**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

| **ý**                                                                                                                                                                                                                                                                                   | **Quarterly  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|
| **for  the Quarterly Period Ended September 30, 2003,**                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                         |
| **or**                                                                                                                                                                                                                                                                                       |
|                                                                                                                                                                                                                                                                                         |
| **o**                                                                                                                                                                                                                                                                                        | **Transition report pursuant to Section 13 or  15(d) Of the Exchange Act**                    |
| **for  the Transition Period from                        to                      .** |

 

**No. 000-25425**

**(Commission File Number)**

 

**MERCERINSURANCE GROUP, INC.**

(Exact name of Registrant as specified in its charter)

 

| **PENNSYLVANIA**                                                                    |   | **23-2934601**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                |
| **10 North Highway 31, P.O. Box 278,  Pennington, NJ**                              |   | **08534**                             |
| (Address of principal executive offices)                                            |   | (Zip Code)                            |
|                                                                                |
| **(609) 737-0426**                                                                  |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |
|                                                                                |
| (Former name, former address and former fiscal year,  if changed since last report) |

 

Check whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes  o    No ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

Yes  o    No ý

 

State the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| Number of Shares Outstanding                 |   |
|----------------------------------------------|--------|
| as of December    , 2003 |   |

 

|                        |   |                 |
|-----------------------------|--------|----------------------|
| COMMON STOCK (No Par Value) |   | None                 |
| (Title of Class             |   | (Outstanding Shares) |

 

 

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Forward-looking Statements

 

Mercer InsuranceGroup, Inc. (the “Company”) may from time to time make written or oral“forward-looking statements,” including statements contained in the Company’sfilings with the Securities and Exchange Commission (including this QuarterlyReport on Form 10-Q and the exhibits hereto and thereto), in its reports toshareholders and in other communications by the Company, which are made in goodfaith by the Company pursuant to the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995.

 

Theseforward-looking statements include statements with respect to the Company’sbeliefs, plans, objectives, goals, expectations, anticipations, estimates andintentions, that are subject to significant risks and uncertainties, and aresubject to change based on various factors (some of which are beyond theCompany’s control).  The words “may,”“could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,”“intend,” “plan” and similar expressions are intended to identifyforward-looking statements.  Thefollowing factors, among others, could cause the Company’s financial performanceto differ materially from the plans, objectives, expectations, estimates andintentions expressed in such forward-looking statements:

 

 

•                  future economicconditions in the regional and national markets in which the Company competeswhich are less favorable than expected;

 

•                  the effects ofweather-related and other catastrophic events;

 

•                  theconcentration of insured accounts in New Jersey and Pennsylvania;

 

•                  theeffect of legislative, judicial, economic, demographic and regulatory events inthe two states in which we do business;

 

•                  thecontinuation of an A.M. Best rating in the Excellent category;

 

•                  theability to enter new markets successfully and capitalize on growthopportunities either through acquisitions or the expansion of our producernetwork;

 

2

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•                  financialmarket conditions, including, but not limited to, changes in interest rates andthe stock markets causing a reduction of investment income or investment gains,an acceleration of the amortization of deferred policy acquisition costs,reduction in the value of our investment portfolio or a reduction in the demandfor our products;

 

•                  theimpact of acts of terrorism and acts of war;

 

•                  theeffects of terrorist related insurance legislation and laws;

 

•                  inflation;

 

•                  thecost, availability and collectibility of reinsurance;

 

•                  estimatesand adequacy of loss reserves and trends in losses and loss adjustmentexpenses;

 

•                  heightenedcompetition, including specifically the intensification of price competition,the entry of new competitors and the development of new products by new andexisting competitors;

 

•                  changesin the coverage terms selected by insurance customers, including higherdeductibles and lower limits;

 

•                  ourinability to obtain regulatory approval of, or to implement, premium rateincreases;

 

•                  thepotential impact on our reported net income that could result from the adoptionof future accounting standards issued by the Financial Accounting StandardsBoard or other standard-setting bodies;

 

•                  inabilityto carry out marketing and sales plans, including, among others, development ofnew products or changes to existing products and acceptance of the new orrevised products in the market;

 

•                  unanticipatedchanges in industry trends and ratings assigned by nationally recognized ratingorganizations;

 

•                  adverselitigation or arbitration results;

 

•                  theability to carry out our business plans; and

 

•                  adverse changesin applicable laws, regulations or rules governing insurance holding companiesand insurance companies, and environmental, tax or accounting matters includinglimitations on premium levels, increases in minimum capital and reserves, andother financial viability requirements, and changes that affect the cost of, ordemand for our products.

 

3

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TheCompany cautions that the foregoing list of important factors is notexclusive.  Readers are also cautionednot to place undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the date of this report.  The Company does not undertake to update anyforward-looking statement, whether written or oral, that may be made from timeto time by or on behalf of the Company.

 

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Independent Accountants’Review Report

 

 

The Board of Directors

Mercer Mutual Insurance Company and subsidiaries:

 

We have reviewed the accompanying condensed consolidated balance sheetof Mercer Mutual Insurance Company and subsidiaries (the Group) as of September30, 2003, the related condensed consolidated statements of earnings for thethree-month and nine-month periods ended September 30, 2003 and 2002, and therelated condensed consolidated statements of changes in equity and cash flowsfor the nine-month periods ended September 30, 2003 and 2002.  These condensed consolidated financialstatements are the responsibility of the Group’s management.

 

We conducted our reviews in accordance with standards established bythe American Institute of Certified Public Accountants.  A review of interim financial informationconsists principally of applying analytical procedures and making inquiries ofpersons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with generally accepted auditing standards, theobjective of which is the expression of an opinion regarding the financialstatements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modificationsthat should be made to the condensed consolidated financial statements referredto above for them to be in conformity with accounting principles generallyaccepted in the United States of America.

 

We have previously audited, in accordance with auditing standardsgenerally accepted in the United States of America, the consolidated balancesheet of Mercer Mutual Insurance Company and subsidiaries as of December 31,2002, and the related consolidated statements of earnings, changes in equity,and cash flows for each of the years in the three-year period ended December31, 2002 (not presented herein); and in our report dated March 28, 2003, weexpressed an unqualified opinion on those consolidated financial statements.Our report contains an explanatory paragraph that refers to the Group’sadoption of the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*,**effectiveJanuary 1, 2002. In our opinion, the information set forth in the accompanyingcondensed consolidated balance sheet as of December 31, 2002, is fairly stated,in all material respects, in relation to the consolidated balance sheet fromwhich it has been derived.

 

 
|   | /s/ KPMG LLP |   |
|--------|--------------|--------|

 

 

Philadelphia, Pennsylvania

December 5, 2003

 

 

5

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Part I – FINANCIALINFORMATION

Item 1 – FinancialStatements

 

**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**As of September 30, 2003 andDecember 31, 2002**

** **
|                                                                                                               |   | **As of  September  30, 2003** |       | **As of  December  31, 2002** |       |
|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|------------|-------------------------------|------------|
|                                                                                                               |   | **(Dollars  in thousands)**    |       |
|                                                                                                               |   | **(Unaudited)**                |       |
| **ASSETS**                                                                                                         |   |                           | ** ** |                          | ** ** |
| Investments, at  fair value:                                                                                       |   |                           |       |                          |       |
| Fixed income  securities, available-for-sale, at fair value (Amortized cost of $48,010 and  $48,330, respectively) |   | $                              | 48,377     |                          | $          | 49,247 |   |
| Equity  securities, at fair value (cost of $15,610 and $16,697, respectively)                                      |   | 21,309                         |       | 20,332                        |       |
| Total  investments                                                                                                 |   | 69,686                         |       | 69,579                        |       |
| Cash and cash  equivalents                                                                                         |   | 8,421                          |       | 7,201                         |       |
| Premiums  receivable                                                                                               |   | 9,372                          |       | 7,121                         |       |
| Reinsurance  receivables                                                                                           |   | 4,368                          |       | 3,489                         |       |
| Prepaid  reinsurance premiums                                                                                      |   | 1,525                          |       | 1,146                         |       |
| Deferred policy  acquisition costs                                                                                 |   | 6,746                          |       | 5,783                         |       |
| Accrued  investment income                                                                                         |   | 540                            |       | 599                           |       |
| Property and  equipment, net                                                                                       |   | 6,516                          |       | 5,713                         |       |
| Deferred income  taxes                                                                                             |   | 1,129                          |       | 1,411                         |       |
| Goodwill                                                                                                           |   | 2,876                          |       | 2,876                         |       |
| Other assets                                                                                                       |   | 2,511                          |       | 930                           |       |
| Total assets                                                                                                       |   | $                              | 113,690    |                          | $          | 105,848 |   |
|                                                                                                               |   |                           |       |                          |       |
| **LIABILITIES AND  SURPLUS**                                                                                       |   |                           | ** ** |                          | ** ** |
| Liabilities:                                                                                                       |   |                           |       |                          |       |
| Losses and loss  adjustment expenses                                                                               |   | $                              | 35,310     |                          | $          | 31,348 |   |
| Unearned  premiums                                                                                                 |   | 29,772                         |       | 24,923                        |       |
| Accounts payable  and accrued expenses                                                                             |   | 5,371                          |       | 8,000                         |       |
| Other reinsurance  balances                                                                                        |   | 203                            |       | 210                           |       |
| Other  liabilities                                                                                                 |   | 1,335                          |       | 1,238                         |       |
| Total  liabilities                                                                                                 |   | 71,991                         |       | 65,719                        |       |
| Minority  interest in subsidiary                                                                                   |   | 3,224                          |       | 3,112                         |       |
| Equity:                                                                                                            |   |                           |       |                          |       |
| Unassigned  equity                                                                                                 |   | 34,474                         |       | 34,029                        |       |
| Accumulated  other comprehensive income:                                                                           |   |                           |       |                          |       |
| Unrealized gains  in investments, net of deferred income taxes                                                     |   | 4,001                          |       | 2,988                         |       |
| Total equity                                                                                                       |   | 38,475                         |       | 37,017                        |       |
| Total  liabilities and equity                                                                                      |   | $                              | 113,690    |                          | $          | 105,848 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

