EXHIBIT 99-2
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected the Company's results and in the
future could cause actual results and needs of the Company to vary materially
from past results and needs and from forward-looking statements made from time
to time by the Company on the basis of management's then-current expectations.
The businesses in which the Company is engaged are in rapidly changing and
competitive markets and involve a high degree of risk. Accuracy with respect to
forward looking projections is difficult.
Risks Relating to Our Property and Casualty Insurance Business
Our results may fluctuate as a result of cyclical changes in the property and
casualty insurance industry.
We generate a significant portion of our total revenues through our
property and casualty insurance subsidiaries. The results of companies in the
property and casualty insurance industry historically have been subject to
significant fluctuations and uncertainties. Our profitability could be affected
significantly by:
o increases in costs, particularly those occurring after the time our
insurance products are priced and including construction, automobile,
and medical and rehabilitation costs;
o competitive and regulatory pressures which may affect the prices of
our products and the nature of the risks covered;
o volatile and unpredictable developments, including severe weather,
catastrophes and terrorist actions;
o legal, regulatory and socio-economic developments, such as new
theories of insured and insurer liability and related claims,
increases in the size of jury awards, and increases in construction,
automobile repair and medical and rehabilitation costs;
o fluctuations in interest rates, inflationary pressures, default rates
and other factors that affect investment returns; and
o other general economic conditions and trends that may affect the
adequacy of reserves.
The demand for property and casualty insurance can also vary significantly
based on general economic conditions, rising as the overall level of economic
activity increases and falling as such activity decreases. The fluctuations in
demand and competition could produce underwriting results that would have a
negative impact on our results of operations and financial condition.
Actual losses from claims against our property and casualty insurance
subsidiaries may exceed their reserves for claims.
Our property and casualty insurance subsidiaries maintain reserves to cover
their estimated ultimate liability for losses and loss adjustment expenses with
respect to reported and unreported claims incurred as of the end of each
accounting period. Reserves do not represent an exact calculation of liability.
Rather, reserves represent estimates, involving actuarial projections at a given
time, of what we expect 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 claims frequency and severity and judicial
theories of liability, costs of repair and replacement, legislative activity and
other factors.
1
The inherent uncertainties of estimating reserves are greater for certain
types of property and casualty insurance lines. These include workers'
compensation, where a longer period of time may elapse before a definitive
determination of ultimate liability may be made, and environmental liability,
where the technological, judicial and political climates involving these types
of claims are changing.
We regularly review our reserving techniques, reinsurance and the overall
adequacy of our reserves based upon:
o our review of historical data, legislative enactments, judicial
decisions, legal developments in imposition of damages, changes in
political attitudes and trends in general economic conditions;
o our review of per claim information;
o historical loss experience of our property and casualty insurance
subsidiaries and the industry as a whole; and
o the form of our property and casualty insurance policies.
Because setting reserves is inherently uncertain, we cannot provide
assurance that the existing reserves or future reserves established by our
property and casualty insurance subsidiaries will prove adequate in light of
subsequent events. Our results of operations and financial condition could
therefore be materially affected by adverse loss development for events that we
insure.
Due to our geographical concentration in our property and casualty business,
changes in the economic, regulatory and other conditions in the regions where we
operate could have a significant negative impact on our business as a whole.
We generate a significant portion of our property and casualty insurance
net premiums written and earnings in Michigan, Massachusetts and other states in
the Northeast, including New York, New Jersey, Maine, Connecticut, New
Hampshire, Rhode Island and Vermont. For the nine months ended September 30,
2003, approximately 37% and 17% of our net written premium in our property and
casualty business was generated in the states of Michigan and Massachusetts,
respectively. Massachusetts and New Jersey in particular, with respect to
private passenger automobile insurance, are highly regulated, impose significant
rate control and residual market charges, and restrict a carrier's ability to
exit such markets. The revenues and profitability of our property and casualty
insurance subsidiaries are subject to prevailing economic, regulatory,
demographic and other conditions, including adverse weather, in Michigan and the
Northeast. Because of our strong regional focus, our business as a whole could
be significantly affected by changes in the economic, regulatory and other
conditions in the regions where we transact business.
