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: March 31, 2002
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: 53,004,461 shares of common
stock outstanding, as of May 1, 2002.
32
Total Number of Pages Included in This Document
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 - 14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15 - 29
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 32
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
---------------------------------
(In millions, except per share data) 2002 2001
- --------------------------------------------------------------------------------------------------------
Revenues
Premiums................................................... $ 582.6 $ 563.5
Universal life and investment product policy fees.......... 96.0 100.4
Net investment income...................................... 150.5 165.8
Net realized investment losses............................. (12.3) (17.4)
Other income............................................... 32.5 33.6
-------------- ---------------
Total revenues.......................................... 849.3 845.9
-------------- ---------------
Benefits, losses and expenses
Policy benefits, claims, losses and loss adjustment expenses 536.4 556.7
Policy acquisition expenses................................ 111.5 116.1
Gains on derivative instruments............................ (16.3) (2.5)
Other operating expenses................................... 152.6 138.8
-------------- ---------------
Total benefits, losses and expenses..................... 784.2 809.1
-------------- ---------------
Income before federal income taxes......................... 65.1 36.8
-------------- ---------------
Federal income tax expense (benefit):
Current................................................. 9.8 (5.4)
Deferred................................................ (0.3) 11.8
-------------- ---------------
Total federal income tax expense..................... 9.5 6.4
-------------- ---------------
Income before minority interest and cumulative effect of
change in accounting principle..................... 55.6 30.4
Minority interest:
Distributions on mandatorily redeemable preferred
securities of a subsidiary trust holding solely
junior subordinated debentures of the Company......... (4.0) (4.0)
-------------- ---------------
Income before cumulative effect of change in accounting
principle.............................................. 51.6 26.4
Cumulative effect of change in accounting principle (less
applicable income tax benefit of $2.0 and $1.7 for the
quarters ended March 31, 2002 and 2001)................ (3.7) (3.2)
-------------- ---------------
Net income................................................. $ 47.9 $ 23.2
============== ===============
PER SHARE DATA
Basic
Income before cumulative effect of change in accounting
principle............................................ $ 0.98 $ 0.50
Cumulative effect of change in accounting principle (less
applicable income tax benefit of $0.04 and $0.03 for
the quarters ended March 31, 2002 and 2001).......... (0.07) (0.06)
-------------- ---------------
Net income.............................................. $ 0.91 $ 0.44
============== ===============
Weighted average shares outstanding..................... 52.8 52.6
============== ===============
Diluted
Income before cumulative effect of change in accounting
principle............................................ $ 0.97 $ 0.50
Cumulative effect of change in accounting principle (less
applicable income tax benefit of $0.04 and $0.03 for
the quarters ended March 31, 2002 and 2001).......... (0.07) (0.06)
-------------- ---------------
Net income.............................................. $ 0.90 $ 0.44
============== ===============
Weighted average shares outstanding..................... 53.1 53.1
============== ===============
The accompanying notes are an integral part of these consolidated financial statements.
3
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
(In millions, except per share data) 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities-at fair value (amortized cost of $9,070.3 and $9,294.0).. $ 9,055.2 $ 9,401.7
Equity securities-at fair value (cost of $61.2 and $61.2)................. 60.0 62.1
Mortgage loans............................................................ 319.4 321.6
Policy loans.............................................................. 375.4 379.6
Other long-term investments............................................... 167.2 161.2
----------- -----------
Total investments....................................................... 9,977.2 10,326.2
----------- -----------
Cash and cash equivalents.................................................... 306.3 350.2
Accrued investment income.................................................... 162.5 152.3
Premiums, accounts and notes receivable, net................................. 616.0 628.4
Reinsurance receivable on paid and unpaid losses,
benefits and unearned premiums............................................ 1,407.1 1,426.8
Deferred policy acquisition costs............................................ 1,872.8 1,784.2
Deferred federal income taxes................................................ 200.7 168.1
Goodwill..................................................................... 131.2 139.2
Other assets................................................................. 532.5 522.3
Separate account assets...................................................... 15,085.9 14,838.4
----------- -----------
Total assets.............................................................. $ 30,292.2 $ 30,336.1
=========== ===========
Liabilities
Policy liabilities and accruals:
Future policy benefits.................................................... $ 4,176.2 $ 4,099.6
Outstanding claims, losses and loss adjustment expenses................... 3,038.6 3,029.8
Unearned premiums......................................................... 1,049.4 1,052.5
Contractholder deposit funds and other policy liabilities................. 1,354.2 1,763.9
----------- -----------
Total policy liabilities and accruals................................... 9,618.4 9,945.8
----------- -----------
Expenses and taxes payable................................................... 941.0 934.1
Reinsurance premiums payable................................................. 98.0 125.3
Trust instruments supported by funding obligations........................... 1,532.3 1,518.6
Short-term debt.............................................................. 132.3 83.3
Long-term debt............................................................... 199.5 199.5
Separate account liabilities................................................. 15,085.9 14,838.4
----------- -----------
Total liabilities......................................................... 27,607.4 27,645.0
----------- -----------
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 10)
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................................................... 1,756.9 1,758.4
Accumulated other comprehensive loss......................................... (70.9) (13.7)
Retained earnings............................................................ 1,100.2 1,052.3
Treasury stock at cost (7.4 and 7.5 million shares).......................... (402.0) (406.5)
----------- -----------
Total shareholders' equity................................................ 2,384.8 2,391.1
----------- -----------
Total liabilities and shareholders' equity.............................. $ 30,292.2 $ 30,336.1
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
4
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
Three Months Ended
March 31,
--------------------------
(In millions) 2002 2001
- -------------------------------------------------------------------------------------------------------------------
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............................................... 1,758.4 1,765.3
Unearned compensation related to restricted stock and other............... (1.5) (4.2)
--------- ----------
Balance at end of period..................................................... 1,756.9 1,761.1
--------- ----------
Accumulated Other Comprehensive (Loss) Income
Net unrealized appreciation (depreciation) on investments:
Balance at beginning of period............................................... 28.4 (5.2)
Net (depreciation) appreciation on available-for-sale securities and
derivative instruments.................................................. (88.0) 106.1
Benefit (provision) for deferred federal income taxes..................... 30.8 (37.1)
--------- ----------
(57.2) 69.0
--------- ----------
Balance at end of period..................................................... (28.8) 63.8
--------- ----------
Minimum Pension Liability:
Balance at beginning and end of period....................................... (42.1) -
--------- ----------
Total accumulated other comprehensive (loss) income.......................... (70.9) 63.8
--------- ----------
Retained earnings
Balance at beginning of period............................................... 1,052.3 1,068.7
Net income................................................................ 47.9 23.2
--------- ----------
Balance at end of period..................................................... 1,100.2 1,091.9
--------- ----------
Treasury Stock
Balance at beginning of period............................................... (406.5) (420.3)
Shares reissued at cost................................................... 4.5 5.4
--------- ----------
Balance at end of period..................................................... (402.0) (414.9)
--------- ----------
Total shareholders' equity............................................ $2,384.8 $ 2,502.5
========= ==========
The accompanying notes are an integral part of these consolidated financial statements.
