FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1998
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: 60,345,396
shares of common stock outstanding, as of August 1, 1998.
40
Total Number of Pages Included in This Document
Exhibit Index is on Page 41
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income 3
Consolidated Balance Sheets 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Interim Consolidated Financial Statements 8 - 14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15 - 37
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions, except per
share data) 1998 1997 1998 1997
REVENUES
Premiums $ 582.1 $ 578.8 $1,159.6 $1,141.1
Universal life and investment
product policy fees 72.7 57.1 142.2 113.4
Net investment income 154.4 170.6 309.5 334.0
Net realized investment
gains (losses) 11.8 (2.0) 41.0 42.0
Other income 35.7 26.4 68.3 56.9
------- ------- -------- --------
Total revenues 856.7 830.9 1,720.6 1,687.4
------- ------- -------- --------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 518.6 508.7 1,025.4 1,001.0
Policy acquisition expenses 115.2 115.3 232.4 230.5
Loss from cession of disability
income business 0.0 0.0 0.0 53.9
Other operating expenses 138.4 130.7 279.0 271.8
Total benefits, losses ------- ------- -------- --------
and expenses 772.2 754.7 1,536.8 1,557.2
------- ------- -------- --------
Income before federal
income taxes 84.5 76.2 183.8 130.2
------- ------- -------- --------
Federal income tax expense
(benefit)
Current 14.1 26.4 43.9 32.4
Deferred 4.3 (7.1) (1.3) (3.4)
------- ------- -------- --------
Total federal income tax expense 18.4 19.3 42.6 29.0
------- ------- -------- --------
Income before minority interest 66.1 56.9 141.2 101.2
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.0) (4.0) (8.0) (6.4)
Equity in earnings (1.8) (15.2) (6.1) (41.2)
------- ------- -------- --------
(5.8) (19.2) (14.1) (47.6)
------- ------- -------- --------
Net income $ 60.3 $ 37.7 $ 127.1 $ 53.6
======= ======= ======== ========
PER SHARE DATA
Basic
Net income $ 1.00 $ 0.75 $ 2.12 $ 1.07
Weighted average shares ======= ======= ======== ========
outstanding 60.0 50.2 59.9 50.2
======= ======= ======== ========
Diluted
Net income $ 1.00 $ 0.75 $ 2.10 $ 1.07
Weighted average shares ======= ======= ======== ========
outstanding 60.5 50.3 60.4 50.3
======= ======= ======== ========
Dividends declared to
shareholders $ 0.05 $ 0.05 $ 0.10 $ 0.10
======= ======= ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
Page 3
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
(In millions, except per share data) 1998 1997
ASSETS
Investments:
Debt securities-at fair value (amortized
cost of $7,562.0 and $7,052.9) $ 7,813.0 $ 7,313.7
Equity securities-at fair value (cost of
$386.4 and $341.1) 574.0 479.0
Mortgage loans 555.2 567.5
Real estate 27.1 50.3
Policy loans 150.4 141.9
Other long-term investments 154.3 148.3
--------- ---------
Total investments 9,274.0 8,700.7
--------- ---------
Cash and cash equivalents 236.0 215.1
Accrued investment income 145.8 142.3
Deferred policy acquisition costs 1,052.7 965.5
Reinsurance receivable on paid and unpaid
losses,benefits and unearned premiums 1,103.6 1,040.3
Premiums, accounts and notes receivable, net 579.9 554.4
Other assets 367.5 368.6
Closed Block assets 796.4 806.7
Separate account assets 12,260.5 9,755.4
--------- ---------
Total assets $25,816.4 $22,549.0
========= =========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits $ 2,622.7 $ 2,598.6
Outstanding claims, losses and loss
adjustment expenses 2,831.7 2,825.1
Unearned premiums 854.8 846.8
Contractholder deposit funds and other
policy liabilities 2,436.2 1,852.7
--------- ---------
Total policy liabilities and accruals 8,745.4 8,123.2
--------- ---------
Expenses and taxes payable 609.5 670.7
Reinsurance premiums payable 58.5 37.7
Short-term debt 46.6 33.0
Deferred federal income taxes 28.0 12.9
Long-term debt 199.5 202.1
Closed Block liabilities 871.4 885.5
Separate account liabilities 12,255.9 9,749.7
--------- ---------
Total liabilities 22,814.8 19,714.8
--------- ---------
Minority interest:
Mandatorily redeemable preferred securities
of a subsidiary trust holding solely junior
subordinated debentures of the Company 300.0 300.0
Common stock 162.2 152.9
--------- ---------
Total minority interest 462.2 452.9
--------- ---------
Commitments and contingencies (Note 9)
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, 60.3 million and
60.0 million shares issued and outstanding,
respectively 0.6 0.6
Additional paid-in capital 1,766.3 1,755.0
Accumulated other comprehensive income 243.6 217.9
Retained earnings 528.9 407.8
--------- ---------
Total shareholders' equity 2,539.4 2,381.3
--------- ---------
Total liabilities and shareholders'
equity $25,816.4 $22,549.0
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
Page 4
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
Six Months Ended
June 30
(In millions) 1998 1997
PREFERRED STOCK
Balance at beginning and end of period $ 0.0 $ 0.0
-------- --------
COMMON STOCK
Balance at beginning and end of period 0.6 0.5
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period 1,755.0 1,382.5
Issuance of common stock 11.3 3.1
Issuance costs of mandatorily redeemable
preferred securities of a subsidiary
trust holding solely junior
subordinated debentures of the Company 0.0 (3.7)
-------- --------
Balance at end of period 1,766.3 1,381.9
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME
NET UNREALIZED APPRECIATION ON INVESTMENTS
Balance at beginning of period 217.9 131.6
Net appreciation on available-for-sale
securities 44.1 24.8
Provision for deferred federal income
taxes (15.7) (8.7)
Minority interest (2.7) (6.2)
-------- --------
Other comprehensive income 25.7 9.9
-------- --------
Balance at end of period 243.6 141.5
-------- --------
RETAINED EARNINGS
Balance at beginning of period 407.8 210.1
Net income 127.1 53.6
Dividends to shareholders (6.0) (5.1)
-------- --------
Balance at end of period 528.9 258.6
-------- --------
Total shareholders' equity $2,539.4 $1,782.5
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
Page 5
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Net income $ 60.3 $ 37.7 $ 127.1 $ 53.6
Other comprehensive income
Net appreciation on
available-for sale
securities 19.0 161.1 44.1 24.8
Provision for deferred
federal income taxes (6.7) (56.4) (15.7) (8.7)
Minority interest (2.0) (32.4) (2.7) (6.2)
------ ------ ------ ------
Other comprehensive income 10.3 72.3 25.7 9.9
------ ------ ------ ------
Comprehensive income $ 70.6 $110.0 $152.8 $ 63.5
====== ====== ====== ======
The accompanying notes are an integral part of
these consolidated financial statements.
Page 6
ALLMERICA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30
(In millions) 1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 127.1 $ 53.6
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Minority interest 14.1 47.6
Net realized gains (42.6) (43.0)
Net amortization and depreciation 15.1 13.7
Loss from cession of disability income
business 0.0 53.9
Deferred federal income taxes (1.4) (3.5)
Change in deferred acquisition costs (86.8) (63.9)
Change in premiums and notes receivable,
net of reinsurance payable (4.0) (2.9)
Change in accrued investment income (3.5) 0.1
Change in policy liabilities and
accruals, net 23.9 (71.1)
Change in reinsurance receivable (63.3) 20.3
Change in expenses and taxes payable (54.9) (36.3)
Separate account activity, net 1.1 0.3
Other, net (0.5) (5.2)
Net cash used in operating -------- --------
activities (75.7) (30.6)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities of
available-for-sale fixed maturities 1,263.5 1,468.6
Proceeds from disposals of equity securities 61.1 121.0
Proceeds from disposals of other investments 49.9 42.9
Proceeds from mortgages matured or collected 92.2 107.9
Purchase of available-for-sale fixed maturities (1,770.3) (1,384.4)
Purchase of equity securities (90.6) (22.0)
Purchase of other investments (118.5) (70.6)
Capital expenditures (3.3) (2.8)
Other investing activities, net (3.9) 0.6
Net cash (used in) provided by -------- --------
investing activities (519.9) 261.2
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds 844.8 125.4
Withdrawals from contractholder deposit funds (259.4) (302.1)
Change in short-term debt 13.6 (4.0)
Change in long-term debt (2.6) 0.0
Net proceeds from issuance of mandatorily
redeemable preferred securities of a subsidiary
trust holding solely junior subordinated
debentures of the Company 0.0 296.3
Proceeds from issuance of common stock 9.8 2.4
Dividends paid to shareholders (6.6) (6.0)
Net cash provided by financing -------- --------
activities 599.6 112.0
-------- --------
Net change in cash and cash equivalents 4.0 342.6
Net change in cash held in the Closed Block 16.9 5.9
Cash and cash equivalents, beginning of period 215.1 178.5
-------- --------
Cash and cash equivalents, end of period $ 236.0 $ 527.0
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
Page 7
ALLMERICA FINANCIAL CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Allmerica
Financial Corporation ("AFC" or the "Company") have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the requirements of Form 10-Q.
The interim consolidated financial statements of AFC include the accounts of
AFC, First Allmerica Financial Life Insurance Company ("FAFLIC"), its
wholly-owned life insurance subsidiary, Allmerica Financial Life Insurance
and Annuity Company ("AFLIAC"), non-insurance subsidiaries (principally
brokerage and investment advisory subsidiaries), and Allmerica Property &
Casualty Companies, Inc. ("Allmerica P&C", a wholly-owned non-insurance
holding company). The Closed Block assets and liabilities at June 30, 1998
and December 31, 1997 are presented in the consolidated financial statements
as single line items. Results of operations for the Closed Block for the
quarter ended and six months ended June 30, 1998 and 1997 are included in
other income in the consolidated financial statements. All significant
intercompany accounts and transactions have been eliminated.
The financial statements reflect minority interest in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The financial statements also reflect
minority interest in Citizens Corporation (an 82.5%-owned non-insurance
holding company subsidiary of Hanover) and its wholly-owned subsidiary,
Citizens Insurance Company of America ("Citizens").
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 1997 consolidated statements of income in order to
conform to the 1998 presentation. The results of operations for the quarter
and six months ended June 30, 1998 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 1997 Annual Report to
Shareholders, as filed on Form 10-K with the Securities and Exchange
Commission.
2. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (Statement No. 133), which
establishes accounting and reporting standards for derivative instruments.
Statement No. 133 requires that an entity recognize all derivatives as
either assets or liabilities at fair value in the statement of financial
position, and establishes special accounting for the following three types
of hedges: fair value hedges, cash flow hedges, and hedges of foreign
currency exposures of net investments in foreign operations. This
statement is effective for fiscal years beginning after June 15, 1999.
The Company believes that the adoption of this statement will not have a
material effect on the results of operations or financial position.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1").
SOP No. 98-1 requires that certain costs incurred in developing internal-use
computer software be capitalized and provides guidance for determining
whether computer software is to be considered for internal use. This
statement is effective for fiscal years beginning after December 15, 1998.
In the second quarter, the Company adopted SOP No.98-1 effective
January 1, 1998, resulting an increase in pre-tax income of $6.2 million.
The adoption of SOP No. 98-1 had no material effect on the results of
operations or financial position for the three months ended March 31, 1998.
In December 1997, the AICPA issued Statement of Position 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" ("SOP No. 97-3"). SOP No. 97-3 provides guidance on when a
liability should be recognized for guaranty fund and other assessments and
how to measure the liability. This statement allows for the discounting of
the liability if the amount and timing of the cash payments are fixed and
determinable. In addition, it provides criteria for when an asset may be
recognized for a portion or all of the assessment liability or paid
assessment that can be recovered through premium tax offsets or policy
surcharges. This statement is effective for fiscal years beginning after
December 15, 1998. The Company believes that the adoption of this
statement will not have a material effect on the results of operations or
financial position.