Catastrophe losses could materially reduce our profitability or cash flow.
Our property and casualty insurance subsidiaries are subject to claims
arising out of catastrophes that may have a significant impact on their results
of operations and financial condition. We may experience catastrophe losses
which could have a material adverse impact on our business. Catastrophes can be
caused by various events including hurricanes, earthquakes, tornadoes, wind,
hail, fires, severe winter weather, sabotage, terrorist actions and explosion.
The frequency and severity of catastrophes are inherently unpredictable.
The extent of gross losses from a catastrophe is a function of two factors:
the total amount of insured exposure in the area affected by the event and the
severity of the event. The extent of net losses depends on the amount and
collectibility of reinsurance.
Although catastrophes can cause losses in a variety of property and
casualty lines, homeowners and commercial multiple peril insurance have, in the
past, generated the vast majority of our catastrophe-related claims. Our
catastrophe losses have historically been principally weather related,
particularly snow and ice damage from winter storms.
2
We purchase catastrophe reinsurance as protection against catastrophe
losses. Based upon our review of our reinsurers' financial statements and
reputations in the reinsurance marketplace, we believe that the financial
condition of our reinsurers is sound. However, reinsurance is subject to credit
risks, including those resulting from over-concentration within the industry.
The availability, scope of coverage and cost of reinsurance could be adversely
affected by the losses incurred from the September 11, 2001 terrorist attacks
and the perceived risks associated with possible future terrorist activities. We
cannot currently estimate the impact of these events on us. We also cannot
provide assurance that our current reinsurance will be adequate to protect us
against future catastrophe losses or that reinsurance will continue to be
available to us at commercially reasonable rates or with coverage provisions
reflective of the risks underwritten in our primary policies.
We may incur financial losses resulting from our participation in shared market
mechanisms and mandatory and voluntary pooling arrangements.
As a condition to conducting business in several states, our property and
casualty insurance subsidiaries are required to participate in mandatory
property and casualty shared market mechanisms or pooling arrangements. These
arrangements are designed to provide various insurance coverages to individuals
or other entities that otherwise are unable to purchase such coverage. We cannot
predict whether our participation in these shared market mechanisms or pooling
arrangements will provide underwriting profits or losses to us. For the nine
months ended September 30, 2003 and 2002, we incurred an underwriting loss from
participation in these mechanisms and pooling arrangements of $24.2 million and
$21.1 million, respectively. We may face similar losses in the future.
In addition, we may be adversely affected by liabilities resulting from our
previous participation in certain voluntary assumed reinsurance pools, including
accident and health reinsurance pools and certain property and casualty
reinsurance pools. We discontinued our participation in the accident and health
reinsurance pools in 1998, but remain subject to claims from periods in which we
participated as well as for certain continuing obligations in a limited number
of accident and health pools that we were prohibited from exiting in full. We
have terminated participation in virtually all property and casualty voluntary
pool business, but also remain subject to claims related to periods in which we
participated. The accident and health and property and casualty assumed
reinsurance businesses have suffered substantial losses during the past several
years, particularly related to environmental and asbestos exposure for property
and casualty coverages. Due to the inherent volatility in these businesses,
possible issues related to the enforceability of reinsurance treaties in the
industry and to the recent history of increased losses, we cannot provide
assurance that our current reserves are adequate or that we will not incur
losses in the future. Although we have discontinued participation in these
reinsurance pools as described above, we are subject to claims related to prior
years or from pools we could not exit in full. Our operating results and
financial position may be harmed from liabilities resulting from any such
claims.
Our profitability could be adversely affected by periodic changes to our
relationships with our agencies.
Our Property and Casualty segment reviews our agencies from time to time to
identify those that do not meet our profitability standards or are not
strategically aligned with our business. Following these periodic reviews, we
may restrict such agencies' access to certain types of policies or terminate our
relationship with them, subject to applicable contractual and regulatory
requirements to renew certain policies for a limited time. For example, in 2001
we identified approximately 700 agencies with whom we either limited or
terminated our relationship. We have realized a decline in our annual written
premium in the first nine months of 2003 as a result of these actions and
anticipate that our written premiums will continue to decline, although at a
lower rate, in future periods. We expect our overall profitability to improve
over time as a result of expected lower losses incurred, however, we cannot be
sure that we will achieve the desired results from these measures, and our
failure to do so could negatively affect our operating results and financial
position.