5
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
March 31,
---------------------------------
(In millions) 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Net income...................................................................... $ 47.9 $ 23.2
Other comprehensive (loss) income:
Available-for-sale securities:
Net (depreciation) appreciation during the period......................... (100.9) 115.0
Benefit (provision) for deferred federal income taxes..................... 35.3 (40.2)
----------- -----------
Total available-for-sale securities ........................................ (65.6) 74.8
----------- -----------
Derivative instruments:
Net appreciation (depreciation) during the period......................... 12.9 (8.9)
(Provision) benefit for deferred federal income taxes..................... (4.5) 3.1
----------- -----------
Total derivative instruments................................................. 8.4 (5.8)
----------- -----------
Other comprehensive (loss) income .............................................. (57.2) 69.0
----------- -----------
Comprehensive (loss) income..................................................... $ (9.3) $ 92.2
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
6
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
--------------------------------
(In millions) 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income.............................................................. $ 47.9 $ 23.2
Adjustments to reconcile net income to net cash provided by
operating activities:
Net realized losses ................................................. 12.3 17.4
Gains on derivative instruments...................................... (16.3) (2.5)
Net amortization and depreciation.................................... 6.5 3.6
Deferred federal income taxes........................................ (0.3) 11.8
Change in deferred acquisition costs................................. (74.0) (17.9)
Change in premiums and notes receivable,
net of reinsurance payable......................................... (2.4) (6.5)
Change in accrued investment income.................................. (10.2) -
Change in policy liabilities and accruals, net....................... 75.9 167.7
Change in reinsurance receivable..................................... 19.7 8.2
Change in expenses and taxes payable................................. 1.0 (81.7)
Separate account activity, net....................................... - 0.1
Other, net........................................................... 8.7 (21.0)
------------- -------------
Net cash provided by operating activities...................... 68.8 102.4
------------- -------------
Cash flows from investing activities
Proceeds from disposals and maturities of available-for-sale fixed
maturities.......................................................... 940.2 356.2
Proceeds from disposals of equity securities............................ 10.6 0.1
Proceeds from disposals of other investments............................ 9.4 24.1
Proceeds from mortgages matured or collected............................ 2.7 16.3
Proceeds from collections of installment finance and notes receivable... 61.6 47.4
Purchase of available-for-sale fixed maturities......................... (723.3) (474.2)
Purchase of equity securities........................................... (0.5) (9.5)
Purchase of other investments........................................... (11.0) (6.5)
Disbursements to fund installment finance and notes receivable.......... (74.2) (56.9)
Capital expenditures.................................................... (1.9) (3.3)
------------- -------------
Net cash provided by (used in) investing activities............ 213.6 (106.3)
------------- -------------
Cash flows from financing activities
Deposits and interest credited to contractholder deposit funds.......... 105.5 47.2
Withdrawals from contractholder deposit funds........................... (494.5) (227.9)
Deposits to trust instruments supported by funding obligations.......... 45.2 728.8
Withdrawals from trust instruments supported by funding obligations..... (31.5) (12.3)
Change in short-term debt............................................... 49.0 8.0
Treasury stock reissued at cost......................................... - 2.4
------------- -------------
Net cash (used in) provided by financing activities............ (326.3) 546.2
------------- -------------
Net change in cash and cash equivalents.................................... (43.9) 542.3
Cash and cash equivalents, beginning of period............................. 350.2 281.1
------------- -------------
Cash and cash equivalents, end of period................................... $ 306.3 $ 823.4
============= =============
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 three months ended March 31, 2002 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 2001 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 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 became effective for fiscal years beginning after December 15, 2001
for all goodwill and other intangible assets held at the date of adoption. The
Company adopted Statement No. 142 on January 1, 2002. In accordance with the
transition provisions of this statement, the Company recorded a $3.7 million
charge, net-of-taxes, in earnings, to recognize the impairment of goodwill
related to two of its non-insurance subsidiaries. The Company utilized a
discounted cash flow model to value these subsidiaries.
8
Effective January 1, 2002, the Company ceased its amortization of goodwill in
accordance with Statement No. 142. Amortization expense in the first quarter of
2001 was $1.0 million, net-of-taxes. In accordance with Statement No. 142, the
following table provides income before the cumulative effect of a change in
accounting principle, net income, and related per-share amounts as of March 31,
2002 and 2001, as reported and adjusted as if the Company had ceased amortizing
goodwill effective January 1, 2001.
(Unaudited)
Three Months Ended
March 31,
---------------------------------
(In millions, except per share data) 2002 2001
- --------------------------------------------------------------------------------------------------------
Reported income before cumulative effect of change in
accounting principle.................................... $ 51.6 $ 26.4
Goodwill amortization................................... - 1.0
-------------- ---------------
Adjusted income before cumulative effect of change in
accounting principle.................................... $ 51.6 $ 27.4
============== ===============
Reported net income........................................ $ 47.9 $ 23.2
Goodwill amortization................................... - 1.0
-------------- ---------------
Adjusted net income........................................ $ 47.9 $ 24.2
============== ===============
Per Share Information
Basic
Reported income before cumulative effect of change in
accounting principle.................................... $ 0.98 $ 0.50
Goodwill amortization................................... - 0.02
-------------- ---------------
Adjusted income before cumulative effect of change in
accounting principle.................................... $ 0.98 $ 0.52
============== ===============
Reported net income........................................ $ 0.91 $ 0.44
Goodwill amortization................................... - 0.02
-------------- ---------------
Adjusted net income........................................ $ 0.91 $ 0.46
============== ===============
Diluted
Reported income before cumulative effect of change in
accounting principle.................................... $ 0.97 $ 0.50
Goodwill amortization................................... - 0.02
-------------- ---------------
Adjusted income before cumulative effect of change in
accounting principle.................................... $ 0.97 $ 0.52
============== ===============
Reported net income........................................ $ 0.90 $ 0.44
Goodwill amortization................................... - 0.02
-------------- ---------------
Adjusted net income........................................ $ 0.90 $ 0.46
============== ===============
3. Discontinued Operations
During the second quarter of 1999, the Company approved a plan to exit its group
life and health insurance business, consisting of its Employee Benefit Services
("EBS") business, its Affinity Group Underwriters ("AGU") business and its
accident and health assumed reinsurance pool business ("reinsurance pool
business"). During the third quarter of 1998, the Company ceased writing new
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
9
measurement date of June 30, 1999, approximately $8.5 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. As a result of this transaction, the
Company has received consideration of approximately $27 million, based on
renewal rights for existing policies. The Company retained policy liabilities
estimated at $83.3 million at March 31, 2002 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 March 31,
2002 and 2001, the discontinued segment had assets of approximately $313.0
million and $448.7 million, respectively, consisting primarily of invested
assets and reinsurance recoverables, and liabilities of approximately $369.1
million and $432.7 million, respectively, consisting primarily of policy
liabilities. Revenues for the discontinued operations were $6.8 million and $9.0
million for the quarters ended March 31, 2002 and 2001, respectively.
4. Significant Transactions
As of March 31, 2002, 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 March 31, 2002, the Board had
authorized total stock repurchases of $500.0 million, leaving approximately
$63.7 million available to the Company for future repurchases. There were no
share repurchases in the first quarter of 2002.
In the fourth quarter of 2001, the Company recognized a pre-tax charge of $2.7
million related to severance and other employee related costs resulting from the
reorganization of its technology support group. Approximately 82 position have
been eliminated as a result of this restructuring plan, of which 81 employees
have been terminated as of March 31, 2002. The Company has made payments of $2.1
million related to this restructuring plan as of March 31, 2002.
5. Federal Income Taxes
Federal income tax expense for the three months ended March 31, 2002 and 2001,
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.