Page 8
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" (Statement No. 130). Statement
No. 130 establishes standards for the reporting and display of comprehensive
income and its components in a full set of general-purpose financial
statements. All items that are required to be recognized under accounting
standards as components of comprehensive income are to be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This statement stipulates that comprehensive income
reflect the change in equity of an enterprise during a period from
transactions and other events and circumstances from non-owner sources.
This statement is effective for fiscal years beginning after December 15,
1997. The Company adopted Statement No. 130 for the first quarter of
1998, which resulted primarily in reporting unrealized gains and losses
on investments in debt and equity securities in comprehensive income.
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information"(Statement No. 131). This statement establishes standards for
the way that public enterprises report information about operating segments
in annual financial statements and requires that selected information about
those operating segments be reported in interim financial statements. This
statement supersedes Statement No. 14, "Financial Reporting for Segments of
a Business Enterprise". Statement No. 131 requires that all public
enterprises report financial and descriptive information about their
reportable operating segments. Operating segments are defined as components
of an enterprise about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance. This statement is
effective for fiscal years beginning after December 15, 1997. The Company
adopted Statement No. 131 for the first quarter of 1998, which resulted in
certain segment re-definitions which have no impact on the consolidated
results of operations. (See Note 7.)
3. Merger with Allmerica Property & Casualty Companies, Inc.
The merger of Allmerica P&C and a wholly-owned subsidiary of the Company
was consummated on July 16, 1997. Through the merger, the Company acquired
all of the outstanding common stock of Allmerica P&C that it did not already
own in exchange for cash of $425.6 million and approximately 9.7 million
shares of AFC stock valued at $372.5 million. On February 3, 1997, the
Company issued $300.0 million of Series A Capital Securities ("Capital
Securities"). Net proceeds from the offering of approximately $296.3
million funded a portion of the July 16, 1997 acquisition.
The merger has been accounted for as a purchase. Total consideration of
approximately $798.1 million has been allocated to the minority interest in
the assets and liabilities based on estimates of their fair values. The
minority interest acquired totaled $703.5 million. A total of $90.6 million
representing the excess of the purchase price over the fair values of the
net assets acquired, net of deferred taxes, has been allocated to goodwill
and is being amortized over a 40-year period.
The Company's consolidated results of operations include minority interest
in Allmerica P&C prior to July 16, 1997. The unaudited pro forma
information below presents consolidated results of operations as if the
merger and issuance of Capital Securities had occurred at the beginning
of 1997 and reflects adjustments which include interest expense related to
the assumed financing of a portion of the cash consideration paid and
amortization of goodwill.
Page 9
The following unaudited pro forma information is not necessarily indicative
of the consolidated results of operations of the combined Company had the
merger and issuance of Capital Securities occurred at the beginning of
1997, nor is it necessarily indicative of future results.
(Unaudited)
Six Months Ended
June 30,
(In millions) 1997
Revenue $ 1,660.4
=========
Net realized capital gains included in revenue $ 28.1
=========
Income before taxes and minority interest $ 101.0
Income taxes (19.2)
Minority interest:
Distributions on mandatorily redeemable
preferred securities of a subsidiary
trust holding solely junior subordinated
debentures of the Company (8.0)
Equity in earnings (7.9)
---------
Net income $ 65.9
=========
Net income per common share (basic and diluted) $ 1.10
=========
Weighted average shares outstanding( diluted) 59.9
=========
Weighted average shares outstanding(basic) 59.8
=========
4. Significant Transactions
Effective January 1, 1998, the Company entered into an agreement with a
highly rated reinsurer to reinsure the mortality risk on the universal life
and variable universal life blocks of business. This agreement did not
have a material effect on the Company's results of operations or financial
position.
On January 1, 1998, substantially all of the Company's defined benefit,
defined contribution 401(K) and postretirement plans were merged with the
existing benefit plans of FAFLIC. The transfer of benefit plans did not
have a material impact on the results of operations or financial position
of the Company.
5. Federal Income Taxes
Federal income tax expense for the periods ended June 30, 1998 and 1997,
has been computed using estimated effective tax rates. These rates are
revised, if necessary, at the end of each successive interim period to
reflect the current estimates of the annual effective tax rates.
Page 10
6. Closed Block
Included in other income in the Consolidated Statements of Income is a net
pre-tax contribution from the Closed Block of $3.6 million and $6.0 million
for the second quarter and six months ended June 30, 1998 respectively,
compared to $0.5 million and $6.0 million, for the second quarter and six
months ended June 30, 1997, respectively. Summarized financial information
of the Closed Block is as follows:
(Unaudited)
June 30, December 31,
(In millions) 1998 1997
ASSETS
Fixed maturities-at fair value
(amortized cost of $403.0 and
$400.1) $ 416.0 $ 412.9
Mortgage loans 124.9 112.0
Policy loans 214.1 218.8
Cash and cash equivalents 8.1 25.1
Accrued investment income 14.1 14.1
Deferred policy acquisition costs 16.5 18.2
Other assets 2.7 5.6
------- -------
Total assets $ 796.4 $ 806.7
======= =======
LIABILITIES
Policy liabilities and accruals $ 861.3 $ 875.1
Other liabilities 10.1 10.4
------- -------
Total liabilities $ 871.4 $ 885.5
======= =======
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
REVENUES
Premiums $ 9.0 $ 9.7 $ 37.2 $ 39.0
Net investment income 13.2 13.2 26.4 26.7
Net realized investment gains 1.6 0.1 1.6 1.0
------ ------ ------ ------
Total revenues 23.8 23.0 65.2 66.7
------ ------ ------ ------
BENEFITS AND EXPENSES
Policy benefits 19.7 21.8 57.4 59.1
Policy acquisition expenses 0.6 0.5 1.3 1.4
Other operating expenses (0.1) 0.2 0.5 0.2
------ ------ ------ ------
Total benefits and expenses 20.2 22.5 59.2 60.7
------ ------ ------ ------
Contribution from the
Closed Block $ 3.6 $ 0.5 $ 6.0 $ 6.0
====== ====== ====== ======
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.
Page 11
7. Segment Information
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Accumulation. Within these broad areas,
the Company conducts business principally in four operating segments.
Effective January 1, 1998, the Company adopted Statement No. 131. Upon
adoption, the separate financial information of each segment was re-defined
consistent with the way results are regularly evaluated by the chief
operating decision maker in deciding how to allocate resources and in
assessing performance. A summary of the significant changes in reportable
segments is included below.
The Risk Management group includes two segments: Property and Casualty and
Corporate Risk Management Services. The 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 Property and Casualty segment's earnings are
generated in Michigan and the Northeast (Connecticut, Massachusetts,
New York, New Jersey, New Hampshire, Rhode Island, Vermont and Maine).
The Corporate Risk Management Services segment includes group life and
health insurance products and services which assist employers in
administering employee benefit programs and in managing the related risks.
The Retirement and Asset Accumulation group includes two segments:
Allmerica Financial Services and Allmerica Asset Management. The Allmerica
Financial Services segment includes variable annuities, variable universal
life and traditional life insurance products distributed via retail
channels as well as group retirement products, such as defined benefit and
401(K) plans and tax-sheltered annuities distributed to institutions.
Through its Allmerica Asset Management segment, the Company offers its
customers the option of investing in three types of Guaranteed Investment
Contracts (GICs); the traditional GIC, the synthetic GIC and the "floating
rate" GIC. This segment is also a Registered Investment Advisor
providing investment advisory services, primarily to affiliates, and to
other institutions, such as insurance companies and pension plans.
In addition to the four operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Capital Securities and corporate overhead expenses. Corporate overhead
expenses reflect costs not attributable to a particular segment, such as
those generated by certain officers and directors, Corporate Technology,
Corporate Finance, Human Resources and the legal department.
Significant changes to the Company's segmentation include a
reclassification of corporate overhead expenses from each operating
segment into the Corporate segment. Additionally, certain products
(group retirement products, such as 401(K) plans and tax-sheltered
annuities, group variable universal life) and certain other non-insurance
operations (telemarketing and trust services) previously reported in the
Allmerica Financial Institutional Services segment were combined with the
Allmerica Financial Services segment. Also, the Company reclassified the
GIC product line previously reported in the Allmerica Financial
Institutional Services segment into the Allmerica Asset Management segment.
Management evaluates the results of the aforementioned segments based on
pre-tax segment income. Pre-tax segment income is determined by adjusting
net income for net realized investment gains and losses, net gains and
losses on disposals of businesses, extraordinary items, the cumulative
effect of accounting changes and certain other items which management
believes are not indicative of overall operating trends. While these items
may be significant components in understanding and assessing the Company's
financial performance, management believes that the presentation of pre-tax
segment income enhances its understanding of the Company's results of
operations by highlighting net income attributable to the normal, recurring
operations of the business. However, pre-tax segment income should not be
construed as a substitute for net income determined in accordance with
generally accepted accounting principles.
Page 12
Summarized below is financial information with respect to business segments
for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment revenues:
Risk Management
Property and Casualty $ 555.9 $ 551.5 $1,109.4 $1,089.0
Corporate Risk Management
Services 103.3 102.9 208.4 198.7
------- ------- -------- --------
Subtotal 659.2 654.4 1,317.8 1,287.7
------- ------- -------- --------
Retirement and Asset
Accumulation
Allmerica Financial Services 172.4 175.0 363.6 366.2
Allmerica Asset Management 29.9 23.6 53.8 47.5
------- ------- -------- --------
Subtotal 202.3 198.6 417.4 413.7
------- ------- -------- --------
Corporate 4.1 5.7 6.1 9.8
Intersegment revenues (2.1) (3.5) (4.1) (6.1)
------- ------- -------- --------
Total segment revenues
including Closed Block 863.5 855.2 1,737.2 1,705.1
Adjustment for Closed Block (18.6) (22.3) (57.6) (59.7)
Net realized gains(losses) 11.8 (2.0) 41.0 42.0
------- ------- -------- --------
Total revenues $ 856.7 $ 830.9 $1,720.6 $1,687.4
======= ======= ======== ========
Segment income (loss) before income
taxes and minority interest:
Risk Management
Property and Casualty $ 36.8 $ 45.4 $ 74.5 $ 83.1
Corporate Risk Management
Services 1.4 6.5 6.5 9.9
------- ------- -------- --------
Subtotal 38.2 51.9 81.0 93.0
------- ------- -------- --------
Retirement and Asset Accumulation
Allmerica Financial Services 43.6 32.0 85.3 61.8
Allmerica Asset Management 6.2 5.4 10.1 8.6
------- ------- -------- --------
Subtotal 49.8 37.4 95.4 70.4
------- ------- -------- --------
Corporate (14.0) (8.0) (26.3) (19.0)
------- ------- -------- --------
Segment income before income
taxes and minority interest 74.0 81.3 150.1 144.4
Adjustments to segment income:
Net realized investment gains,
net of amortization 10.5 (2.6) 34.4 42.2
Loss on cession of disability
income business 0.0 0.0 0.0 (53.9)
Other items 0.0 (2.5) (0.7) (2.5)
Income before taxes and ------- ------- -------- --------
minority interest $ 84.5 $ 76.2 $ 183.8 $ 130.2
======= ======= ======== ========
Identifiable Assets Deferred Acquisition
Costs
(Unaudited) (Unaudited)
(In millions) June 30, December 31, June 30, December 31,
1998 1997 1998 1997
Risk Management
Property and Casualty $ 5,538.8 $ 5,650.4 $ 163.5 $ 167.2
Corporate Risk
Management Services 638.2 621.9 2.9 2.9
--------- --------- -------- --------
Subtotal 6,177.0 6,272.3 166.4 170.1
Retirement and
Asset Accumulation
Allmerica Financial
Services 17,743.3 15,159.2 885.5 794.5
Allmerica Asset
Management 1,651.3 1,035.1 0.8 0.9
--------- --------- -------- --------
Subtotal 19,394.6 16,194.3 886.3 795.4
Corporate 244.8 82.4 0.0 0.0
--------- --------- -------- --------
Total $25,816.4 $22,549.0 $1,052.7 $ 965.5
========= ========= ======== ========
Page 13
8. Earnings Per Share
In 1997, the FASB issued Statement of Financial Accounting Standards
No. 128,"Earnings Per Share", (Statement No. 128) which supersedes
Accounting Principle Board Opinion No. 15, "Earnings Per Share". This
standard replaces the primary earnings per share with a basic and diluted
earnings per share computation and requires a dual presentation of basic
and diluted earnings per share for those companies with complex capital
structures. All earnings per share amounts for all periods have been
presented to conform to the Statement No. 128 requirements. The adoption
of the aforementioned standard had no effect on the company's previously
reported earnings per share.