3
Risks Relating to Our Allmerica Financial Services and Asset Management
Businesses
Interest rate fluctuations could negatively affect our profitability.
Some of our products, including guaranteed investment contracts, funding
agreements, the general account options in our variable products, traditional
whole and universal life insurance and fixed annuities expose us to the risk
that changes in interest rates will reduce our "spread", or the difference
between the amounts that we are required to pay under the contracts and the rate
of return we are able to earn on our general account investments intended to
support our obligations under the contracts. Declines in our spread from these
products or other spread businesses we conduct could have a material adverse
effect on our business or results of operations.
In periods of increasing interest rates, we may not be able to replace the
assets in our general account investment portfolios with higher yielding assets
needed to fund the higher crediting rates necessary to keep our interest
sensitive products profitable. We therefore may have to accept a lower spread
and thus lower profitability or face greater loss of existing contracts and
related assets. In periods of declining interest rates, we may have to reinvest
the cash we receive as interest or return of principal on our investments in
lower yielding instruments then available. Moreover, borrowers may prepay
fixed-income securities, commercial mortgages and mortgage-backed securities in
our general account in order to borrow at lower market rates, which increases
this risk. Because we are entitled to reset the interest rates on our general
account supported life insurance and annuity products and guaranteed investment
contracts only at limited, pre-established intervals, and since many of our
policies have guaranteed minimum interest or crediting rates, our spreads could
decrease and potentially become negative.
A decline in market interest rates available on investments could also
reduce our return from investments of capital that do not support particular
policy obligations, which could have a material adverse effect on our results of
operations.
Increases in interest rates may cause increased surrenders and withdrawal of
insurance products.
In periods of increasing interest rates, policy loans and surrenders and
withdrawals of life insurance policies and annuity contracts may increase as
policyholders seek to buy products with perceived higher returns. This process
may lead to a flow of cash out of our businesses. These outflows may require
investment assets to be sold at a time when prices for those assets are lower
because of the increase in market interest rates, which may result in realized
investment losses. The value of fixed income investments, in particular, tends
to fluctuate in an inverse relationship to interest rates. A sudden demand among
consumers to change product types or withdraw funds could lead us to sell assets
at a loss to meet the demand for funds. In addition, unanticipated withdrawals
and terminations, as well as adverse selection on the basis of age, may require
us to accelerate the amortization of deferred policy acquisition costs. This
would increase our current expenses.
A decline or increase in volatility in the securities markets may negatively
affect our business.
Our investment-based and asset management products and services expose us
to the risk that surrenders in variable life and annuity products and withdrawal
of assets from other investment products will increase if, as a result of a
continued market downturn, increased market volatility or other market
conditions, customers become dissatisfied with their investments. A declining
market also leads to lower account balances as a result of decreases in market
value of assets under management. In many cases, our fees in these businesses
are based on a percentage of the assets we manage and, if account values
decline, our fee revenue declines.
These factors may lead to a flow of cash out of our businesses. These
outflows may require investment assets to be sold at a time when prices for
those assets are lower, which may result in realized investment losses. A sudden
demand among consumers to change product types or withdraw funds could lead us
to sell assets at a loss to meet the demand for funds. In addition,
unanticipated withdrawals and terminations, as well as adverse selection on the
basis of age, or guaranteed minimum death benefit exposure may require us to
accelerate the amortization of deferred policy acquisition costs. This would
increase our current expenses.
4
In addition, the lower account balances that result from a declining
securities market particularly affect our variable annuity products that offer
guaranteed minimum death benefits, or GMDB. Under certain market conditions,
including those we currently face, the assets in an annuitant's account may be
insufficient to satisfy our GMDB obligations at the time of an annuitant's
death. In this case, we must satisfy the difference from other cash sources. In
the event that a significant number of deaths of such annuitants occur at a time
that account balances are decreased as a result of a market downturn which
resulted in claims in excess of our GMDB reserve, our liquidity, level of
statutory capital and earnings would be significantly and adversely affected. At
September 30, 2003, our GMDB reserve under GAAP (Generally Accepted Accounting
Principles) was $32.0 million. We cannot provide assurance that this reserve
will prove adequate in light of subsequent events.