6. Other Comprehensive Income
The following table provides a reconciliation of gross unrealized (losses) gains
to the net balance shown in the Statements of Comprehensive Income:
(Unaudited)
Three Months Ended
March 31,
----------------------------
(In millions) 2002 2001
- ------------------------------------------------------------------------------------------------------
Unrealized (losses) gains on available-for-sale securities:
Unrealized holding (losses) gains arising during period (net
of income tax benefit (expense) of $35.8 million and $(37.4)
million in 2002 and 2001, respectively)........................ $ (64.4) $ 63.8
Less: reclassification adjustment for gains (losses) included
in net income (net of income tax benefit of $0.5 million and
$2.8 million in 2002 and 2001, respectively)................... 1.2 (11.0)
----------- -----------
Total available-for-sale securities.................................. (65.6) 74.8
----------- -----------
Unrealized losses on derivative instruments:
Unrealized holding losses arising during period (net of
income tax benefit of $4.8 million and $4.2 million in 2002
and 2001, respectively)........................................ (5.3) (7.5)
Less: reclassification adjustment for losses included in net
income (net of income tax benefit of $9.3 million and $1.1
million in 2002 and 2001, respectively)........................ (13.7) (1.7)
----------- -----------
Total derivative instruments......................................... 8.4 (5.8)
----------- -----------
Other comprehensive (loss) income................................. $ (57.2) $ 69.0
=========== ===========
10
7. Closed Block
Summarized financial information of the Closed Block is as follows for the
periods indicated:
(Unaudited)
March 31, December 31,
(In millions) 2002 2001
- ----------------------------------------------------------------------------------------------------
Assets
Fixed maturities-at fair value (amortized cost of $514.3 and
$498.1)............................................................ $ 509.3 $ 504.2
Mortgage loans....................................................... 55.2 55.7
Policy loans......................................................... 179.0 182.1
Cash and cash equivalents............................................ - 9.2
Accrued investment income............................................ 14.9 14.6
Deferred policy acquisition costs.................................... 9.6 10.4
Other assets......................................................... 12.4 6.2
--------- -------
Total assets...................................................... $ 780.4 $ 782.4
========= =======
Liabilities
Policy liabilities and accruals...................................... $ 805.0 $ 798.2
Policyholder dividends............................................... 15.2 30.7
Other liabilities.................................................... 18.8 7.0
--------- -------
Total liabilities................................................. $ 839.0 $ 835.9
========= =======
Excess of Closed Block liabilities over assets designated to the
Closed Block........................................................ $ 58.6 $ 53.5
Amounts included in other comprehensive income:
Net unrealized investment losses, net of deferred federal income
tax benefit of $5.7 million and $8.8 million........................ (10.6) (16.4)
--------- -------
Maximum future earnings to be recognized from Closed Block
assets and liabilities............................................. $ 48.0 $ 37.1
========= =======
(Unaudited)
Three Months Ended
March 31,
---------------------
(In millions) 2002 2001
- -------------------------------------------------------------------------------------------------
Revenues
Premiums.............................................................. $ 24.4 $ 25.1
Net investment income................................................. 12.9 14.0
Net realized investment losses ....................................... (0.1) -
-------- -------
Total revenues..................................................... 37.2 39.1
-------- -------
Benefits and expenses
Policy benefits....................................................... 33.9 33.5
Policy acquisition expenses........................................... 0.5 -
Other operating expenses.............................................. 0.3 0.3
-------- -------
Total benefits and expenses........................................ 34.7 33.8
-------- -------
Contribution from the Closed Block.............................. $ 2.5 $ 5.3
======== =======
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.
8. 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.
11
The Risk Management Segment sells property and casualty insurance products
through independent agents and brokers primarily in the Northeast, Midwest and
Southeast United States as well as to members of affinity groups and other
organizations. In addition, the Risk Management Segment offers discounted
property and casualty (automobile and homeowners) insurance through employer
sponsored programs.
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, as well as group retirement products. Allmerica Financial
Services also includes brokerage and non-institutional investment advisory
services. Through its Allmerica Asset Management segment, the Company offers
GICs, also referred to as funding agreements, which are investment contracts
that can contain either short-term or long-term maturities and are issued to
institutional buyers or to various business or charitable trusts. Also, this
segment is 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 (mandatorily redeemable preferred securities of a subsidiary trust
holding solely junior subordinated debentures of the Company) 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, gains and
losses on derivative instruments, 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.
12
Summarized below is financial information with respect to business segments:
(Unaudited)
Three Months Ended
March 31,
--------------------------
(In millions) 2002 2001
- -------------------------------------------------------------------------------------------
Segment revenues:
Risk Management.......................................... $ 614.7 $ 601.3
---------- ---------
Asset Accumulation:
Allmerica Financial Services.......................... 214.9 223.2
Allmerica Asset Management............................ 32.2 39.7
---------- ---------
Subtotal............................................ 247.1 262.9
---------- ---------
Corporate................................................ 1.7 1.0
Intersegment revenues.................................... (1.9) (1.9)
---------- ---------
Total segment revenues.................................. 861.6 863.3
Adjustments to segment revenues:
Net realized losses........................................ (12.3) (17.4)
---------- ---------
Total revenues.......................................... $ 849.3 $ 845.9
========== =========
Segment income (loss) before federal income taxes, minority
interest and cumulative effect of change in accounting
principle:
Risk Management............................................ $ 39.0 $ 16.2
---------- ---------
Asset Accumulation:
Allmerica Financial Services............................ 29.7 44.3
Allmerica Asset Management.............................. 5.1 6.0
---------- ---------
Subtotal............................................. 34.8 50.3
---------- ---------
Corporate.................................................. (16.4) (16.2)
---------- ---------
Segment income before federal income taxes and
minority interest.................................... 57.4 50.3
Adjustments to segment income:
Net realized investment losses, net of amortization........ (8.6) (16.0)
Gains on derivatives....................................... 16.3 2.5
---------- ---------
Income before federal income taxes, minority interest
and cumulative effect of change in accounting
principle............................................ $ 65.1 $ 36.8
========== =========
Identifiable Assets Deferred Acquisition Costs
- --------------------------------------------- ----------------------------------------- -----------------------------------------
(Unaudited) (Unaudited)
March 31, December 31, March 31, December 31,
(In millions) 2002 2001 2002 2001
- --------------------------------------------- -------------------- -------------------- -------------------- --------------------
Risk Management.......................... $ 5,976.7 $ 6,239.8 $ 201.0 $ 199.0
------------- -------------- -------------- --------------
Asset Accumulation:
Allmerica Financial Services......... 21,668.8 21,113.0 1,671.8 1,585.2
Allmerica Asset Management........... 2,538.7 2,829.3 - -
------------- -------------- -------------- --------------
Subtotal........................... 24,207.5 23,942.3 1,671.8 1,585.2
Corporate................................ 108.0 154.0 - -
------------- -------------- -------------- --------------
Total................................. $ 30,292.2 $ 30,336.1 $ 1,872.8 $ 1,784.2
============= ============== ============== ==============
13
9. Earnings Per Share
The following table provides share information used in the calculation of the
Company's basic and diluted earnings per share:
(Unaudited)
Quarter Ended
March 31,
------------------------
(In millions, except per share data) 2002 2001
- ------------------------------------------------------------------------------------------
Basic shares used in the calculation of earnings per share... 52.8 52.6
Dilutive effect of securities:
Employee stock options................................... 0.1 0.4
Non-vested stock grants.................................. 0.2 0.1
---------- ----------
Diluted shares used in the calculation of earnings per share 53.1 53.1
========== ==========
Per share effect of dilutive securities on income before
cumulative effect of change in accounting principle..... $ 0.01 $ -
========== ==========
Per share effect of dilutive securities on net income....... $ 0.01 $ -
========== ==========
10. 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 2001, the Company recognized a pre-tax benefit of $7.7 million
resulting from the refinement of cost estimates. Although the Company believes
that it has appropriately recognized 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.
14
PART I
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 2001 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, gains and losses on derivative instruments, 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 first quarter increased $24.7
million, or 106.5%, to $47.9 million, compared to $23.2 million for the same
period in 2001. The increase in net income resulted primarily from a $9.0
million and $8.2 million increase in gains on derivatives and adjusted net
income, respectively, as well as an $8.0 million decrease in net realized
investment losses.
15
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 Capital
Securities (mandatorily redeemable preferred securities of a subsidiary trust
holding solely junior subordinated debentures of the Company).