6

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**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFEARNINGS**

**Nine Months Ended September 30,2003 and 2002**

 
|                                                                      |   | **2003**                     |   | **2002** |   |
|---------------------------------------------------------------------------|--------|------------------------------|--------|----------|--------|
|                                                                      |   | **(Dollars  in  thousands)** |   |
|                                                                      |   | **(Unaudited)**              |   |
| Revenue:                                                                  |   |                         |   |     |   |
| Net premiums  earned                                                      |   | $                            | 34,762 |     | $      | 29,607 |   |
| Investment  income, net of expenses                                       |   | 1,221                        |   | 1,620    |   |
| Net realized  investment gains (losses)                                   |   | 130                          |   | (270     | )      |
| Other revenue                                                             |   | 292                          |   | 245      |   |
| Total revenue                                                             |   | 36,405                       |   | 31,202   |   |
| Expenses:                                                                 |   |                         |   |     |   |
| Losses and loss  adjustment expenses                                      |   | 19,600                       |   | 14,657   |   |
| Amortization of  deferred policy acquisition costs                        |   | 9,396                        |   | 7,951    |   |
| Other expenses                                                            |   | 6,587                        |   | 5,823    |   |
| Stock conversion  expenses                                                |   | 65                           |   | —   |   |
| Total expenses                                                            |   | 35,648                       |   | 28,431   |   |
| Income before  income taxes and minority interest in income of subsidiary |   | 757                          |   | 2,771    |   |
| Income taxes                                                              |   | 188                          |   | 857      |   |
| Income before  minority interest in income of subsidiary                  |   | 569                          |   | 1,914    |   |
| Minority  interest in income of subsidiary                                |   | (124                         | )      | (79      | )      |
| Net income                                                                |   | $                            | 445    |     | $      | 1,835 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFEARNINGS**

**Three Months Ended September 30,2003 and 2002**

 
|                                                                      |   | **2003**                     |   | **2002** |   |
|---------------------------------------------------------------------------|--------|------------------------------|--------|----------|--------|
|                                                                      |   | **(Dollars  in  thousands)** |   |
|                                                                      |   | **(Unaudited)**              |   |
| Revenue:                                                                  |   |                         |   |     |   |
| Net premiums  earned                                                      |   | $                            | 12,379 |     | $      | 10,611 |   |
| Investment  income, net of expenses                                       |   | 400                          |   | 525      |   |
| Net realized  investment gains (losses)                                   |   | 167                          |   | (282     | )      |
| Other revenue                                                             |   | 101                          |   | 84       |   |
| Total revenue                                                             |   | 13,047                       |   | 10,938   |   |
| Expenses:                                                                 |   |                         |   |     |   |
| Losses and loss  adjustment expenses                                      |   | 6,859                        |   | 5,166    |   |
| Amortization of  deferred policy acquisition costs                        |   | 3,325                        |   | 2,704    |   |
| Other expenses                                                            |   | 2,571                        |   | 2,408    |   |
| Stock conversion  expenses                                                |   | 3                            |   | —   |   |
| Total expenses                                                            |   | 12,758                       |   | 10,278   |   |
| Income before  income taxes and minority interest in income of subsidiary |   | 289                          |   | 660      |   |
| Income taxes                                                              |   | 84                           |   | 227      |   |
| Income before  minority interest in income of subsidiary                  |   | 205                          |   | 433      |   |
| Minority  interest in income of subsidiary                                |   | (33                          | )      | (35      | )      |
| Net income                                                                |   | $                            | 172    |     | $      | 398 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFCHANGES IN EQUITY**

**Nine Months Ended September 30,2003 and 2002**

** **
|                                                                                                                                       |   | **2003**                    |   | **2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|----------|--------|
|                                                                                                                                       |   | **(Dollars  in thousands)** |   |
|                                                                                                                                       |   | **Unaudited**               |   |
|                                                                                                                                       |   |                        |   |
| Balance,  beginning of period                                                                                                              |   | $                           | 37,017 |     | $      | 35,397 |   |
| Net income                                                                                                                                 |   | 445                         |   | 1,835    |   |
|                                                                                                                                       |   |                        |   |     |   |
| Other  comprehensive income (loss), net of tax:                                                                                            |   |                        |   |     |   |
| Unrealized gains  (losses) on securities:                                                                                                  |   |                        |   |     |   |
| Unrealized  holding gains (losses) arising during period, net of related income tax  expense (benefit) of $566, and $(608)                 |   | 1,099                       |   | (1,181   | )      |
|                                                                                                                                       |   |                        |   |     |   |
| Less  reclassification adjustment for (gains) losses included in net income, net of  related income tax benefit (expense) of $(44) and $91 |   | (86                         | )      | 179      |   |
|                                                                                                                                       |   | 1,013                       |   | (1,002   | )      |
| Comprehensive  income                                                                                                                      |   | 1,458                       |   | 833      |   |
| Balance, end of  period                                                                                                                    |   | $                           | 38,475 |     | $      | 36,230 |   |

 

See accompanyingnotes to consolidated financial statements.

 

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**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**Nine Months Ended September 30,2003 and 2002**

 
|                                                                               |   | **September 30,**       |   |
|------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                               |   | **2003**                     |   | **2002** |   |
|                                                                               |   | **(Dollars  in  thousands)** |   |
|                                                                               |   | **(Unaudited)**              |   |
| Cash flows from  operating activities:                                             |   |                         |   |   |   |
| Net income                                                                         |   | $                            | 445    |   | $ | 1,835 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                         |   |   |   |
| Depreciation and  amortization of fixed assets                                     |   | 974                          |   | 579 |   |
| Net accretion of  discount                                                         |   | (50                          | )      | (193 | ) |
| Net realized  investment (gains) losses                                            |   | (130                         | )      | 270 |   |
| Deferred income  tax                                                               |   | (234                         | )      | (640 | ) |
| Change in assets  and liabilities:                                                 |   |                         |   |   |   |
| Premiums  receivable                                                               |   | (2,251                       | )      | (1,933 | ) |
| Reinsurance  receivables                                                           |   | (879                         | )      | 1,976 |   |
| Prepaid  reinsurance premiums                                                      |   | (379                         | )      | (365 | ) |
| Deferred policy  acquisition costs                                                 |   | (963                         | )      | (486 | ) |
| Other assets                                                                       |   | (1,522                       | )      | (579 | ) |
| Losses and loss  expenses                                                          |   | 3,962                        |   | 920 |   |
| Unearned  premiums                                                                 |   | 4,849                        |   | 3,505 |   |
| Other  liabilities                                                                 |   | (2,413                       | )      | 699 |   |
| Net cash  provided by operating activities                                         |   | 1,409                        |   | 5,588 |   |
| Cash flows from  investing activities:                                             |   |                         |   |   |   |
| Purchase of  fixed income securities, available-for-sale                           |   | (23,189                      | )      | (25,753 | ) |
| Purchase of  equity securities                                                     |   | (3,342                       | )      | (3,619 | ) |
| Sale and  maturity of fixed income securities available-for-sale                   |   | 23,694                       |   | 26,903 |   |
| Sale of equity  securities                                                         |   | 4,424                        |   | 2,017 |   |
| Purchase of  property and equipment                                                |   | (1,776                       | )      | (2,183 | ) |
| Net cash used in  investing activities                                             |   | (189                         | )      | (2,635 | ) |
| Cash flows from  financing activities:                                             |   |                         |   |   |   |
| Proceeds from  sale of securities in subsidiary to minority interest shareholder   |   | —                       |   | 689 |   |
| Net increase in  cash and cash equivalents                                         |   | 1,220                        |   | 3,642 |   |
| Cash and cash  equivalents at beginning of period                                  |   | 7,201                        |   | 8,435 |   |
| Cash and cash  equivalents at end of period                                        |   | $                            | 8,421  |   | $ | 12,077 |   |
| Cash paid during  the period for:                                                  |   |                         |   |   |   |
| Interest                                                                           |   | $                            | 36     |   | $ | 25 |   |
| Income taxes                                                                       |   | $                            | 0      |   | $ | 1,130 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**MERCER MUTUAL INSURANCE COMPANY ANDSUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Dollars in thousands)**

