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: September 30, 1996
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: 50,134,651 shares of common
stock outstanding, as of September 30, 1996.
33
Total Number of Pages Included in This Document
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Income 3
Consolidated Statements of Shareholders' Equity 4
Consolidated Balance Sheets 5
Consolidated Statements of Cash Flows 6
Notes to Interim Consolidated Financial Statements 7 - 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 31
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 33
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions, except
per share data) 1996 1995 1996 1995
REVENUES
Premiums $557.1 $562.4 $1,658.4 $1,675.3
Universal life and
investment product policy
fees 49.9 43.1 144.9 128.0
Net investment income 173.9 181.6 501.8 542.8
Net realized investment
(losses) gains (0.6) 18.4 53.3 24.1
Realized gain on sale of
mutual fund processing
business 0.0 0.0 0.0 20.7
Other income 26.0 17.3 76.6 65.2
-------- -------- -------- --------
Total revenues 806.3 822.8 2,435.0 2,456.1
-------- -------- -------- --------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims,losses
and loss adjustment expenses 475.6 498.5 1,461.0 1,514.3
Policy acquisition expenses 117.3 119.8 358.1 355.2
Other operating expenses 124.3 114.7 361.7 349.5
-------- -------- -------- --------
Total benefits, losses and
expenses 717.2 733.0 2,180.8 2,219.0
-------- -------- -------- --------
Income before federal income
taxes 89.1 89.8 254.2 237.1
-------- -------- -------- --------
Federal income tax expense
(benefit)
Current 32.7 23.8 77.0 75.3
Deferred (11.5) 9.0 (19.0) (0.1)
-------- -------- -------- --------
Total federal income
tax expense 21.2 32.8 58.0 75.2
-------- -------- -------- --------
Income before minority interest
and extraordinary item 67.9 57.0 196.2 161.9
Minority interest (21.2) (22.2) (59.6) (58.0)
-------- -------- -------- --------
Income before extraordinary item 46.7 34.8 136.6 103.9
Extraordinary item-
demutualization expenses 0.0 (4.7) 0.0 (10.7)
-------- -------- -------- --------
Net income $ 46.7 $ 30.1 $ 136.6 $ 93.2
======== ======== ======== ========
PER SHARE DATA
Net income $ 0.93 $ 2.72
======== ========
Dividends declared to
shareholders $ 0.05 $ 0.15
======== ========
Weighted average shares
outstanding 50.1 50.1
======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 3
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
Nine Months Ended
September 30,
(In millions) 1996 1995
COMMON STOCK
Balance at beginning and end of period $ 0.5 $ 0.0
-------- --------
ADDITIONAL PAID-IN-CAPITAL
Balance at beginning and end of period 1,382.5 0.0
-------- --------
RETAINED EARNINGS
Balance at beginning of period 38.2 1,071.4
Net income 136.6 93.2
Dividends to shareholders (7.5) 0.0
Balance at end of period -------- --------
167.3 1,164.6
-------- --------
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 153.0 (79.0)
Net (depreciation) appreciation on
available-for-sale securities (139.2) 360.5
Benefit (provision) for deferred federal
income taxes 48.7 (126.2)
Minority interest 20.2 (64.4)
---------- ---------
Balance at end of period 82.7 90.9
Total shareholders' equity $1,633.0 $1,255.5
========== =========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 4
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
(In millions, except per share data) 1996 1995
ASSETS
Investments:
Fixed maturities-at fair value
(amortized cost of $7,635.3 and
$7,467.9) $7,731.4 $7,739.3
Equity securities-at fair value
(cost of $326.6 and $410.6) 438.0 517.2
Mortgage loans 690.4 799.5
Real estate 145.4 179.6
Policy loans 130.6 123.2
Other long-term investments 111.4 71.9
---------- ----------
Total investments 9,247.2 9,430.7
---------- ----------
Cash and cash equivalents 164.2 289.5
Accrued investment income 158.2 163.2
Deferred policy acquisition costs 816.3 735.7
Reinsurance receivables:
Future policy benefits 104.2 97.1
Outstanding claims, losses and loss
adjustment expenses 763.9 799.6
Unearned premiums 45.2 43.8
Other 56.0 58.9
---------- ----------
Total reinsurance receivables 969.3 999.4
---------- ----------
Deferred federal income taxes 113.0 81.2
Premiums, accounts and notes receivable 557.1 526.7
Other assets 309.3 363.6
Closed Block assets 807.5 818.9
Separate account assets 5,586.8 4,348.8
---------- ----------
Total assets $18,728.9 $17,757.7
========== ==========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $2,628.3 $2,639.3
Outstanding claims, losses and
loss adjustment expenses 3,057.7 3,081.3
Unearned premiums 848.0 800.9
Contractholder deposit funds and other
policy liabilities 2,142.0 2,737.4
-------- --------
Total policy liabilities and accruals 8,676.0 9,258.9
Expenses and taxes payable 601.9 603.0
Reinsurance premiums payable 51.6 42.0
Short-term debt 326.1 31.2
Deferred federal income taxes 14.8 47.8
Long-term debt 202.2 202.3
Closed Block liabilities 890.4 902.0
Separate account liabilities 5,581.5 4,337.8
---------- ----------
Total liabilities 16,344.5 15,425.0
---------- ----------
Minority interest 751.4 758.5
---------- ----------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 20.0
million shares authorized, none issued 0.0 0.0
Common stock, $0.01 par value, 300.0
million shares authorized, 50.1 million
shares issued and outstanding 0.5 0.5
Additional paid-in-capital 1,382.5 1,382.5
Unrealized appreciation on investments, net 82.7 153.0
Retained earnings 167.3 38.2
-------- --------
Total shareholders' equity 1,633.0 1,574.2
---------- ----------
Total liabilities and shareholders'
equity $18,728.9 $17,757.7
========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 5
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
(In millions)
1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $136.6 $93.2
Adjustments to reconcile net income
to net cash provided by operating
activities:
Minority interest 59.6 58.0
Net realized gains (53.5) (44.8)
Deferred federal income taxes (18.9) (0.1)
Changes in assets and liabilities:
Deferred policy acquisition costs (55.7) (31.4)
Premiums and notes receivable, net
of reinsurance payable (20.4) (64.5)
Accrued investment income 6.3 2.3
Policy liabilities and accruals,
net (31.3) 85.1
Reinsurance receivable 30.2 (22.2)
Expenses and taxes payable 8.3 59.2
Separate account activity, net 5.6 0.4
Other, net 78.4 44.5
---------- ---------
Net cash provided by operating
activities 145.2 179.7
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of available-
for-sale fixed maturities 2,025.2 1,147.1
Proceeds from maturities and calls
of available-for-sale fixed
maturities 1,058.3 804.5
Proceeds from maturities of
held-to-maturity fixed maturities 0.0 238.0
Proceeds from disposals of equity
securities 218.3 77.3
Proceeds from disposals of other
investments 60.3 9.7
Proceeds from mortgages matured or
collected 122.9 157.2
Purchase of available-for-sale
fixed maturities (3,282.8) (2,212.6)
Purchase of held-to-maturity fixed
maturities 0.0 (49.2)
Purchase of equity securities (81.1) (172.6)
Purchase of other investments (91.1) (10.2)
Proceeds from sale of mutual fund
processing business 0.0 32.8
Capital expenditures (8.0) (10.1)
Other activities, net 2.6 0.0
---------- ---------
Net cash provided by investing
activities 24.6 11.9
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 241.6 357.7
Withdrawals from contractholder
deposit funds (790.4) (765.4)
Change in short-term debt 294.9 (6.4)
Dividends paid to shareholders (10.4) (3.1)
Subsidiary treasury stock purchased,
at cost (42.0) (13.1)
---------- ---------
Net cash used in financing
activities (306.3) (430.3)
---------- ---------
Net decrease in cash and cash
equivalents (136.5) (238.7)
Net change in cash held in the Closed
Block 11.2 0.0
Cash and cash equivalents, beginning
of period 289.5 539.7
---------- ---------
Cash and cash equivalents, end of
period $164.2 $301.0
========== =========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 6
ALLMERICA FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
First Allmerica Financial Life Insurance Company ("FAFLIC", formerly
State Mutual Life Assurance Company of America ["State Mutual"]) was
organized as a mutual life insurance company until October 16, 1995.
FAFLIC converted to a stock life insurance company pursuant to a plan
of reorganization effective October 16, 1995 and became a wholly owned
subsidiary of Allmerica Financial Corporation ("AFC" or the
"Company"). The consolidated financial statements have been prepared
as if FAFLIC were organized as a stock life insurance company for all
periods presented. Thus, generally accepted accounting principles for
stock life insurance companies have been applied for all periods
presented.
The interim consolidated financial statements of AFC include the
accounts of AFC, FAFLIC, its wholly owned life insurance subsidiary,
Allmerica Financial Life Insurance and Annuity Company ("AFLIAC",
formerly SMA Life Assurance Company), non-insurance subsidiaries
(principally brokerage and investment advisory subsidiaries), and
Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C", a
59.5%-owned non-insurance holding company). The Closed Block assets
and liabilities at September 30, 1996 and December 31, 1995 are
presented in the consolidated financial statements as single line
items. Results of operations for the Closed Block for the nine month
and three month periods ended September 30, 1996 are included in other
income in the consolidated financial statements. Prior to
demutualization such amounts are presented line by line in the
consolidated financial statements. All significant intercompany
accounts and transactions have been eliminated.
Minority interest relates to the Company's investment in Allmerica P&C
and its subsidiary, The Hanover Insurance Company ("Hanover").
Hanover's 82.5%-owned subsidiary is Citizens Corporation, the holding
company for Citizens Insurance Company of America ("Citizens").
Minority interest also includes an amount related to the minority
interest in Citizens Corporation.
The accompanying interim consolidated financial statements reflect, in
the opinion of the Company's management, all adjustments, consisting
of only normal and recurring adjustments, necessary for a fair
presentation of the financial position and results of operations.
Certain reclassifications have been made to the 1995 consolidated
statements of income in order to conform to the 1996 presentation.
The results of operations for the nine months and quarter ended
September 30, 1996 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 1995 Annual Report to Shareholders,
as filed on Form 10-K to the Securities and Exchange Commission.
2. Federal Income Taxes
Federal income tax expense for the periods ended September 30, 1996
and 1995, has been computed using estimated effective tax rates for
the AFC and Allmerica P&C tax-paying groups. 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.