(Unaudited)
Three Months Ended
March 31,
--------------------------------
(In millions) 2002 2001
- ---------------------------------------------------------------------------------------------------
Segment income (loss) before federal income taxes and
minority interest:
Risk Management.......................................... $ 39.0 $ 16.2
------------ ------------
Asset Accumulation:
Allmerica Financial Services......................... 29.7 44.3
AllmericaAsset Management............................ 5.1 6.0
------------ ------------
34.8 50.3
Corporate................................................ (16.4) (16.2)
------------ ------------
Segment income before federal income taxes and
minority interest.................................... 57.4 50.3
Federal income taxes on segment income................... (8.0) (9.1)
Minority interest on Capital Securities.................. (4.0) (4.0)
------------ ------------
Adjusted net income........................................... 45.4 37.2
Adjustments (net of taxes and amortization, as applicable):
Net realized investment losses........................... (4.4) (12.4)
Gains on derivatives..................................... 10.6 1.6
------------ ------------
Income before cumulative effect of change in
accounting principle..................................... 51.6 26.4
Cumulative effect of change in accounting principle,
net of applicable taxes............................... (3.7) (3.2)
------------ ------------
Net income.................................................... $ 47.9 $ 23.2
============ ============
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
The Company's segment income before taxes and minority interest increased $7.1
million, or 14.1%, to $57.4 million in the first quarter of 2002. This increase
was primarily attributable to an increase in income from the Risk Management
segment of $22.8 million, partially offset by lower income from the Allmerica
Financial Services segment of $14.6 million. The increase in Risk Management
segment income is primarily attributable to decreased weather related losses in
2002. The first quarter of 2001 results reflected weather related adverse
development on prior years' reserves of approximately $15 million. In addition,
segment income in the first quarter of 2001 reflected approximately $9 million
of higher non-catastrophe weather related claims, compared to the first quarter
of 2002 which included a benefit from reduced non-catastrophe weather related
claims of approximately $6 million. Additionally, segment income in the first
quarter of 2001 was negatively affected by $19.4 million of adverse development
of loss and loss adjustment expense ("LAE") reserves, including the
aforementioned $15 million of weather related claims, which compares to $3.4
million of favorable development in the first quarter of 2002. Segment income
for the first quarter of 2002 also reflected a benefit of approximately $14
million of net rate increases, primarily in commercial lines. Partially
offsetting these items is increased current year non-catastrophe claims
severity, primarily in the personal automobile line. The decrease in Allmerica
Financial Services' segment income of $14.6 million was principally due to
higher policy benefits as well as lower asset-based fees and other income,
resulting from a decline in the equity markets. These decreases in segment
income were partially offset by lower deferred policy acquisition costs.
The effective tax rate for segment income was 14.0% for the first quarter of
2002 compared to 18.2% for the first quarter of 2001. The decrease in the tax
rate is primarily due to lower expected underwriting income in 2002, partially
offset by lower tax-exempt investment income in 2002.
16
Net realized losses on investments, after taxes, were $4.4 million in the first
quarter of 2002, resulting primarily from impairments of fixed maturities and
losses related to the termination of certain derivative instruments, partially
offset by gains recognized from the sale of fixed maturities. During the first
quarter of 2001, net realized losses on investments, after tax, of $12.4 million
primarily reflects impairments of fixed maturities. Gains on derivatives, after
taxes, increased $9.0 million, to $10.6 million in the first quarter of 2002,
resulting primarily from the aforementioned termination of certain derivatives.
During the first quarter of 2002, the Company recognized a $3.7 million loss,
net-of-taxes, upon adoption of Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets." 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:
(Unaudited)
Three Months Ended
March 31,
-----------------------------
(In millions) 2002 2001
- ----------------------------------------------------------------------------------------------------
Segment revenues
Net premiums written..................................... $ 554.9 $ 566.7
=========== =============
Net premiums earned...................................... $ 558.1 $ 538.0
Net investment income.................................... 51.8 56.8
Other income............................................. 4.8 6.5
----------- -------------
Total segment revenues........................ 614.7 601.3
Losses and operating expenses
Losses and loss adjustment expenses (1).................. 421.1 437.9
Policy acquisition expenses.............................. 104.6 96.4
Other operating expenses................................. 50.0 50.8
----------- -------------
Total losses and operating expenses........... 575.7 585.1
----------- -------------
Segment income................................................ $ 39.0 $ 16.2
=========== =============
(1) Includes policyholders' dividends of $(0.3) million and $2.1 million for the quarters ended
March 31, 2002 and 2001, respectively.
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Risk Management's segment income increased $22.8 million to $39.0 million for
the first quarter of 2002. The increase in segment income is primarily
attributable to decreased weather related losses in 2002. The first quarter of
2001 results reflected weather related adverse development on prior years'
reserves of approximately $15 million. In addition, segment income in the first
quarter of 2001 reflected approximately $9 million of higher non-catastrophe
weather related claims, compared to the first quarter of 2002 which included a
benefit from reduced non-catastrophe weather related claims of approximately $6
million. Development on prior year' reserves improved $22.8 million to $3.4
million of favorable development in the first quarter of 2002 from $19.4 million
of adverse development for the same period in 2001, including the aforementioned
$15.0 million of weather related claims. Segment income for the first quarter of
2002 also reflected a benefit of approximately $14 million of net rate
increases, primarily in commercial lines. Partially offsetting these items is
increased current year non-catastrophe claims severity, primarily in the
personal automobile line. Segment income also reflected approximately $6 million
of increased reinsurance costs and a $5.0 million decrease in net investment
income to
17
$51.8 million for the quarter ended March 31, 2002. In addition,
catastrophe losses increased $4.4 million, to $11.2 million for the first
quarter of 2002, compared to $6.8 million for the same period in 2001. Policy
acquisition expenses increased in the first quarter of 2002 primarily due to
earned premium growth since March 31, 2001.
Underwriting 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.
In 2002, the Company reorganized its Risk Management segment. Under the new
structure, the Risk Management segment manages its operations through two lines
of business based upon product and identified as Personal Lines and Commercial
Lines. Personal Lines include property and casualty coverages such as personal
automobile, homeowners and other personal policies, while Commercial Lines
include property and casualty coverages such as workers' compensation,
commercial automobile, commercial multiple peril and other commercial policies.
The following tables summarize the results of operations for the Risk Management
segment:
(Unaudited)
Three Months Ended March 31, 2002
--------------------------------------------------
Personal Commercial
(In millions, except ratios) Lines Lines Total
- ------------------------------------------------------------------------------------------
Statutory net premiums written::
Personal automobile................ $ 285.2 $ - $ 285.2
Homeowners......................... 65.5 - 65.5
Workers' compensation.............. - 42.0 42.0
Commercial automobile.............. - 51.5 51.5
Commercial multiple peril.......... - 79.7 79.7
Other property & casualty.......... 8.6 21.7 30.3
--------------------------------------------------
Total.............................. $ 359.3 $ 194.9 $ 554.2
==================================================
Statutory combined ratio (1).......... 105.1 103.6 104.3
==================================================
Statutory underwriting loss........... $ (21.7) $ (1.6) $ (23.3)
---------------------------------------
Reconciliation to segment income:
Net investment income.............. 51.8
Other income and expenses, net..... 3.4
Other Statutory to GAAP adjustments 7.1
----------
Segment income........................ $ 39.0
==========
- ------------------------------------------------------------------------------------------
18
(Unaudited)
Three Months Ended March 31, 2001
-----------------------------------------------
Personal Commercial
(In millions, except ratios) Lines Lines Total
- ------------------------------------------------------------------------------------------
Statutory net premiums written:
Personal automobile................ $ 266.5 $ - $ 266.5
Homeowners......................... 58.5 - 58.5
Worker' compensation............... - 57.1 57.1
Commercial automobile.............. - 61.3 61.3
Commercial multiple peril.......... - 88.5 88.5
Other property & casualty.......... 8.7 24.7 33.4
-------------------------------------------------
Total.............................. $ 333.7 $ 231.6 $ 565.3
=================================================
Statutory combined ratio (1).......... 107.5 108.3 107.8
=================================================
Statutory underwriting loss........... $ (27.0) $ (22.8) $ (49.8)
--------------------------------------
Reconciliation to segment income:
Net investment income.............. 56.8
Other income and expenses, net..... 3.5
Other Statutory to GAAP adjustments 5.7
----------
Segment income........................ $ 16.2
==========
- ------------------------------------------------------------------------------------------
(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.