**(Unaudited)**

 

**(1)****                                 Basisof Presentation**

 

The financial informationfor the interim periods included herein is unaudited; however, such informationreflects all adjustments which are, in the opinion of management, necessary toa fair presentation of the financial position, results of operations, and cashflows for the interim periods. The results of operations for interim periodsare not necessarily indicative of results to be expected for the full year.

 

These financialstatements should be read in conjunction with the financial statements andnotes for the year ended December 31, 2002 included in the Company’sregistration statement no. 333-104897 filed with the SEC.

 

**(2)****                                 NewAccounting Pronouncements**

 

In May 2003, the FASB issued Statement No. 150, *Accountingfor Certain Financial Instruments with Characteristics of Both Liabilities andEquity*, which provides guidance on how an entity classifies andmeasures such instruments. This statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003. The statement requires cumulative effect transition forfinancial instruments existing at adoption date. Adoption of this statement didnot result in any changes to the Company’s financial position or its results ofoperations.

 

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**(3)****                                 SegmentInformation**

 

The Company manages itsbusiness in three segments: commercial lines insurance, personal linesinsurance, and investments. The commercial lines insurance and personal linesinsurance segments are managed based on underwriting results determined inaccordance with accounting principles generally accepted in the United Statesof America, and the investment segment is managed based on after-tax investmentreturns.

 

Underwriting results forcommercial lines and personal lines take into account premiums earned, incurredlosses and loss adjustment expenses, and underwriting expenses. The investmentssegment is evaluated by consideration of net investment income, (investmentincome less investment expenses), and realized gains and losses.

 

In determining theresults of each segment, assets are not allocated to segments and are reviewedin the aggregate for decision-making purposes.

 

Financial data by segmentis as follows for the nine months ended September 30, 2003 and 2002:

 
|                                                                      |   | **Nine  Months  Ended  September  30,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                      |   | **2003**                                |   | **2002** |   |
| Revenues:                                                                 |   |                                    |   |   |   |
| Net premiums  earned:                                                     |   |                                    |   |   |   |
| Commercial lines                                                          |   | $                                       | 18,569 |   | $ | 14,490 |   |
| Personal lines                                                            |   | 16,193                                  |   | 15,117 |   |
| Total net  premiums earned                                                |   | 34,762                                  |   | 29,607 |   |
| Net investment  income                                                    |   | 1,221                                   |   | 1,620 |   |
| Realized  investment gains (losses)                                       |   | 130                                     |   | (270 | ) |
| Other                                                                     |   | 292                                     |   | 245 |   |
| Total Revenues                                                            |   | 36,405                                  |   | 31,202 |   |
|                                                                      |   |                                    |   |   |   |
| Income before  income taxes:                                              |   |                                    |   |   |   |
| Underwriting  income (loss):                                              |   |                                    |   |   |   |
| Commercial lines                                                          |   | 2,568                                   |   | 2,386 |   |
| Personal lines                                                            |   | (3,389                                  | )      | (1,210 | ) |
| Total  underwriting income (loss)                                         |   | (821                                    | )      | 1,176 |   |
| Net investment  income                                                    |   | 1,221                                   |   | 1,620 |   |
| Realized  investment gains (losses)                                       |   | 130                                     |   | (270 | ) |
| Other                                                                     |   | 227                                     |   | 245 |   |
| Income before  income taxes and minority interest in income of subsidiary |   | $                                       | 757    |   | $ | 2,771 |   |

 

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Financial data by segmentis as follows for the three months ended September 30, 2003 and 2002:

 
|                                                                      |   | **Three  Months  Ended  September  30,** |   |
|---------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                      |   | **2003**                                 |   | **2002** |   |
| Revenues:                                                                 |   |                                     |   |   |   |
| Net premiums  earned:                                                     |   |                                     |   |   |   |
| Commercial lines                                                          |   | $                                        | 6,881  |   | $ | 5,540 |   |
| Personal lines                                                            |   | 5,498                                    |   | 5,071 |   |
| Total net  premiums earned                                                |   | 12,379                                   |   | 10,611 |   |
| Net investment  income                                                    |   | 400                                      |   | 525 |   |
| Realized  investment gains (losses)                                       |   | 167                                      |   | (282 | ) |
| Other                                                                     |   | 101                                      |   | 84 |   |
| Total Revenues                                                            |   | $                                        | 13,047 |   | $ | 10,938 |   |
|                                                                      |   |                                     |   |   |   |
| Income before  income taxes:                                              |   |                                     |   |   |   |
| Underwriting  income (loss):                                              |   |                                     |   |   |   |
| Commercial lines                                                          |   | $                                        | 899    |   | $ | 950 |   |
| Personal lines                                                            |   | (1,275                                   | )      | (617 | ) |
| Total  underwriting income (loss)                                         |   | (376                                     | )      | 333 |   |
| Net investment  income                                                    |   | 400                                      |   | 525 |   |
| Realized  investment gains (losses)                                       |   | 167                                      |   | (282 | ) |
| Other                                                                     |   | 98                                       |   | 84 |   |
| Income before  income taxes and minority interest in income of subsidiary |   | $                                        | 289    |   | $ | 660 |   |

 

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**(4)****                                 Reinsurance**

 

Premiums earned are netof amounts ceded of $7,087 and $5,068 for the nine months ended September 30,2003 and 2002, respectively, and $2,428 and $1,616  for the three months ended September 30 2003 and 2002,respectively. Losses and loss adjustment expenses are net of amounts ceded of$2,122 and $132 for the nine months ended September 30, 2003 and 2002,respectively, and $1,513 and $(97) for the three months endedSeptember 30, 2003 and 2002, respectively.

 

**(5)****                                 ComprehensiveIncome**

 

The Company’scomprehensive income for the nine month periods and three month periods endedSeptember 30, 2003 and 2002 are as follows:

 
|                                                                                                                                       |   | **Nine Months ended  September 30** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                                                                                       |   | **2003**                                 |   | **2002** |   |
|                                                                                                                                       |   |                                     |   |   |   |
| Net income                                                                                                                                 |   | $                                        | 445    |   | $ | 1,835 |   |
|                                                                                                                                       |   |                                     |   |   |   |   |   |
| Other  comprehensive income (loss), net of tax:                                                                                            |   |                                     |   |   |   |
| Unrealized gains  (losses) on securities:                                                                                                  |   |                                     |   |   |   |
| Unrealized  holding gains (losses) arising during period, net of related income tax  expense (benefit) of $566, and $(608)                 |   | 1,099                                    |   | (1,181 | ) |
|                                                                                                                                       |   |                                     |   |   |   |
| Less  reclassification adjustment for (gains) losses included in net income, net of  related income tax benefit (expense) of $(44) and $91 |   | (86                                      | )      | 179 |   |
|                                                                                                                                       |   | 1,013                                    |   | (1,002 | )  |
| Comprehensive  Income                                                                                                                      |   | $                                        | 1,458  |   | $ | 833 |   |

 
|                                                                                                                                       |   | **Three Months ended  September 30** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                       |   | **2003**                                  |   | **2002** |   |
|                                                                                                                                       |   | **(Dollars  in thousands)**               |   |
|                                                                                                                                       |   |                                      |   |   |   |
| Net income                                                                                                                                 |   | $                                         | 172    |   | $ | 398 |   |
|                                                                                                                                       |   |                                      |   |   |   |   |   |
| Other  comprehensive income (loss), net of tax:                                                                                            |   |                                      |   |   |   |
| Unrealized gains  (losses) on securities:                                                                                                  |   |                                      |   |   |   |
| Unrealized  holding gains (losses) arising during period, net of related income tax  expense (benefit) of $89, and $(323)                  |   | 173                                       |   | (627 | ) |
|                                                                                                                                       |   |                                      |   |   |   |
| Less  reclassification adjustment for (gains) losses included in net income, net of  related income tax benefit (expense) of $(57) and $96 |   | (110                                      | )      | 186 |   |
|                                                                                                                                       |   | 63                                        |   | (441 | ) |
| Comprehensive  Income                                                                                                                      |   | $                                         | 235    |   | $ | (43 | ) |

 

14

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Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following presentsmanagement’s discussion and analysis of our financial condition and results ofoperations as of the dates and for the periods indicated. You should read thisdiscussion in conjunction with the condensed consolidated financial statementsand notes thereto included in this report. This discussion containsforward-looking information that involves risks and uncertainties. Actualresults could differ significantly from these forward-looking statements. See“Forward-Looking Statements”.