The weighted average number of shares of common stock and equivalents which
were utilized in the calculation of basic earnings per share were 59.9
million and 50.2 million for the six months ended June 30, 1998 and 1997,
respectively and 60.0 million and 50.2 million for the quarters ended
June 30, 1998 and 1997, respectively. The weighted average shares
outstanding used in the calculation of diluted earnings per share include
the 0.5 million and 0.1 million share effect of dilutive employee stock
options and grants for the quarter and six months ended June 30, 1998 and
1997, respectively. This difference causes a $0.02 per share difference
between basic and diluted earnings per share for the first six months
of 1998. There are no differences between basic and diluted earnings per
share in the second quarter of 1998, or for periods presented in 1997.
9. Commitments and Contingencies
Litigation
In July 1997, a lawsuit was instituted in Louisiana against AFC and certain
of its subsidiaries by individual plaintiffs alleging fraud, unfair or
deceptive acts, breach of contract, misrepresentation and related claims in
the sale of life insurance policies. In October 1997, plaintiffs
voluntarily dismissed the Louisiana suit and refiled the action in Federal
District Court in Worcester, Massachusetts. The plaintiffs seek to be
certified as a class. The case is in early stages of discovery and the
Company is evaluating the claims. Although the Company believes it has
meritorious defenses to plaintiffs' claims, there can be no assurance that
the claims will be resolved on a basis which is satisfactory to the Company.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
Although the Company does not believe that there is a material contingency
associated with the Year 2000 project, there can be no assurance that
exposure for material contingencies will not arise.
Page 14
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the interim consolidated results of operations and
financial condition of the Company should be read in conjunction with the
interim Consolidated Financial Statements and related footnotes included
elsewhere herein.
INTRODUCTION
The results of operations for Allmerica Financial Corporation and
subsidiaries ("AFC" or "the Company") include the accounts of AFC, First
Allmerica Financial Life Insurance Company ("FAFLIC") its wholly-owned life
insurance subsidiary, Allmerica Financial Life Insurance and Annuity Company
("AFLIAC"), Allmerica Property & Casualty Companies, Inc. ("Allmerica P&C",
a wholly-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.
The results of operations reflect minority interest in Allmerica P&C and its
subsidiary, the Hanover Insurance Company ("Hanover") of approximately 40.5%
prior to the merger on July 16, 1997. The results of operations also
reflect minority interest in Citizens Corporation.
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 $3.6 million and $6.0 million for the second quarter
and six months ended June 30, 1998, respectively, compared to $0.5 million
and $6.0 million for the second quarter and six months ended June 30, 1997,
respectively.
Page 15
The following table presents the results of operations of the Closed Block
combined with the results of operations outside the Closed Block for all
periods presented. Management's discussion and analysis addresses the
results of operations as combined unless otherwise noted.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
REVENUES
Premiums $ 591.1 $ 588.5 $1,196.8 $1,180.1
Universal life and investment
product policy fees 72.7 57.1 142.2 113.4
Net investment income 167.6 183.8 335.9 360.7
Net realized investment
gains (losses) 13.4 (1.9) 42.6 43.0
Other income 32.1 25.9 62.3 50.9
-------- -------- -------- --------
Total revenues 876.9 853.4 1,779.8 1,748.1
-------- -------- -------- --------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses
and loss adjustment expenses 538.3 530.5 1,082.8 1,060.1
Policy acquisition expenses 115.8 115.8 233.7 231.9
Loss from cession of disability
income business 0.0 0.0 0.0 53.9
Other operating expenses 138.3 130.9 279.5 272.0
-------- -------- -------- --------
Total benefits, losses
and expenses 792.4 777.2 1,596.0 1,617.9
-------- -------- -------- --------
Income before federal income
taxes 84.5 76.2 183.8 130.2
-------- -------- -------- --------
Federal income tax expense
(benefit):
Current 14.1 26.4 43.9 32.4
Deferred 4.3 (7.1) (1.3) (3.4)
-------- -------- -------- --------
Total federal income tax
expense 18.4 19.3 42.6 29.0
-------- -------- -------- --------
Income before minority interest 66.1 56.9 141.2 101.2
Minority interest:
Distributions on mandatorily
redeemable preferred securities
of a subsidiary trust holding
solely junior subordinated
debentures of the Company (4.0) (4.0) (8.0) (6.4)
Equity in earnings (1.8) (15.2) (6.1) (41.2)
-------- -------- -------- --------
(5.8) (19.2) (14.1) (47.6)
-------- -------- -------- --------
Net income $ 60.3 $ 37.7 $ 127.1 $ 53.6
======== ======== ======== ========
Page 16
Description of Operating Segments
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Accumulation. Within these broad areas,
the Company conducts business principally in four operating segments.
These segments are Property and Casualty; Corporate Risk Management
Services; Allmerica Financial Services; and Allmerica Asset Management.
Effective January 1, 1998, the Company adopted Statement No. 131.
Consistent with the Company's adoption of this statement, the separate
financial information of each segment was re-defined consistent with the
way results are regularly evaluated by the chief operating decision maker
in deciding how to allocate resources and in assessing performance. A
summary of the significant changes in reportable segments is included below.
The Risk Management group includes two segments: Property and Casualty and
Corporate Risk Management Services. The 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 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).
Prior to 1998, certain corporate overhead expenses were allocated to
the Property and Casualty business and were reflected in the results of
this segment. In addition, results of operations from the property and
casualty holding companies and certain non-insurance subsidiaries of
Allmerica P&C were reflected in the results of this segment. These
overhead expenses and the activity from the holding companies are now
reported in the Corporate segment. Results from certain non-insurance
subsidiaries are no longer being reflected in the results of the Property
and Casualty segment.
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. Prior to 1998, certain corporate overhead expenses were
allocated to the Corporate Risk Management Services business and were
reflected in the results of this segment. These overhead expenses are
now reported in the Corporate segment. In addition, results from certain
non-insurance subsidiaries, which were previously reported in the
Property and Casualty segment, are now being reported in the Corporate
Risk Management Services segment.
The Retirement and Asset Accumulation group includes two segments:
Allmerica Financial Services and Allmerica Asset Management. The Allmerica
Financial Services segment includes variable annuities, variable universal
life and traditional life insurance products distributed via retail
channels as well as group retirement products, such as defined benefit and
401(K) plans and tax-sheltered annuities distributed to institutions.
Prior to 1998, certain corporate overhead expenses were allocated to the
Allmerica Financial Services business and were reflected in the results of
this segment. These overhead expenses are now reported in the Corporate
segment. Certain products (including defined benefit and defined
contribution plans, group variable universal life) and certain other
non-insurance operations (telemarketing and trust services)) previously
reported in the Allmerica Financial Institutional Services segment
have been combined with the Allmerica Financial Services segment.
Through its Allmerica Asset Management segment, the Company offers its
customers the option of investing in three types of Guaranteed Investment
Contracts (GICs); the traditional GIC, the synthetic GIC and the "floating
rate" GIC. This segment is also a Registered Investment Advisor providing
investment advisory services, primarily to affiliates, and to other
institutions, such as insurance companies and pension plans. Prior to 1998,
certain corporate overhead expenses were allocated to the Allmerica Asset
Management business and were reflected in the results of this segment.
These overhead expenses are now reported in the Corporate segment.
Additionally, the GIC products, now offered through Allmerica Asset
Management, were previously reported in the results of the Allmerica
Financial Institutional Services segment.
In addition to the four operating segments, the Company has a Corporate
segment, which consists primarily of cash, investments, corporate debt,
Series A Capital Securities ("Capital Securities") and corporate overhead
expenses. Corporate overhead expenses reflect costs not attributable to a
particular segment, such as those generated by certain officers and
directors, Corporate Technology, Corporate Finance, Human Resources and
the legal department. Through implementation of Statement No. 131, the
definition of the Corporate segment was redefined to include all holding
companies, as well as the parent company and the corporate debt.
Corporate overhead expenses, which were previously allocated to the
operating segments, are now included in the Corporate segment.
Page 17
Results of Operations
Consolidated Overview
The Company's consolidated net income increased $22.6 million, or 59.9%, to
$60.3 million, and $73.5 million, or 137.1%, to $127.1 million, for the
second quarter and six months ended June 30, 1998, respectively, compared
to the same periods in 1997. Net income includes certain items which
management believes are not indicative of overall operating trends, such
as net realized investment gains and losses, net gains and losses on
disposals of businesses, extraordinary items and the cumulative effect of
accounting changes. While these items may be significant components in
understanding and assessing the Company's financial performance,
management believes adjusted net income enhances the understanding of the
Company's results of operations by highlighting net income attributable
to the normal, recurring operations of the business. However, adjusted
net income should not be construed as a substitute for net income
determined in accordance with generally accepted accounting principles.
For purposes of assessing each segment's contribution to adjusted net
income, management evaluates the results of these segments on a
pre-tax basis. The following table reflects each segment's contribution
to adjusted net income and a reconciliation to consolidated net income
as adjusted for these items.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment income (loss) before
income taxes and minority
interest:
Risk Management
Property and Casualty $ 36.8 $ 45.4 $ 74.5 $ 83.1
Corporate Risk Management
Services 1.4 6.5 6.5 9.9
------ ------ ------ ------
Subtotal 38.2 51.9 81.0 93.0
------ ------ ------ ------
Retirement and Asset Accumulation
Allmerica Financial Services 43.6 32.0 85.3 61.8
Allmerica Asset Management 6.2 5.4 10.1 8.6
------ ------ ------ ------
Subtotal 49.8 37.4 95.4 70.4
Corporate (14.0) (8.0) (26.3) (19.0)
------ ------ ------ ------
Segment income before income
taxes and minority interest 74.0 81.3 150.1 144.4
------ ------ ------ ------
Federal income taxes on
segment income (12.8) (21.1) (30.7) (34.0)
Minority interest:
Distributions on Capital
Securities (4.0) (4.0) (8.0) (6.4)
Equity in earnings -
P & C Segment (1.7) (16.5) (5.5) (31.1)
------ ------ ------ ------
Adjusted net income 55.5 39.7 105.9 72.9
Adjustments (net of tax):
Net realized investment
gains(losses) 4.8 (1.0) 22.3 28.0
Loss on cession of disability
income business 0.0 0.0 0.0 (35.0)
Other items 0.0 (2.3) (0.6) (2.2)
Minority interest on
adjustments 0.0 1.3 (0.5) (10.1)
------ ------ ------ ------
Net income $ 60.3 $ 37.7 $127.1 $ 53.6
====== ====== ====== ======
Page 18
Quarter Ended June 30, 1998 Compared to Quarter Ended June 30, 1997
The Company's segment income before taxes and minority interest declined
$7.3 million, or 9.0%, to $74.0 million in the second quarter of 1998.