Personal Lines
Personal lines' net premiums written increased $25.6 million, or 7.7%, to $359.3
million for the first quarter of 2002. This is primarily the result of increases
of $18.7 million, or 7.0%, and $7.0 million, or 12.0%, in the personal
automobile and homeowners lines, respectively. The increase in the personal
automobile line is primarily the result of 2.0% and 0.6% net rate increases in
Michigan and Massachusetts, respectively, and a 3.5% policies in force increase
since March 31, 2001. The increase in the homeowners line resulted primarily
from a 16.8% rate increase in Michigan and an overall increase of 1.8% in
policies in force since March 31, 2001.
Personal lines' underwriting results improved $5.3 million, or 19.3%, to an
underwriting loss of $21.7 million for the first quarter of 2002. The
improvement in underwriting results is primarily attributable to the absence of
unfavorable development in 2002 and the aforementioned combined effect of
adverse weather and mild weather on 2001 and 2002, respectively. This is
partially offset by increased current year claims severity in the personal
automobile line in the first quarter of 2002. Underwriting results were also
unfavorably affected by approximately $7 million of increased policy acquisition
and other underwriting expenses, primarily related to increased cession expenses
for assigned risk personal automobile business in New York. This assigned
business is mandated as a condition to write premium in the state of New York.
The Company has an agreement to cede this business to a third party due to its
unsatisfactory underwriting results. Management expects the cost of this
agreement for 2002 to increase by approximately $10 million as compared to 2001.
In addition, catastrophe losses increased $3.3 million, to $9.5 million for the
first quarter of 2002, compared to $6.2 million for the same period in 2001.
Commercial Lines
Commercial lines' net premiums written decreased $36.7 million, or 15.8%, to
$194.9 million for the first quarter of 2002. This is primarily the result of
the Company's termination of 377 agencies and the withdrawal of commercial
lines' underwriting authority from an additional 314 agencies during the fourth
quarter of 2001. These agencies consistently produced unsatisfactory loss
ratios. In addition, the Company has seen a reduction in premium levels from
active agents as re-underwriting efforts continue. Management believes that
premium level reductions from active agents may continue to unfavorably affect
future premiums. Policies in force decreased 17.2%, 11.3% and 0.9% in the
workers' compensation, commercial automobile, and commercial multiple peril
lines, respectively, since March 31, 2001 primarily as a result of the
aforementioned agency actions. Partially offsetting these decreases in policies
in force were rate increases in all of the commercial lines since March 31,
2001. In addition, net premiums written in other commercial lines decreased $3.0
million, or 12.1%, as a result of the Company having terminated virtually all of
its specialty commercial programs during the fourth quarter of 2001.
19
Commercial line' underwriting results improved $21.2 million to an underwriting
loss of $1.6 million in the first quarter of 2002. The improvement in
underwriting results is primarily attributable to approximately $12 million of
net rate increases during the first quarter of 2002. In addition, a decrease in
current year claims severity in the commercial automobile and workers'
compensation lines of approximately $3 million and $2 million, respectively,
favorably affected results in 2002. Commercial lines' favorable development on
prior years' reserves increased $3.2 million to $4.3 million in the first
quarter of 2002 from $1.1 million for the same period in 2001. First quarter of
2002 underwriting results reflected approximately $4 million and $1.2 million of
decreased underwriting expenses and policyholder dividends, respectively,
compared to the same period in 2001. Partially offsetting these favorable items
is approximately $3 million of increased current year claims severity in the
commercial multiple peril line. In addition, catastrophe losses increased $1.1
million, to $1.7 million for the first quarter of 2002, compared to $0.6 million
for the same period in 2001.
Investment Results
Net investment income before tax declined $5.0 million, or 8.8%, to $51.8
million for the quarter ended March 31, 2002. The decrease in net investment
income primarily reflects the impact of high yield bonds that defaulted, a
reduction in average pre-tax yields on debt securities and the transfer of
assets to the Corporate segment and the Allmerica Financial Services segment.
Average pre-tax yields on debt securities decreased to 6.5% in 2002 compared to
7.1% in 2001 due to the shift from higher yielding below investment grade
securities to lower yielding, but higher quality investment grade securities.
Reserve for Losses and Loss Adjustment Expenses
The Risk Management segment maintains reserves for its property and casualty
products to provide for the Company's ultimate liability for losses and loss
adjustment expenses with respect to reported and unreported claims incurred as
of the end of each accounting period. These reserves are estimates, involving
actuarial projections at a given point in time, of what management expects the
ultimate settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claim severity and judicial theories of liability and other factors.
The inherent uncertainty of estimating insurance reserves is greater for certain
types of property and casualty insurance lines, particularly workers'
compensation and other liability lines, where a longer period of time may elapse
before a definitive determination of ultimate liability may be made, and where
the technological, judicial and political climates involving these types of
claims are changing.
The Company regularly updates its reserve estimates as new information becomes
available and further events occur which may impact the resolution of unsettled
claims. Changes in prior reserve estimates are reflected in results of
operations in the 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)
Three Months Ended
March 31,
----------------------------
(In millions) 2002 2001
- ---------------------------------------------------------------------------------------------------
Reserve for losses and LAE, beginning of period............... $ 2,921.5 $ 2,719.1
Incurred losses and LAE, net of reinsurance recoverable:
Provision for insured events of current year............. 425.5 416.0
(Decrease) increase in provision for insured events of
prior years............................................ (3.4) 19.4
------------ ------------
Total incurred losses and LAE.............................. 422.1 435.4
------------ ------------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events of current
year................................................... 134.4 119.7
Losses and LAE attributable to insured events of prior
years.................................................. 270.3 305.5
------------ ------------
Total payments............................................. 404.7 425.2
------------ ------------
Change in reinsurance recoverable on unpaid losses......... (9.0) (11.8)
------------ ------------
Reserve for losses and LAE, end of period..................... $ 2,929.9 $ 2,717.5
============ ============
As part of an ongoing process, the reserves have been re-estimated for all prior
accident years and were decreased by $3.4 million and increased by $19.4 million
for the quarters ended March 31, 2002 and 2001, respectively.
20
During the first quarter, estimated loss reserves for claims occurring in prior
years developed unfavorably by $3.4 million and $35.9 million in 2002 and 2001,
respectively. Favorable development on prior years' LAE reserves was $6.8
million and $16.5 million for the first quarters of 2002 and 2001, respectively.
The adverse loss reserve development in 2002 is primarily the result of
approximately $4 million of increased reserves related to a recent judicial
decision in Maine expanding eligibility for permanent impairment status related
to worker' compensation claims. In addition, adverse loss reserve development
in 2002 resulted from increased severity on homeowner' prior years' reserves.
These unfavorable items are partially offset by a decrease in commercial lines
non-catastrophe claims severity. The adverse loss reserve development in 2001
was primarily related to fourth quarter 2000 non-catastrophe weather related
claims in Michigan. These claims primarily affected the personal automobile and
homeowners lines. The adverse loss development in 2001 is also attributable to
an increase in commercial lines' loss costs in the 1999 and 2000 accident years.
The favorable LAE reserve development in both 2002 and 2001 is primarily
attributable to claims process improvement initiatives taken by the Company over
the past four 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 complete. The Company currently expects no
significant favorable or adverse loss or LAE reserve development for the
remainder of the year.