 

**Overview**

 

Mercer Mutual is aPennsylvania mutual insurance company that underwrites property and casualtyinsurance in New Jersey and Pennsylvania. Our consolidated operating insurancecompany subsidiaries are:

 

•        MercerInsurance Company of New Jersey, Inc., a New Jersey property and casualty stockinsurance corporation that currently offers only workers’ compensationinsurance to businesses located in New Jersey; and

 

•        FranklinInsurance Company, a property and casualty stock insurance company offeringprivate passenger automobile and homeowners insurance to individuals located inPennsylvania.

 

Mercer Mutual isin the process of converting from the mutual to the stock form of organization,subject to the approval of its eligible policyholders. Mercer Insurance Group,Inc. was formed to become the holding company for Mercer Mutual upon completionof the conversion, and currently has no significant assets or liabilities andno operations. After the conversion, its primary assets will be all of theoutstanding capital stock of Mercer Mutual and a portion of the net proceeds ofthe conversion. Upon completion of the conversion, the name of Mercer Mutualwill become Mercer Insurance Company. As part of the conversion, MercerInsurance Group, Inc. offered 6,261,111 shares of its common stock at apurchase price of $10.00 per share. The offering period ended onDecember 3, 2003, and during that period we received subscriptions for allof the offered shares. We anticipate that December 12, 2003, will be theeffective date of the conversion. After the completion of the conversion, theconsolidated financial statements of Mercer Mutual prior to the conversion willbecome the consolidated financial statements of Mercer Insurance Group, Inc.

 

We report our operatingresults in three operating segments: commercial lines insurance, personal linesinsurance and the investment function. See Note 3 of the notes to our condensedconsolidated financial statements included in this report. However, assets arenot allocated to segments and are reviewed in the aggregate for decision-makingpurposes. Our commercial lines insurance business consists primarily ofmulti-peril and general liability and related coverages. Our personal linesinsurance business consists primarily of homeowners and private passengerautomobile insurance coverages. We market both the commercial and personalinsurance lines through independent producers.

 

15

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**CriticalAccounting Policies**

 

*General.* We are required to make estimates and assumptions in certaincircumstances that affect amounts reported in our consolidated financialstatements and related footnotes. We evaluate these estimates and assumptions onan on-going basis based on historical developments, market conditions, industrytrends and other information that we believe to be reasonable under thecircumstances. There can be no assurance that actual results will conform toour estimates and assumptions, and that reported results of operation will notbe materially adversely affected by the need to make accounting adjustments toreflect changes in these estimates and assumptions from time to time. Webelieve the following policies are the most sensitive to estimates andjudgments.

 

*Liabilities for Loss and Loss Adjustment Expenses.*  The liability for losses and loss adjustmentexpenses represents estimates of the ultimate unpaid cost of all lossesincurred, including losses for claims that have not yet been reported to ourinsurance companies. The amount of loss reserves for reported claims is basedprimarily upon a case-by-case evaluation of the type of risk involved,knowledge of the circumstances surrounding each claim and the insurance policyprovisions relating to the type of loss. The amounts of loss reserves forunreported claims and loss adjustment expenses are determined using historicalinformation by line of insurance as adjusted to current conditions. Inflationis implicitly provided for in the reserving function through analysis of costs,trends and reviews of historical reserving results.

 

Reserves are closelymonitored and are recomputed periodically using the most recent information onreported claims and a variety of statistical techniques. Specifically, on aquarterly basis, we review, by line of business, existing reserves, new claims,changes to existing case reserves, and paid losses with respect to the currentand prior accident years. We use historical paid losses and accident year datato derive expected ultimate loss and loss adjustment expense ratios by line ofbusiness. We then apply these expected loss and loss adjustment expense ratiosto in-force business to derive a reserve level for each line of business. Thisamount, together with reserves required by new reported claims and changes toexisting case reserves, is compared to existing reserves to establish theaddition to reserves that is required. In connection with the determination ofthe reserves, we also consider other specific factors such as recent weather-relatedlosses, trends in historical paid losses, and legal and judicial trends withrespect to theories of liability. Because of the nature of our business, whichgenerally provides coverage for short-term risks, loss development iscomparatively rapid and historical paid losses have been a reliable predictivemeasure of future losses.

 

Nevertheless, reservesare estimates because there are uncertainties inherent in the determination ofultimate losses. Court decisions, regulatory changes and economic conditionscan affect the ultimate cost of claims that occurred in the past as well ascreate uncertainties regarding future loss cost trends. Accordingly, theultimate liability for unpaid losses and loss settlement expenses will likelydiffer from the amount recorded at September 30, 2003. Changes inestimates or differences between estimates and amounts ultimately paid arereflected in current operations. Loss reserving techniques and assumptions havebeen consistently applied during the periods presented. The table belowsummarizes the effect on net loss reserves and surplus in the event ofreasonably likely changes in the variables evaluated in establishing loss andloss adjustment expense reserves. The range of reasonably likely changes wasestablished based on a review of changes in

 

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accident year development by line of business andapplied to loss reserves as a whole. The selected changes do not indicate whatcould be the potential best or worst case scenarios:

 

 
| **Change in  Loss and Loss  Adjustment  Reserves Net  of Reinsurance** |   | **Adjusted  Loss  and Loss  Adjustment  Reserves Net  of Reinsurance  as of  September 30,  2003** |   | **Percentage  Change in  Equity as of  September 30,  2003 (1)** |   | **Adjusted  Loss  and Loss  Adjustment  Reserves Net  of  Reinsurance as  of  December 31,  2002** |   | **Percentage  Change in  Equity as of  December 31,  2002 (1)** |      |
|------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|-----------|
| **(Dollars  in thousands)**                                            |   |
| -10.0                                                                  | %      | 27,415                                                                                                  |   | 5.2                                                                   | %      | $                                                                                                       | 24,478 |                                                                 | 4.8       | % |
| -7.5                                                                   | %      | 28,176                                                                                                  |   | 3.9                                                                   | %      | 25,158                                                                                                  |   | 3.6                                                                  | %         |
| -5.0                                                                   | %      | 28,938                                                                                                  |   | 2.6                                                                   | %      | 25,838                                                                                                  |   | 2.4                                                                  | %         |
| -2.5                                                                   | %      | 29,699                                                                                                  |   | 1.3                                                                   | %      | 26,518                                                                                                  |   | 1.2                                                                  | %         |
| Base                                                                   |   | 30,461                                                                                                  |   | —                                                                |   | 27,198                                                                                                  |   | —                                                               |      |
| 2.5                                                                    | %      | 31,223                                                                                                  |   | -1.3                                                                  | %      | 27,878                                                                                                  |   | -1.2                                                                 | %         |
| 5.0                                                                    | %      | 31,984                                                                                                  |   | -2.6                                                                  | %      | 28,558                                                                                                  |   | -2.4                                                                 | %         |
| 7.5                                                                    | %      | 32,746                                                                                                  |   | -3.9                                                                  | %      | 29,238                                                                                                  |   | -3.6                                                                 | %         |
| 10.0                                                                   | %      | 33,507                                                                                                  |   | -5.2                                                                  | %      | 29,918                                                                                                  |   | -4.8                                                                 | %

  |
|                                                                        |        |                                                                                                         |        |                                                                       |        |                                                                                                         |        |                                                                      |           |  |

 

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(1)                                  Netof Tax

 

The property and casualtyindustry has incurred substantial aggregate losses from claims related toasbestos-related illnesses, environmental remediation, product and constructiondefect liability, mold, and other uncertain exposures. We have not experiencedsignificant losses from these types of claims.

