreement deposits of $1.1 billion, partially offset by lower
investment income due to the aforementioned bond defaults. The decrease in
external fees and other income primarily resulted from the aforementioned
decrease in fees from the management of a securitized investment portfolio,
partially offset by an increase in other external assets under management from
additional deposits.
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------------------------
(In millions) 2001 2000 2001 2000
- --------------------------------------------------------------------------------
Segment revenues
Net investment income $ 1.5 $ 1.7 $ 2.5 $ 2.7
Interest expense 3.8 3.8 7.6 7.6
Other operating expenses 13.3 10.1 26.7 21.8
-------- -------- -------- -------
Segment loss $ (15.6) $ (12.2) $ (31.8) $ (26.7)
======== ======== ======== =======
30
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
Segment loss increased $3.4 million, or 27.9%, to $15.6 million in the second
quarter of 2001 primarily due to the timing of corporate overhead costs and
certain corporate overhead expenses previously allocated to other operating
segments.
Interest expense for both periods relates to the interest paid on the Senior
Debentures of the Company.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Segment loss increased $5.1 million, or 19.1%, to $31.8 million in the first six
months of 2001 primarily due to the timing of corporate overhead costs and
certain corporate overhead expenses previously allocated to other operating
segments.
Interest expense for both periods relates to the interest paid on the Senior
Debentures of the Company.
Investment Portfolio
The Company held general account investment assets diversified across several
asset classes, as follows:
(Unaudited)
June 30, 2001 December 31, 2000
----------------------------------------------------------
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
- ---------------------------------------------------------------------------------------------------
Fixed maturities (1) $ 9,031.3 84.4% $ 8,118.0 83.9%
Equity securities (1) 75.1 0.7 85.5 0.9
Mortgages 568.8 5.3 617.6 6.4
Policy loans 384.6 3.6 381.3 3.9
Cash and cash equivalents 482.7 4.5 281.1 2.9
Other long-term investments 162.3 1.5 193.2 2.0
------------ ------------- ------------- ------------
Total $ 10,704.8 100.0% $ 9,676.7 100.0%
============ ============= ============= ============
(1) The Company carries fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets increased $1.0 billion, or 10.6%, to $10.7 billion
during the first six months of 2001. This increase consisted primarily of
additional fixed maturities of $913.3 million and additional cash and cash
equivalents of $201.6 million. The increases in fixed maturities and cash and
cash equivalents are primarily due to the investment of funds received from the
sale of GICs by the Allmerica Asset Management segment, as well as the
aforementioned promotional annuity program in the Allmerica Financial Services
segment.
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 89.2% and 88.1% of the Company's total fixed maturity portfolio at
June 30, 2001 and December 31, 2000, respectively. The average yield on fixed
maturities was 7.4% and 7.3% for the six months ended June 30, 2001 and 2000,
respectively. Although management expects that new funds will be invested
primarily in investment grade fixed maturities, the Company may invest a portion
of new funds in below investment grade fixed maturities or equity interests.
As a result of the Company's exposure to below investment grade securities, the
Company recognized $95.2 million and $19.9 million of realized losses on other
than temporary impairments of fixed maturities during the first six months of
2001 and 2000, respectively. The losses reflect the continued deterioration of
the high-yield market. The recognition of these losses followed the review of
recent defaults on interest payments, financial information from issuers,
estimated future cash flows and other trends in the high-yield market. No
assurance can be given that the fixed maturity impairments will, in-fact, be
adequate to cover future losses or that substantial additional impairments will
not be required in the future.
In addition, the Company had fixed maturity securities with a carrying value of
$19.6 million and $7.5 million on non-accrual status at June 30, 2001 and
December 31, 2000, respectively. The effect of non-accruals, compared with
amounts that would have been recognized in accordance with the original terms of
the investments, was a reduction in net investment income of $6.8 million and
$1.7 million for the six months ended June 30, 2001 and 2000, respectively.
Management expects that defaults in the fixed maturities portfolio will
continue to negatively impact investment income.
31
Income Taxes
AFC and its domestic subsidiaries (including certain non-insurance operations)
file a consolidated United States federal income tax return. Entities included
within the consolidated group are segregated into either a life insurance or a
non-life insurance company subgroup. The consolidation of these subgroups is
subject to certain statutory restrictions on the percentage of eligible non-life
tax losses that can be applied to offset life company taxable income.