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.
Environmental Reserves
Although the Company does not specifically underwrite policies that include
environmental damage and toxic tort liability, the Company may be required to
defend such claims. Loss and LAE reserves for all direct business written by its
property and casualty companies related to environmental damage and toxic tort
liability, included in the reserve for losses and LAE, were $25.3 million and
$26.5 million, net of reinsurance of $12.9 million and $12.5 million for the
quarters ended March 31, 2002 and 2001, respectively. Loss and LAE reserves for
assumed reinsurance pool business with environmental damage and toxic tort
liability were $39.3 million and $10.0 million for the quarters ended March 31,
2002 and 2001, respectively. These reserves relate to pools in which the Company
has terminated its participation; however, the Company continues to be subject
to claims related to prior years in which it was a participant. Because of the
inherent uncertainty regarding the types of claims in these pools, there can be
no assurance that these reserves will be sufficient. The increase in assumed
reinsurance pool business environmental damage and toxic tort liability reserves
is primarily related to a $33.0 million fourth quarter of 2001 adjustment for a
voluntary excess and casualty reinsurance pool (Excess and Casualty Reinsurance
Association "ECRA").
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, notwithstanding the evolution of case law
expanding liability in environmental claims, recorded reserves related to these
claims are adequate. In addition, the Company is not aware of any litigation or
pending claims that may result in additional material liabilities in excess of
recorded reserves. The environmental liability could be revised in the near term
if the estimates used in determining the liability are revised.
21
Asset Accumulation
Allmerica Financial Services
The following table summarizes the results of operations for the Allmerica
Financial Services segment for the periods indicated.
(Unaudited)
Three Months Ended
March 31,
--------------------------
(In millions) 2002 2001
- --------------------------------------------------------------------------------------------
Segment revenues
Premiums.................................................. $ 24.5 $ 25.5
Fees................................................... 96.0 100.4
Net investment income.................................. 70.7 71.2
Other income........................................... 23.7 26.1
--------- ---------
Total segment revenues.................................... 214.9 223.2
Policy benefits, claims and losses........................ 107.2 93.7
Policy acquisition and other operating expenses........... 78.0 85.2
--------- ---------
Segment income............................................ $ 29.7 $ 44.3
========= =========
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Segment income decreased $14.6 million, or 33.0%, to $29.7 million during the
first quarter of 2002. This decrease primarily reflects increased policy
benefits, as well as lower asset-based fees and other income due to the decline
in the equity markets. These decreases were partially offset by lower deferred
acquisition costs. Policy benefits increased primarily as a result of higher
guaranteed minimum death benefits related to variable annuities.
Segment revenues decreased $8.3 million, or 3.7%, in the first quarter of 2002,
primarily due to lower asset-based fees and other income. Fee income decreased
$4.4 million, or 4.4%, to $96.0 million, primarily due to variable annuity and
group annuity fees which decreased $3.1 million and $2.6 million, respectively.
The decrease in variable annuity fees was primarily due to a decline in the
market value of average variable annuity assets under management, while the
decline in group annuity fees was primarily due to lower average invested assets
resulting from the Company's exit from the defined contribution group retirement
business. These decreases in fees were partially offset by a $2.1 million
increase in variable universal life fees principally due to higher insurance
fees and additional deposits. These increases in variable universal life fees
were partially offset by market depreciation which reduced account values
subject to such fees. Other income decreased $2.4 million, or 9.2%, to $23.7
million. This decline was primarily due to lower investment management fees
resulting from reduced average assets under management and to lower brokerage
income.
Policy benefits, claims and losses increased $13.5 million, or 14.4%, to $107.2
million in the first quarter of 2002, primarily due to increased guaranteed
minimum death benefits ("GMDB") related to variable annuities. In the event of
the death of the annuitant, the GMDB provides beneficiaries with a payment equal
to the greater of a prescribed death benefit or the current account value of the
annuity. This results in increased annuity policy benefits in periods of
declining financial markets and in periods of stable financial markets following
a decline. The Company provides for reserves for GMDB based on its best estimate
of the long-term cost of GMDB. In the first quarter of 2002, the GMDB expense
increased $11.0 million primarily due to the effect of the 2001 decline in the
financial markets. If market levels as of March 31, 2002 continue, management
expects GMDB expenses and segment income to be unfavorably affected during the
remainder of 2002. Additional declines in the financial markets would further
increase GMDB expenses. Policy benefits, claims and losses also increased due to
interest credited on general account assets.
Policy acquisition and other operating expenses decreased $7.2 million, or 8.5%,
to $78.0 million in the first quarter of 2002. Policy acquisition expenses
decreased $9.5 million, or 45.0%, to $11.6 million primarily due to lower
variable annuity profits. Since variable products' deferred policy acquisition
costs are amortized in proportion to gross profits, the lower annuity gross
profits in the first quarter of 2002 resulted in less amortization expenses.
However, if lower annuity gross profits persist, a partial writeoff of the
existing DAC asset may occur. This would increase policy acquisition expenses in
the period of the partial writeoff. Other operating expenses increased $2.3
million. This increase was primarily due to higher technology costs, partially
offset by lower operating expenses resulting from the exit of the defined
contribution group retirement business.
22
Statutory Premiums and Deposits
The following table sets forth statutory premiums and deposits by product for
the Allmerica Financial Services segment.
(Unaudited)
Three Months Ended
March 31,
-----------------------
(In millions) 2002 2001
- --------------------------------------------------------------------------
Insurance:
Traditional life......................... $ 22.3 $ 23.1
Universal life........................... 4.2 4.6
Variable universal life.................. 63.3 58.3
Individual health........................ - 0.1
Group variable universal life............ 25.3 38.4
--------- ---------
Total insurance....................... 115.1 124.5
--------- ---------
Annuities:
Separate account annuities............... 577.8 498.4
General account annuities................ 207.1 230.4
Retirement investment accounts........... 1.9 2.3
--------- ---------
Total individual annuities............ 786.8 731.1
Group annuities.......................... 24.4 94.9
--------- ---------
Total annuities....................... 811.2 826.0
--------- ---------
Total premiums and deposits.............. $ 926.3 $ 950.5
========= =========
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
For the three months ended March 31, 2002, total premiums and deposits decreased
$24.2 million, or 2.5%, to $926.3 million. These decreases are primarily due to
lower group annuity and general account deposits, partially offset by higher
separate account annuity deposits. Group annuity deposits decreased due to the
Company's exit from the defined contribution retirement plan business and
cessation of marketing activities for new defined benefit retirement business.
General account annuity deposits were higher in 2001 principally due to a
promotional annuity program offered for a limited period in 2001. Partially
offsetting these decreases were higher annuity deposits into the Company's
separate accounts, primarily due to a renewed emphasis by Scudder Investments
("Scudder") on marketing and sales of the Company's products. Group variable
universal life deposits also decreased in the quarter due to the cessation of
marketing activities for this product.
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 Scudder, Pioneer
Investment Management, Inc. and Delaware Management Company ("Delaware").
Partners, Select and Agency represented, respectively, approximately 41%, 36%,
and 23% of individual annuity deposits in the first quarter of 2002, and Scudder
represented 34% of all individual annuity deposits. During the first quarter of
2001, Partners, Select and Agency represented, respectively, approximately 36%,
38% and 26% of individual annuity deposits and Scudder represented 26% of all
individual annuity deposits. The increase in deposits within the Partners
channel resulted primarily from the aforementioned renewed emphasis on marketing
and sales with Scudder.
23
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica Asset
Management segment for the periods indicated.