 

In the discussions thatfollow, we use the term “loss development,” which refers to the calendar yearincome statement impact of changes in the provision for loss and lossadjustment expenses incurred in prior accident years.

 

17

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The table belowsummarizes loss and loss adjustment reserves by major line of business:

 
|                         |   | **September  30,**          |   | **December 31,** |   |
|------------------------------|--------|-----------------------------|--------|-----------------------|--------|
|                         |   | **2003**                    |   | **2002**              |   | **2001** |   |
|                         |   | **(Dollars  in thousands)** |   |
| Commercial  lines:           |   |                        |   |                  |   |   |   |
| Commercial  multi-peril      |   | $                           | 6,548  |                  | $      | 6,017 |   | $ | 5,098 |   |
| Other liability              |   | 7,982                       |   | 6,390                 |   | 7,927 |   |
| Workers’  compensation  |   | 4,565                       |   | 4,224                 |   | 3,935 |   |
| Commercial  automobile       |   | 2,141                       |   | 1,886                 |   | 1,763 |   |
| Fire, allied,  inland marine |   | 125                         |   | 119                   |   | 1,149 |   |
|                         |   | 21,361                      |   | 18,636                |   | 19,872 |   |
| Personal lines:              |   |                        |   |                  |   |   |   |
| Homeowners                   |   | 9,716                       |   | 8,896                 |   | 7,801 |   |
| Personal  automobile         |   | 2,508                       |   | 2,070                 |   | 1,343 |   |
| Fire, allied,  inland marine |   | 533                         |   | 477                   |   | 736 |   |
| Other liability              |   | 1,122                       |   | 1,201                 |   | 1,257 |   |
| Workers’  compensation  |   | 70                          |   | 68                    |   | 50 |   |
|                         |   | 13,949                      |   | 12,712                |   | 11,187 |   |
| Total                        |   | $                           | 35,310 |                  | $      | 31,348 |   | $ | 31,059 |   |

 

*Investments.*  Unrealized investment gains or losses on investments carried atfair value, net of applicable income taxes, are reflected directly in owners’equity as a component of comprehensive income and, accordingly, have no effecton net income. A decline in fair value of an investment below its cost that isdeemed other than temporary is charged to earnings as a realized loss. Wemonitor our investment portfolio and review investments that have experienced adecline in fair value below cost to evaluate whether the decline is other thantemporary. These evaluations involve judgment and consider the magnitude andreasons for a decline and the prospects for the fair value to recover in thenear term. In the nine months ended September 30, 2003 and 2002, werecorded a pre-tax charge to earnings of $445,000, and $667,000, respectively,and in the three months ended September 30, 2003 and 2002, we recorded apre-tax charge to earnings of $0 and $385,000, respectively. These charges areprimarily with respect to equity securities that we determined were other thantemporarily impaired. Adverse investment market conditions, or poor operatingresults of underlying investments, could result in impairment charges in thefuture.

 

We generally apply thefollowing standards in determining whether the decline in fair value of aninvestment is other than temporary:

 

*Equities* – If an equity security has afair value below 50% of cost or remains below 80% of cost for more than threemonths, a review of the financial condition and prospects of the company isperformed by the Investment Committee of the Board of Directors to determine ifthe decline in fair value is other than temporary. A specific determination ismade for any such security. Other equity securities in an unrealized lossposition not meeting these quantitative thresholds are evaluated considering,among other things, the magnitude and reasons for the decline and the prospectsfor the fair value of the securities to recover in the near term. If it isdetermined that the decline in fair value is judged to be “other thantemporary” then the cost basis of the security is written down to “realizablevalue” and the amount of the write down accounted for as a realized loss.“Realizable value”

 

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is defined as the quoted market price of the security.Write-down to a value other than the market price requires objective evidencein support of that value. All write downs during 2003 and 2002 have been toquoted market prices.

 

*Fixed Income Securities* – A fixed maturitysecurity generally is written down if we are unable to hold or otherwise intendto sell a security with an unrealized loss, or if it is probable that we willbe unable to collect all amounts due according to the contracted terms of adebt security not impaired at acquisition.

 

A fixed maturity securityreview for collectibility is done if any of the following situations occur:

 

•             Areview of the financial condition and prospects of the company performed by theInvestment Committee indicates that the security should be evaluated.

 

•             Moody’sor Standard & Poors rate the security below investment grade.

 

•             Thesecurity has a fair value below 70% of amortized cost at quarter end due todeterioration in credit quality.

 

We have one materialnon-traded security, non-voting common stock in Excess Reinsurance Company,which is carried at $1.2 million. Its fair value is estimated at the statutorybook value as reported to the National Association of Insurance Commissioners(NAIC). Other non-traded securities, which are not material in the aggregate,are carried at cost.

 

*Policy Acquisition Costs.*  We defer policy acquisition costs, such ascommissions, premium taxes and certain other underwriting expenses that varywith and are directly related to the production of business. These costs areamortized over the effective period of the related insurance policies. Themethod followed in computing deferred policy acquisition costs limits theamount of deferred costs to their estimated realizable value, which giveseffect to the premium to be earned, related investment income, loss and lossadjustment expenses, and certain other costs expected to be incurred as thepremium is earned. Future changes in estimates, the most significant of whichis expected loss and loss adjustment expenses, may require acceleration of theamortization of deferred policy acquisition costs.

 

*Reinsurance.*  Amounts recoverable from property and casualty reinsurers areestimated in a manner consistent with the claim liability associated with thereinsured policy. Amounts paid for reinsurance contracts are expensed over thecontract period during which insured events are covered by the reinsurancecontracts.

 

Ceded unearned premiumsand reinsurance balances recoverable on paid and unpaid loss and lossadjustment expenses are reported separately as assets, instead of being nettedwith the appropriate liabilities, because reinsurance does not relieve us ofour legal liability to our policyholders. Reinsurance balances recoverable aresubject to credit risk associated with the particular reinsurer. Additionally,the same uncertainties associated with estimating unpaid loss and loss adjustmentexpenses affect the estimates for the ceded portion of these liabilities.

 

We continually monitorthe financial condition of our reinsurers.

 

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*Income Taxes.*  We use the asset and liability method of accounting for incometaxes. Deferred income taxes arise from the recognition of temporarydifferences between financial statement carrying amounts and the tax bases ofour assets and liabilities. A valuation allowance is provided when it is morelikely than not that some portion of the deferred tax asset will not berealized. The effect of a change in tax rates is recognized in the period ofthe enactment date.

 

**Resultsof Operations**

 

Our results of operationsare influenced by factors affecting the property and casualty insuranceindustry in general. The operating results of the United States property andcasualty insurance industry are subject to significant variations due tocompetition, weather, catastrophic events, regulation, general economic conditions,judicial trends, fluctuations in interest rates and other changes in theinvestment environment.

 

Our premium growth andunderwriting results have been, and continue to be, influenced by marketconditions. Pricing in the property and casualty insurance industryhistorically has been cyclical. During a soft market cycle, price competitionmakes it difficult to attract and retain properly priced personal andcommercial lines business. Our policy is to maintain our disciplinedunderwriting and pricing standards during soft markets, even at the expense ofpremium growth. The insurance industry is currently experiencing a hard marketcycle during which price competition is less significant than during a softmarket cycle, although some pricing competition is evident currently in linesof business which are predominantly property exposures. Therefore, during ahard market cycle insurers are able to increase premiums and receive a moreacceptable profit margin. A hard market typically has a positive effect onpremium growth.

 

On June 1, 2001, weacquired 49% of the outstanding shares of common stock of Franklin Holding andthereafter consolidated the financial condition and results of operations ofFranklin Holding with Mercer Mutual. For the period between June 1, 2001and September 30, 2003, we allocated a portion of Franklin Holding’s netincome or loss to the minority interest in Franklin Holding. This resulted inallocations of income to minority interest of $124,000 and $79,000 for the ninemonths ended September 30, 2003 and 2002, respectively, and $33,000 and$35,000 for the three months ended September 30, 2003 and 2002,respectively. Immediately after the completion of the conversion, we willacquire the remaining outstanding shares of common stock of Franklin Holding inexchange for 502,525 shares of Holding Company common stock, as projectedthrough the anticipated conversion completion date. As a result of our purchaseof these remaining shares, Franklin Holding will be a wholly owned subsidiary ofMercer Mutual.