This decrease is primarily attributable to reduced income of $13.7 million
from the Risk Management segment and an increased loss of $6.0 million from
the Corporate segment, partially offset by increased income from Allmerica
Financial Services. The decrease in the Property & Casualty segment was
primarily attributable to a $36.5 million increase in catastrophic losses
incurred as a result of severe spring storms, partially offset by growth in
net premiums earned and a $14.2 million increase in favorable development
on prior year reserves, primarily at Hanover. The decrease in the
Corporate Risk Management segment income is due to unfavorable loss
experience in the risk sharing and non-affinity group reinsurance product
lines totaling $3.7 million, as well as increased expenses of $2.1
million. The Corporate segment's greater net loss primarily reflects the
absence of $4.0 million in income generated by the temporary investment of
the net proceeds from the issuance of Capital Securities in 1997. These
items were partially offset by higher asset based fee income driven by
growth in the variable annuity and variable universal life product lines
of Allmerica Financial Services segment. Fee revenue from these products
increased $16.4 million or 49.0% to $49.9 million in the second quarter of
1998. Allmerica Asset Management segment income for the second quarter of
1998 continued to grow as sales of "floating rate" GICs more than offset
the withdrawals of traditional GICs.
The effective tax rate for segment income was 17.3% for the second quarter
of 1998 compared to 26.0% for the second quarter of 1997. The decrease in
tax rates was principally driven by the reduction in underwriting income
resulting primarily from increased catastrophe losses.
After-tax net realized gains on investments were $4.8 million in the
second quarter of 1998, resulting primarily from net realized gains on
equity securities and fixed maturities of $1.4 million and $3.5 million,
respectively. During the second quarter of 1997, after-tax net realized
loss on investments of $1.0 million resulted primarily from the sale of
fixed maturity investments in the Property and Casualty segment.
Minority interest on both segment income and adjustments to net income
decreased in the current period as compared to the prior year due primarily
to the Company's merger with Allmerica P&C on July 16, 1997. Prior to the
acquisition, minority interest reflected 40.5% of the results of operations
from this subsidiary.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
The Company's segment income before taxes and minority interest increased
$5.7 million, or 3.9%, to $150.1 million during the first six months of
1998. This increase is primarily attributable to an increase of $23.5
million from the Allmerica Financial Services segment, partially offset by
declines in the Risk Management segment of $12.0 million and $7.3 million
in the Corporate segment. The increase in the Allmerica Financial Services
segment was primarily attributable to growth and market appreciation in the
variable annuity and variable universal life assets resulting in increased
asset based fee revenue. Fee revenue from these products increased $30.9
million or 48.7% to $94.4 million in during the first six months of 1998.
Property and Casualty income for the first six months of 1998 was
negatively impacted by an increase in catastrophe losses of $37.2
million, partially offset by growth in earned premium, lower policy
acquisition and other underwriting expenses, and increased favorable
development on prior year reserves. The decrease in the Corporate Risk
Management segment income was primarily due to increased operating expenses
of approximately $3.2 million as well as unfavorable loss experience in the
non-affinity group reinsurance product line totaling $1.3 million. The
operating loss in the Corporate segment increased for the first
six months of 1998 primarily due to the absence of $6.4 million of net
investment income earned on the proceeds from the aforementioned issuance of
Capital Securities.
The effective tax rate for segment income was 20.5% for the first six
months of 1998 compared to 23.5% for the same time period in 1997. The
decrease in tax rates was principally driven by the reduction in
underwriting income resulting primarily from increased catastrophe losses.
After-tax net realized gains on investments were $22.3 million during the
first six months of 1998, resulting primarily from net realized gains on
equity securities and fixed maturities of $12.3 million and $9.6 million,
respectively. Sales of equity securities primarily reflect the disposal
of the Company's own investments in separate accounts, while disposals of
fixed maturities principally reflect the reduced holdings of lower rated
fixed income securities. During the first six months of 1997, after-tax
net realized gains on investments of $28.0 million resulted primarily
from the sale of appreciated equity securities, due to the Company's
strategy of shifting to a higher level of debt securities, as well as
sales of real estate investment properties.
Page 19
Effective October 1, 1997, the Company ceded substantially all of its
individual disability income line of business. The Company recognized
a $35.0 million loss, net of taxes, during the first quarter of 1997
upon entering into an agreement in principal to transfer the business.
Minority interest on both segment income and adjustments to net income
decreased in the current period as compared to the prior year due
primarily to the Company's merger with Allmerica P&C on July 16, 1997.
Prior to the acquisition, minority interest reflected 40.5% of the results
of operations from this subsidiary.
Risk Management
Property and Casualty
The following table summarizes the results of operations for the Property
and Casualty segment.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment revenues
Net premiums earned $ 498.1 $ 485.9 $ 989.3 $ 961.0
Net investment income 55.7 65.1 114.7 125.7
Other income 2.1 0.5 5.4 2.3
-------- -------- -------- --------
Total segment revenues 555.9 551.5 1,109.4 1,089.0
Losses and loss adjustment
expenses <F1> 378.8 362.2 750.0 710.4
Policy acquisition and other
operating expenses 140.3 143.9 284.9 295.5
-------- -------- -------- --------
Segment income before taxes
and minority interest $ 36.8 $ 45.4 $ 74.5 $ 83.1
======== ======== ======== ========
<FN>
<F1>
Includes policyholders' dividends of $1.9 million, $2.5 million, $5.6
million and $4.1 million for the quarters ended June 30, 1998 and 1997
and the six months ended June 30, 1998 and 1997, respectively.
</FN>
Quarter Ended June 30, 1998 Compared to Quarter Ended June 30, 1997
Property and Casualty segment's income before taxes and minority interest
decreased $8.6 million, to $36.8 million, in the second quarter of 1998,
compared to income before taxes and minority interest of $45.4 million,
for the same period in 1997. This decrease is primarily attributable to
a $36.5 million increase in catastrophe losses, primarily at Citizens,
to $43.8 million for the second quarter of 1998 compared to $7.3 million
for the comparable quarter of 1997, as well as a decrease in net
investment income. This was partially offset by growth in net premiums
earned and a $14.2 million increase in favorable development on prior
year reserves, primarily at Hanover. Net investment income before taxes
decreased $9.4 million, or 14.4%, to $55.7 million during the second
quarter of 1998 compared to $65.1 million in the comparable quarter of
1997. The decrease is primarily the result of a decrease in average
invested assets at Hanover and a decrease in limited partnership
income at both Hanover and Citizens. The average pre-tax yield on debt
securities was 6.6% and 6.8% for the second quarter of 1998 and 1997,
respectively.
Page 20
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 62.1% and 61.6% of total net
premiums earned in the second quarter of 1998 and 1997, respectively.
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended
June 30, (In millions) 1998 1997 1998 1997 1998 1997
Net premiums earned $158.6 $156.2 $150.5 $143.3 $309.1 $299.5
Losses and loss
adjustment expenses 119.3 120.7 125.6 108.1 244.9 228.8
Policy acquisition and
other underwriting
expenses 42.8 45.4 38.2 36.4 81.0 81.8
------ ------ ------ ------ ------ ------
Underwriting loss $ (3.5) $ (9.9) $(13.3) $ (1.2) $(16.8) $(11.1)
====== ====== ====== ====== ====== ======
Revenues
Personal lines' net premiums earned increased $9.6 million, or 3.2%, to
$309.1 million during the second quarter of 1998, compared to $299.5 million
in the second quarter of 1997. Hanover's personal lines' net premiums
earned increased $2.4 million, or 1.5%, to $158.6 million during the second
quarter of 1998, primarily due to rate increases in the homeowners line.
These increases were partially offset by decreases in policies in force of
1.4% and 1.7% in the personal automobile and homeowners lines, respectively,
since June 30, 1997, and by a mandated 4.0% decrease in Massachusetts
personal automobile rates which became effective January 1, 1998.
Citizens' personal lines' net premiums earned increased $7.2 million, or
5.0%, to $150.5 million for the quarter ended June 30, 1998, from $143.3
million for the quarter ended June 30, 1997. This increase is primarily
attributable to a twelve month average rate increase in the personal
automobile and homeowners lines of 5.9% and 15.8%, respectively. This is
partially offset by a slight decrease in policies in force in both the
personal automobile and homeowners lines.
While management has taken steps to increase penetration in the affinity
groups and has initiated other marketing programs, the Company believes
that heightened competition may result in reduced premium growth in the
personal segment.
Underwriting results
The personal lines' underwriting results in the second quarter of 1998
deteriorated $5.7 million, to a loss of $16.8 million compared to a loss of
$11.1 million for the same period in 1997. Hanover's underwriting results
improved $6.4 million, to a loss of $3.5 million. Citizens' underwriting
results deteriorated $12.1 million, to a loss of $13.3 million.
The improvement in Hanover's underwriting results is primarily attributable
to an $8.6 million increase in favorable development on prior year reserves
in the personal automobile and homeowners lines. This was partially
offset by a $5.8 million increase in catastrophe losses, primarily in the
homeowners line, as a result of spring storms which generated losses of
approximately $7.4 million during the second quarter of 1998.
Citizens' losses and LAE increased $17.5 million, or 16.2%, to $125.6
million. This increase is primarily as a result of the increase in
catastrophe losses. Catastrophe losses increased $16.6 million, to $18.8
million for the quarter ended June 30, 1998, from $2.2 million for the
same period ended 1997, primarily in the homeowners line.
Page 21
Policy acquisition and other underwriting expenses in the personal lines
decreased $0.8 million, or 1.0%, to $81.0 million in the first quarter of
1998, primarily reflecting reductions in employee related expenses,
partially offset by growth in earned premium and increased technology
expenses.
Commercial Lines of Business
The commercial lines of business represented 37.9% and 38.4% of total net
premiums earned in the second quarter of 1998 and 1997, respectively.
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended 1998 1997 1998 1997 1998 1997
June 30, (In millions)
Net premiums earned $ 118.2 $ 119.6 $ 70.8 $ 66.8 $ 189.0 $ 186.4
Losses and loss adjustment
expenses 78.7 81.3 53.3 49.6 132.0 130.9
Policy acquisition and
other underwriting expenses 42.5 44.9 18.2 17.1 60.7 62.0
Policyholders' dividends 1.0 0.7 0.9 1.8 1.9 2.5
------ ----- ----- ----- ----- -----
Underwriting loss $ (4.0) $ (7.3) $ (1.6) $ (1.7) $ (5.6)$ (9.0)
====== ===== ===== ===== ===== =====
Revenues
Commercial lines' net premiums earned increased $2.6 million, or 1.4%, to
$189.0 million for the quarter ended June 30, 1998 from $186.4 for the
quarter ended June 30, 1997. Hanover's commercial lines' net premiums
earned decreased $1.4 million, or 1.2%, to $118.2 million. This decrease is
primarily related to the Company's disposal of the majority of its assumed
reinsurance business, which contributed $1.7 million in net premiums earned
for the quarter ended June 30, 1998, compared to $9.3 million for the same
period of 1997. Also contributing to this decrease is a twelve month
average rate decrease of 11.2% in the workers' compensation line. These
decreases were partially offset by increases in policies in force in the
workers' compensation line and commercial automobile line for Hanover of
9.0% and 8.4%, respectively.
Citizens' commercial lines' net premiums earned increased $4.0 million, or
6.0%, to $70.8 million, in the second quarter of 1998. This increase
primarily reflects growth in policies in force of 14.0% in the commercial
multiple peril line and a twelve month average rate increase of 8.3% and
6.2% in the commercial multiple peril and commercial automobile lines,
respectively. These increases are partially offset by a 10.2% decrease in
policies in force and a twelve month average rate decrease of 3.1% in the
workers' compensation line.
Management believes competitive conditions in the workers' compensation
line may impact future growth in net premiums earned.
Underwriting results
The commercial lines' underwriting results in the second quarter of 1998
improved $3.4 million, to a loss of $5.6 million compared to a loss of $9.0
million for the same period in 1997. Hanover's underwriting results
improved $3.3 million, to a loss of $4.0 million. Citizens' underwriting
results improved $0.1 million, to a loss of $1.6 million.
The improvement in Hanover's underwriting results reflects an increase in
favorable development on prior accident years in the commercial automobile
and commercial multiple peril lines. This was partially offset by a $4.3
million increase in catastrophe losses primarily in the commercial multiple
peril line, to $4.7 million from $0.4 million, for the quarters ended
June 30, 1998 and 1997, respectively.