(Unaudited)
Three Months Ended
March 31,
--------------------------
(In millions) 2002 2001
- -------------------------------------------------------------------------------------
Interest margins on GICs:
Net investment income.............................. $ 26.5 $ 36.9
Interest credited.................................. 23.6 32.0
--------- ---------
Net interest margin................................... 2.9 4.9
--------- ---------
Fees and other income:
External........................................... 4.6 1.7
Internal........................................... 1.3 1.4
Other operating expenses.............................. (3.7) (2.0)
--------- ---------
Segment income........................................ $ 5.1 $ 6.0
========= =========
Average GIC deposits outstanding...................... $ 2,470.7 $ 2,253.9
========= =========
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Segment income decreased $0.9 million, or 15.0%, to $5.1 million during the
first quarter of 2002 primarily due to decreased earnings on GICs, partially
offset by increased earnings related to external clients. Earnings on GICs
decreased $2.0 million primarily due to the continued shift from short-term
funding agreements to lower margin long-term funding agreements and to lower net
investment income. Net investment income declined primarily due to the shift
from higher yielding below investment grade securities to lower yielding, but
higher quality investment grade securities during 2001, and to the effect of
defaults on certain bonds supporting GIC obligations. These declines were
partially offset by increased earnings from higher average GIC deposits during
the quarter. An increase in earnings from external clients resulted from new
external assets under management.
At December 31, 2001, the Company held $761.8 million of short-term funding
agreements with put features which allow the policyholder to cancel the
contract prior to maturity. During the first quarter of 2002, payments related
to short-term funding agreement withdrawals were approximately $282 million.
Also, during the first quarter of 2002, the Company was notified of
approximately $187 million of additional withdrawals. Payments related to these
withdrawal notifications are expected in the second quarter of 2002. Management
expects income from the GIC product line to be unfavorably affected in future
periods due to short-term funding agreement withdrawals and the continued shift
to lower margin long-term funding agreements.
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
(Unaudited)
Three Months Ended
March 31,
---------------------------
(In millions) 2002 2001
- ---------------------------------------------------------------------------------------
Segment revenues
Net investment income.............................. $ 1.7 $ 1.0
Interest expense................................... 3.8 3.8
Other operating expenses........................... 14.3 13.4
---------- ----------
Segment loss ........................................ $ (16.4) $ (16.2)
========== ==========
24
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
The segment loss increased $0.2 million, or 1.2%, to $16.4 million in the first
quarter of 2002, primarily as a result of the timing of certain corporate
overhead costs and increased employee related costs. These increases were
partially offset by higher net investment income and state tax credits
recognized by the holding company.
Interest expense for both periods relates principally 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)
March 31, 2002 December 31, 2001
-------------------------------- --------------------------------
Carrying % of Total Carrying % of Total
(In millions) Value Carrying Value Value Carrying Value
- -------------------------------------------------------------------------------------------------------------------------------
Fixed maturities (1)............................ $ 9,055.2 88.1% $ 9,401.7 88.1%
Equity securities (1)........................... 60.0 0.6 62.1 0.6
Mortgages....................................... 319.4 3.1 321.6 3.0
Policy loans.................................... 375.4 3.6 379.6 3.5
Cash and cash equivalents....................... 306.3 3.0 350.2 3.3
Other long-term investments..................... 167.2 1.6 161.2 1.5
-------------------------------- --------------------------------
Total...................................... $ 10,283.5 100.0% $ 10,676.4 100.0%
================================ ================================
- ---------------------------------------------------------------------------------------------------------------------------
(1) The Company carries fixed maturities and equity securities in its investment portfolio at market value.
Total investment assets decreased $392.9 million, or 3.7%, to $10.3 billion
during the first quarter of 2002. This decrease consisted primarily of
reductions in fixed maturities of $346.5 million, principally due to short-term
funding agreement withdrawals in the Allmerica Asset Management segment.
The Company's fixed maturity portfolio is comprised primarily of 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 90.8% and 90.7% of the Company's total fixed maturity portfolio at
March 31, 2002 and December 31, 2001, 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. The average yield on fixed maturities was 6.9%
and 7.7% for the three months ended March 31, 2002 and 2001, respectively. This
decline reflects the shift from higher yielding below investment grade
securities to lower yielding, but higher quality investment grade securities, as
well as lower prevailing fixed maturity investment rates since the first quarter
of 2001. Due to the current interest rate environment, management expects its
investment yield to be negatively affected by lower prevailing fixed maturity
investment rates in 2002.
Principally as a result of the Company's exposure to below investment grade
securities, the Company recognized $22.4 million and $14.6 million of realized
losses on other-than-temporary impairments of fixed maturities during the first
quarter of 2002 and 2001, 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.
The Company had fixed maturity securities with a carrying value of $28.5 million
and $9.8 million on non-accrual status at March 31, 2002 and December 31, 2001,
respectively. The effect of holding securities for which income is not accrued,
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
$4.0 million and $1.2 million for the quarters ended March 31, 2002 and 2001,
respectively. This includes the impact of securities held as of the
aforementioned financial statement dates, as well as securities sold during
those periods. Management expects that defaults in the fixed maturities
portfolio may continue to negatively impact investment income.
25
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.
The provision for federal income taxes before minority interest and the
cumulative effect of a change in accounting principle was $9.5 million during
the first quarter of 2002 compared to $6.4 million during the same period in
2001. These provisions resulted in consolidated effective federal tax rates of
14.6% and 17.4% for the quarters ended March 31, 2002 and 2001, respectively.
The decrease in the tax rate is primarily due to lower expected underwriting
income in 2002, partially offset by lower tax-exempt investment income in 2002.
Critical Accounting Policies
The discussion and analysis of the Company's financial condition and results of
operations are based upon the consolidated financial statements. These
statements have been prepared in accordance with generally accepted accounting
principles which require management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The following critical accounting
policies, among others, are those which management believes affect the more
significant judgments and estimates used in the preparation of the Company's
financial statements. Additional information about the Company's significant
accounting policies may be found in Note 1, "Summary of Significant Accounting
Policies" to the consolidated financial statements contained in the Company's
Annual Report on Form 10-K for the period ended December 31, 2001.
Property & Casualty Insurance Loss Reserves
The amount of loss and loss adjustment expense reserves (the "loss reserves") is
determined based on an estimation process that is very complex and uses
information obtained from both company specific and industry data, as well as
general economic information. The estimation process is highly judgmental, and
requires the Company to continuously monitor and evaluate the life cycle of
claims on type-of-business and nature-of-claim bases. Using data obtained from
this monitoring and assumptions about emerging trends, the Company develops
information about the size of ultimate claims based on its historical experience
and other available market information. The most significant assumptions, which
vary by line of business, used in the estimation process include determining the
trend in loss costs, the expected consistency in the frequency and severity of
claims incurred but not yet reported to prior year claims, changes in the timing
of the reporting of losses from the loss date to the notification date, and
expected costs to settle unpaid claims. Because the amount of the loss reserves
is sensitive to the Company's assumptions, the Company does not completely rely
on only one estimate to determine its loss reserves. Rather, the Company
develops several estimates using generally recognized actuarial projection
methodologies that result in a range of reasonably possible loss reserve
outcomes; the Company's best estimate is within that range. When trends emerge
that the Company believes affect the future settlement of claims, the Company
would react accordingly by adjusting its reserves. Reserve adjustments are
reflected in the Consolidated Statements of Income as adjustments to losses and
loss adjustment expenses. Often, these adjustments are recognized in periods
subsequent to the period in which the underlying loss event occurred. These
types of subsequent adjustments are disclosed and discussed separately as "prior
year reserve development". Such development can be either favorable or
unfavorable to the financial results of the Company.