 

***Nine Months andthree months Ended September 30, 2003 Compared to Nine Months and threemonths Ended September 30, 2002***

 

For the nine months endedSeptember 30, 2003, Mercer Mutual had net income of $445,000 compared to$1.8 million for the nine months ended September 30, 2002, a decline of75.3%. Although the underwriting gain from our commercial lines segment for thenine months ended September 30, 2003, increased from the prior comparableperiod by $182,000 to $2.6 million, our personal lines segment incurred anunderwriting loss of $3.4 million, which is an increased loss of $2.2 millionover the prior comparable period. See note 3 of the

 

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notes to our condensed consolidated financial statementsfor the nine months ended September 30, 2003 and 2002 included in this10-Q for a reconciliation of underwriting gain (loss) by segment toconsolidated amounts determined in accordance with GAAP. In our investmentsegment, net investment income decreased in the nine months endedSeptember 30, 2003 by $399,000 to $1,221,000 compared to the same periodin 2002, and net realized gains were $130,000 as compared to a net realizedloss of $270,000 for the same period in 2002.

 

For the three months endedSeptember 30, 2003, Mercer Mutual had net income of $172,000 compared to$398,000 for the three months ended September 30, 2002, a decline of56.8%. The underwriting gain from our commercial lines segment for the threemonths ended September 30, 2003 decreased only marginally from the priorcomparable period by $51,000 to $899,000. The personal lines segment incurredan underwriting loss of $1.3 million, which represented an increased loss of$658,000 from the prior comparable period. In our investment segment, netinvestment income decreased in the three months ended September 30, 2003,by $125,000 to $400,000 compared to the same period in 2002, and net realizedgains were $167,000 as compared to a net realized loss of $282,000 for the sameperiod in 2002.

 

Total revenues for thenine months ended September 30, 2003, were $36.4 million, which were $5.2million, or 16.7%, greater than revenues of $31.2 million for the nine monthsended September 30, 2002. This increase was due to a $5.2 million increasein net premiums earned for the nine months ended September 30, 2003,offset by a decrease in revenues from investments, as compared to the ninemonths ended September 30, 2002.

 

Total revenues for thethree months ended September 30, 2003, were $13.0 million, which were $2.1million, or 19.3%, greater than revenues of $10.9 million for the three monthsended September 30, 2002. This increase was due to a $1.8 million increasein net premiums earned for the three months ended September 30, 2003, offsetby a decrease in revenues from investments, as compared to the three monthsended September 30, 2002.

 

Direct premiums writtenincreased by 21.3% to $45.6 million for the nine months endedSeptember 30, 2003, from $37.6 million for the nine months ended September 30,2002, and consisted of $26.5 million of commercial lines premiums and $19.1million of personal lines premiums for the nine months ended September 30,2003, compared to $20.3 million in commercial lines premiums and $17.3 millionin personal lines premiums for the same period in 2002. Net premiums earnedincreased by 17.4% to $34.8 million from $29.6 million for the comparableperiod. Commercial lines comprised $18.6 million and personal lines comprised$16.2 million of net premiums earned in the nine months endedSeptember 30, 2003, compared to $14.5 million and $15.1 million,respectively, in the nine months ended September 30, 2002. The overallincreases in direct premiums written and net premiums earned are generallyattributable to firmer pricing but also represent continued strong growth inour commercial lines business.

 

Direct premiums writtenincreased by 15.1% to $15.1 million for the three months endedSeptember 30, 2003, from $13.1 million for the three months endedSeptember 30, 2002, and consisted of $8.1 million of commercial linespremiums and $7.0 million of personal lines premiums for the three months endedSeptember 30, 2003, compared to $6.7 million in commercial lines premiumsand $6.4 million in personal lines premiums for the same period in

 

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2002. Net premiums earned increased by 16.7% to $12.4million from $10.6 million for the comparable period. Commercial linescomprised $6.9 million and personal lines comprised $5.5 million of netpremiums earned in the three months ended September 30, 2003, compared to$5.5 million and $5.1 million, respectively, in the three months endedSeptember 30, 2002. Firmer pricing and continued commercial lines growthwere responsible for the growth in the 2003 quarter over the prior yearquarter.

 

Consistent with our goalof increasing commercial business, we increased direct commercial multi-perilpremiums written, the largest component of our commercial lines segment, by41.4% to $13.4 million for the nine months ended September 30, 2003,compared to $9.5 million for the comparable prior period, and increasedcommercial multi-peril net premiums earned by 30.1% to $9.1 million for thenine months ended September 30, 2003, compared to $7.0 million for thenine months ended September 30, 2002. We expect this trend of increasingcommercial writings to continue.

 

For the same comparativeperiods, net premiums earned for our homeowners insurance, the largestcomponent of our personal lines segment, increased 4.5% to $9.3 million for thenine months ended September 30, 2003, compared to $8.9 million for thecomparable period in 2002, while the increase in homeowners direct premiumswritten increased 8.6% to $11.0 million for the nine months ended September 30,2003, from $10.1 million for the nine months ended September 30, 2002. Forthe three months ended September 30, 2003, net premiums earned for ourhomeowners insurance, the largest component of our personal lines segment,increased 5.8% to $3.1 million, compared to $3.0 million for the comparableperiod in 2002, while the increase in homeowners direct premiums writtenincreased 6.9% to $4.1 million for the three months ended September 30,2003, from $3.9 million for the three months in 2002. The growth rate forhomeowners insurance reflects the reclassification of certain homeowners risksfrom our preferred program to our standard program. Premiums are higher for thestandard program compared to the preferred program.

 

Personal automobile direct written premiums, writtenexclusively in Pennsylvania**,** increased 17.2% to $6.0 million for thenine months ended September 30, 2003, compared to $5.1 million for thesame period in 2002. Net earned premiums for personal automobile increased by16.9% to $5.1 million for the nine months ended September 30, 2003, from$4.3 million for the nine months ended September 30, 2002. Net earnedpremiums for personal automobile increased by 16.9% to $1.8 million for thethree months ended September 30, 2003, from $1.5 million for the threemonths ended September 30, 2002. Despite the increases in personal linespremiums, we will continue to principally focus on commercial lines growth.

 

Net investment incomedecreased $399,000, or 24.6%, to $1,221,000 for the nine months ended September 30,2003, compared to the same period in 2002, due to declining interest rates andan increase in investment expenses. For the three months endedSeptember 30, 2003 and 2002, net investment income decreased $125,000, or23.8%, to $400,000, due to declining interest rates. Net realized investmentgains increased by $400,000 for the nine months ended September 30, 2003to $130,000 compared to $(270,000) for the nine months ended September 30,2002, and increased $449,000 to $167,000 for the three months endedSeptember 30, 2003, as compared to $(282,000) for the same period in theprior year.

 

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For the nine months endedSeptember 30, 2003, the realized investment gains of $130,000 werecomprised of gains on securities sales of $887,000, offset by other thantemporary writedowns of $445,000 and losses on securities sales of $312,000.The losses from securities sales were comprised of $35,000 from the sale ofbonds and $277,000 from the sale of equities. The following table summarizesthe period of time that equity securities sold at a loss during the nine monthsended September 30, 2003 had been in a continuous unrealized lossposition:

 
| **Period of time in an  Unrealized loss position** |   | **Fair  Value  on  Sale  Date** |       | **Reali  -zed  Loss** |   |
|----------------------------------------------------|--------|---------------------------------|------------|-----------------------|--------|
|                                               |   | **(Dollars  in thousands)**     | ** ** |
| 0-6 months                                         |   | $                               | 100        |                  | $      | 6 |   |
| 7-12 months                                        |   | 417                             |       | 206                   |   |
| More than 12  months                               |   | 265                             |       | 65                    |   |
| Total                                              |   | $                               | 782        |                  | $      | 277 |   |

 

The equity securitiessold at a loss had been expected to appreciate in value but after reevaluationwere sold so that sale proceeds could be reinvested. Securities were sold dueto a desire to reduce exposure to certain issuers and industries or in light ofchanging economic conditions.

 

For the nine months endedSeptember 30, 2002, the realized investment losses of $270,000 werecomprised of gains on securities sales of $500,000, offset by other thantemporary writedowns of $667,000 and losses on securities sales of $103,000.The losses from securities sales were comprised of $13,000 from the sale ofbonds and $90,000 from the sale of equities.