Citizens' underwriting results reflect favorable current year claims
activity in all major commercial lines, partially offset by a $9.8 million
increase in catastrophe losses, primarily in the commercial multiple peril
line.
Page 22
Policy acquisition and other underwriting expenses in the commercial lines
decreased $1.3 million, or 2.1%, to $60.7 million in the second quarter of
1998, primarily reflecting reductions in employee related expenses,
partially offset by the effect of higher premiums and increased technology
expenses.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Property and Casualty's segment income before taxes and minority interest
decreased $8.6 million, or 10.3%, to $74.5 million for the six months ended
June 30 1998, compared to $83.1 million, for the same period in 1997. This
decrease is primarily attributable to an increase in catastrophe losses of
$37.2 million, primarily at Citizens, partially offset by growth in earned
premium, lower policy acquisition and other underwriting expenses and
increased favorable development on prior year reserves. Net investment
income before taxes decreased $11.0 million, or 8.8%, to $114.7 million
during the first six months of 1998 compared to $125.7 million in the
comparable period of 1997. The decrease is primarily the result of a
decrease in Hanover's average invested assets. The average pre-tax
yield on debt securities was 6.7% and 6.8% for the six months ended June
30,1998 and 1997, respectively.
LINE OF BUSINESS RESULTS
Personal Lines of Business
The personal lines of business represented 61.8% and 61.9% of total net
premiums earned in the six months ended June 30, 1998 and 1997, respectively.
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended 1998 1997 1998 1997 1998 1997
June 30, (In millions)
Net premiums earned $ 313.4 $ 307.9 $ 298.4 $ 287.0 $ 611.8 $594.9
Losses and loss adjustment
expenses 244.4 233.5 224.7 221.9 469.1 455.4
Policy acquisition and
other underwriting expenses 89.9 95.1 76.3 75.6 166.2 170.7
------ ----- ----- ----- ----- -----
Underwriting loss $ (20.9) $ (20.7) $ (2.6)$ (10.5)$ (23.5)$(31.2)
====== ===== ===== ===== ====== =====
Revenues
Personal lines' net premiums earned increased $16.9 million, or 2.8%, to
$611.8 million during the six months ended June 30, 1998, compared to $594.9
million in the same period of 1997. Hanover's personal lines' net premiums
earned increased $5.5 million, or 1.8%, to $313.4 million during the six
months ended June 30, 1998 primarily due to rate increases in the homeowners
line. This was partially offset by decreases in policies in force in the
personal automobile and homeowners lines and by a mandated 4.0% decrease in
Massachusetts personal automobile rates which became effective January 1,
1998.
Citizens' personal lines' net premiums earned increased $11.4 million, or
4.0%, to $298.4 million for the six months ended June 30, 1998, from $287.0
million for the six months ended June 30, 1997. This increase is primarily
attributable to a twelve month average rate increase in the personal
automobile and homeowners lines of 5.9% and 15.8%, respectively. This is
partially offset by a slight decrease in policies in force in both the
personal automobile and homeowners lines.
While management has taken steps to increase penetration in the affinity
groups and has initiated other marketing programs, the Company believes that
heightened competition may result in reduced premium growth in the personal
segment.
Page 23
Underwriting results
The personal lines' underwriting results for the six months ended June 30,
1998 improved $7.7 million, to a loss of $23.5 million, compared to a loss
of $31.2 million for the same period in 1997. Hanover's underwriting
results deteriorated $0.2 million, to a loss of $20.9 million. Citizens'
underwriting results improved $7.9 million, to a loss of $2.6 million.
The slight deterioration in Hanover's underwriting results is primarily
attributable to a $10.3 million increase in catastrophe losses, primarily
in the homeowners line. These catastrophes included a severe winter ice
storm that struck Maine in January 1998 generating approximately $5.9
million in losses, as well as spring storms which generated losses of
approximately $7.4 million during the second quarter of 1998. This was
significantly offset by an increase in favorable development on prior
year reserves in both the personal automobile and homeowners lines.
The improvement in Citizens' underwriting results is attributable to an
increase in favorable development on prior year reserves, and to improved
current year claims activity in the personal automobile and homeowners
lines. This is partially offset by an increase in catastrophe losses of
$10.7 million over the prior year, primarily in the homeowners line.
Policy acquisition and other underwriting expenses in the personal lines
decreased $4.5 million, or 2.6%, to $166.2 million in the first six months
of 1998, primarily reflecting reductions in employee related expenses,
partially offset by growth in earned premium and increased technology
expenses.
Commercial Lines of Business
The commercial lines of business represented 38.2% and 38.1% of total net
premiums earned in the six months ended June 30, 1998 and 1997,
respectively.
Total
Property
Hanover Citizens and Casualty
For the Quarters Ended 1998 1997 1998 1997 1998 1997
June 30, (In millions)
Net premiums earned $ 237.5 $ 233.1 $ 140.0 $ 133.0 $ 377.5 $ 366.1
Losses and loss adjustment
expenses 162.9 156.6 112.4 94.3 275.3 250.9
Policy acquisition and
other underwriting expenses 83.0 90.5 35.4 34.8 118.4 125.3
Policyholders' dividends 2.8 0.7 2.8 3.4 5.6 4.1
------ ----- ----- ----- ----- -----
Underwriting (loss) profit $ (11.2) $(14.7) $ (10.6) $ 0.5 $ (21.8) $(14.2)
====== ===== ===== ===== ===== =====
Revenues
Commercial lines' net premiums earned increased $11.4 million, or 3.1%, to
$377.5 million in the six months ended June 30, 1998 from $366.1 million in
the same period of 1997. Hanover's commercial lines' net premiums earned
increased $4.4 million, or 1.9%, to $237.5 million. This increase is
primarily attributable to increases in policies in force in the workers'
compensation and commercial automobile lines of 9.0% and 8.4%, respectively.
This was partially offset by the effect of the Company's disposal of the
majority of its assumed reinsurance business. Assumed reinsurance business
contributed $6.9 million and $15.8 million in net premium earned during the
six months ended June 30, 1998 and 1997, respectively.
Page 24
Citizens' commercial lines' net premiums earned increased $7.0 million, or
5.3%, to $140.0 million, for the six months ended June 30, 1998, from $133.0
million for the six months ended June 30,1997. The increase in net premiums
earned primarily reflects growth in policies in force of 14.0% in the
commercial multiple peril line and to a twelve month average rate increase
of 8.3% and 6.2% in the commercial multiple peril and commercial automobile
lines, respectively. These increases are partially offset by a 10.2%
decrease in policies in force and a twelve month average rate decrease of
3.1% in the workers' compensation line.
Management believes competitive conditions in the workers' compensation line
may impact future growth in net premiums earned.
Underwriting results
The commercial lines' underwriting results for the six months ended June 30,
1998 deteriorated $7.6 million, to a loss of $21.8 million compared to a
loss of $14.2 million for the same period in 1997. Hanover's underwriting
results improved $3.5 million, to a loss of $11.2 million. Citizens'
underwriting results deteriorated $11.1 million to an underwriting loss of
$10.6 million compared to an underwriting profit of $0.5 million for the
six months ended June 30, 1998 and 1997, respectively.
The improvement in Hanover's underwriting results is attributable to a $7.5
million decrease in policy acquisition and other underwriting expenses, and
a $3.6 million increase in favorable development on prior year reserves.
This is partially off-set by an increase in catastrophe losses of $6.8
million, primarily in the commercial multiple peril line.
The deterioration in Citizens' underwriting results is primarily
attributable to a $9.4 million increase in catastrophe losses, primarily
in the commercial multiple peril line, as well as a $9.2 million decrease
in favorable development on prior year reserves, primarily in the workers'
compensation line. These increases are partially offset by favorable
current year claims activity in the commercial multiple peril and
commercial automobile lines.
Policy acquisition and other underwriting expenses in the commercial lines
decreased $6.9 million, or 5.5%, to $118.4 million in the six months ended
June 30, 1998, primarily reflecting reductions in employee related
expenses, partially offset by the effect of increases in premiums earned
and increased technology expenses.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The 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 definitive determination of ultimate
liability may be made, where the technological, judicial, and political
climates involving these types of claims are changing.
Page 25
The Property & 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 six months ended June 30, (In millions) 1998 1997
Reserve for losses and LAE, beginning of period $ 2,615.4 $ 2,744.1
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of the
current year 812.5 769.5
Decrease in provision for insured events of
prior years (68.1) (61.0)
------ ------
Total incurred losses and LAE 744.4 708.5
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events
of current year 335.2 310.5
Losses and LAE attributable to insured events
of prior years 433.6 440.4
------ ------
Total payments 768.8 750.9
Change in reinsurance recoverable on unpaid losses (11.3) (38.0)
------- ----------
Reserve for losses and LAE, end of period $ 2,579.7 $ 2,663.7
======= ==========
As part of an ongoing process, the reserves have been re-estimated for all
prior accident years and were decreased by $68.1 million and $61.0 million
for the six months ended June 30, 1998 and 1997, respectively. Favorable
reserve development at Citizens decreased $5.7 million, to $29.9 million,
from $35.6 million, for the six months ended June 30, 1998 and June 30,
1997, respectively. The decline in favorable development is primarily
due to a decrease in workers' compensation favorable development and
unfavorable development in the commercial automobile line for the six
months ended June 30, 1998. The overall favorable reserve development in
both years primarily reflects a modest shift over the past few years of the
workers' compensation business to Western and Northern Michigan which have
demonstrated more favorable loss experience than Eastern Michigan.
Hanover's favorable development increased $12.8 million to $38.2 million
during 1998, from $25.4 million in 1997. This increase is primarily
attributable to a reduction in LAE, in most major lines, due to claims
process improvement initiatives.
This favorable development reflects the Company's reserving philosophy
consistently applied over these periods. Conditions and trends that have
affected development of the losses and LAE reserves in the past may not
necessarily occur in the future.
Inflation generally increases the cost of losses covered by insurance
contracts. The effect of inflation on the Property and Casualty segment
varies by product. Property and casualty insurance premiums are
established before the amount of losses and LAE, and the extent to which
inflation may affect such expenses, are known. Consequently, the Property
and Casualty segment attempts, in establishing rates, to anticipate the
potential impact of inflation in the projection of ultimate costs. The
impact of inflation has been relatively insignificant in recent years.
However, inflation could contribute to increased losses and LAE in the
future.
The Company regularly reviews its reserving techniques, its overall
reserving position and its reinsurance. Based on (i) review of historical
data, legislative enactments, judicial decisions, legal developments in
impositions of damages, changes in political attitudes and trends in
general economic conditions, (ii) review of per claim information, (iii)
historical loss experience of the Company and the industry, (iv) the
relatively short-term nature of most policies and (v) internal estimates
of required reserves, management believes that adequate provision has been
made for loss reserves. However, establishment of appropriate reserves is
an inherently uncertain process and there can be no certainty that current
established reserves will prove adequate in light of subsequent actual
experience. The Company believes that a significant change to the
estimated reserves could have a material impact on the results of
operations.
Page 26
REINSURANCE
The Property and Casualty segment maintains a reinsurance program designed
to protect against large or unusual losses and allocated LAE activity,
which includes pro-rata, excess of loss reinsurance and catastrophe
reinsurance. Catastrophe reinsurance serves to protect the ceding insurer
from significant aggregate losses arising from a single event such as
windstorm, hail, hurricane, tornado, riot or other extraordinary events.
The Property and Casualty segment determines the appropriate amount of
reinsurance based on the evaluation of the risks accepted and analyses
prepared by consultants and reinsurers and on market conditions including
the availability and pricing of reinsurance. The Property and Casualty
segment also has reinsurance for casualty business.