Actual losses from claims against our life insurance subsidiaries may exceed
their reserves for claims.
For our life insurance and annuity products, we calculate reserves based on
assumptions and estimates such as estimated premiums we will receive over the
assumed life of each policy, the timing of the event covered by the insurance
policy, the expected life of the insured or annuitant, the anticipated market
performance of underlying investments, the amount of benefits or claims to be
paid and the investment returns on the assets we purchase with the premiums we
receive. We establish reserves based on assumptions and estimates of mortality
and morbidity rates, policy and claim termination rates, benefit amounts,
investment returns and other factors. Because setting reserves is inherently
uncertain, we cannot provide assurance that our existing reserves or future
reserves to support our obligations under our life and insurance annuity
products will prove adequate in light of subsequent events. Our results of
operations and financial condition could therefore be materially affected by
adverse loss development for events that we insure.
We could be adversely affected by litigation regarding insurers' and
broker/dealers' sales practices or changes in regulations or the regulatory
environment.
A number of civil jury verdicts have been returned against life and health
insurers and broker/dealer distributors in the jurisdictions in which we do
business. These cases involved the insurers' or distributors' sales practices or
disclosures, alleged agent misconduct, failure to properly supervise agents, and
other matters. Some of the lawsuits have resulted in the award of substantial
judgments against the insurer or distributor, including material amounts of
punitive damages. In some states, juries are given substantial discretion in
awarding punitive damages in these circumstances. We, from time to time, are
subject to litigation of this type.
The insurance, broker/dealer, investment management (particularly mutual
funds and variable product separate accounts) and investment advisory industries
are heavily regulated by federal and state laws. The success of our business
could be affected by changes in such laws or regulations or the interpretation
of such laws and regulations and the corresponding civil litigation environment.
We could be adversely affected by the decision to cease retail sales through our
broker/dealer, VeraVest Investments, Inc. ("VeraVest").
The registered representatives appointed by VeraVest are primarily
comprised of advisors who made up our former Agency channel. The activities of
these advisors after termination of these appointments could affect persistency
of the products previously sold by them, as well as additional payments or
deposits made with respect to such products. It is difficult to predict the
impact that this action, including any potential related litigation, will have
on our future financial results.
5
Risk Relating to Our Business Generally
Other market fluctuations and general economic, market and political conditions
may also negatively affect our business and profitability.
At September 30, 2003, we held approximately $8.6 billion of investment
assets in categories such as fixed maturities, equity securities, mortgage loans
and other long-term investments. Our investment returns, and thus our
profitability, may be adversely affected from time to time by conditions
affecting our specific investments and, more generally, by bond, stock, real
estate and other market fluctuations and general economic, market and political
conditions. Our ability to make a profit on insurance products, fixed annuities
and guaranteed investment products depends in part on the returns on investments
supporting our obligations under these products and the value of specific
investments may fluctuate substantially depending on the foregoing conditions.
We use a variety of strategies to hedge our exposure to interest rate and other
market risk. However, hedging strategies are not always available and carry
certain credit risks, and our hedging could be ineffective.
The current uncertainties in the U.S. and international economic and
investment climates have adversely affected our businesses and profitability in
2003, and can be expected to continue to do so, unless conditions improve. These
general uncertainties contributed to ratings downgrades in our business, which
led us, in 2002, to cease new sales of our life insurance and annuity products.
In 2003, we have discontinued the retail operations of our broker/dealer,
VeraVest.