Page 7
3. Closed Block
Included in other income in the Consolidated Statements of Income in
the third quarter and first nine months of 1996 is a net pre-tax
contribution from the Closed Block of $1.9 million and $7.9 million,
respectively. Summarized financial information of the Closed Block is
as follows:
(Unaudited)
September 30, December 31,
1996 1995
(In millions)
ASSETS
Fixed maturities, at fair value
(amortized cost of $450.0 and $447.4) $450.2 $458.0
Mortgage loans 77.9 57.1
Policy loans 233.6 242.4
Cash and cash equivalents 6.4 17.6
Accrued investment income 15.2 16.6
Deferred policy acquisition costs 21.8 24.5
Other assets 2.4 2.7
-------- --------
Total assets $807.5 $818.9
======== ========
LIABILITIES
Policy liabilities and accruals $880.5 $899.2
Other liabilities 9.9 2.8
-------- --------
Total liabilities $890.4 $902.0
======== ========
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
1996 1996
REVENUES
Premiums $10.4 $50.9
Net investment income 13.3 39.4
Net realized investment (losses)
gains (0.2) 0.2
-------- --------
Total revenues 23.5 90.5
-------- --------
BENEFITS AND EXPENSES
Policy benefits 20.7 79.8
Policy acquisition expenses 0.7 2.3
Other operating expenses 0.2 0.5
-------- --------
Total benefits and expenses 21.6 82.6
-------- --------
Contribution from the Closed Block $ 1.9 $ 7.9
======== ========
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.
4. Segment Information
The Company offers financial products and services in two major areas:
Risk Management and Retirement and Asset Management. Within these
broad areas, the Company operates principally in five segments.
The Risk Management group includes two segments: Regional Property and
Casualty and Corporate Risk Management Services. The Regional
Property and Casualty segment includes property and casualty insurance
products, such as automobile insurance, homeowners' insurance,
commercial multiple peril insurance, and workers' compensation
insurance. These products are offered by Allmerica P&C through its
operating subsidiaries, Hanover and Citizens. Substantially all of
the Regional Property and Casualty segment's earnings are generated in
Michigan and the Northeast (Connecticut, Massachusetts, New York, New
Jersey, New Hampshire, Rhode Island, Vermont and Maine). The
Corporate Risk Management Services segment includes group life and
health insurance products and services which assist employers in
administering employee benefit programs and in managing the related
risks.
Page 8
The Retirement and Asset Management group includes three segments:
Retail Financial Services, Institutional Services and Allmerica Asset
Management. The Retail Financial Services segment includes variable
annuities, variable universal life, traditional and health insurance
products distributed via retail channels to individuals across the
country. The Institutional Services segment includes primarily group
retirement products such as 401(k) plans, tax-sheltered annuities and
GIC contracts which are distributed to institutions across the country
via worksite marketing and other arrangements. Allmerica Asset
Management is a Registered Investment Advisor which provides
investment advisory services to other institutions, such as insurance
companies and pension plans.
In addition to the five operating segments, the Company also has a
Corporate segment, which consists primarily of Senior Debentures and a
portion of the net proceeds from the Company's initial public
offering.
Summarized below is financial information with respect to business
segments for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions, except
per share data) 1996 1995 1996 1995
Revenues:
Risk Management
Regional Property and
Casualty $ 539.3 $ 540.3 $ 1,634.9 $ 1,569.9
Corporate Risk Management
Services 90.7 82.0 267.1 235.8
--------- --------- --------- ---------
Subtotal 630.0 622.3 1,902.0 1,805.7
--------- --------- --------- ---------
Retirement and Asset Management
Retail Financial Services 112.2 123.0 332.7 383.3
Institutional Services 63.8 76.3 198.6 263.8
Allmerica Asset Management 1.7 1.2 6.2 3.3
--------- --------- --------- ---------
Subtotal 177.7 200.5 537.5 650.4
--------- --------- --------- ---------
Corporate 0.5 0.0 1.8 0.0
Eliminations (1.9) 0.0 (6.3) 0.0
--------- --------- --------- ---------
Total $ 806.3 $ 822.8 $ 2,435.0 $ 2,456.1
========= ========= ========= =========
Income (loss) from continuing
operations before income taxes:
Risk Management
Regional Property and
Casualty $ 57.8 $ 63.2 $ 162.4 $ 157.8
Corporate Risk Management
Services 3.7 5.1 11.2 9.9
--------- --------- --------- ---------
Subtotal 61.5 68.3 173.6 167.7
--------- --------- --------- ---------
Retirement and Asset Management
Retail Financial Services 18.9 11.9 54.0 27.7
Institutional Services 12.7 9.0 38.3 40.0
Allmerica Asset Management 0.0 0.6 0.5 1.7
--------- --------- --------- ---------
Subtotal 31.6 21.5 92.8 69.4
--------- --------- --------- ---------
Corporate (4.0) 0.0 (12.2) 0.0
--------- --------- --------- ---------
Total $ 89.1 $ 89.8 $ 254.2 $ 237.1
========= ========= ========= =========
(Unaudited)
As of As of
September December 31,
30, 1996 1995
Identifiable assets:
Risk Management
Regional Property and
Casualty $ 5,773.6 $ 5,741.8
Corporate Risk Management
Services 519.7 458.9
--------- ---------
Subtotal 6,293.3 6,200.7
--------- ---------
Retirement and Asset Management
Retail Financial Services 8,490.5 7,218.6
Institutional Services 3,898.6 4,280.9
Allmerica Asset Management 2.9 2.1
--------- ---------
Subtotal 12,392.0 11,501.6
Corporate 43.6 55.4
--------- ---------
Total $18,728.9 $17,757.7
========= =========
Page 9
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.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
subsidiaries ("AFC" or "the Company") include the accounts of AFC,
First Allmerica Financial Life Insurance Company ("FAFLIC", formerly
State Mutual Life Assurance Company of America ["State Mutual"]), its
wholly owned life insurance subsidiary, Allmerica Financial Life
Insurance and Annuity Company ("AFLIAC", formerly SMA Life), Allmerica
Property & Casualty Companies, Inc. ("Allmerica P&C", a 59.5%-owned
non-insurance holding company), The Hanover Insurance Company
("Hanover", a wholly owned subsidiary of Allmerica P&C), Citizens
Corporation ("Citizens", an 82.5%-owned subsidiary of Hanover),
Citizens Insurance Company of America (a wholly owned subsidiary of
Citizens) and certain other insurance and non-insurance subsidiaries.
CLOSED BLOCK
On completion of its demutualization, FAFLIC established a Closed
Block for the payment of future benefits, policyholders' dividends and
certain expenses and taxes relating to certain classes of policies.
FAFLIC allocated to the Closed Block an amount of assets expected to
produce cash flows which, together with anticipated revenues from the
Closed Block business, are reasonably expected to be sufficient to
support the Closed Block business. The Closed Block includes only
those revenues, benefit payments, dividends and premium taxes
considered in funding the Closed Block and excludes many costs and
expenses associated with operating the Closed Block and administering
the policies included therein. Since many expenses related to the
Closed Block were excluded from the calculation of the Closed Block
contribution, the contribution from the Closed Block does not
represent the actual profitability of the Closed Block. As a result
of such exclusion, operating costs and expenses outside the Closed
Block are disproportionate to the business outside the Closed Block.
The contribution from the Closed Block is included in 'Other income'
in the interim Consolidated Financial Statements. The pre-tax
contribution from the Closed Block was $1.9 million for the quarter
ended and $7.9 million for the nine months ended September 30, 1996.
Page 10
FAFLIC's conversion to a stock life insurance company, which was
completed October 16, 1995, and the establishment of the Closed Block
have affected the presentation of the Company's interim Consolidated
Financial Statements. For comparability with the prior period, the
following table presents the results of operations of the Closed Block
combined with the results of operations outside the Closed Block for
the quarter ended and the nine months ended September 30, 1996.
Management's discussion and analysis addresses the results of
operations as combined unless otherwise noted.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
REVENUES
Premiums $567.6 $562.4 $1,709.3 $1,675.3
Universal life and
investment product
policy fees 49.9 43.1 144.9 128.0
Net investment income 187.2 181.6 541.2 542.8
Net realized investment
(losses) gains (0.8) 18.4 53.5 24.1
Realized gain on sale of
mutual fund processing
business 0.0 0.0 0.0 20.7
Other income 24.1 17.3 68.7 65.2
-------- -------- -------- --------
Total revenues 828.0 822.8 2,517.6 2,456.1
-------- -------- -------- --------
BENEFITS, LOSSES AND
EXPENSES
Policy benefits, claims,
losses and loss adjustment
expenses 496.3 498.5 1,540.8 1,514.3
Policy acquisition
expenses 118.1 119.8 360.4 355.2
Other operating
expenses 124.5 114.7 362.2 349.5
-------- -------- -------- --------
Total benefits, losses
and expenses 738.9 733.0 2,263.4 2,219.0
-------- -------- -------- --------
Income before federal
income taxes 89.1 89.8 254.2 237.1
-------- -------- -------- --------
Federal income tax expense
(benefit)
Current 32.7 23.8 77.0 75.3
Deferred (11.5) 9.0 (19.0) (0.1)
-------- -------- -------- --------
Total federal income tax
expense 21.2 32.8 58.0 75.2
-------- -------- -------- --------
Income before minority
interest and extraordinary
item 67.9 57.0 196.2 161.9
Minority interest (21.2) (22.2) (59.6) (58.0)
-------- -------- -------- --------
Income before extraordinary
item 46.7 34.8 136.6 103.9
Extraordinary item -
demutualization expenses 0.0 (4.7) 0.0 (10.7)
-------- -------- -------- --------
Net Income $46.7 $30.1 $136.6 $93.2
======== ======== ======== ========
Page 11
Results of Operations
Consolidated Overview
Quarter Ended September 30, 1996 Compared to Quarter Ended September
30 ,1995
The Company's consolidated net income for the third quarter increased
$16.6 million, or 55.1%, to $46.7 million, compared to the same period
in 1995. Net income includes certain items which management believes
are not indicative of overall operating trends.
The following table reflects consolidated net income adjusted for
these items, all net of taxes and minority interest.
(Unaudited)
Quarter Ended
September 30,
(In millions) 1996 1995
Net income $ 46.7 $ 30.1
Adjustments:
Net realized investment gains (1.6) (9.3)
Extraordinary item - demutualization expenses 0.0 4.7
Differential earnings tax adjustment (2.4) 6.4
-------- --------
Adjusted net income $ 42.7 $ 31.9
======== ========
The Company's adjusted net income increased $10.8 million, or 33.9%, to $42.7
million in the third quarter of 1996, compared to the same period in 1995.
This increase is primarily attributable to a pre-tax increase of $12.5 million
in the Retail Financial Services segment and an after-tax and minority interest
increase of $3.7 million in the Regional Property and Casualty segment. These
increases were partially offset by pre-tax adjusted net losses in the Corporate
segment of $3.8 million in the quarter ended September 30, 1996 primarily due
to the interest expense on the Company's 7 5/8% Senior Debentures issued in
October 1995. The increase in the Retail Financial Services segment relates
primarily to increased variable products' fee revenue and income earned on
proceeds from the Company's October, 1995 inital public offering. The increase
in the Regional Property and Casualty segment was due primarily to a $5.7
million arbitrated settlement from a voluntary pool, a $4.0 million
reapportionment of an involuntary pool and a change in estimated equity in
earnings from a limited partnership of $6.7 million. These items were mostly
offset by a decrease in favorable claims experience on the prior accident years
at Hanover, where favorable development decreased from $25.6 million in the
third quarter of 1995 to $13.0 million in the third quarter of 1996. The
Company expects reduced favorable reserve development at Hanover to continue to
impact future earnings.