Property & Casualty Reinsurance Recoverables
The Company shares a significant amount of insurance risk of the primary
underlying contracts with various insurance entities through the use of
reinsurance contracts. As a result, when the Company experiences loss events
that are subject to the reinsurance contract, reinsurance recoverables are
recorded. The amount of the reinsurance recoverable can vary based on the size
of the individual loss or the aggregate amount of all losses in a particular
line, book of business or an aggregate amount associated with a particular
accident year. The valuation of losses recoverable depends on whether the
underlying loss is a reported loss, or an incurred but not reported loss. For
reported losses, the Company values reinsurance recoverable at the time the
underlying loss is recognized, in accordance with contract terms. For incurred
but not reported losses, the Company estimates the amount of reinsurance
recoverable based on the terms of the reinsurance contracts and historical
reinsurance recovery information and applies that information to the gross loss
reserve estimates. The most significant assumption the Company uses is the
average size of the individual losses for those claims that have occurred but
have not yet been recorded by the Company. The reinsurance recoverable is based
on reasonable estimates and is disclosed separately on the financial statements.
However, the ultimate amount of the reinsurance recoverable is not known until
all losses are settled.
26
Variable Products' Deferred Policy Acquisition Costs
Deferred policy acquisition costs consist of commissions, underwriting costs and
other costs, which vary with, and are primarily related to, the production of
insurance deposits. Acquisition costs related to the Company's variable products
(variable universal life and variable annuities) are recorded on the balance
sheet and amortized through the income statement in proportion to total
estimated gross profits over the expected life of the contracts. The Company's
estimated gross profits are based on assumptions including mortality,
persistency, asset growth rates and expenses associated with policy maintenance.
The principal source of earnings for these policies are from asset based fees,
which can vary in relation to changes in the equity markets.
At each balance sheet date, the Company evaluates the historical and expected
future gross profits. Any adjustment in estimated profit requires that the
amortization rate be revised retroactively to the date of policy/annuity
issuance. The cumulative difference related to prior periods is recognized as a
component of the current periods' amortization, along with amortization
associated with the actual gross profits of the period. Lower actual gross
profits would typically result in less amortization expense. The converse would
also be true. However, if lower gross profits were to continue into the future,
a partial write-off of the existing deferred acquistion costs ("DAC") asset may
occur.
The Company periodically reviews the DAC asset to determine if it is recoverable
from future income. If DAC is determined to be unrecoverable, such costs are
expensed at the time of determination. The amount of DAC considered realizable
would be reduced in the near term if the estimate of ultimate or future gross
profits is reduced. The amount of DAC amortization would be revised if any of
the estimates discussed above are revised.
Other-Than-Temporary Impairments
The Company employs a systematic methodology to evaluate declines in market
values below cost or amortized cost for its investments. This methodology
ensures that available evidence concerning the declines is evaluated in a
disciplined manner. In determining whether a decline in market value below
amortized cost is other-than-temporary, the Company evaluates the length of time
and the extent to which the market value has been less than amortized cost; the
financial condition and near-term prospects of the issuer; the issuer's
financial performance, including earnings trends, dividend payments, and asset
quality; any specific events which may influence the operations of the issuer;
general market conditions; and, the financial condition and prospects of the
issuer's market and industry. The Company applies judgment in assessing whether
the aforementioned factors have caused an investment to decline in value to be
other-than-temporary. When an other-than-temporary decline in value is deemed to
have occurred, the Company reduces the cost basis of the investment to the new
estimated realizable value. This reduction is permanent and is recognized as a
realized investment loss.
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 quarter of 2002, AFC did not receive any dividend payments from its
insurance subsidiaries.
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 $68.8 million and $102.4 million
during the first quarters of 2002 and 2001, respectively. Net cash was higher in
2001 compared to 2002 primarily as a result of a promotional annuity program
with enhanced crediting rates in 2001 as well as an increase in federal income
tax payments. These were partially offset by lower loss and LAE payments in 2002
in the property and casualty business.
27
Net cash provided by investing activities was $213.6 million for the first
quarter of 2002, compared to net cash used in investing activities of $106.3
million for the same period of 2001. The $319.9 million increase in cash
provided is primarily the result of net sales of fixed maturities in 2002 due to
funding agreement withdrawals. In 2001, net purchases of fixed maturities
resulted from the investment of net deposits from funding agreements.
Net cash used in financing activities was $326.3 million during the first
quarter of 2002, while net cash provided by financing activities was $546.2
million during the same period of 2001. The decrease in 2002 is primarily due to
net funding agreement withdrawals, including trust instruments supported by
funding obligations, of $375.3 million as compared to net deposits of $535.8
million in 2001.
In the opinion of management, AFC has sufficient funds at the holding company or
available through dividends from FAFLIC and Hanover, or through available credit
facilities to meet its obligations to pay interest on the Senior Debentures,
Capital Securities and dividends, when and if declared by the Board of
Directors, on the common stock. Whether the Company will pay dividends in the
future depends upon the costs of administration as compared to the benefits
conferred, and upon the earnings and financial condition of AFC.
Based on current trends, the Company expects to continue to generate sufficient
positive operating cash to meet all short-term and long-term cash requirements.
The Company maintains a high degree of liquidity within the investment portfolio
in fixed maturity investments, common stock and short-term investments. AFC has
$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 March 31, 2002, no
amounts were outstanding under this agreement. The Company had $132.3 million of
commercial paper borrowings outstanding at March 31, 2002. These borrowings are
used in connection with the Company's premium financing business, which is
included in the Allmerica Asset Management segment and for short-term funding
requirements in the Allmerica Financial Services segment. The Company intends to
fund its premium financing business through sales of receivables in 2002.
Contingencies
The Company's insurance subsidiaries are routinely engaged in various legal
proceedings arising in the normal course of business, including claims for
extracontractual or punitive damages. Additional information on other litigation
and claims may be found in Note 10 "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 could be materially affected
by an unfavorable outcome.
Recent Development
During April 2002, Fitch rating service revised downward its financial strength
rating of the life insurance companies from "AA" (Very Strong) to "AA-" (Very
Strong). In addition, Fitch downgraded its senior debt rating for the Company
from "A+" (Strong) to "A-" (Strong), its rating of the Company's Capital
Securities from "A" (Strong) to "BBB+" (Good) and its short-term debt ratings
from "F1" (Strong) to "F2" (Satisfactory).
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 2002
and beyond to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company. When used in Management's
Discussion and Analysis, 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,
2001.
28
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, requirements to write certain classes of business and
recent and future changes affecting the 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, broker-dealers 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 costs, particularly those occurring after the time
our products are priced and including construction, automobile, and medical and
rehabilitation costs; (xi) changes in the Company's liquidity due to changes in
asset and liability matching; (xii) restrictions on insurance underwriting;
(xiii) adverse changes in the ratings obtained from independent rating agencies,
such as Fitch, 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 variable product, management and brokerage fees, lapses and
increased surrenders, as well as increased cost of guaranteed minimum death
benefits/decreased account balances supporting our guaranteed benefits products;
(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 or adverse effects on the cost and availability of
reinsurance resulting from the September 11 terrorist attack; (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) losses due to foreign
currency fluctuations; (xxi) defaults in debt securities held by the Company,
and (xxii) higher employee benefit costs due to changes in market values of plan
assets, interest rates and employee compensation levels.
29
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, 2001, included in the Company's Form 10-K for the year ended
December 31, 2001. There have been no material changes in the first three months
of 2002 to such risks or our management of such risks.
30
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
None
(b) Reports on Form 8K
On February 15, 2002, Allmerica Financial Corporation adjusted
its previously disclosed Shareholders' Equity balance and book value per share
as of December 31, 2001 due to final valuation work associated with Statement of
Financial Accounting Standards No. 87 "Employers' Accounting for Pensions."
31
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 May 14, 2002
/s/ John F. O'Brien
-----------------------------------
John F. O'Brien
President and Chief Executive Officer
Dated May 14, 2002
/s/ Edward J. Parry III
------------------------------------
Edward J. Parry III
Vice President, Chief Financial Officer
and Principal Accounting Officer
32