Market conditions also affect the value of assets under our employee
pension plans. The expense or benefit related to our employee pension plans
results from several factors, including changes in the market value of plan
assets, interest rates and employee compensation levels. For the first nine
months of 2003, we recognized net expenses of $35.9 million related to our
employee pension plans. We expect an additional $10.2 million of expenses in the
fourth quarter of 2003. Declines in the market value of plan assets and interest
rates from levels at December 31, 2002 could negatively affect our results of
operations. Additionally, in 2003, we contributed $23 million to our qualified
pension plan. We may have to contribute additional funds to our benefit plans in
future periods due to the inherent uncertainty surrounding the financial markets
and their effect on plan assets.In addition, debt securities comprise a material
portion of our investment portfolio. The issuers of those securities, as well as
borrowers under the loans we make, customers, trading counterparties,
counterparties under swaps and other derivative contracts and reinsurers, may be
affected by the declining market. These parties may default on their obligations
to us due to bankruptcy, lack of liquidity, downturns in the economy or real
estate values, operational failure or other reasons. The current uncertain trend
in the U.S. and other economies has resulted in increased levels of investment
impairments, as indicated by the $238.5 million of impairment charges we took in
2002 and the $52.9 million of impairment charges we took in the first nine
months of 2003. We cannot assure you that further impairment charges will not be
necessary in the future. Our ability to fulfill our debt and other obligations
could be adversely affected by the default of third parties on their obligations
owed to us.
We are a holding company and rely on our insurance company subsidiaries for cash
flow; we may not be able to receive dividends from our subsidiaries in needed
amounts.
We are a holding company for a diversified group of insurance and financial
services companies and our principal assets are the shares of capital stock of
our subsidiaries. Our ability to make required debt service payments as well as
our ability to pay operating expenses and pay dividends to shareholders, depends
upon the receipt of sufficient funds from our subsidiaries.
6
The payment of dividends by our insurance company subsidiaries is subject
to regulatory restrictions and will depend on the surplus and future earnings of
these subsidiaries, as well as the regulatory restrictions. For example, during
2002, we received $92.1 million of dividends from our property and casualty
businesses. Additional dividends from our property and casualty insurance
subsidiaries prior to July 2003 would be considered "extraordinary" and would
require approval from state regulators. In addition, neither AFLIAC nor FAFLIC
can pay dividends except with the permission of the Massachusetts Insurance
Commissioner. AFC's need for funds may be affected by its commitment with the
Commonwealth of Massachusetts Insurance Commissioner to maintain a minimum
risk-based capital ratio for AFLIAC of 100% of the Company Action Level,
indefinitely. We have not received dividends from our life insurance
subsidiaries.
Because of the regulatory limitations on the payment of dividends from our
insurance company subsidiaries, we may not always be able to receive dividends
from these subsidiaries at times and in amounts necessary to meet our debt and
other obligations. The inability of our subsidiaries to pay dividends to us in
an amount sufficient to meet our debt service and funding obligations would have
a material adverse effect on us. These regulatory dividend restrictions also
impede our ability to transfer cash and other capital resources among our
subsidiaries.
Our dependence on our insurance subsidiaries for cash flow exposes us to
the risk of changes in their ability to generate sufficient cash inflows from
new or existing customers or from increased cash outflows. Cash outflows may
result from claims activity, surrenders, lapses or investment losses. Reductions
in cash flow from our subsidiaries would have a material adverse effect on our
business and results of operations.
Fluctuations in currency exchange rates may adversely affect our financial
condition.
We have investments in securities denominated in foreign currencies. As of
September 30, 2003, our investments in foreign currency denominated securities
amounted to approximately $23.3 million, based on the exchange ratio prevailing
on that date between the U.S. dollar and the relevant foreign currency. We also
hold trust obligations backed by funding obligations denominated in foreign
currencies. As a result, we are exposed to changes in exchange rates between the
U.S. dollar and various foreign currencies, including the Swiss Franc, Japanese
Yen, British Pound and the Euro. To the extent these exchange rates fluctuate in
the future, our financial condition could be adversely affected.
We enter into foreign exchange swap, futures or options contracts, as well
as compound foreign currency or interest rate swap contracts from time to time
to mitigate risks from foreign currency fluctuations. However, we cannot provide
assurance that these measures will be adequate, or that these risks will not
adversely affect our business. Furthermore, swap contracts and similar
transactions also expose us to credit risk with the counter-party to the
transaction.