Premium revenue remained relatively stable, increasing $5.2 million, or 0.9%,
to $567.6 million in the third quarter of 1996. Premiums in the Corporate Risk
Management Services segment increased $5.3 million, or 7.5%, to $75.7 million
due to increases in group dental, group life and reinsurance coverages totaling
$6.6 million. Premium revenue in the Regional Property and Casualty segment
was relatively flat, decreasing $1.7 million, or 0.4%, to $472.7 million.
Universal life and investment-type product policy fees increased $6.8 million,
or 15.8%, to $49.9 million during the third quarter of 1996. This reflected
additional deposits and appreciation on variable products account balances.
Net realized losses on investments were $0.8 million in the third quarter of
1996, compared to net realized gains of $18.4 million in 1995. This change is
primarily attributable to increased losses on sales of fixed maturities and
equity securities of $20.5 million and $3.1 million, respectively, due to less
favorable market conditions in the third quarter of 1996, partially offset by
additional gains on sales of real estate of $7.1 million.
Net investment income increased $5.6 million, or 3.1%, to $187.2 million during
the third quarter of 1996 compared to the same period in 1995. Income on
investments financed with repurchase agreements ("pre-invested assets") in 1996
totaled approximately $9.5 million during the third quarter and income on the
proceeds of the initial public offering and from the issuance of Senior
Debentures in October 1995 was approximately $6.8 million. Additionally, there
was a $6.7 million change in estimated equity in earnings from a limited
partnership in 1996. These increases were partially offset by a decrease of
$13.8 million resulting from a reduction in invested assets due to declining
GIC deposits. Since March 1995, when S&P lowered the claims-paying ratings of
FAFLIC to A+ (Good), sales of traditional GICs have substantially ceased.
Additionally, income on mortgage loans and real estate decreased due to
reductions in these portfolios.
Page 12
Other income increased $6.8 million to $24.1 million for the quarter ended
September 30, 1996. This increase was primarily attributable to an arbitrated
settlement on a reinsurance contract of $2.9 million in the Regional Property
and Casualty segment, a $2.2 million increase in investment management income
in the Retail Financial Services segment and a $2.5 million increase in
administrative fees in the Corporate Risk Management Services segment.
Policy benefits, claims, losses and loss adjustment expenses remained
relatively stable, decreasing $2.2 million, or 0.4% to $496.3 million during
the third quarter of 1996. This decrease is primarily attributable to decreased
policy benefits of $15.2 million, or 28.6%, in the Institutional Services
segment primarily attributable to the continuing decline of Guaranteed
Investment Contracts ("GICs") during 1996, as well as a $4.0 million, or 5.4%
decrease in Retail Financial Services due primarily to reserve strengthening in
the disability insurance line in 1995 and improved morbidity experience in this
line during 1996. These increases were partially offset by an $11.5 million, or
3.5%, increase in losses and loss adjustment expenses ("LAE") in the Company's
Regional Property and Casualty segment primarily as a result of a decrease in
favorable claims experience on prior accident years at Hanover. Additionally,
Corporate Risk Management Services benefits increased $5.5 million, or 11.7% in
the third quarter of 1996, principally due to premium growth and less favorable
loss experience.
Policy acquisition expenses consist primarily of commissions, premium taxes and
other policy issuance costs. Policy acquisition expenses decreased $1.7
million, or 1.4%, to $118.1 million during the quarter ended September 30, 1996
compared to the same period in 1995. This was primarily due to a decrease of
$3.2 million, or 3.0%, to $102.8 million in the Regional Property and Casualty
segment due primarily to the reapportionment of a involuntary pool and an
increase in deferrable costs attributable to premiums assumed in a
reinsurance contract. This decrease was partially offset by an increase in the
Retail Financial Services segment of $1.3 million, or 10.5%, to $13.7 million,
primarily due to growth in variable products.
Other operating expenses increased $9.8 million, or 7.9%, to $124.5 million in
the third quarter of 1996 compared to the same period in 1995. This change was
primarily due to short-term borrowing costs of $6.2 million incurred in 1996,
$3.8 million of interest paid on the Company's Senior Debentures and increased
commissions and claims processing expenses of $4.1 million in the Corporate
Risk Management segment. These increases were partially offset by a $4.0
million decrease in the Regional Property and Casualty segment primarily
attributable to reduced employee related expenses and commissions.
Federal income tax expense decreased $11.6 million in the third quarter of
1996, while the effective tax rate decreased from 36.6% to 23.8% in the same
period. For the life insurance subsidiaries, a decrease in the effective rate
from 63.4% to 28.4% resulted primarily from a differential earnings charge of
$6.4 million during the third quarter of 1995 compared to a differential
earnings benefit of $2.4 million for the same period in 1996. For the Regional
Property and Casualty subsidiaries, a slight decrease in the effective rate
from 25.3% to 21.3% reflects a higher underwriting loss and a greater
proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves
provided for revisions in estimated prior year tax liabilities in the third
quarter of 1995.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
The Company's consolidated net income for the nine months ended September 30,
1996 increased $43.4 million, or 46.6%, to $136.6 million, compared to the same
period in 1995. Net income includes certain items which management believes
are not indicative of overall operating trends.
The following table reflects consolidated net income adjusted for these items,
all net of taxes and minority interest.
(Unaudited)
Nine Months Ended
September 30,
(In millions) 1996 1995
Net income $ 136.6 $ 93.2
Adjustments:
Net realized investment gains (23.9) (11.7)
Realized gain on sale of mutual fund
processing business 0.0 13.4
Contingency payment from sale of mutual
fund processing business (3.1) 0.0
Extraordinary item - demututaliztion expenses 0.0 10.7
Differential earnings tax adjustment (8.3) 7.7
--------- --------
Adjusted net income $ 101.3 $ 86.5
========= ========
Page 13
The increase in adjusted net income of $14.8 million is primarily attributable
to pre-tax increases of $29.3 million and $8.9 million in the Retail Financial
Services and Institutional Services segments, respectively, partially offset by
a pre-tax loss of $11.8 million and an after-tax decrease of $5.6 million in
the Corporate and Regional Property and Casualty segments, respectively. The
increase in the Retail Financial Services segment resulted primarily from
increased fees from strong variable product growth and income earned on
proceeds from the Company's October, 1995 inital public offering. The increase
in the Institutional Services segment related principally to exiting certain
unprofitable businesses in 1995. These increases were partially offset by
losses in the Corporate segment primarily due to the interest expense on the
Company's 7 5/8% Senior Debentures issued in October 1995. Additionally, the
Regional Property and Casualty segment's adjusted net income decreased
primarily due to severe weather-related claims during the first six months of
1996, partially offset by a $5.7 million arbitrated settlement from a voluntary
pool, a $4.0 million reapportionment of an involuntary pool and a change in
estimated equity in earnings from a limited partnership of $6.7 million.
Premium revenue increased $34.0 million, or 2.0%, to $1,709.3 million during
the first nine months of 1996. Premiums in the Corporate Risk Management
Services segment increased $22.2 million, or 11.0%, to $224.6 million due to
increases in group dental, group life, and reinsurance coverages totaling $18.4
million as well as increases of $3.6 million in stop loss products. Property
and casualty premiums earned increased $16.5 million, or 1.2%, to $1,407.5
million. This increase is primarily attributable to price increases in the
homeowners' line at Hanover and price increases in the personal automobile and
homeowners' lines at Citizens. A 1.6 % increase in policies in force in the
homeowners' line at Hanover and modest increases in policies in force in the
personal automobile line at Hanover partially offset by rate decreases in this
line, also contributed to the increase in net premiums earned. Premiums in the
Retail Financial Services segment decreased $4.5 million, or 5.5%, to $77.2
million, primarily reflecting the Company's shift in focus from traditional
life insurance products to variable life insurance and annuity products.
Universal life and investment product policy fees increased $16.9 million, or
13.2%, to $144.9 million during the first nine months of 1996. This resulted
from additional deposits and appreciation on variable products account
balances.
Net investment income before taxes decreased $1.6 million, or 0.3%, to $541.2
million during the first nine months of 1996. This decrease primarily reflects
a reduction in invested assets due to declining GIC deposits resulting in a
decline in investment income of $42.5 million. This decrease was offset by
approximately $17.3 million of income on proceeds from the Company's initial
public offering and from the issuance of Senior Debentures in October 1995, as
well as approximately $14.3 million in income from pre-invested assets and a
$6.7 million adjustment in 1996 related to a change in estimated equity in
earnings from a limited partnership. The average gross yield of the fixed
maturity investment portfolio decreased from 7.3% in the first nine months of
1995 to 7.2% for the same period in 1996.
Net realized gains on investments were $53.5 million and $24.1 million, before
taxes, and $34.8 million and $15.7 million, after taxes, in the first nine
months of 1996 and 1995, respectively. In 1996, the Regional Property and
Casualty segment revised its investment strategy, resulting in the sale of a
substantial portion of its equity portfolio and the purchase of tax-exempt
securities. Consequently, Regional Property and Casualty segment realized
gains increased $20.1 million, to $29.8 million on an after-tax basis for the
nine months ended September 30, 1996. These sales are consistent with the
segment's strategy to maximize after-tax net investment income.
Results in the first nine months of 1995 included a $20.7 million pre-tax gain
from the March 1995 sale of the Company's mutual fund processing business.
Other income increased $3.5 million, or 5.4%, to $68.7 million in the first
nine months of 1996. Other income attributable to the Corporate Risk
Management Services segment increased $6.2 million, primarily from growth in
Administrative Services Only ("ASO") and contract fees. Other income from the
Retail Financial Services segment increased $5.9 million, primarily
attributable to increased investment management income. Additionally, other
income in the Allmerica Asset Management and Regional Property and Casualty
segments increased $2.9 million and $2.6 million, respectively. These
increases were partially offset by decreases in the Institutional Services
segment resulting primarily from the sale of the mutual fund processing
business in March of 1995 which had contributed revenues of approximately $13.6
million in that year. Other income in 1996 also included a non-recurring $4.8
million pre-tax contingent payment related to the sale.
Policy benefits, claims, losses and loss adjustment expenses increased $26.5
million, or 1.7%, to $1,540.8 million during the first nine months of 1996.
This increase is primarily attributable to a $59.8 million, or 6.2%, increase
in losses and LAE in the Company's Regional Property and Casualty segment as a
result of catastrophe losses and severe weather during the first six months of
1996. Additionally, a $14.9 million, or 10.4%, increase in the Corporate Risk
Management Services segment resulted primarily from product growth. These
increases were partially offset by decreased policy benefits of $44.9 million,
or 26.7%, in the Institutional Services segment primarily resulting from the
continuing decline of GICs during 1996.
Page 14
Policy acquisition expenses consist primarily of commissions, premium taxes and
other policy issuance costs. Policy acquisition expenses increased $5.2
million, or 1.5%, to $360.4 million during the first nine months of 1996. This
was primarily due to an increase of $5.8 million, or 1.9%, to $313.3 million in
the Regional Property and Casualty segment reflecting growth in net premiums
earned.