Quarter Ended June 30, 2001 Compared to Quarter Ended June 30, 2000
The provision for federal income taxes before minority interest, discontinued
operations and the effect of a change in accounting principle was a $1.7 million
benefit during the second quarter of 2001 compared to an $8.4 million expense
during the same period in 2000. These provisions resulted in consolidated
effective federal tax rates of (11.0%) and 14.0% for the quarters ended June 30,
2001 and 2000, respectively. The decrease in the rate is primarily due to
increased realized losses in the second quarter of 2001, to lower underwriting
income resulting in an increase in the proportion of tax-exempt investment
income to pre-tax income, and to an increase in the dividends received deduction
associated with the Company's variable products.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
The provision for federal income taxes before minority interest, discontinued
operations and the effect of a change in accounting principle was $4.7 million
during the first six months of 2001 compared to $15.9 million during the same
period in 2000. These provisions resulted in consolidated effective federal tax
rates of 9.0% and 15.6% for the six months ended June 30, 2001 and 2000,
respectively. The decrease in the rate is primarily due to lower underwriting
income in the first six months of 2001 resulting in an increase in the
proportion of tax-exempt investment income to pre-tax income, as well as to an
increase in the dividends received deduction associated with the Company's
variable products.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. As a holding company,
AFC's primary source of cash is dividends from its insurance subsidiaries.
However, dividend payments to AFC by its insurance subsidiaries are subject to
limitations imposed by state regulators, such as the requirement that cash
dividends be paid out of unreserved and unrestricted earned surplus and
restrictions on the payment of "extraordinary" dividends, as defined. During the
first six months of 2001, AFC received $100.0 million of dividends from its
property and casualty businesses. Additional dividends from the Company's
insurance subsidiaries in 2001 would be considered "extraordinary" and would
require prior approval from the respective state regulators.
Sources of cash for the Company's insurance subsidiaries are from premiums and
fees collected, investment income and maturing investments. Primary cash
outflows are paid benefits, claims, losses and loss adjustment expenses, policy
acquisition expenses, other underwriting expenses and investment purchases. Cash
outflows related to benefits, claims, losses and loss 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 $263.4 million during the first
six months of 2001, compared to net cash used in operating activities of $128.3
million for the same period of 2000. The increase in 2001 is primarily the
result of funds received from the aforementioned promotional annuity program, an
increase in premiums received from the property and casualty business and
decreased federal income tax payments. These increases in cash were partially
offset by increased loss and LAE payments in the property and casualty business.
Net cash used in investing activities was $784.9 million and $482.5 million
during the first six months of 2001 and 2000, respectively. The increase in cash
used in 2001 is primarily due to a $358.2 million year over year increase in net
purchases of fixed maturites primarily due to the timing of investing new
funding agreement deposits and from additional deposits into the general
account, including those related to the aforementioned promotional annuity
program. The increased use of cash was partially offset by a decline in the
purchase of other investments.
32
Net cash provided by financing activities was $723.1 million and $486.9 million
during the first six months of 2001 and 2000, respectively. The increase in 2001
is primarily due to an increase in net funding agreement deposits, including
trust instruments supported by funding obligations, of $193.1 million and a
$46.8 million year over year reduction in cash used for the Company's share
repurchase program.
In the opinion of management, AFC has sufficient funds at the holding company or
available through dividends from its insurance subsidiaries, or through
available credit facilities to meet its obligations to pay interest on the
Senior Debentures, Capital Securities and dividends, when and if declared by the
Board of Directors, on the common stock.
Based on current trends, the Company expects to continue to generate sufficient
positive operating cash to meet all short-term and long-term cash requirements.
The Company maintains a high degree of liquidity within the investment portfolio
in fixed maturity investments, common stock and short-term investments. AFC has
$215.0 million available under a committed syndicated credit agreement which
expires on May 24, 2002. Borrowings under this agreement are unsecured and incur
interest at a rate per annum equal to, at the Company's option, a designated
base rate or the eurodollar rate plus applicable margin. At June 30, 2001, no
amounts were outstanding under this agreement. The Company had $69.3 million of
commercial paper borrowings outstanding at June 30, 2001. These borrowings are
used in connection with the Company's premium financing business, which is
included in the Risk Management segment.
Contingencies
The Company's insurance subsidiaries are routinely engaged in various legal
proceedings arising in the normal course of business, including claims for
punitive damages. Additional information on other litigation and claims may be
found in Note 12 "Commitments and Contingencies - Litigation" to the
consolidated financial statements. In the opinion of management, none of such
contingencies are expected to have a material effect on the Company's
consolidated financial position, although it is possible that the results of
operations in a particular quarter or annual period would be materially affected
by an unfavorable outcome.
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 2001
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, 2000.