Effective January 1, 1998, the Property and Casualty segment modified its
catastrophe reinsurance program to include a higher retention. Under the
1998 catastrophe reinsurance program, the Company retains the first $45.0
million. For losses in excess of $45.0 million and up to $180.0 million,
the Company retains 10% of the loss. Effective June 1, 1998, the Company
purchased an additional treaty for losses in excess of $180.0 million and
up to $230.0 million, of which the Company retains 10% of the loss. Amounts
in excess of $230.0 million are retained 100% by the Company. Under the
1997 catastrophe reinsurance program, Hanover retained the first $25.0
million of loss per occurrence and all amounts in excess of $180.0 million,
55% of all aggregate loss amounts in excess of $25.0 million up to $45.0
million, and 10% of all aggregate loss amounts in excess of $45.0 million
up to $180.0 million. Also, under the 1997 catastrophic reinsurance
program, Citizens retained 5% of losses in excess of $10.0 million, up to
$25.0 million, and 10% of losses in excess of $25.0 million up to $180.0
million. Amounts in excess of $180.0 million were retained 100% by the
Company.
Under the Property and Casualty segment's casualty reinsurance program, the
reinsurers are responsible for 100% of the amount of each loss in excess of
$0.5 million per occurrence up to $30.5 million for general liability and
workers' compensation. Additionally, this reinsurance covers workers'
compensation losses in excess of $30.5 million to $60.5 million per
occurrence. Amounts in excess of $60.5 million are retained 100% by the
Company.
The Property and Casualty segment cedes to reinsurers a portion of its risk
and pays a fee based upon premiums received on all policies subject to such
reinsurance. Reinsurance contracts do not relieve the Company from its
obligations to policyholders. Failure of reinsurers to honor their
obligations could result in losses to the Company in the Property and
Casualty segment. The Company also believes that the terms of its
reinsurance contracts are consistent with industry practice in that they
contain standard terms with respect to lines of business covered, limit
and retention, arbitration and occurrence. Based on its review of its
reinsurers' financial statements and reputations in the reinsurance
marketplace, the Company believes that its reinsurers are financially
sound.
INVESTMENT RESULTS
Net investment income before taxes decreased $9.4 million, or 14.4%, to
$55.7 million during the second quarter of 1998 compared to $65.1 million
in the comparable quarter of 1997. The decrease is primarily the result of
a decrease in Hanover's average invested assets as a result of a $117.1
million and a $53.9 million transfer of assets to the Corporate Segment in
April, 1998 and December 1997, respectively. Also contributing to this
decrease is a $4.3 million decrease in income on limited partnerships. The
limited partnerships pursue investment opportunities primarily through
global fixed-income trading strategies. The average pre-tax yield on debt
securities was 6.6% and 6.8% for the second quarter of 1998 and 1997,
respectively.
Net investment income before taxes decreased $11.0 million, or 8.8%, to
$114.7 million during the six months ended June 30, 1998 compared to $125.7
million in the comparable quarter of 1997. The decrease is primarily the
result of a decrease in Hanover's average invested assets and a $4.0
million decrease in limited partnership income. The average pre-tax
yield on debt securities was 6.7% and 6.8% for the six months ended
June 30, 1998 and 1997, respectively.
Page 27
Corporate Risk Management Services
The following table summarizes the results of operations for the Corporate
Risk Management Services segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Quarter Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Premiums and premium equivalents
Premiums $ 83.7 $ 84.3 $ 169.3 $ 163.0
Premium equivalents 165.2 147.4 331.8 298.2
----- ------ ------ ------
Total premiums and premium equivalents $ 248.9 $231.7 $ 501.1 $ 461.2
===== ====== ====== ======
Segment revenues
Premiums $ 83.7 $ 84.3 $ 169.3 $ 163.0
Net investment income 5.4 5.9 11.4 11.5
Other income 14.2 12.7 27.7 24.2
------ ----- ----- -----
Total segment revenues 103.3 102.9 208.4 198.7
Policy benefits, claims and losses 63.2 60.2 125.5 118.8
Policy acquisition expenses 1.2 0.8 2.0 1.7
Other operating expenses 37.5 35.4 74.4 68.3
------- ------ ------ ------
Segment income before taxes $ 1.4 $ 6.5 $ 6.5 $ 9.9
======= ====== ====== ======
Quarter Ended June 30, 1998 Compared to Quarter Ended June 30, 1997
Segment income before taxes decreased $5.1 million, or 78.5%, to $1.4
million in the second quarter of 1998. This decrease was primarily due to
unfavorable loss experience in the risk sharing and non-affinity group
reinsurance product lines totaling $3.7 million. Also, expenses increased
$2.1 million due, in part, to claims processing costs.
Premiums decreased $0.6 million, or 0.7%, to $83.7 million in the second
quarter of 1998 primarily due to decreases in affinity group life and health
reinsurance business and fully insured medical and dental product lines
totaling $6.4 million. The affinity group life and health reinsurance
business' decrease is primarily due to unusually high reinsurance premiums
assumed under a new reinsurance agreement entered into during the second
quarter of 1997. The decline in fully insured medical and dental product
lines primarily reflects the Company's cancellation of several large
unprofitable accounts. These decreases were mostly offset by growth in
premium in the non-affinity group reinsurance product, as well as stop loss
and risk sharing product lines of $5.2 million.
Other income increased $1.5 million, or 11.8%, to $14.2 million in the
second quarter of 1998 due to an increase in administrative service fees.
Policy benefits, claims and losses increased $3.0 million, or 5.0%, to $63.2
million in the second quarter of 1998. This increase is principally
attributable to increases of $3.9 million from the risk sharing product line
and $2.5 million from the non-affinity group reinsurance product line as a
result of growth and less favorable loss experience. Additionally, stop
loss policy benefits increased $1.0 million primarily due to growth. These
increases were partially offset by lower policy benefits of $1.5 million due
to more favorable loss experience in the remaining policies of the fully
insured dental product line related to the aforementioned cancellation of
several large unprofitable accounts, coupled with lower benefits on
affinity group life and health reinsurance business of $2.8 million due
to the reinsurance agreement noted above.
Operating expenses increased $2.1 million, or 5.9%, to $37.5 million in the
second quarter of 1998 primarily due to increased claims processing
expenses, as well as increases in commissions, expense allowances, and
premium taxes, related to the growth in the non-affinity group reinsurance
product line.
Page 28
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Segment income before taxes decreased $3.4 million, or 34.3%, to $6.5
million in the six months ended June 30, 1998. This decrease was primarily
due to an increase in expenses related to claims processing costs of
approximately $3.2 million. Also, policy benefits experience in the
non-affinity group reinsurance product line increased $1.3 million. These
decreases were partially offset by higher premiums in the stop loss product
lines, due to growth, and additional administrative service fee income.
Premiums increased $6.3 million, or 3.9%, to $169.3 million for the first
six months in 1998 primarily due to increases in the non-affinity group
reinsurance product of $5.0 million and risk sharing and stop loss products
of $4.7 million. These increases were partially offset by decreases on
fully insured medical and dental products of $4.4 million. These decreases
reflect the cancellation of several large unprofitable accounts.
Other income increased $3.5 million, or 14.5%, to $27.7 million in the first
six months of 1998 due to an increase in administrative service fees.
Policy benefits, claims and losses increased $6.7 million, or 5.6%, to
$125.5 million in the first six months of 1998. This increase is
principally attributable to $6.0 million of higher policy benefits in the
non-affinity group reinsurance product, as well as $4.7 million of higher
policy benefits in the risk sharing and stop loss product lines, primarily
due to growth. These increases were partially offset by reduced losses in
the fully insured medical and dental product lines totaling $3.9 million,
primarily due to improved experience.
Operating expenses increased $6.1 million, or 8.9%, to $74.4 million in the
first six months of 1998 primarily due to increased claims processing
expenses, as well as growth related increases in commissions, expense
allowances, and premium taxes.
Retirement and Asset Accumulation
Allmerica Financial Services
The following table summarizes the results of operations, including the
Closed Block, for the Allmerica Financial Services segment for the periods
indicated.
(Unaudited) (Unaudited)
Quarter Ended Quarter Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment revenues
Premiums $ 9.3 $ 18.3 $ 38.2 $ 56.1
Fees 72.7 57.1 142.2 113.4
Net investment income 75.8 86.4 156.4 171.9
Other income 14.6 13.2 26.8 24.8
------ ----- ----- -----
Total segment revenues 172.4 175.0 363.6 366.2
Policy benefits, claims and losses 74.4 89.4 167.9 194.5
Policy acquisition expenses 15.6 14.1 30.1 30.5
Other operating expenses 38.8 39.5 80.3 79.4
------- ------ ------ ------
Segment income before taxes $ 43.6 $ 32.0 $ 85.3 $ 61.8
======= ====== ====== ======
Quarter Ended June 30, 1998 Compared to Quarter Ended June 30, 1997
Segment income before taxes increased $11.6 million, or 36.3%, to $43.6
million in the second quarter of 1998. This increase is primarily
attributable to higher asset based fee income driven by growth in the
variable annuity and variable universal life product lines.
Page 29
Premiums decreased $9.0 million, or 49.2%, to $9.3 million during the second
quarter of 1998. This decrease is due primarily to the cession in 1997 of
substantially all of the Company's individual disability income block of
business, which contributed premiums of $8.4 million in the second quarter of
1997 compared to $0.1 million in the same period of 1998. The remaining
decrease in premiums was a result of the Company's continued shift in focus
from traditional life insurance products to annuity and variable life
insurance products.
The increase in fee revenue of $15.6 million, or 27.3%, to $72.7 million in
the second quarter of 1998 is due to additional deposits and appreciation on
variable products' account balances. Fees from individual annuities increased
$13.8 million, or 68.0%, to $34.1 million in the second quarter of 1998
compared to the same period in 1997. Distribution arrangements with several
third party mutual fund advisors continue to contribute to the increase in
annuity sales in 1998. Fees from individual variable universal life
policies increased $2.6 million, or 19.7%, to $15.8 million in the second
quarter of 1998. These increases were partially offset by a continued
decline in fees from non-variable universal life of $1.2 million. The
Company expects fees from this product to continue decreasing as policies
in force and related contract values decline.
Net investment income decreased $10.6 million, or 12.3%, to $75.8 million
in the second quarter of 1998. This decrease is primarily due to a
reduction in average fixed maturities invested resulting from the
aforementioned cession of the individual disability income line of
business and transfers to the separate accounts in the annuity and
retirement products.
Other income increased $1.4 million, or 10.6%, to $14.6 million in the
second quarter of 1998. This increase is primarily attributable to higher
investment management fee income resulting from growth in variable product
assets under management.
Policy benefits, claims and losses decreased $15.0 million, or 16.8%, to
$74.4 million in the second quarter of 1998. This decrease is primarily due
to the aforementioned cession of substantially all of the individual
disability income line of business, which incurred policy benefits of $9.6
million in the second quarter of 1997, compared to $0.8 million in the
current year quarter. Also contributing to the overall decrease was a
reduction in interest credited on individual annuities and group retirement
products of $3.2 million and $2.4 million due to transfers to the separate
accounts.
Policy acquisition expenses increased $1.5 million, or 10.6%, to $15.6
million in the second quarter of 1998 primarily due from growth in the
individual variable annuity line of business. This increase was partially
offset by decreased policy acquisition expenses due to the aforementioned
cession of the individual disability line of business, along with lower
policy acquisition expenses in the individual universal life and variable
universal life lines of business resulting from a change in mortality
assumptions in 1997. This change was consistent with the January 1, 1998
reinsurance of a significant portion of the related mortality risk on
these lines.
Other operating expenses decreased $0.7 million, or 1.8%, to $38.8 million
in 1998. Excluding the effect of adopting SOP 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" which
resulted in the capitalization of $4.0 million of technology costs during
the second quarter of 1998, operating expenses increased $3.3 million, or
8.4%. This increase was primarily attributable to continued growth in the
variable product lines, partially offset by reductions in employee related
costs generated by the restructuring of defined benefit plan and defined
contribution plan business during the fourth quarter of 1997.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Segment income before taxes increased $23.5 million, or 38.0%, to $85.3
million in the first half of 1998. This increase is primarily due to
continued growth from new deposits and market appreciation in the variable
annuity and variable universal life assets resulting in increased fee
revenue.