Our businesses are heavily regulated and changes in regulation may reduce our
profitability.
Our insurance businesses are subject to supervision and regulation by the
state insurance authority in each state in which we transact business. This
system of supervision and regulation relates to numerous aspects of an insurance
company's business and financial condition, including limitations on the
authorization of lines of business, underwriting limitations, the ability to
terminate agents, supervisory and liability responsibilities for agents and
registered representatives, the setting of premium rates, the requirement to
write certain classes of business which we might otherwise avoid or charge
different premium rates, restrictions on the ability to withdraw from certain
lines of business, the establishment of standards of solvency, the licensing of
insurers and agents, concentration of investments, levels of reserves, the
payment of dividends, transactions with affiliates, changes of control and the
approval of policy forms. Most insurance regulations are designed to protect the
interests of policyholders rather than stockholders and other investors.
7
State regulatory oversight and various proposals at the federal level may
in the future adversely affect our ability to sustain adequate returns in
certain lines of business or in some cases, such as Massachusetts private
passenger automobile business, operate the line profitably. In recent years, the
state insurance regulatory framework has come under increased federal scrutiny,
and certain state legislatures have considered or enacted laws that alter and,
in many cases, increase state authority to regulate insurance companies and
insurance holding company systems. Products that are also "securities", such as
variable life insurance and variable annuities, are also subject to federal and
state securities laws and such products and their distribution by our
broker/dealer are regulated and supervised by the Securities and Exchange
Commission, the National Association of Securities Dealers, or NASD, and state
securities commissions. Our business could be negatively impacted by adverse
state and federal legislation or regulation, including those resulting in:
o decreases in rates;
o limitations on premium levels;
o increases in minimum capital and reserve requirements;
o benefit mandates;
o limitations on the ability to manage care and utilization;
o requirements to write certain classes of business;
o tax treatment of insurance and annuity products; and
o restrictions on underwriting.
In addition, broker/dealers are subject to regulations which cover all
aspects of securities business, including:
o sales methods and supervision;
o trading practices among broker/dealers;
o use and safekeeping of customers' funds and securities;
o recordkeeping;
o compensation;
o and the conduct of directors, officers and employees.
These regulations serve to protect the customers and other third parties
who deal with us and are designed to protect the integrity of the financial
markets. If we are found to have violated an applicable regulation,
administrative or judicial proceedings may be initiated against us which could
result in censures, fines, civil penalties, the issuance of cease-and-desist
orders, the deregistration or suspension of our broker/dealer activities, among
other consequences. These actions could have a material adverse effect on our
financial position and results of operations.
We are rated by several rating agencies, and our ratings could adversely affect
our operations.
Ratings have become increasingly important in establishing the competitive
position of insurance companies. Our ratings are important in marketing the
products of our insurance companies to our agents and customers, since rating
information is broadly disseminated and generally used throughout the industry.
8
Our insurance company subsidiaries are rated by A.M. Best and Moody's, and
certain of our insurance company subsidiaries are rated for their claims-paying
ability by Standard & Poor's. These ratings reflect a rating agency's opinion
of our insurance subsidiaries' financial strength, operating performance,
strategic position and ability to meet their obligations to policyholders. These
ratings are not evaluations directed to investors, and are not recommendations
to buy, sell or hold our securities. Our ratings are subject to periodic review
by the rating agencies and we cannot guarantee the continued retention or
improvement of our current ratings.
During 2002, our ratings were lowered by A.M. Best, Moody's and Standard &
Poor's. As a result of the ratings downgrades in 2002 of the life insurance
companies, we determined not to continue new sales of proprietary products in
the AFS segment and we experienced increased surrender rates in the life
insurance and annuity business. In addition, we are no longer able to sell GIC
products. These downgrades have also caused counterparties to terminate certain
swap agreements, which have been replaced with alternative derivative
instruments.
The decrease in the property and casualty ratings, in particular the A.M.