33
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 has insured in either the current or 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, or as the result of consolidation within the financial services
industry and the entry of additional financial institutions into the insurance
industry; (iv) adverse state and federal legislation or regulation, including
decreases in rates, limitations on premium levels, increases in minimum capital
and reserve requirements, benefit mandates, limitations on the ability to manage
care and utilization, and tax treatment of insurance and annuity products, as
well as continued compliance with state and federal regulations; (v) changes in
interest rates causing a reduction of investment income or in the market value
of interest rate sensitive investments; (vi) failure to obtain new customers,
retain existing customers or reductions in policies in force by existing
customers; (vii) difficulties in recruiting new or retaining existing career
agents, wholesalers and partnership relations to support the sale of variable
products; (viii) higher service, administrative, or general expense due to the
need for additional advertising, marketing, administrative or management
information systems expenditures; (ix) loss or retirement of key executives; (x)
increases in medical costs, including increases in utilization, costs of medical
services, pharmaceuticals, durable medical equipment and other covered items;
(xi) changes in the Company's liquidity due to changes in asset and liability
matching; (xii) restrictions on insurance underwriting, based on genetic testing
and other criteria; (xiii) adverse changes in the ratings obtained from
independent rating agencies, such as Moody's, Standard and Poor's and A.M. Best;
(xiv) lower appreciation on or decline in value of the Company's managed
investments or the investment markets in general, resulting in reduced variable
product sales, assets and related fees and increased surrenders; (xv) possible
claims relating to sales practices for insurance products; (xvi) failure of a
reinsurer of the Company's policies to pay its liabilities under reinsurance
contracts; (xvii) earlier than expected withdrawals from the Company's general
account annuities, GICs (including funding agreements), and other insurance
products; (xviii) changes in the mix of assets comprising the Company's
investment portfolio and the fluctuation of the market value of such assets;
(xix) losses resulting from the Company's participation in certain reinsurance
pools; (xx) adverse results of regulatory audits related to the Company's prior
years' federal income tax filings; (xxi) losses due to foreign currency
fluctuations; (xxii) the inability to realize expense savings and enhanced
revenues from restructuring initiatives and (xxiii) defaults in debt securities
held by the Company.
34
PART I - FINANCIAL INFORMATION
ITEM 3
QUANTITATIVE AND QUALITATIVE DICLOSURES
ABOUT MARKET RISK
Our market risks, and the ways we manage them, are summarized in management's
discussion and analysis of financial condition and results of operations as of
December 31, 2000, included in the Company's Form 10-K for the year ended
December 31, 2000. There have been no material changes in the first six months
of 2001 to such risks or our management of such risks.
35
PART II - OTHER INFORMATION
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This registrant's annual shareholder's meeting was held on May 15, 2001. All
five directors nominated for re-election by the Board of Directors were named in
proxies for the meeting, which proxies were solicited pursuant to Regulations
14A of the Securities and Exchange Act of 1934.
VOTES FOR WITHHELD
Michael P. Angelini 39,432,378 248,014
Robert P. Henderson 39,522,201 158,191
Terrence Murray 39,527,872 152,520
John F. O'Brien 39,532,335 148,057
Herbert M. Varnum 39,529,033 151,359
The other directors whose terms were continued after the Annual Meeting are Mr.
E. Gordon Gee, Mr. Samuel J. Gerson, Ms. Gail L. Harrison, Mr. M Howard
Jacobson, Mr. Wendell J. Knox, Mr. Robert J. Murray and Mr. John R. Towers.
Shareholders ratified the appointment of PricewaterhouseCoopers LLP as the
Independent Public Accountants of the Company for 2001: for 39,383,311; against
208,500; abstain 88,581.
36
PART II - OTHER INFORMATION
ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EX-10.38 Amendment to the Credit Agreement dated as of May 25, 2001
between the Registrant and the Chase Manhattan Bank
EX-10.39 Stock Pledge and Loan Agreement dated as of February 5,
2001 between AMGRO, Inc., a subsidiary of the Registrant,
and Robert P. Restrepo, Jr.
(b) Reports on Form 8-K
None
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
Registrant
Dated August 14, 2001
/s/John F. O'Brien
------------------
John F. O'Brien
President and Chief Executive Officer
Dated August 14, 2001
/s/Edward J. Parry III
----------------------
Edward J. Parry III
Vice President, Chief Financial Officer and
Principal Accounting Officer
38
EXHIBIT INDEX
Exhibit
Number Exhibit
10.38 Amendment to the Credit Agreement dated as of May 25, 2001 between
the Registrant and the Chase Manhattan Bank.
10.39 Stock Pledge and Loan Agreement dated as of February 5, 2001
between AMGRO, Inc., a subsidiary of the Registrant, and
Robert P. Restrepo, Jr.
39