Premiums decreased $17.9 million, or 31.9%, to $38.2 million during the first
six months of 1998. This decrease is due primarily to the cession in 1997 of
substantially all of the Company's individual disability income block of
business, which contributed premiums of $16.4 million in the first six months
of 1997 compared to $0.4 million for the same period in 1998. The remaining
decrease in premiums was a result of the Company's continued shift in focus
from traditional life insurance products to variable life insurance and
annuity products.
Page 30
The increase in fee revenue of $28.8 million, or 25.4%, to $142.2 million in
the first half of 1998 is due to additional deposits and appreciation on
variable products' account balances. Fees from individual annuities increased
$25.2 million, or 66.3%, to $63.2 million in the first half of 1998 compared
to the same period in 1997. Fees from individual variable universal life
policies increased $5.7 million, or 22.4%, to $31.2 million in the first half
of 1998. These increases were partially offset by a continued decline in fees
from non-variable universal life of $2.8 million.
Net investment income decreased $15.5 million, or 9.0%, to $156.4 million
in the first half of 1998. This decrease is primarily due to a reduction
in average fixed maturities invested resulting from the aforementioned
cession of the individual disability income line of business and transfers
to the separate accounts.
Other income increased $2.0 million, or 8.1%, to $26.8 million in the first
half of 1998. This increase is primarily attributable to higher investment
management fee income resulting from growth in variable product assets under
management.
Policy benefits, claims and losses decreased $26.6 million, or 13.7%, to
$167.9 million in the first half of 1998. This decrease is primarily due to
the cession of substantially all of the individual disability income line of
business, which incurred policy benefits of $19.9 million in the first six
months of 1997, compared to $1.2 million for the same period in 1998. Also
contributing to the overall decrease was a reduction in interest credited on
individual annuities and group retirement products of $4.0 million and $4.4
million, respectively, due to the aforementioned shift to separate accounts.
Policy acquisition expenses were relatively consistent, decreasing $0.4
million, or 1.3%, to $30.1 million in the first half of 1998. This decrease
is due, in part, to the aforementioned cession in 1997 of the individual
disability income line of business. In addition, a decrease in amortization
in the individual universal life and variable universal life lines of
business resulted from the change in mortality assumptions in 1997 which are
consistent with the aforementioned reinsurance transaction. These decreases
were substantially offset by higher policy acquisition expenses in the
individual variable annuity lines due to growth in these lines of business.
Other operating expenses increased $0.9 million, or 1.1%, to $80.3 million
in the first half of 1998. Excluding the effect of adopting SOP 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" which resulted in the capitalization of $4.0 million of
technology costs during the first half of 1998, operating expenses
increased $4.9 million, or 6.2%. This increase was primarily attributable
to continued growth in the variable product lines, partially offset by
reductions in employee related costs generated by the restructuring of
defined benefit plan and defined contribution plan business during the
fourth quarter of 1997.
Interest Margins
The results of the Allmerica Financial Services segment depend, in part, on
the maintenance of profitable margins between investment results from
investment assets supporting universal life and general account annuity
products and the interest credited on those products.
The following table sets forth interest earned, interest credited and the
related interest margin.
(Unaudited) (Unaudited)
Quarter Ended Quarter Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Net investment income $ 34.6 $ 38.7 $ 67.5 $ 73.1
Less: Interest credited 20.7 24.6 43.8 49.2
------ ----- ----- -----
Interset margins <F1> 13.9 14.1 23.7 23.9
====== ===== ===== =====
<FN>
<F1> Interest margins represent the difference between income earned on
investment assets and interest credited to customers' universal life and
general account annuity policies. Earnings on surplus assets are
excluded from net investment income in the calculation of the above
interest margins.
</FN>
Interest margins were relatively consistent in the second quarter and first
six months of 1998.
Page 31
Allmerica Asset Management
The following table summarizes the results of operations for the Allmerica
Asset Management segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment revenues:
Net investment income <F1> $27.6 $21.4 $49.2 $43.0
Fees and other income:
External 0.6 0.7 1.2 1.4
Internal 1.7 1.5 3.4 3.1
----- ----- ----- -----
Total segment revenues 29.9 23.6 53.8 47.5
Policy benefits, claims
and losses <F1> 21.9 16.5 39.4 34.2
Other operating expenses 1.8 1.7 4.3 4.7
----- ----- ----- -----
Segment income before taxes $ 6.2 $ 5.4 $10.1 $ 8.6
===== ===== ===== =====
<FN>
<F1> For all periods presented, net investment income and policy benefits,
claims and losses reflect only the income earned and interest credited,
respectively, on GICs. Interest margins on GICs reflect the difference
between income earned on deposits from policyholder contracts and interest
credited to these policies.
</FN>
Quarter Ended June 30, 1998 compared to Quarter Ended June 30, 1997
Segment income before taxes increased $0.8 million, or 14.8%, to $6.2
million. Interest margins on GICs increased as new deposits generated by
floating rate" GICs more than offset withdrawals of traditional GICs.
Interest margins on "floating rate" GICs increased $2.7 million which more
than offset a $1.9 million decline in interest margins from traditional
GICs during the second quarter of 1998.
Six Months Ended June 30, 1998 compared to Six Months Ended June 30, 1997
Segment income before taxes increased $1.5 million, or 17.4% to $10.1
million. The increase is primarily attributable to improved interest
margins on GICs, combined with a decrease in expenses. Interest margins
on GICs increased as new deposits generated by "floating rate" GICs more
than offset withdrawals of traditional GICs. Interest margins on
floating rate GICs increased $3.7 million while margins on traditional
GICs declined $2.7 million during 1998.
Page 32
Corporate
The following table summarizes the results of operations for the Corporate
segment for the periods indicated.
(Unaudited) (Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
(In millions) 1998 1997 1998 1997
Segment revenues
Investment and other income $ 4.1 $ 5.7 $ 6.1 $ 9.8
Interest expense 3.8 3.8 7.6 7.6
Other operating expenses 14.3 9.9 24.8 21.2
Segment loss before taxes ------ ------ ------ ------
and minority interest $(14.0) $ (8.0) $(26.3) $(19.0)
====== ====== ====== ======
Quarter Ended June 30, 1998 compared to Quarter Ended June 30, 1997
Segment loss before taxes and minority interest increased $6.0 million, or
75.0%, to $14.0 million in the second quarter of 1998. Net investment and
other income decreased $1.6 million in 1998 primarily from the absence of
$4.0 million of short-term income generated by the temporary investment of
the net proceeds from the issuance of Capital Securities in 1997. This was
principally offset by increased income on fixed maturities due to higher
average invested assets which resulted from $125 million and $195 million
transfers of assets from the Property and Casualty segment in April 1998 and
December 1997, respectively, offset by approximately $140.0 million
repayment of a maturing short-term revolving credit loan. Interest expense
for both periods relates solely to the interest paid on the Senior
Debentures of the Company. Other operating expenses for the quarter ended
June 30, 1998 increased $4.4 million, or 44.4%. This expense category
consists primarily of corporate overhead expenses which reflect costs not
attributable to a particular segment, such as those generated by certain
officers and directors, Corporate Technology, Corporate Finance, Human
Resources and the Legal department. Other operating expenses increased
$4.4 million primarily due to $1.7 million of higher corporate technology
costs, $0.5 million of prepayment penalties for the settlement of
subsidiary debt, and other miscellaneous items.
Six Months Ended June 30, 1998 compared to Six Months Ended June 30, 1997
Segment loss before taxes and minority interest increased $7.3 million, or
38.4%, to $26.3 million for the six months ended June 30, 1998. Net
investment and other income decreased $3.7 million in 1998 primarily from
the absence of $6.4 million of short-term income generated by the temporary
investment of the net proceeds from the issuance of Capital Securities in
1997. This was partially offset by income on higher average invested assets
due to the aforementioned transfers of assets from the Property and Casualty
segment. Interest expense for both periods relates solely to the interest
paid on the Senior Debentures of the Company. Other operating expenses
increased $3.6 million, or 17.0%, primarily due to $1.6 million of higher
corporate technology costs, $0.5 million of prepayment penalties for the
settlement of subsidiary debt, and other miscellaneous items.
Page 33
Investment Portfolio
The Company had investment assets diversified across several asset classes,
as follows:
June 30, 1998 <F1> December 31, 1997 <F1>
Carrying % of Total Carrying % of Total
(Dollars in millions) Value Carrying Value Value Carrying Value
Fixed Maturities <F2> $ 8,229.0 80.1% $ 7,726.6 79.8%
Equity securities<F2> 574.0 5.6 479.0 4.9
Mortgages 680.1 6.6 679.5 7.0
Policy loans 364.5 3.5 360.7 3.7
Real estate 27.1 0.3 50.3 0.5
Cash and cash equivalents 244.1 2.4 240.1 2.5
Other invested assets 154.3 1.5 148.3 1.6
--------- ----- --------- -----
Total $10,273.1 100.0% $ 9,684.5 100.0%
========= ===== ========= =====
<FN>
<F1> Includes Closed Block invested assets with a carrying value of
$763.1 million and $768.8 million at June 30, 1998 and December 31, 1997,
respectively.
<F2> The Company carries the fixed maturities and equity securities in
its investment portfolio at market value.
</FN>
Total investment assets increased $588.6 million, or 6.1%, to $10.3 billion
during 1998. Fixed maturities increased $502.4 million, or 6.5%. The
increase in fixed maturities was primarily due to an increase in funds
available for investment generated from the sale of "floating rate" GICs.
Equity securities increased $95.0 million, or 19.8% to $574.0 million
during 1998 primarily due to market appreciation. Real estate decreased
$23.2 million, or 46.1%, to $27.1 million during the first six months of
1998 due to continued sales of investment properties. The Company intends
to sell its remaining holdings in the real estate portfolio.
The Company's fixed maturity portfolio is comprised of primarily investment
grade corporate securities, tax-exempt issues of state and local
governments, U.S. government and agency securities and other issues.
Based on ratings by the National Association of Insurance Commissioners,
investment grade securities comprised 82.4% and 82.5% of the Company's
total fixed maturity portfolio at June 30, 1998 and December 31, 1997,
respectively. In 1997, there was a modest shift to higher yielding debt
securities, including longer duration and non-investment grade securities.
The average yield on debt securities was 7.3% and 7.6% for the six months
ended June 30, 1998 and 1997, 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.
The following table illustrates asset valuation allowances and additions to
or deductions from such allowances for the periods indicated.
Real
(Dollars in millions) Mortgages Estate Total
Year Ended December 31, 1997
Beginning balance $ 19.6 $ 14.9 $ 34.5
Provision 2.5 6.0 8.5
Write-offs <F1> (1.4) (20.9) (22.3)
------ ------ ------
Ending balance $ 20.7 $ 0.0 $ 20.7
Valuation allowance as a
percentage of carrying value
before reserves 3.0% 0.0% 3.0%
Six months ended June 30, 1998
Provision (benefits) (2.2) 0.0 (2.2)
Write-offs <F1> (0.9) 0.0 (0.9)
------ ------ ------
Ending balance $(17.6) $ 0.0 $(17.6)
====== ====== ======
Valuation allowance as a
percentage of carrying value
before reserves 2.5% 0.0% 2.5%
<FN>
<F1> Write-offs reflect asset sales, foreclosures and forgiveness of debt
upon restructurings.
</FN>
Write-offs of real estate reserves during 1997 reflect the permanent write
down of all real estate assets to the estimated fair value less costs of
disposal. During 1997, the Company adopted a definitive plan to sell its
real estate holdings.
Page 34
Income Taxes
AFC and its domestic subsidiaries (including certain non-insurance
operations) file a consolidated United States federal income tax return.
Entities included within the consolidated group are segregated into either
a life insurance or a non-life insurance company subgroup. The consolidation
of these subgroups is subject to certain statutory restrictions on the
percentage of eligible non-life tax losses that can be applied to offset
life company taxable income. Prior to the merger in July 1997, Allmerica
P&C and its subsidiaries filed a separate United States federal income tax
return.