Other operating expenses increased $12.7 million, or 3.6%, to $362.2 million in
the first nine months of 1996 compared to the same period in 1995 primarily due
to increased expenses in the Corporate Risk Management Services, Corporate and
Retail Financial Services segments. Other operating expenses in the Corporate
Risk Management Services segment increased $14.8 million, or 18.3%, to $95.6
million in 1996 as a result of increased commissions, claims processing
expenses and field office expenses, resulting from the increased volume of both
premiums and claims. Other operating expenses in the Retail Financial Services
segment increased $9.7 million, or 12.3%, to $88.5 million in 1996, primarily
from an increase in short-term borrowing costs of $9.0 million. Additionally,
the Company incurred $14.0 million of other operating expenses in the
Corporate segment in the first nine months of 1996, principally related to
interest paid on the Company's Senior Debentures. These increases were
partially offset by a decrease of $18.6 million in the Institutional services
segment related to the sale of the mutual fund processing business in March
1995, and by a decrease of $5.3 million in the Regional Property and Casualty
segment resulting from lower employee related expenses.
Federal income tax expense decreased $17.2 million in the first nine months of
1996, while the effective tax rate decreased from 31.8% to 22.8% in the same
period. For the life insurance subsidiaries, a decrease in the effective rate
from 50.8% to 27.9% resulted primarily from a differential earnings benefit of
$8.3 million in the first nine months of 1996 versus a differential earnings
charge $7.7 million in the same period of 1995. For the property and casualty
subsidiaries, a slight decrease in the effective rate from 22.2% to 20.0%
resulted from a higher underwriting loss and a greater proportion of pre-tax
income from tax-exempt bonds in 1996, and to reserves provided for revisions of
estimated prior tax liabilities in the first nine months of 1995.
Segment Results
The following is management's discussion and analysis of the Company's results
of operations by business segment. The Company offers financial products and
services in two major areas: Risk Management and Retirement and Asset
Management. Within these broad areas, the Company conducts business principally
in five operating segments. These segments are Regional Property and
Casualty; Corporate Risk Management Services; Retail Financial Services;
Institutional Services; and Allmerica Asset Management. The Regional Property
and Casualty segment consists of the Company's 59.5% ownership of Allmerica
P&C; however, all property and casualty results presented include 100% of
Allmerica P&C's pre-tax results of operations, consistent with the presentation
in the Company's consolidated financial statements. The other segments are all
owned and operated by FAFLIC and its wholly owned subsidiaries.
In addition to the five operating segments, the Company also has a Corporate
segment, which consists primarily of Senior Debentures and a portion of the net
proceeds from the Company's initial public offering. These proceeds are
invested in fixed maturities at September 30, 1996.
Risk Management
Regional Property and Casualty
The following table summarizes the results of operations for the Regional
Property and Casualty segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
Revenues
Net premiums earned $472.7 $474.4 $1,407.5 $1,391.0
Net investment income 63.0 53.7 171.6 157.7
Net realized gains (1.6) 10.4 45.9 13.9
Other income 5.2 1.8 9.9 7.3
------- ------- --------- ---------
Total revenues 539.3 540.3 1,634.9 1,569.9
Losses and LAE <fn1> 336.4 324.9 1,029.3 969.5
Policy acquisition and other
operating expenses 145.1 152.2 443.2 442.6
------- ------- --------- --------
Income before taxes $ 57.8 $ 63.2 $ 162.4 $ 157.8
======= ======= ========= =========
<FN>
<fn1>
Includes policyholders' dividends of $8.7 million and $7.0 million for the
nine months ended September 30, 1996 and 1995, respectively, and $3.7 million
and $2.6 million for the quarters ended September 30, 1996 and 1995,
respectively.
</FN>
Page 15
Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995
INCOME BEFORE TAXES
Income before taxes decreased $5.4 million, to $57.8 million in the third
quarter of 1996, compared to the same period in 1995. Excluding realized gains
and losses, income before taxes increased $6.6 million, to $59.4 million in the
third quarter of 1996. The increase in income before taxes is primarily
attributable to a $5.7 million arbitrated settlement from a voluntary pool and
$4.0 million reapportionment of an involuntary pool. Net investment income
increased $9.3 million, or 17.3% to $63.0 million, reflecting a change in
estimated equity in earnings from a limited partnership of $6.7 million. This
was offset by a $10.4 million increase in losses and loss adjustment expenses
("LAE") to $332.7 million in the third quarter of 1996, resulting from a $12.6
million decrease from $25.6 million in favorable claims experience on the prior
accident years at Hanover. The Company expects reduced favorable development at
Hanover to continue to impact future earnings.
LINES OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 61.4% and 60.1% of total net
premiums earned in the third quarter of 1996 and 1995, respectively.
Hanover Citizens Consolidated
For the Quarters
Ended September 30, 1996 1995 1996 1995 1996 1995
(In millions)
Net premiums earned $149.4 $148.9 $141.0 $136.1 $290.4 $285.0
Losses and loss
adjustment expenses 107.6 94.5 96.5 105.6 204.1 200.1
Policy acquisition and
other underwriting
expenses 46.8 48.7 37.6 36.0 84.4 84.7
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $ (5.0) $ 5.7 $ 6.9 $ (5.5) $ 1.9 $ 0.2
======= ======= ======= ======= ======= =======
Revenues
Personal lines of business net premiums earned increased $5.4 million, to
$290.4 million during the third quarter of 1996, compared to $285.0 million in
the third quarter of 1995. Hanover's personal lines of business net premiums
earned remained relatively flat at $149.4 million during the third quarter of
1996. Increases in earned premium resulting from rate increases and increases
in policies in force in the homeowners line were offset by rate decreases in
the personal automobile line and a lower participation in an involuntary pool.
Hanover's premium growth in the personal automobile line has been impacted by
a combined 16% rate decrease in Massachusetts during the past two years.
Massachusetts currently accounts for approximately 36% of Hanover's personal
automobile writings. Citizens' personal lines of business net premiums earned
increased $4.9 million, or 3.6%, to $141.0 million in the third quarter of
1996. This increase is primarily attributable to price increases in the
personal automobile and homeowners lines. This increase is partially offset by
a 2.5% decrease in policies in force in the personal automobile line since
December 31, 1995, attributable to continued strong competition in Michigan.
Underwriting results
The personal lines of business underwriting profit increased $1.7 million, to a
profit of $1.9 million in the third quarter of 1996. Hanover's underwriting
profit decreased $10.7 million to a loss of $5.0 million, while Citizens'
underwriting loss increased $12.4 million to a profit of $6.9 million.
Page 16
The decrease in Hanover's underwriting profit resulted primarily from a $13.1
million or 13.9% increase in losses and loss adjustment expenses to $107.6
million in the third quarter of 1996. This increase is primarily attributable
to a $7.3 million increase in the personal automobile line due to an increase
in claims severity. Homeowners' losses and LAE increased $4.9 million,
primarily attributable to increased loss frequency and severity and a $2.2
million increase in catastrophe losses to $3.8 million.
Citizens' underwriting results improved by $12.4 million, primarily
attributable to a decrease in catastrophe losses. Catastrophe losses provided a
$2.3 million benefit during the third quarter of 1996, resulting from a
favorable re-estimation of catastrophe losses which occurred in the first half
of 1996. Citizens incurred catastrophe losses of $6.9 million in the third
quarter of 1995.
Policy acquisition and other underwriting expenses at Hanover decreased $1.9
million, to $46.8 million, primarily due to decreased commission and
assessment expenses reflecting the reapportionment of a involuntary pool and an
increase in deferrable costs attributable to premiums assumed in a
reinsurance contract. The reapportionment resulted in a decrease in Hanover's
participation in an involuntary pool that currently has operating losses.
Citizens' policy acquisition and other underwriting expenses increased $1.6
million, to $37.6 million in the third quarter of 1996. The increase is
primarily attributable to the increase in net earned premium and expenses
associated with an ongoing policy administration technology project, partially
offset by decreases in employee related expenses and commissions.
Commercial Lines of Business
The commercial lines of business represented 38.6% and 39.9% of total net
premiums earned in the third quarter of 1996 and 1995, respectively.
Hanover Citizens Consolidated
For the Quarters
Ended September 30, 1996 1995 1996 1995 1996 1995
(In millions)
Net premiums earned $112.5 $116.0 $ 69.8 $ 73.4 $182.3 $189.4
Losses and loss
adjustment expenses 83.5 82.5 45.1 39.7 128.6 122.2
Policy acquisition and
other underwriting
expenses 40.3 46.1 18.5 21.4 58.8 67.5
Policyholders' dividends 1.7 1.1 2.0 1.5 3.7 2.6
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $(13.0) $(13.7) $ 4.2 $ 10.8 $ (8.8) $ (2.9)
======= ======= ======= ======= ======= =======
Revenues
Commercial lines of business net premiums earned decreased $7.1 million, to
$182.3 million in the third quarter of 1996. Hanover's commercial lines of
business net premiums earned decreased $3.5 million, to $112.5 million. This
decrease is primarily attributable to a $4.3 million, or 15.7% decrease in
earned premium in the workers' compensation line primarily resulting from rate
decreases of 15.8% since January 1, 1995, in this line. Hanover's withdrawal
from a large voluntary pool on December 1, 1995 also contributed to the
decrease in net premiums earned. This was partially offset by a $2.1 million,
or 8.4%, increase in earned premium, to $27.2 million in the commercial
automobile line due to a 2.9% increase in policies in force. Citizens'
commercial lines of business net premiums earned decreased $3.6 million, or
4.9%, to $69.8 million in the third quarter of 1996. This decrease was
primarily attributable to rate decreases in the workers' compensation line at
Citizens as a result of continuing competition in this line in Michigan. Rates
in the workers' compensation line at Citizens were decreased 8.5%, 7.0% and
6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively.
Continued competitive conditions in the workers' compensation line at both
Hanover and Citizens may result in future price decreases that will impact
growth in this line. In addition, Hanover's premium growth in the commercial
lines of business may be impacted by continued competitive pricing as a result
of soft market conditions combined with Hanover's effort to maintain its
current underwriting standards.
Page 17
Underwriting results
The commercial lines of business underwriting loss increased $5.9 million, to a
loss of $8.8 million in the third quarter of 1996. Hanover's underwriting loss
improved $0.7 million, or 5.1%, to a loss of $13.0 million, while Citizens'
underwriting profit decreased $6.6 million, to $4.2 million in the third
quarter of 1996.
Hanover's commercial lines of business losses and LAE increased $1.0 million,
or 1.2%, to $83.5 million in the third quarter of 1996. This increase is
primarily attributable to a $7.5 million increase, to $16.9 million, in losses
and LAE in the workers' compensation line, reflecting a decrease in favorable
claims experience on prior accident years. A $3.4 million increase in the
commercial automobile line resulting from increased severity also contributed
to the increase in losses and LAE. This was offset by decreased losses in the
voluntary pools resulting from Hanover's withdrawal from a large voluntary pool
on December 1, 1995.