Best rating, could continue to negatively impact earnings and growth in this
business, primarily in commercial lines and relations with our agents, including
our ability to appoint new agents. We secured third party guarantees, which
expire in June 2004, in an effort to minimize the loss of commercial lines
business as a result of the downgrades. These measures are primarily intended to
reduce the risk of cancellation or non-renewal of these commercial policies in
the near term. We believe that the longer the ratings remain at the current
level, the greater the adverse effect of the lower ratings on the operating
results of the Property and Casualty segment. There can be no assurance that
these downgrades, or any further downgrades that may occur, will not have a
material adverse effect on our results of operations and financial position.
Ratings downgrades have also adversely affected the cost and availability
of any additional debt or equity financing, including financing of operating
funds for AMGRO, our property and casualty premium financing subsidiary, and
will continue to do so in the future should ratings remain at current levels or
decrease further.
Negative changes in our level of statutory surplus could adversely affect our
ratings and profitability.
The capacity for an insurance company's growth in premiums is in part a
function of its statutory surplus. Maintaining appropriate levels of statutory
surplus, as measured by state insurance regulators, is considered important by
state insurance regulatory authorities and the private agencies that rate
insurers' claims-paying abilities and financial strength. Regulators may require
that additional capital be contributed to increase the level of statutory
surplus. Failure to maintain certain levels of statutory surplus could result in
increased regulatory scrutiny, action by state regulatory authorities or a
downgrade by private rating agencies.
The National Association of Insurance Commissioners, or NAIC, uses a system
for assessing the adequacy of statutory capital for life and health insurers and
property and casualty insurers. The system, known as risk-based capital, is in
addition to the states' fixed dollar minimum capital and other requirements. The
system is based on risk-based formulas (separately defined for life and health
insurers and property and casualty insurers) that apply prescribed factors to
the various risk elements in an insurer's business and investments to report a
minimum capital requirement proportional to the amount of risk assumed by the
insurer. We believe that any failure to maintain appropriate levels of statutory
surplus would have an adverse impact on our ability to grow our property and
casualty business profitably.
We are subject to mandatory assessments by state guaranty funds; an increase in
these assessments could adversely affect our results of operations and financial
condition.
All fifty states of the United States have insurance guaranty fund laws
requiring life and property and casualty insurance companies doing business
within the state to participate in guaranty associations. These associations are
organized to pay contractual obligations under insurance policies issued by
impaired or insolvent insurance companies. The associations levy assessments, up
to prescribed limits, on all member insurers in a particular state on the basis
of the proportionate share of the premiums written by member insurers in the
lines of business in which the impaired or insolvent insurer is engaged.
Mandatory assessments by state guaranty funds are used to cover losses to
policyholders of insolvent or rehabilitated companies and can be partially
recovered through a reduction in future premium taxes in many states, although
the ability of our life insurance subsidiaries to recover such assessments in
the future will be greatly limited by the fact that we receive premiums, and
thus pay premium taxes, only on existing business. During 2002, we had a total
assessment of approximately $7.1 million levied against us. Through
9
September 30, 2003, we had a total assessment of approximately $1.3 million. A
significant portion of our assessments occur in the fourth quarter. As such, we
anticipate our assessments will increase significantly in the fourth quarter of
2003 as compared to the first nine months of 2003. Although the total assessment
amount for 2003 is still unknown, these assessments may increase above levels
experienced in 2002. Increases in these assessments in the future depend upon
the rate of insolvencies of insurance companies. An increase in assessments
could adversely affect our results of operations and financial condition.
Intense competition could negatively affect our ability to maintain or increase
our profitability.
We compete with a large number of other companies in each of our three
principal segments: property and casualty insurance, financial services and
asset management. We compete, and will continue to compete, with national and
regional insurers, mutual companies, specialty insurance companies, underwriting
agencies and financial services institutions. In recent years, there has been
substantial consolidation and convergence among companies in the financial
services industry, particularly as the laws separating banking, insurance and
securities have been relaxed, resulting in increased competition from large,
well-capitalized financial services firms. Many of our competitors have greater
financial, technical and operating resources than we do. In addition,
competition in the property and casualty insurance markets has intensified over
the past several years. This competition may have an adverse impact on our
revenues and profitability.