 

The following tablesummarizes the length of time equity securities with unrealized losses atSeptember 30, 2003 have been in an unrealized loss position:

 
|                   |   |                        |   |                   |   | **Length of  Unrealized Loss** |   |
|------------------------|--------|-----------------------------|--------|------------------------|--------|--------------------------------|--------|
|                   |   | **Fair  Value**             |   | **Unrealized  Losses** |   | **Less  than  6  months**      |   | **6 to 12  Months** |   | **Over 12  Months (1)** |   |
|                   |   | **(Dollars  in thousands)** |   |
| Equity  securities     |   |                        |   |                   |   |                           |   |   |   |   |   |
| More than 80% of  cost |   | $                           | 2,137  |                   | $      | 163                            |   | $ | 123 |   | $ | 0 |   | $ | 40 |   |
| Less than 80% of  cost |   | 334                         |   | 102                    |   | 0                              |   | 0 |   | 102 |   |
| Total                  |   | $                           | 2,471  |                   | $      | 265                            |   | $ | 123 |   | $ | 0 |   | $ | 142 |   |

 

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(1)                        Of the$142,000 reflected in this table as having been below cost over 12 months atSeptember 30, 2003, $40,000 pertains to equity securities for which themarket price, as of November 30, 2003, has increased to a price in excessof our cost.

 

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For the nine months endedSeptember 30, 2003, we had a combined ratio of 102.4%, a loss and lossadjustment expense ratio of 56.4% and an underwriting expense ratio of 46.0%,compared to a combined ratio of 96.0%, a loss and loss adjustment expense ratioof 49.5% and an underwriting expense ratio of 46.5% for the nine months endedSeptember 30, 2002.

 

For the three monthsended September 30, 2003, we had a combined ratio of 103.0%, a loss andloss adjustment expense ratio of 55.4% and an underwriting expense ratio of47.6%, compared to a combined ratio of 96.9%, a loss and loss adjustmentexpense ratio of 48.7% and an underwriting expense ratio of 48.2% for the threemonths ended September 30, 2002.

 

In the commercial linessegment for the nine months ended September 30, 2003, we had anunderwriting gain of $2.6 million, a combined ratio of 86.2%, a loss and lossadjustment expense ratio of 37.2% and an underwriting expense ratio of 49.0%,compared to an underwriting gain of $2.4 million, a combined ratio of 83.5%, aloss and loss adjustment expense ratio of 34.7% and an underwriting expenseratio of 48.8% for the nine months ended September 30, 2002.

 

In the commercial linessegment for the three months ended September 30, 2003, we had anunderwriting gain of $899,000, a combined ratio of 86.9%, a loss and lossadjustment expense ratio of 39.2% and an underwriting expense ratio of 47.7%,compared to an underwriting gain of $950,000, a combined ratio of 82.9%, a lossand loss adjustment expense ratio of 37.5% and an underwriting expense ratio of45.4% for the three months ended September 30, 2002.

 

In the personal linessegment for the nine months ended September 30, 2003, we had anunderwriting loss of $3.4 million, a combined ratio of 120.9%, a loss and lossadjustment expense ratio of 78.4% and an underwriting expense ratio of 42.5%,compared to an underwriting loss of $1.2 million, a combined ratio of 108.0%, aloss and loss adjustment expense ratio of 63.7% and an underwriting expenseratio of 44.3% for the nine months ended June September 30, 2002.

 

In the personal linessegment for the three months ended September 30, 2003, we had anunderwriting loss of $1.3 million, a combined ratio of 123.2%, a loss and lossadjustment expense ratio of 75.7% and an underwriting expense ratio of 47.5%,compared to an underwriting loss of $617,000, a combined ratio of 112.1%, aloss and loss adjustment expense ratio of 60.9% and an underwriting expenseratio of 51.2% for the three months ended September 30, 2002.

 

Net loss and lossadjustment expenses incurred increased overall by $4.9 million, or 33.7%, to$19.6 million for the nine months ended September 30, 2003, from the sameperiod in 2002, and $1.7 million, or 32.8%, to $6.9 million for the threemonths ended September 30, 2003 over the same period in 2002. The increasein loss and loss adjustment expenses reflects the increase in commercial andpersonal lines volume and an increase in the frequency of personal lineslosses. The increase in personal lines losses is attributable to harsherweather conditions for the nine months ended September 30, 2003, comparedto the same period in 2002. After a number of winters with relatively mildweather conditions in our operating region, we experienced one of the coldestwinters in recent history. In addition, there was

 

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considerably more snow during the first quarter of2003, compared to the same period in 2002. These conditions lead to losses fromfrozen pipes, structure collapses and more frequent automobile losses. Theincrease in these losses is evidenced by the increase in the homeowners lossand loss expense ratio to 77.7% for the nine months ended September 30,2003, compared to 65.9% for the nine months ended September 30, 2002, andan increase in the personal automobile loss and loss expense ratio to 86.1% forthe nine months ended September 30, 2003, compared to 72.8% for the ninemonths ended September 30, 2002. Loss development of prior year net lossand loss adjustment expense reserves was a favorable $2.0 million and wasgenerally attributable to accident years 1998 through 2002 for commercialmulti-peril and commercial workers’ compensation, which accounted for $1.7million of this favorable development. Loss reserves for the commercialmulti-peril and workers’ compensation lines have been established based oncompany trends and our consideration of industry trends. Recent settlement ofreported cases has been favorable. In addition, we originally had expected adevelopment of losses that was more in line with the industry, but this has notoccurred. These factors have resulted in the favorable development indicatedand are a reflection of the disciplined underwriting employed by the Company.The remainder of the favorable development was spread among other lines ofbusiness and resulted from the normal claims review process and not from anychange in key assumptions or changes in reserving philosophy.

 

Underwriting expensesincreased by $2.2 million, or 16.0%, to $16.0 million for the nine months endedSeptember 30, 2003, from the same period in 2002, and $784,000, or 15.3 %for the three months in 2003 over the same period in 2002. This increase wasprincipally attributable to an increase in expenses due to higher amortizationof deferred policy acquisition costs resulting from higher premium volume. Weare currently in the process of converting our information system. When completed,we expect some costs to moderate as conversion costs and costs associated withoperating dual systems end. These reduced costs will be offset by some higherstaffing costs, but we also should be positioned to expand premium volumewithout material incremental expense because of increased processing capacity.

 

We also expectunderwriting expenses to moderate in future periods because we intend tosignificantly reduce the amount of business written in Mercer Mutual, the NewJersey business of which became subject to New Jersey’s retaliatory premium taxwhen it redomesticated to Pennsylvania in 1997. We plan to do this by renewing,to the extent possible, Mercer Mutual premium volume in Mercer InsuranceCompany of New Jersey, Inc., our New Jersey domestic insurer that is notsubject to this retaliatory tax. We have not previously renewed policies in ourNew Jersey subsidiary because only policyholders of Mercer Mutual, domiciled inPennsylvania, have subscription and voting rights. Therefore, renewing policiesin the New Jersey subsidiary before adoption of the Plan of Conversion wouldhave denied subscription rights to Mercer Mutual’s policyholders anddisenfranchised them. The cost of the additional premium tax was $551,000 forthe nine months ended September 30, 2003, and $450,000 for the nine monthsended September 30, 2002, and $187,000 and $162,000 for the three monthperiods ending September 30, 2003 and 2002, respectively.

 

Federal income taxexpense was $188,000 for the nine months ended September 30, 2003, aneffective rate of 24.8%, compared to $857,000, an effective rate of 30.9%, in2002. The decrease in the effective tax rate for the nine months endedSeptember 30, 2003, is attributable to tax-exempt investment income beinga larger percentage of net income.

 

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Federal income taxexpense was $84,000 for the three months ended September 30, 2003, aneffective rate of 29.1%, compared to $227,000, an effective rate of 34.4%, in2002. The decrease in the effective tax rate for the three months endedSeptember 30, 2003, is attributable to the larger percentage of net incomerepresented by tax-exempt investment income.

 

 

***Effect of Conversion on Our Future Financial Condition andResults of Operations***

 

Our future financialcondition and results of operations will be affected by Mercer Mutual’sconversion to stock and the related transactions. Upon completion of theconversion, we estimate our consolidated shareholders’ equity will be between$78.5 million and $97.1 million, an increase of approximately 104.0% to 152.3%over the consolidated surplus of Mercer Mutual at September 30, 2003. Thisincreased capitalization should permit us to (i) increase direct premium volumeto the extent competitive conditions permit, (ii) increase net premium volumeby decreasing our reliance on reinsurance, and (iii) enhance investment incomeby increasing our investable capital.

 

**ESOP**

 

In connection with theconversion, the Employee Stock Ownership Plan (ESOP) intends to finance thepurchase of 10% of the common stock issued in the conversion with the proceedsof a loan from Mercer Insurance Group, and Mercer Mutual will make annualcontributions to the ESOP sufficient to repay that loan, which we estimate willtotal, on a pre-tax basis, between $512,000 and $770,000 annually.