Citizens' underwriting profit decreased $6.6 million, to $4.2 million as a
result of increased loss frequency in the commercial multiple peril and workers
compensation lines. Catastrophe losses decreased $2.3 million to a benefit of
$1.5 million. This benefit resulted from a favorable re-estimation of
catastrophe losses which occurred in the first half of 1996. Losses and LAE in
the commercial multiple peril line increased $2.9 million, or 31.5%, to $12.1
million and losses and LAE in the workers' compensation line increased $1.5
million, or 10.2%, to $16.2 million.
Policy acquisition and other underwriting expenses in the commercial lines of
business decreased $8.7 million, or 12.9%, to $58.8 million in the third
quarter of 1996. Hanover's policy acquisition and other underwriting expenses
decreased $5.8 million, or 12.6%, to $40.3 million, primarily attributable to a
decrease in commissions and assessment expenses resulting from a
reapportionment of an involuntary pool and the decrease in net earned premium.
Citizens' policy acquisition and other underwriting expenses decreased $2.9
million, or 13.6%, to $18.5 million, resulting from decreases in net earned
premium and decreases in employee related expenses and commissions.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
INCOME BEFORE TAXES
Income before taxes for the nine months ended September 30, 1996 increased $4.6
million, or 2.9%, to $162.4 million, compared to the same period in 1995. The
increase in income before taxes is primarily attributable to a $32.0 million
increase in realized gains, primarily related to the sale of equity securities.
This increase reflects the Company's decision during the first quarter of 1996
to increase the proportion of debt securities in the Regional Property and
Casualty segment's portfolio. Excluding net realized gains, income before
taxes decreased $27.4 million, to $116.5 million for the nine months ended
September 30, 1996. Net income in the nine month period of 1996 was
significantly impacted by catastrophes and other severe weather related losses.
This resulted in a $58.1 million increase in losses and loss adjustment
expenses to $1,020.6 million in the nine months ended September 30, 1996.
Catastrophe losses in the nine months ended September 30, 1996 were $58.5
million, compared to $29.1 million in the comparable 1995 period. The increase
in losses and LAE were partially offset by an increase in net investment income
of $13.9 million, or 8.8%, to $171.6 million. This increase was partially a
result of a change in estimated equity in earnings from a limited partnership
of $6.7 million. Net investment income in the nine month period ended September
30, 1995 was unfavorably impacted by a $2.4 million charge related to the pre-
refunding of municipal bonds. Net income during the nine month period ended
September 30, 1996 was also favorably impacted by a $5.7 million arbitrated
settlement from a voluntary pool during the third quarter of 1996.
Page 18
LINES OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 60.8% and 59.6% of total net
premiums earned in the nine months ended September 30, 1996 and 1995,
respectively.
Hanover Citizens Consolidated
For the Nine Months
Ended September 30, 1996 1995 1996 1995 1996 1995
(In millions)
Net premiums earned $442.2 $429.7 $413.3 $399.1 $855.5 $828.8
Losses and loss
adjustment expenses 321.2 279.1 308.1 304.4 629.3 583.5
Policy acquisition and
other underwriting
expenses 146.1 136.8 110.2 108.8 256.3 245.6
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $(25.1) $ 13.8 $ (5.0) $(14.1) $(30.1) $ (0.3)
======= ======= ======= ======= ======= =======
Revenues
Personal lines of business net premiums earned for the nine months ended
September 30, 1996 increased $26.7 million, or 3.2%, to $855.5 million,
compared to $828.8 million in the same period of 1995. Hanover's personal
lines of business net premiums earned increased $12.5 million, or 2.9%, to
$442.2 million during the nine months ended September 30, 1996. This increase
is primarily attributable to price increases in the homeowners line and a 1.6%
increase in policies in force in the homeowners line along with a modest
increase in policies in force in the personal automobile line. Citizens'
personal lines of business net premiums earned increased $14.2 million, or
3.6%, to $413.3 million in the nine months ended September 30, 1996. This
increase is primarily attributable to price increases in the personal
automobile and homeowners lines. Citizens' increase is partially offset by a
2.5% decrease in policies in force in the personal automobile line since
December 31, 1995, attributable to continued strong competition in Michigan.
Underwriting results
The personal lines of business underwriting loss for the nine months ended
September 30, 1996 increased $29.8 million, to a loss of $30.1 million.
Hanover's underwriting results deteriorated $38.9 million to a loss of $25.1
million, while Citizens' underwriting loss improved $9.1 million to a loss of
$5.0 million.
Hanover's personal lines of business losses and LAE increased $42.1 million, or
15.1%, to $321.2 million in the nine months ended September 30, 1996. This
increase is primarily attributable to a $23.9 million increase in losses and
LAE in the homeowners line, resulting from increased catastrophes and severe
weather. Losses and LAE in the personal automobile line increased $14.3
million, or 6.8%, to $223.2 million reflecting primarily increased loss
frequency. Catastrophe losses in the personal lines of business increased
$15.6 million, to $25.9 million in the nine months ended September 30, 1996
from $10.3 million during the comparable 1995 period.
Citizens' underwriting loss decreased primarily as a result of the increase in
net premiums earned in the personal automobile line and homeowners line of $8.6
million and $4.5 million, respectively. Favorable claims experience on current
and prior years resulted in a $17.7 million decrease in losses and LAE in the
personal automobile line. This decrease was offset by a $20.9 million increase
in losses and LAE in the homeowners line as a result of increases in
catastrophes of $8.5 million in this line.
Policy acquisition and other underwriting expenses in the personal lines of
business increased $10.7 million, or 4.4%, to $256.3 million in the nine months
ended September 30, 1996. This increase is primarily attributable to an
increase of $9.3 million, or 6.8%, to $146.1 million at Hanover for the nine
months ended September 30, 1996. This increase is due to increases in net
earned premium, a $3.3 million increase in group business expenses and a $2.2
million increase in expenses
Page 19
associated with the policy administration technology project. Policy
acquisition and other underwriting expenses in the personal lines of business
at Citizens increased $1.4 million, to $110.2 million for the nine months ended
September 30, 1996. This increase is primarily attributable to increases in net
earned premium and expenses associated with an ongoing policy administration
technology project, partially offset by decreases in employee related expenses.
Commercial Lines of Business
The commercial lines of business represented 39.2% and 40.4% of total net
premiums earned in the nine months ended September 30, 1996 and 1995,
respectively.
Hanover Citizens Consolidated
For the Nine Months
Ended September 30, 1996 1995 1996 1995 1996 1995
(In millions)
Net premiums earned $338.9 $353.6 $213.1 $208.6 $552.0 $562.2
Losses and loss
adjustment expenses 238.3 252.0 153.0 127.0 391.3 379.0
Policy acquisition and
other underwriting
expenses 128.4 140.8 52.1 56.2 180.5 197.0
Policyholders' dividends 3.1 2.8 5.6 4.2 8.7 7.0
------- ------- ------- ------- ------- -------
Underwriting (loss)
profit $(30.9) $(42.0) $ 2.4 $ 21.2 $(28.5) $(20.8)
======= ======= ======= ======= ======= =======
Revenues
Commercial lines of business net premiums earned for the nine months ended
September 30, 1996 decreased $10.2 million, or 1.8%, to $552.0 million.
Hanover's commercial lines of business net premiums earned decreased $14.7
million, or 4.2%, to $338.9 million. This decrease is primarily attributable to
Hanover's withdrawal from a large voluntary pool on December 1, 1995, and to
rate decreases of 15.8% since January 1, 1995, in the workers compensation
line. Citizens' commercial lines of business net premiums earned increased
$4.5 million, or 2.2%, to $213.1 million in the nine months ended September 30,
1996. The increase is primarily attributable to a 9.5% increase in policies in
force in the commercial multiple peril line since December 31, 1995. This
growth continues to be offset by rate reductions in the workers compensation
line as a result of continuing competition in this line. Rates in the
workers' compensation line at Citizens were decreased 8.5%, 7.0% and 6.4%
effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively.
Underwriting results
The commercial lines of business underwriting loss for the nine months ended
September 30, 1996 increased $7.7 million, or 37.0% to a loss of $28.5 million.
Hanover's underwriting loss improved $11.1 million, or 26.4%, to a loss of
$30.9 million and Citizens' underwriting profit decreased $18.8 million, to a
profit of $2.4 million in the nine months ended September 30, 1996.
Hanover's commercial lines of business losses and LAE decreased $13.7 million,
or 5.4%, to $238.3 million in the nine months ended September 30, 1996. This
improvement is primarily attributable to a decrease of $8.7 million in the
commercial automobile line as a result of favorable claims experience on the
current and prior years and an $23.1 million decrease in losses in LAE
resulting from the withdrawal of a large voluntary pool. However, losses and
LAE in the workers' compensation line increased $7.9 million, to $40.7 million,
primarily due to an increase in claims severity and a decrease in favorable
claims experience on prior accident years. Commercial multiple peril losses
and LAE increased $4.3 million, to $114.9 million due to unfavorable claims
experience on prior accident years and an increase in catastrophes from $5.8
million in 1995 to $11.3 million in 1996.
Citizens' underwriting profit decreased primarily due to increased claims
activity in the commercial multiple peril line, resulting from severe weather
and catastrophe losses which adversely impacted this line. Commercial multiple
peril losses
Page 20
and LAE increased $15.4 million, or 53.1%, to $44.4 million in the nine months
ended September 30, 1996. Catastrophe losses were $1.5 million in this lines of
business during the nine months ended September 30, 1996 compared to $0.8
million in the comparable period of 1995.
Policy acquisition and other underwriting expenses in the commercial lines of
business decreased $16.5 million, or 8.4%, to $180.5 million in the nine
months ended September 30, 1996. Hanover's policy acquisition expenses and
other underwriting expenses decreased $12.4 million, or 8.8%, to $128.4
million, primarily attributable to the decrease in net earned premium and a
decrease in commissions and assessment expenses resulting from the
reapportionment of an involuntary pool. This was partially offset by a $1.4
million increase associated with the policy administration technology project.
Citizens' policy acquisition and other underwriting expenses in the commercial
lines of business decreased $4.1 million, or 7.3%, to $52.1 million, primarily
attributable to decreases in employee related expenses, partially offset by the
effect of increases in net earned premium.
INVESTMENT RESULTS
Net investment income before taxes increased $13.9 million, or 8.8%, to $171.6
million during the first nine months of 1996 compared to $157.7 million in the
comparable period of 1995. This increase was partially as a result of a change
in estimated equity in earnings from a limited partnership of $6.7 million.
Net investment income in 1995 was adversely impacted by a $2.4 million charge
related to the pre-refunding of municipal bond securities. Average yields on
debt securities remained constant at 6.3% for both nine month periods. Net
investment income after taxes increased $11.6 million, to $138.9 million,
primarily attributable to the increase in tax-exempt debt securities. During
the first quarter of 1996, the Regional Property and Casualty segment revised
its investment strategy, resulting in the sale of a substantial portion of its
equity portfolio and the purchase of tax-exempt securities. This is consistent
with this segment's strategy of maximizing after-tax net investment income. As
a result of the sale of equity securities, the Regional Property and Casualty
segment had realized gains of $45.9 million during the nine months ended
September 30, 1996, compared to realized gains of $13.9 million in 1995.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Regional Property and Casualty segment maintains reserves to provide for
its estimated ultimate liability for losses and loss adjustment expenses with
respect to reported and unreported claims incurred as of the end of each
accounting period. These reserves are estimates, involving actuarial
projections at a given point in time, of what management expects the ultimate
settlement and administration of claims will cost based on facts and
circumstances then known, predictions of future events, estimates of future
trends in claim severity and judicial theories of liability and other factors.