A number of new, proposed or potential legislative or industry developments
could further increase competition in our industry. These developments include:
o the enactment of the Gramm-Leach-Bliley Act of 1999, which could
result in increased competition from new entrants to our markets;
o the implementation of commercial lines deregulation in several states;
o programs in which state-sponsored entities provide property insurance
in catastrophe prone areas or other alternative markets types of
coverage;
o changing practices caused by the Internet, which have led to greater
competition in the insurance business in general, and
o proposals, from time to time, to provide for federal chartering of
insurance companies.
In addition, we could face heightened competition resulting from the entry
of new competitors and the introduction of new products by new and existing
competitors. Increased competition could make it difficult for us to obtain new
customers, retain existing customers or maintain policies in force by existing
customers. It could also result in increasing our service, administrative,
policy acquisition or general expense due to the need for additional advertising
and marketing of our products or products of our strategic alliances. In
addition, our administrative or management information systems expenditures
could also increase substantially as we try to maintain our competitive
position. We cannot provide assurance that we will be able to maintain our
current competitive position in the markets in which we operate, or that we will
be able to expand our operations into new markets. If we fail to do so, our
business could be materially adversely affected.
If we are unable to attract and retain qualified personnel, we may not be
able to compete effectively and our operations could be impacted significantly.
Our future success will be affected by our continued ability to attract and
retain qualified executives, particularly those experienced in the property and
casualty industry.
10
We cannot be sure that our reinsurers will pay in a timely fashion, if at all.
We purchase reinsurance by transferring part of the risk that we have assumed
(known as ceding) to a reinsurance company in exchange for part of the premium
we receive in connection with the risk. As of September 30, 2003, our
reinsurance receivable amounted to approximately $2 billion. Although
reinsurance makes the reinsurer liable to us to the extent the risk is
transferred or ceded to the reinsurer, it does not relieve us (the reinsured) of
our liability to our policyholders or, in cases where we are a reinsurer to our
reinsureds. Accordingly, we bear credit risk with respect to our reinsurers. We
cannot be sure that our reinsurers will pay the reinsurance recoverables owed to
us currently or in the future or that they will pay such recoverables on a
timely basis. Additionally, the availability, scope of coverage, cost, and
creditworthiness of reinsurance, could be adversely affected as a result of the
September 11, 2001 terrorist attacks, the conflict in Iraq and the perceived
risks associated with future terrorist activities. We cannot currently estimate
the impact of these events on us.
Changes in federal income tax law could make some of our products less
attractive to customers and increase our tax costs.
In June 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001
was enacted. The 2001 Act contains provisions that will, over time,
significantly lower individual tax rates. This will have the effect of reducing
the benefits of deferral on the build-up value of annuities and life insurance
products. The 2001 Act also includes provisions that will eliminate, over time,
the estate, gift and generation-skipping taxes and partially eliminate the
step-up in basis rule applicable to property held in a decedent's estate. Some
of these changes might result in increased surrenders of insurance products. We
cannot predict the overall effect on such products of tax law changes included
in the 2001 Act.
Congress has, from time to time, also considered other tax legislation,
including legislation that would reduce or eliminate the benefit of the current
federal income tax rule under which tax on the build-up value of annuities and
life insurance products can generally be deferred until payments are made to the
policyholder or other beneficiary and excluded when paid as a death benefit
under a life insurance contract and proposals to eliminate any income tax on
dividend income.
Congress, as well as foreign, state and local governments, also consider
from time to time, legislation that could increase our tax costs. If such
legislation is adopted, our consolidated net income could decline.
We cannot predict whether such legislation will be enacted, what the
specific terms of any such legislation will be or how, if at all, it might
affect retention of our products.
Our business continuity and disaster recovery plans may not sufficiently address
all contingencies.
Terrorist actions, catastrophes or other significant events affecting our
infrastructure may interrupt our ability to conduct business, and delays in
recovery of our operating capabilities could negatively affect our business and
profitability.
The effect of our restructuring efforts may adversely impact our business and
profitability.
We could be adversely affected by the restructuring actions that result
from our ongoing review of operational matters related to our business,
including a review of our markets, products, organization, financial
capabilities, agency management, regulatory environment, ancillary businesses
and service processes.