Provision for federal income taxes before minority interest was $18.4
million during the second quarter of 1998 compared to $19.3 million during
the same period in 1997. These provisions resulted in consolidated
effective federal tax rates of 21.8% and 25.4%, respectively. The
effective tax rates for AFLIAC and FAFLIC and its non-insurance
subsidiaries were 32.6% and 37.9% during the second quarter of 1998 and
1997, respectively. The decrease in the rate for AFLIAC and FAFLIC and
its non-insurance subsidiaries resulted primarily from tax credits on
investment partnerships in the second quarter of 1998 as well as to
changes in reserves for estimated prior year tax liabilities. The
effective tax rates for Allmerica P&C and its subsidiaries were 9.1%
and 12.9% during the second quarter of 1998 and 1997, respectively. The
decrease in the rate for the Allmerica P&C subsidiaries primarily reflects
lower underwriting income in 1998.
Provision for federal income taxes before minority interest was $42.6
million during the first six months of 1998 compared to $29.0 million
during the same period in 1997. These provisions resulted in consolidated
effective federal tax rates of 23.2% and 22.2%, respectively. The effective
tax rates for AFLIAC and FAFLIC and its non-insurance subsidiaries were
32.0% and 44.8% during the first six months of 1998 and 1997, respectively.
The decrease in the rate for AFLIAC and FAFLIC and its non-insurance
subsidiaries resulted primarily from an $18.9 million tax benefit related
to the agreement to cede the individual disability income business in 1997.
The effective tax rates for Allmerica P&C and its subsidiaries were
11.4% and 18.0% during the first six months of 1998 and 1997, respectively.
The decrease in the rate for the Allmerica P&C subsidiaries primarily
reflects a smaller proportion of pre-tax income from realized capital
gains and lower underwriting income in 1998.
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, claims, losses
and loss adjustment expenses can be variable because of uncertainties
surrounding settlement dates for liabilities for unpaid losses and
because of the potential for large losses either individually or in the
aggregate. The Company periodically adjusts its investment policy to
respond to changes in short-term and long-term cash requirements.
Net cash used in operating activities was $75.7 million for the first six
months of 1998, compared to $30.6 million for the same period of 1997. The
change in 1998 resulted primarily from the timing of recoveries of
reinsurance related to the universal life reinsurance agreement which was
effective January 1, 1998. In addition, cash was used in 1998 operations
to fund increased commissions and other deferrable expenses related to
continued growth in the variable annuity product lines of the Allmerica
Financial Services segment.
Net cash used in investing activities was $519.9 million during the first
six months of 1998, as compared to $261.2 million provided by investing
activities during the same period in 1997. This change is primarily due to
greater net purchases of fixed maturities in 1998 resulting from an increase
in funds available for investment from new "floating rate" GIC deposits.
Net cash provided by financing activities was $599.6 million during the
first six months of 1998, as compared to $112.0 million during the
comparable prior year period. In 1998, cash provided by financing
activities was positively impacted by net GIC deposits of $585.4 million
compared to net GIC withdrawals of $176.7 million in the prior year. This
increase was partially offset by the 1997 receipt of net proceeds of
$296.3 million from the issuance of mandatorily redeemable preferred
securities of a subsidiary trust holding solely junior debentures of the
Company.
Page 35
AFC has sufficient funds at the holding company or available through
dividends from FAFLIC and Allmerica P&C to meet its obligations to pay
interest on the Senior Debentures, Capital Securities and dividends,
when and if declared by the Board of Directors, on the common stock. On
January 12, 1998, FAFLIC's Board of Directors declared a common stock
dividend to AFC of $50.0 million, to be paid in installments upon the
Company's request. As of June 30, 1998, approximately $20.0 million has
been paid, with the remaining balance to be paid during the third and
fourth quarters of 1998. 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. Effective May 29,1998, AFC entered into a
committed syndicated credit agreement with Chase Manhattan Bank as the
administrative agent. This agreement, which replaces lines of credit
previously held by FAFLIC and Allmerica P&C, provides for a $150.0 million
credit facility which expires on May 28, 1999. Borrowings under this
agreement are unsecured and incur interest at a rate per annum equal to,
at the Company's option, a designated base rate or the eurodollar rate
plus applicable margin. There were no amounts outstanding under this
agreement during the period. At June 30, 1998, $113.1 million was
available for borrowing by the Company. The remaining $36.9 million
represents the Company's commercial paper borrowings outstanding at
June 30, 1998.
Contingencies
In July 1997, a lawsuit was instituted in Louisiana against AFC and
certain of its subsidiaries by individual plaintiffs alleging fraud,
unfair or deceptive acts, breach of contract, misrepresentation and related
claims in the sale of life insurance policies. In October 1997, plaintiffs
voluntarily dismissed the suit and refiled the action in Federal District
Court in Worcester, Massachusetts. The plaintiffs seek to be classified
as a class. The case is in early stages of discovery and the Company is
evaluating the claims. Although the Company believes it has meritorious
defenses to plaintiffs' claims, there can be no assurance that the claims
will be resolved on a basis which is satisfactory to the Company.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar
normal business activities.
Based on a recent assessment, the Company determined that it will be
required to modify or replace significant portions of its software so
that its computer systems will properly utilize dates beyond December
31, 1999. The Company presently believes that with modifications to
existing software and conversions to new software, the Year 2000 issue
will be resolved. However, if such modifications and conversions are
not made, or are not completed timely, the Year 2000 issue could have
a material impact on the operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company
is vulnerable to those third parties' failure to remediate their own Year
2000 issue. The Company's total Year 2000 project cost and estimates to
complete the project include the estimated costs and time associated with
the impact of a third party's Year 2000 issue, and are based on presently
available information. However, there can be no guarantee that the
systems of other companies on which the Company's systems rely will be
timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Company's systems, would not have
material adverse effect on the Company. The Company does not believe that
it has material exposure to contingencies related to the Year 2000 Issue
for the products it has sold. Although the Company does not believe that
there is a material contingency associated with the Year 2000 project,
there can be no assurance that exposure for material contingencies will
not arise.
Page 36
The Company will utilize both internal and external resources to reprogram
or replace, and test the software for Year 2000 modifications. The Company
plans to complete the mission critical elements of the Year 2000 by December
31, 1998. The cost of the Year 2000 project will be expensed as incurred
over the next two years and is being funded primarily through a reallocation
of resources from discretionary projects. Therefore, the Year 2000 project
is not expected to result in any significant incremental technology costs
and is not expected to have a material effect on the results of
operations. Through June 30, 1998, the Company has incurred and expensed
approximately $40 million related to the assessment of, and preliminary
efforts in connection with, the project and the development of a
remediation plan. The total remaining cost of the project is estimated
at between $50-80 million.
The Company's contingency plans related to the Year 2000 issue are addressed
in a plan developed jointly with an outside vendor. The plan contains
immediate steps to keep business functions operating while unforeseen Year
2000 issues are being addressed. It outlines responses to situations that
may affect critical business functions and also provides triage guidance, a
documented order of actions to respond to problems. During the triage
process, business priorities are established and "Critical Points of
Failure" are identified as having a significant impact on the business.
The Company's contingency plans are designed to keep a business unit's
operation functioning in the event of a failure or delay due to Year 2000
record format and date calculation changes.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events including the continued availability of certain resources, third
party modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results
could differ materially from those plans. Specific factors that might
cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
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 1997 and beyond to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. When used in the MD&A discussion, the words "believes",
"anticipated", "expects" and similar expressions are intended to
identify forward looking statements. See "Important Factors Regarding
Forward-Looking Statements" filed as Exhibit 99-2 to the Company's Annual
Report on Form 10-K for the period ended December 31, 1997.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include among others, the following possibilities: (i)
adverse catastrophe experience and severe weather; (ii) adverse loss
development for events the Company insured in prior years or adverse trends
in mortality and morbidity; (iii) heightened competition, including the
intensification of price competition, the entry of new competitors, and the
introduction of new products by new and existing competitors; (iv) adverse
state and federal legislation or regulation, including decreases in rates,
limitations on premium levels, increases in minimum capital and reserve
requirements, benefit mandates, limitations on the ability to manage care
and utilization, and tax treatment of insurance and annuity products; (v)
changes in interest rates causing a reduction of investment income or in
the market value of interest rate sensitive investments; (vi) failure to
obtain new customers, retain existing customers or reductions in policies
in force by existing customers; (vii) higher service, administrative, or
general expense due to the need for additional advertising, marketing,
administrative or management information systems expenditures; (viii) loss
or retirement of key executives; (ix) increases in medical costs,
including increases in utilization, costs of medical services,
pharmaceuticals, durable medical equipment and other covered items;
(x) termination of provider contracts or renegotiations at less
cost-effective rates or terms of payment; (xi) changes in the Company's
liquidity due to changes in asset and liability matching;
(xii) restrictions on insurance underwriting, based on genetic testing
and other criteria; (xiii) adverse changes in the ratings obtained from
independent rating agencies, such as Moody's, Standard and Poor's,
A.M. Best, and Duff & Phelps; (xiv) lower appreciation on and decline
in value of managed investments, resulting in reduced variable products,
assets and related fees; (xv) possible claims relating to sales practices
for insurance products; and (xvi) uncertainty related to the Year
2000 issue.
Page 37
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This registrant's annual shareholder's meeting was held on May 12, 1998.
All four directors nominated for reelection by the Board of Directors were
named in proxies for the meeting, which proxies were solicited pursuant to
Regulations 14A of the Securities and Exchange Act of 1934. The following
individuals were elected to serve a three year term:
VOTES FOR WITHHELD
Michael P. Angelini 36,170,497 8,146,205
J. Terrence Murray 30,714,131 13,602,571
John F. O'Brien 36,159,455 8,157,247
Herbert M. Varnum 36,178,811 8,137,891
The other directors whose terms were continued after the Annual Meeting
are Ms. Gail L. Harrison, Mr. Robert P. Henderson, Mr. M. Howard
Jacobson, Mr. Robert J. Murray, Mr. John L. Sprague, Mr. Robert G.
Stachler, and Mr. Richard M. Wall.
Shareholders ratified the appointment of PricewaterhouseCoopers LLP as the
Independent Public Accountants of the Company for 1998: for 44,101,790;
against 75,411; abstain 139,501.
Page 38
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
EX - 10.29 Credit agreement dated as of May 29, 1998 between
the Registrant and the Chase Manhattan Bank.
EX - 27 Financial Data Schedule
(b) Reports on Form 8K
On June 10, 1998, a report on Form 8-K was filed reporting under
item 5, Other Events, that second quarter results will be negatively
impacted by catastrophe losses as a result of electrical, rain and wind
storms that struck Michigan and the Northeast during the final days of
May. Currently the Company expects to incur approximately $33.6 million
of pre-tax losses, which includes $29.6 million from its subsidiary,
Citizens Corporation.
On August 3, 1998, a report on Form 8-K was filed reporting under
item 5, Other Events, that third quarter results will be negatively
impacted by catastrophe losses as a result of electrical, rain and wind
storms that struck the metropolitan Detroit, Michigan and the Northern
Illinois areas on July 22. Currently, the Company expects to incur
approximately $6.8 million of pre-tax, pre-minority interest losses from
it subsidiary, Citizens Corporation.
Page 39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allmerica Financial Corporation
-------------------------------
Registrant
Dated August 13, 1998
---------------
/s/ John F. O'Brien
-------------------
John F. O'Brien
President and Chief
Executive Officer
Dated August 13, 1998
---------------
/s/ Edward J. Parry III
-----------------------
Edward J. Parry III
Vice President, Chief
Financial Officer,
and Treasurer
Page 40
EXHIBIT INDEX
Exhibit Number Exhibit
- -------------- -------
10.29 Credit agreement dated as of May 29, 1998
between the Registrant and the Chase
Manhattan Bank.
27 Financial Data Schedule
Page 41