The inherent uncertainty of estimating insurance reserves is greater for
certain types of property and casualty insurance lines, particularly workers'
compensation and other liability lines, where a longer period of time may
elapse before a definitive determination of ultimate liability may be
made, where the technological, judicial and political climates involving these
types of claims are changing.
Page 21
The Regional Property and Casualty segment regularly updates its reserve
estimates as new information becomes available and further events occur which
may impact the resolution of unsettled claims. Changes in prior reserve
estimates are reflected in results of operations in the year such changes are
determined to be needed and recorded. The table below provides a
reconciliation of the beginning and ending reserve for unpaid losses and LAE as
follows:
For the nine months ended September 30, (In millions) 1996 1995
Reserve for losses and LAE, beginning of period $2,896.0 $2,821.7
Incurred losses and LAE, net of
reinsurance recoverable:
Provision for insured events of the current year 1,100.9 1,042.8
Decrease in provision for insured
events of prior years (80.3) (80.4)
--------- ---------
Total incurred losses and LAE 1,020.6 962.4
--------- ---------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to
insured events of current year 516.0 428.0
Losses and LAE attributable to
insured events of prior years 504.7 491.0
--------- ---------
Total payments 1,020.7 919.0
--------- ---------
Change in reinsurance recoverable on unpaid losses (35.6) 7.9
--------- ---------
Reserve for losses and LAE, end of period $2,860.3 $2,873.0
========= =========
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $80.3 million and $80.4 million for
the nine month periods ended September 30, 1996 and 1995, respectively.
Citizens' favorable development increased $9.6 million, to $26.0 million,
primarily attributable to reduced medical costs in the personal automobile
line. Favorable development at Hanover during the nine month period decreased
$9.7 million, to $54.3 million, primarily attributable to unfavorable
development in the commercial multiple peril lines. During the third quarter
of 1996, Hanover's favorable development decreased $12.6 million, to $13.0
million, primarily attributable to decreased favorable development in the
workers compensation and commercial multiple peril lines. Although Hanover is
experiencing decreases in favorable development in the workers compensation and
commercial multiple peril lines, Hanover continues to experience increased
favorable development in the personal automobile and commercial automobile
lines. The Company expects reduced favorable development at Hanover to
continue to impact future earnings.
The Regional Property and Casualty segment regularly reviews its reserving
techniques, its overall reserving position and its reinsurance. Based on (i)
review of historical data, legislative enactment, 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) periodic estimates of
required reserves by an independent actuarial consulting firm, 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.
Page 22
Corporate Risk Management Services
The following table summarizes the results of operations for the
Corporate Risk Management Services ("CRMS") lines of business for the
periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
Premiums and premium
equivalents
Premiums $ 75.7 $ 70.4 $224.6 $202.4
Premium equivalents 145.9 130.2 432.4 379.3
-------- -------- -------- --------
Total premiums and
premium equivalents $221.6 $200.6 $657.0 $581.7
======== ======== ======== ========
Revenues
Premiums $ 75.7 $ 70.4 $224.6 $202.4
Net investment income 5.8 4.9 16.0 12.8
Net realized gains 0.1 0.2 0.2 0.5
Other income 9.1 6.5 26.3 20.1
-------- -------- -------- --------
Total revenues 90.7 82.0 267.1 235.8
Policy benefits,
claims and losses 52.5 47.0 158.0 143.1
Policy acquisition
expenses 0.8 0.7 2.3 2.0
Other operating
expenses 33.7 29.2 95.6 80.8
-------- -------- -------- --------
Income before taxes $ 3.7 $ 5.1 $11.2 $ 9.9
======== ======== ======== ========
Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995
Income before taxes decreased $1.4 million, or 27.5%, to $3.7 million in the
third quarter of 1996 compared to the third quarter of 1995, primarily due to
increases in other operating expenses, partially offset by growth in ASO fees.
Premium growth in the Company's fully insured group dental, reinsurance and
group life product lines was offset by unfavorable claims experience during
the quarter.
Premiums increased $5.3 million, or 7.5%, to $75.7 million in the third quarter
of 1996, primarily due to increases in fully insured group dental, reinsurance
and group life product lines totaling $6.6 million. These increases were
partially offset by decreases of $1.2 million in full indemnity medical
products.
Net investment income increased $0.9 million, or 18.4% in the third quarter of
1996, primarily due to income earned on proceeds from the Company's October,
1995 initial public offering.
Other income increased $2.6 million, or 40%, to $9.1 million in the third
quarter of 1996, due primarily to growth in ASO contract fees.
Policy benefits, claims and losses increased $5.5 million, or 11.7%, to $52.5
million in the third quarter of 1996 compared to the same period in 1995. This
increase is principally attributable to premium growth, as noted above, and to
unfavorable loss experience in the fully insured group dental, group life, full
indemnity medical and accidental death and dismemberment products,
partially offset by favorable loss experience in the risk sharing product
lines.
Other operating expenses increased $4.5 million, or 15.4%, to $33.7 million in
the third quarter of 1996, primarily due to increases in commissions and claims
processing expenses to cover growth in premiums and claims volume.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
Income before taxes increased $1.3 million, or 13.1%, to $11.2 million in the
first nine months of 1996 compared to the same period in 1995. This increase
is primarily attributable to premium growth in the Company's fully insured
group dental, group life and reinsurance product lines, partially offset by
increases in policy benefits and operating expenses.
Premiums increased $22.2 million, or 11.0%, to $224.6 million in the
first nine months of 1996, primarily due to increases in fully insured group
dental, group life, reinsurance and stop loss product lines totaling $21.8
million. These increases were partially offset by a decrease of $1.7 million
in fully insured medical premiums.
Page 23
Net investment income increased $3.2 million, or 25.0%, to $16.0 million in the
first nine months of 1996, due to growth in invested assets, and to income
earned on proceeds from the Company's October, 1995 initial public offering.
Other income increased $6.2 million, or 30.8%, to $26.3 million in the first
nine months of 1996, due primarily to growth in fees from ASO contracts.
Policy benefits, claims and losses increased $14.9 million, or 10.4%, to $158.0
million in the first nine months of 1996 compared to the same period in 1995.
This increase is principally related to increased premium growth. Unfavorable
loss experience in the fully insured group dental, reinsurance, fully
insured medical and accidental death and dismemberment product lines was offset
by favorable experience in the group life, stop loss and risk sharing product
lines.
Other operating expenses increased $14.8 million, or 18.3%, to $95.6 million
for the nine months ended September 30, 1996, due primarily to increases in
commissions, claims processing expenses and field office expenses, resulting
from the increased volume of both premiums and claims.
Retirement and Asset Management
Retail Financial Services
The following table summarizes the results of operations for the
Retail Financial Services lines of business for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
Revenues
Premiums $ 19.2 $ 17.5 $ 77.2 $81.7
Fees 45.9 39.5 132.8 116.5
Net investment income 65.6 57.5 188.8 168.4
Net realized gains (losses) (4.5) 3.3 (4.7) 1.4
Other income 7.6 5.2 21.2 15.3
------- ------- ------- -------
Total revenues 133.8 123.0 415.3 383.3
Policy benefits, claims and
losses 69.5 73.5 230.1 233.4
Policy acquisition expenses 13.7 12.4 42.7 43.4
Other operating expenses 31.7 25.2 88.5 78.8
------- ------- ------- -------
Income before taxes $ 18.9 $ 11.9 $ 54.0 $ 27.7
======= ======= ======= =======
Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995
Income before taxes increased $7.0 million, or 58.8%, to $18.9 million in the
third quarter of 1996 compared to the third quarter of 1995. This increase was
primarily attributable to growth in variable products' fee revenue, income
earned on the proceeds from the October, 1995 initial public offerings and a
decrease in policy benefits. These increases were partially offset by realized
losses on sales of investments and increased short-term borrowing costs.
Premiums increased $1.7 million, or 9.7%, to $19.2 million, during the third
quarter of 1996. This increase was primarily due to a $1.3 million increase in
the disability income product line resulting from the timing of reinsurance
contracts in 1995.
The increase in fee revenue of $6.4 million, or 16.2%, to $45.9 million in the
third quarter of 1996 is due to additional deposits and appreciation on
variable products' account balances. Fees from annuities increased $4.1
million, or 40.2%, to $14.3 million in the third quarter of 1996. Fees from
variable universal life policies increased $2.5 million, or 28.1%, to $11.4
million for the third quarter of 1996
Net investment income increased $8.1 million, or 14.1%, to $65.6 million in the
third quarter of 1996 compared to the third quarter of 1995 resulting primarily
from $5.2 million in income earned on proceeds from the Company's October, 1995
initial public offerings. Additionally, increases in repurchase agreements
used to finance additions to the investment portfolio have resulted in
increased investment income.
Net realized gains of $3.3 million for the quarter ended September 30, 1995
decreased $7.8 million to net realized losses of $4.5 million for the quarter
ended September 30, 1996. This change is principally related to $3.5 million
of losses on
Page 24
disposals of fixed maturities during the third quarter of 1996 versus $3.3
million of gains on disposals of fixed maturities for the third quarter of
1995, due to less favorable market interest rate conditions in the third
quarter of 1996.
Policy benefits, claims, and losses decreased $4.0 million, or 5.4%, to $69.5
million in the third quarter of 1996 compared to the same period in 1995. This
resulted primarily from $2.8 million of reserve strengthening in the disability
insurance line in 1995 and improved morbidity experience in this line during
1996.
Other operating expenses increased $6.5 million, or 25.8%, to $31.7 million for
the quarter ended September 30, 1996. This increase was primarily attributable
to $4.7 million of additional interest expense in 1996 relating to short-term
debt.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
Income before taxes increased $26.3 million, or 94.9%, to $54.0 million in the
first nine months of 1996 compared to the same period in 1995. This increase
was primarily attributable to growth in variable products' fee revenue, income
earned on the proceeds from the October, 1995 initial public offerings and
income on pre-invested assets, partially offset by increased short-term
borrowing costs.
The decrease in premiums of $4.5 million, or 5.5%, to $77.2 million in the
first nine months of 1996 is primarily due to the Company's shift in focus from
traditional life insurance products to variable life insurance and annuity
products. Premiums from traditional life products decreased $3.9 million, or
7.0%, to $51.6 million in the first nine months of 1996. Premiums from
individual health products decreased $0.8 million, or 3.1%, to $25.4 million in
1996.
The increase in fee revenue of $16.3 million, or 14.0%, to $132.8 million in
the first nine months of 1996 is due to additional deposits and appreciation on
variable products account balances. Fees from annuities increased $14.2
million, or 55.3%, to $39.9 million in 1996. Fees from variable universal life
policies increased $5.9 million, or 22.8%, to $31.8 million in the first nine
months of 1996. These increases were partially offset by a continued decline
in fees from non-variable universal life of $3.8 million. The Company expects
fees on this product to decrease as policies in force and related contract
values decline.
Net investment income increased $20.4 million, or 12.1%, to $188.8 million in
the first nine months of 1996 primarily from $13.6 million in income earned on
proceeds from the Company's October, 1995 initial public offerings.
Additionally, increases in repurchase agreements used to finance additions to
the investment portfolio have resulted in a significant increase in investment
income.
Policy benefits, claims, and losses decreased $3.3 million, or 1.4%, to $230.1
million in the first nine months of 1996 compared to the same period in 1995.
Decreases in individual health and non-variable universal life of $4.5 million
and $3.5 million, respectively, resulted from improved morbidity and mortality
experience in 1996. These decreases were partially offset by an increase in
variable products' policy benefits of $3.0 million, which related primarily to
growth in these product lines.
Other operating expenses increased $9.7 million, or 12.3%, to $88.5 million for
the nine months ended September 30, 1996. This increase was primarily
attributable to $9.0 million of additional interest expense in 1996 relating to
short-term debt.
Page 25
Institutional Services
The following table summarizes the results of operations for the
Institutional Services segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
(In millions) September 30, September 30,
1996 1995 1996 1995
Revenues
Fees, premiums,
non-insurance and other
income <FN1> $6.4 $6.3 $23.6 $31.0
Net investment income
GICs 22.5 36.3 76.2 118.7
Other 29.5 29.2 86.3 85.1
Net realized gains 5.4 4.5 12.5 8.3
Gain on sale of mutual
fund processing business 0.0 0.0 0.0 20.7
----- ----- ----- -----
Total revenues 63.8 76.3 198.6 263.8
Policy benefits, claims and
losses
GICs 20.3 33.2 71.0 107.8
Other 17.6 19.9 52.4 60.5
Policy acquisition expenses 0.7 0.7 2.1 2.3
Other operating expenses 12.5 13.5 34.8 53.2
----- ----- ----- -----
Income before taxes $12.7 $9.0 $38.3 $40.0
===== ===== ===== =====
<FN>
<FN1>
Fees, premiums and non-insurance income includes fees from
retirement services, mutual fund services, institutional 401(K)
recordkeeping services, and other miscellaneous non-insurance related
fees. In March 1995, the Company sold its mutual fund processing
business.
</FN>
Quarter Ended September 30, 1996 compared to Quarter Ended September
30, 1995
Income before taxes increased $3.7 million, or 41.1%, to $12.7 million
for the third quarter of 1996 compared to the third quarter of 1995.
This increase was primarily attributable to a decline in other policy
benefits, claims and losses of $2.3 million as a result of
cancellations of defined benefit and defined contribution plans.
Additionally, a decrease of $1.0 million in other operating expenses
resulted from exiting certain unprofitable businesses in 1995. An
increase in realized investment gains of $0.9 million was offset by a
decline in the interest margins on GICs of $0.9 million, due to
declining GIC deposits.
Net investment income related to GICs and interest credited to GIC
contractholders have declined as a result of declining GIC deposits
due to the downgrading in March 1995 of FAFLIC's S&P
Rating to A+ (Good). As a result, sales of traditional GICs have
substantially ceased. Management expects GIC deposits and related
income to continue to decline.
Net realized gains increased $0.9 million, to $5.4 million in the
third quarter of 1996 primarily due to increased gains on the sale of
real estate investments of $7.2 million, partially offset by
additional losses of $4.5 million on sales of fixed maturity
investments and to increased mortgage loan impairments of $2.0
million.
Other policy benefits, claims and losses consist primarily of benefits
provided by the Company's defined contribution and defined benefit
plans, including annuity benefits for certain defined benefit plan
participants electing that option. Other policy benefits, claims and
losses decreased $2.3 million, or 11.6%, to $17.6 million for the
third quarter of 1996, primarily due to reductions in interest
credited to participants resulting from the aforementioned
cancellations.
Other operating expenses decreased $1.0 million, or 7.4%, to $12.5
million for the third quarter of 1996. This decrease was primarily
attributable to exiting certain unprofitable recordkeeping businesses
in 1995.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended
September 30, 1995
Income before taxes decreased $1.7 million, or 4.3%, to $38.3 million
for the nine months ended September 30, 1996 compared to the nine
months ended September 30, 1995. This decrease was primarily
attributable to the sale of the Company's mutual fund processing
business in March 1995, resulting in a pre-tax gain of $20.7 million,
partially offset by a pre-tax operating loss from that business of
$4.8 million for the first nine months of 1995. Also, a non-recurring
$4.8 million contingent payment related to the sale was received in
1996 and included in other income. Additionally, other policy
benefits, claims and losses declined $8.1 million as a result of
defined benefit and defined contribution plan cancellations and
favorable mortality experience in the group annuity line. A decline
in the interest margins on GICs of $5.7 million, due to declining GIC
deposits was partially offset by an increase in realized investment
gains of $4.2 million.
Page 26
Fees, premiums, non-insurance and other income decreased $7.4 million,
or 23.9%, to $23.6 million in the first nine months of 1996. This
decrease was primarily attributable to a $13.6 million decrease in
revenues from the mutual fund processing business, partially offset by
the 1996 receipt of a non-recurring $4.8 million contingent payment
related to the sale. Additionally, fee income increased $1.3 million
from the appreciation of separate account balances in related defined
benefit and defined contribution plans.
Net investment income related to GICs and interest credited to GIC
contractholders have declined during the first nine months of 1996 as
a result of the aforementioned discontinuation of sales of traditional
GICs. Other net investment income increased $1.2 million in the first
nine months of 1996, primarily due to income earned on proceeds from
the Company's October, 1995 initial public offering.
Net realized gains increased $4.2 million, to $12.5 million in the
first nine months of 1996. This change resulted primarily from
increased gains from sales of real estate properties of $9.8 million,
as well as decreases in impairments of other invested assets totaling
$0.6 million. These increases were partially offset by losses on
sales of bonds of $7.2 million.
Other policy benefits, claims and losses consist primarily of benefits
provided by the Company's defined contribution and defined benefit
plans, including annuity benefits for certain defined benefit plan
participants electing that option. Other policy benefits, claims and
losses for defined benefit and defined contribution plans declined
from $60.5 million in 1995 to $52.4 million in 1996. This was
primarily due to reductions in the interest credited to participants
resulting from the aforementioned cancellations, and to favorable
mortality experience in the group annuity line.
Other operating expenses decreased $18.6 million, or 35.0%, to $34.8
million in the first nine months of 1996. This decrease was primarily
attributable to the sale of the mutual fund processing business, which
incurred $18.4 million of operating expenses in the first nine months
of 1995.
Allmerica Asset Management
The following table summarizes the results of operations for the
Allmerica Asset Management segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
Fees and other income:
External $0.3 $0.3 $0.8 $0.7
Internal 1.4 0.9 5.4 2.6
----- ----- ----- -----
Total revenues 1.7 1.2 6.2 3.3
Other operating expenses 1.7 0.6 5.7 1.6
----- ----- ----- -----
Income before taxes $0.0 $0.6 $0.5 $1.7
===== ===== ===== =====
Since 1994, the Company has provided investment advisory and
subadvisory services, primarily to affiliates, through its registered
investment advisor, Allmerica Asset Management ("AAM"). In the second
quarter of 1996, AAM finalized contracts with two related parties,
FAFLIC and AFLIAC, to provide investment advisory services at cost.
The internal fees and corresponding operating expenses related to
these contracts totaled $0.7 million for the quarter ended, and $3.0
million for the nine months ended, September 30, 1996, respectively.
Page 27
Corporate
The following table summarizes the results of operations for the
Corporate segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1996 1995 1996 1995
Revenues
Investment and other
income $0.7 $0.0 $2.2 $0.0
Realized loss (0.2) 0.0 (0.4) 0.0
----- ----- ----- -----
Total revenues 0.5 0.0 1.8 0.0
Other operating expenses 4.5 0.0 14.0 0.0
----- ----- ------ -----
Loss before taxes $(4.0) $0.0 $(12.2) $0.0
===== ===== ====== =====
This segment consists primarily of $43.6 million of cash, investments,
and other assets remaining from the $52.9 million in net proceeds
retained by the holding company in the Company's initial public
offering. These investments earned $2.2 million in net investment
income in the first nine months of 1996. The segment incurred $14.0
million of other operating expenses in 1996 primarily including $11.4
million in interest expense on the Company's 7 5/8% Senior Debentures
issued in October 1995.
Investment Portfolio
The Company had investment assets diversified across several asset classes, as
follows:
September 30, 1996<FN1> December 31, 1995<FN1>
Carrying % of Total Carrying % of Total
Value Carrying Value Value Carrying Value
(Dollars in millions)
Fixed maturities<FN2> $8,181.6 80.4% $8,197.3 78.1%
Equity securities<FN2> 438.0 4.3 517.2 4.9
Mortgages 768.3 7.5 856.5 8.2
Policy loans 364.2 3.6 365.7 3.5
Real estate 145.4 1.4 179.6 1.7
Cash and cash equivalents 170.6 1.7 307.1 2.9
Other invested assets 111.4 1.1 71.9 0.7
---------- -------- ---------- --------
Total $10,179.5 100.0% $10,495.3 100.0%
=========== ======== ========== =========
<FN>
<FN1>
Includes Closed Block invested assets with a carrying value of $768.1 million
and $775.1 million at September 30, 1996 and December 31, 1995, respectively.
<FN2>
The Company carries the fixed maturities and equity securities in its
investment portfolio at market value.
</FN>
Total investment assets decreased $315.8 million, or 3.0%, to $10.2 billion
during the first nine months of 1996. This decrease is primarily attributable
to a decline in invested assets related to GIC contracts, and to market value
depreciation in the fixed maturities portfolio, partially offset by increased
investments financed with repurchase agreements. Equity securities decreased
$79.2 million, or 15.3%, to $438.0 million, as a result of the Regional
Property and Casualty segment's shift in portfolio holdings from equity
securities to tax-exempt fixed maturity securities. Despite this portfolio
shift and an increase in fixed maturities financed with repurchase agreements
in 1996, fixed maturities decreased $15.7 million, or 0.2%, due primarily
to market value depreciation of $185.7 million and to financing of net GIC
withdrawals. Additionally, mortgage loans decreased $88.2 million, or 10.3%,
to $768.3 million caused primarily by loan repayments. The real estate
portfolio decreased $34.2 million, or 19.0%, to $145.4 million during the first
nine months of 1996 due to sales of these properties. The increase in other
invested assets of $39.5 million, or 54.9% to $111.4 million primarily relates
to the third quarter purchase of limited partnerships by FAFLIC. Cash and
cash equivalents decreased $136.5 million, or 44.4%, to $170.6 million.
The Company's fixed maturity portfolio is comprised of primarily investment
grade corporate securities, tax-exempt issues of state and local governments,
U.S. government and agency securities and other issues. Investment grade
securities comprised 85.4% and 88.7% of the Company's total fixed maturity
portfolio at September 30, 1996 and December 31, 1995, respectively. Although
management expects that a substantial portion of new funds will be invested in
investment grade fixed maturities, the Company may invest a portion of new
funds in below investment grade fixed maturities or equity interests, which
management anticipates will not become a significant portion of its total
investment portfolio.
Page 28
The following table illustrates asset valuation allowances and additions to or
deductions from such allowances for the periods indicated.
Other
Invested
(Dollars in millions) Mortgages Real Estate Assets Total
Year Ended December 31, 1995
Beginning balance $47.2 $22.9 $3.7 $73.8
Provision (benefits) 1.5 (0.6) 0.0 0.9
Write-offs<FN1> (14.9) (2.7) 0.0 (17.6)
-------- -------- -------- --------
Ending balance $33.8 $19.6 $3.7 $57.1
Valuation allowance as a
percentage of carrying value
before reserves 3.8 % 9.8 % 4.9 % 4.9 %
Nine months ended September
30, 1996
Provision (benefits) 2.4 (1.2) 0.0 1.2
Write-offs<FN1> (4.9) 0.0 0.0 (4.9)
-------- -------- -------- --------
Ending balance
$31.3 $18.4 $3.7 $53.4
Valuation allowance as a
percentage of carrying value
before reserves 3.9 % 11.2 % 3.2 % 5.0 %
<FN>
<FN1>
Write-offs reflect asset sales, foreclosures and forgiveness of debt upon
restructuring.
</FN>
The decrease in write-offs of mortgages during 1996 as compared to
1995 reflects a decrease in foreclosures, debt restructuring
agreements and discounted payoffs, as well as the improved real estate
market.
Income Taxes
AFC and its life insurance subsidiaries (including certain
noninsurance 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 nonlife insurance company
subgroup. The consolidation of these subgroups is subject to certain
statutory restrictions on the percentage of eligible nonlife tax
losses that can be applied to offset life company taxable income.
Allmerica P&C and its subsidiaries file a separate United States
federal income tax return.
For the nine months ended September 30, 1995, FAFLIC, as a mutual
insurance company until October 1995, was required to adjust its
deduction for policyholder dividends by the differential earnings
amount under Section 809 of the Internal Revenue Code. This amount
was computed, for each tax year, by multiplying the average equity
base of the FAFLIC/AFLIAC consolidated group, as determined for tax
purposes, by the estimate of an excess of an imputed earnings rate
over the average mutual life insurance companies' earnings rate. The
differential earnings amount for each tax year was subsequently
recomputed when actual earnings rates were published by the IRS. As a
stock company, AFC, including its life insurance subsidiaries, is no
longer required to reduce its policyholder dividend deduction by the
differential earnings amount. The differential earnings amount in the
current period related to an adjustment for the 1994 tax year based on
the actual average mutual life insurance companies' earnings estimated
rate issued by the IRS in 1996.
Provision for federal income taxes before minority interest was $21.2
million during the third quarter of 1996 compared to $32.8 million
during the same period in 1995. These provisions resulted in
consolidated effective federal tax rates of 23.8% and 36.6%,
respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 28.4% and 63.4% during the third
quarter of 1996 and 1995, respectively. The effective tax rates for
the Regional Property and Casualty subsidiaries were 21.3% and 25.3%
during the third quarter of 1996 and 1995, respectively. The
reduction in the rate for FAFLIC resulted primarily from a
differential earnings benefit of $2.4 million during the third quarter
of 1996 compared to a differential earnings charge of $6.4 million for
the same period in 1995. The slight decrease in the rate for the
Regional Property and Casualty subsidiaries reflects a higher
underwriting loss and a greater proportion of pre-tax income from
tax-exempt bonds in 1996, and to reserves provided for revisions in
estimated prior tax liabilities in the third quarter of 1995.
Provision for federal income taxes before minority interest was $58.0
million during the first nine months of 1996 compared to $75.2 million
during the same period in 1995. These provisions resulted in
consolidated effective federal tax rates of 22.8% and 31.8%,
respectively. The effective tax rates for AFLIAC and FAFLIC and its
non-insurance subsidiaries were 27.9% and 50.8% during the first nine
months of 1996 and 1995, respectively. The effective tax rates for
the Regional Property and Casualty subsidiaries were 20.0% and 22.2%
during the first nine months of 1996 and 1995, respectively. The
reduction in the rate for FAFLIC resulted primarily from a
differential earnings benefit of $8.3 million in the first nine months
of 1996
Page 29
compared to a differential earnings charge of $7.7 million in the first nine
months of 1995. The slight decrease in the rate for the Regional Property and
Casualty subsidiaries reflects a higher underwriting loss and a greater
proportion of pre-tax income from tax-exempt bonds in 1996, and to reserves
provided for revision in estimated prior tax liabilities in the first nine
months of 1995.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient
cash flows to meet the cash requirements of business operations. As a
holding company, AFC's primary source of cash is dividends from its
insurance subsidiaries. However, dividend payments to AFC by its
insurance subsidiaries are subject to limitations imposed by state
regulators, such as the requirement that cash dividends be paid out of
unreserved and unrestricted earned surplus and restrictions on the
payment of "extraordinary" dividends, as defined.
Sources of cash for the Company's insurance subsidiaries are from
premiums and fees collected, investment income and maturing investments.
Primary cash outflows are paid benefits, claims losses and loss
adjustment expenses, policy acquisition expenses, other underwriting
expenses and investment purchases. Cash outflows related to benefits,
claim losses and loss adjustment expenses can be variable because of
uncertainties surrounding settlement dates for liabilities for unpaid
losses and because of the potential for large losses either
individually or in the aggregate. The Company periodically adjusts its
investment policy to respond to changes in short-term and long-term cash
requirements.
Net cash provided by operating activities was $145.2 million and
$179.7 million for the first nine months of 1996 and 1995,
respectively. This decrease is primarily attributable to the increase
in underwriting losses in the Regional Property and Casualty lines of
business during the first nine months of 1996 which resulted in an
increase in claims payments.
Net cash provided by investing activities was $24.6 million and $11.9
million during the first nine months of 1996 and 1995, respectively.
The increase is primarily attributable to increased sales of
investments used to finance net withdrawals from GICs and increased
investments from maintaining a smaller balance of cash and cash
equivalents. These changes were offset by delayed sales of investments
financed instead with repurchase agreements and a decline in investable cash
generated by operations.
Net cash used for financing activities was $306.3 million during the
nine months ended September 30, 1996 compared to $430.3 used during
the comparable prior year period. This change is due to increases in
short-term debt partially offset by the continued negative financing
cash flows from GIC withdrawals. During 1996, the Company increased
its short-term debt in order to finance additions to the investment
portfolio and maximize investment earnings. These inflows were
partially offset by cash payments on withdrawals from GICs that
exceeded cash received from deposits on these contracts by $548.8
million and $407.7 million in the first nine months of 1996 and 1995,
respectively. Although the Company expects this trend in negative
financing cash flows from GIC withdrawals to continue, particularly in
1996, the Company does not expect GIC withdrawals to have a material
impact on liquidity. Also, cash used to purchase subsidiary common stock
increased $28.9 million, to $42.0 million during the first nine months
of 1996.
On October 16, 1995, FAFLIC converted from a policyholder owned to
stockholder owned insurance company and AFC became the holding company
for FAFLIC. AFC also raised net proceeds of $248.0 million from the
sale of Common Stock and issued $200.0 million principal amount 7 5/8%
Senior Debentures due 2025 with net proceeds to the Company of $197.2
million. The Company will also pay approximately $15.3 million per
year in interest payments on the Senior Debentures. AFC has
sufficient funds at the holding company or available through dividends
from FAFLIC to meet its obligations to pay interest on the Senior
Debentures and dividends, when and if declared by the Board of
Directors, on the common stock. Whether the Company will pay
dividends in the future depends upon the costs of administering a
dividend program as compared to the benefits conferred, and upon the
earnings and financial condition of AFC.
Based on current trends, the Company expects to continue to generate
sufficient positive operating cash to meet all short-term and
long-term cash requirements. The Company maintains a high degree of
liquidity within the investment portfolio in fixed maturity
investments, common stock and short-term investments. FAFLIC and
Allmerica P&C have $100.0 million and $40.0 million available,
respectively, under various committed short-term lines of credit, with
no amounts outstanding at September 30, 1996. FAFLIC and Allmerica
P&C had $55.0 million and $21.7 million, respectively, of commercial
paper borrowings outstanding at September 30, 1996. In addition,
FAFLIC and AFLIAC had $186.2 million and $63.2 million, respectively,
of repurchase agreements outstanding at September 30, 1996 down from
$235.6 million and $171.4 million, respectively, at June 30, 1996.
The repurchase agreements were used to finance the purchase of investments and
are expected to be substantially repaid by the end of the year. The
Company, at its option, could liquidate these investments at any time
and settle the repurchase agreements.
Page 30
Forward-Looking Statements
The Company wishes to caution readers that the following important factors,
among others, in some cases have affected and in the future could affect, the
Company's actual results and could cause the Company's actual results for 1996
and beyond to differ materially from those expressed in any forward-looking
statements made by, or on behalf of, the Company. When used in the MD&A
discussion, the words "believes," "anticipated," "expects" and similar
expressions are intended to identify forward looking statements. See
"Important Factors Regarding Forward-Looking Statements" filed herewith as
Exhibit 99-1 and incorporated herein by reference.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include among others, the following possibilities: (i)
adverse catastrophe experience and severe weather; (ii) adverse loss
development for events the Company insured in prior years or adverse trends in
mortality and morbidity; (iii) heightened competition, including the
intensification of price competition, the entry of new competitors, and the
introduction of new products by new and existing competitors; (iv) adverse
state and federal legislation, including decreases in rates, limitations on
premium levels, increases in minimum capital and reserve requirements, benefit
mandates, and limitations on the ability to manage care and utilization; (v)
changes in interest rates causing a reduction of investment income and in the
market value of interest rate sensitive investments; (vi) failure to obtain new
customers, retain existing customers or reductions in policies in force by
existing customers; (vii) higher service, administrative, or general expense
due to the need for additional advertising, marketing, administrative or
management information systems expenditures; (viii) loss or retirement of key
executives; (ix) increases in medical costs, including increases in
utilization, costs of medical services, pharmaceuticals, durable medical
equipment and other covered items; (x) termination of provider contracts or
renegotiation at less cost-effective rates or terms of payment; (xi) changes in
the Company's liquidity due to changes in asset and liability matching; (xii)
adverse changes in the ratings obtained by independent rating agencies, such as
Moody's, Standard and Poors and A.M. Best; (xiii) lower appreciation on managed
investments, resulting in reduced variable products' and investment management
fees.
Page 31
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX-11 Statement regarding computation of per share earnings
EX-27 Financial Data Schedule
EX-99-1 Important Factors Regarding Forward-Looking Statements
(b) Reports on Form 8K
None.
Page 32
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 November 13, 1996
/s/ John F. O'Brien
John F. O'Brien
President and Chief Executive Officer
Dated November 13, 1996
/s/ Edward J. Parry III
Edward J. Parry III
Vice President, Treasurer and
Principal Accounting Officer
Page 33