 

**HoldingCompany Purchase of Common Stock**

 

Mercer Insurance Grouphas adopted a stock-based incentive plan, subject to the approval of itsshareholders at Mercer Insurance Group’s 2004 annual meeting of shareholders.  Pursuant to that plan, Mercer InsuranceGroup may issue a total number of shares equal to 14% of the shares of commonstock that were issued in the conversion. Of this amount, an amount equal to 4%of the shares of common stock issued in the conversion may be used to makerestricted stock awards under the stock-based incentive plan.

 

Following the proposedimplementation of the stock-based incentive plan in 2004, the Holding Companymay purchase shares of its common stock in the open market and contribute thoseshares to the stock-based incentive plan for use in making restricted stockawards under that plan. Any such purchase will require the prior approval ofthe Pennsylvania Insurance Department.

 

The fair market value ofany common stock used for restricted stock awards will initially representunearned compensation. As Mercer Insurance Group accrues compensation expenseto reflect the vesting of such shares, unearned compensation will be reducedaccordingly. This compensation expense will be deductible for federal incometax purposes upon vesting.

 

**Liquidityand Capital Resources**

 

Our insurance companiesgenerate sufficient funds from their operations and maintain a high degree ofliquidity in their investment portfolios. The primary source of funds to meetthe demands of claim settlements and

 

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operating expenses are premium collections, investmentearnings and maturing investments. As of September 30, 2003, Mercer Mutualhas plans to spend $2.5 million for the expansion of its existing facilities inPennington, New Jersey. We are also in the process of building an informationsystem platform that will allow our producers to conduct their business throughthe Internet or through the method they have historically used. As ofSeptember 30, 2003, we have spent $2.1 million on the development of thisplatform, which includes license fees for software used in the platform. Itshould be completed by June 30, 2005, at an additional cost of $1.0 million.As they are incurred, these costs are capitalized and amortized over afive-year period once the corresponding asset is placed in service. MercerMutual possesses sufficient resources for these future expenditures withoutincurring any debt.

 

Our insurance companiesmaintain investment and reinsurance programs that are intended to providesufficient funds to meet their obligations without forced sales of investments.They maintain a portion of their investment portfolio in relatively short-termand highly liquid assets to ensure the availability of funds.

 

The principal source ofliquidity for Mercer Insurance Group will be the net proceeds it retains fromthe conversion stock offering, and dividend payments and other fees receivedfrom Mercer Mutual. For a period of three years after the conversion, MercerMutual may not declare or pay any dividend to Mercer Insurance Group withoutthe approval of the Pennsylvania Insurance Department. After this three-yearperiod, Mercer Mutual will be restricted by the insurance laws of Pennsylvaniaas to the amount of dividends or other distributions it may pay to its holdingcompany. Under Pennsylvania law, there is a maximum amount that may be paid byMercer Mutual during any twelve-month period after notice to, but without priorapproval of, the Pennsylvania Insurance Department. This limit is the greaterof 10% of Mercer Mutual’s statutory surplus as reported on its most recentannual statement filed with the Pennsylvania Insurance Department, or the netincome of Mercer Mutual for the period covered by such annual statement.

 

If the dividendrestrictions related to the conversion were not in effect, then as ofDecember 31, 2002, the amounts available for payment of dividends fromMercer Mutual in 2003, without the prior approval of the Pennsylvania InsuranceDepartment would have been approximately $2.9 million.

 

Prior to its payment ofany dividends to Mercer Mutual, Mercer Insurance Company of New Jersey, Inc. isrequired to provide notice of the dividends to the New Jersey Department ofBanking and Insurance. New Jersey law sets the maximum amount of dividends thatmay be paid, which amount cannot exceed the greater of 10% of Mercer InsuranceCompany of New Jersey, Inc.’s statutory surplus as reported on the most recentannual statement filed with New Jersey, or the net income, not includingrealized capital gains, for the period covered by the annual statement. The NewJersey Department has the power to limit or prohibit dividend payments ifcertain conditions exist. These restrictions or any subsequently imposedrestrictions may affect our future liquidity. As of December 31, 2002, theamount available for payment of dividends by Mercer Insurance Company of NewJersey, Inc. to Mercer Mutual in 2003 without the prior approval of New JerseyDepartment of Banking and Insurance is approximately $887,000.

 

As a Pennsylvaniadomiciled insurance company, dividends payable to Mercer Mutual by FranklinInsurance Company are subject to the same formula

 

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limitation describedabove for Mercer Mutual. As of December 31, 2002, the amount available forpayment of dividends from Franklin Insurance Company to Mercer Mutual in 2003,without the prior approval of the Pennsylvania Insurance Department, isapproximately $355,000.

 

Total assets increased7%, or $7.8 million, at September 30, 2003 from December 31, 2002.Increased premium volume drove increases in premium receivables of $2.3 millionand deferred policy acquisition costs of $1.0 million. Reinsurance recoverableon unpaid losses and loss expenses increased $879,000 due to loss activityabove the Company’s loss retention under its reinsurance agreements, and cashbalances increased $1.2 million principally due to cash provided by operations.

 

Totalliabilities increased 10%, or $6.3 million, at September 30, 2003 fromDecember 31, 2002. Increased premium volume is primarily responsible forthe increase in unearned premium reserves of $4.8 million. Loss and lossexpense reserves increased $4.0 million as a result of premium volume increasesand the related increases in loss exposures. Accounts payable and accruedexpenses decreased by $2.6 million due primarily to the payment under protestof the contested New Jersey retaliatory premium taxes discussed above inconnection with underwriting expenses.

 

**Impactof Inflation**

 

Inflation increasesconsumers’ needs for property and casualty insurance coverage. Inflation alsoincreases claims incurred by property and casualty insurers as propertyrepairs, replacements and medical expenses increase. These cost increasesreduce profit margins to the extent that rate increases are not implemented onan adequate and timely basis. We establish property and casualty insurancepremiums levels before the amount of losses and loss expenses, or the extent towhich inflation may affect these expenses, are known. Therefore, our insurancecompanies attempt to anticipate the potential impact of inflation whenestablishing rates. Because inflation has remained relatively low in recentyears, financial results have not been significantly affected by inflation.

 

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**Off Balance Sheet Commitments andContractual Obligations**

 

TheCompany was not a party to any unconsolidated arrangement or financialinstrument with special purpose entities or other vehicles atSeptember 30, 2003, which would give rise to previously undisclosedmarket, credit or financing risk.

 

The company has nosignificant contractual obligations.

 

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Item 3.             Quantitative and Qualitative DisclosuresAbout Market Risk

 

*General.* Market risk is the risk that we will incur losses due to adverse changesin market rates and prices. We have exposure to three principal types of marketrisk through our investment activities: interest rate risk, credit risk andequity risk. Our primary market risk exposure is to changes in interest rates.We have not entered, and do not plan to enter, into any derivative financialinstruments for hedging, trading or speculative purposes.

 

*Interest Rate Risk.*  Interest rate risk is the risk that we willincur economic losses due to adverse changes in interest rates. Our exposure tointerest rate changes primarily results from our significant holdings of fixedrate investments. Fluctuations in interest rates have a direct impact on themarket valuation of these securities.

 

*Equity Risk.*  Equity price risk is the risk that we will incur economic lossesdue to adverse changes in equity prices. Our exposure to changes in equityprices primarily results from our holdings of common stocks, mutual funds andother equities. Our portfolio of equity securities is carried on the balancesheet at fair value. Therefore, an adverse change in market prices of thesesecurities would result in losses

 

There have been no material changes in Market Riskfrom the end of the most recent fiscal year ended December 31, 2002, andthe information disclosed in connection therewith.

 

Item 4.             Controls andProcedures

 

TheCompany, under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and the Chief FinancialOfficer, has evaluated the effectiveness of the design and operation of theCompany’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer andChief Financial Officer conclude that the Company’s disclosure controls andprocedures are effective as of September 30, 2003.  There has been no change in the Company’sinternal control over financial reporting that occurred during the quarterended September 30, 2003 that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

Securitiesand Exchange Commission rules define “disclosure controls and procedures” ascontrols and other procedures of an issuer that are designed to ensure thatinformation required to be disclosed by the issuer in the reports that it filesor submits under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time specified in the Commission’s rules andforms.  Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that such information is accumulated and communicated to the issuer’smanagement, including its principal executive officer and principal financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

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PART II - OTHERINFORMATION

 

Item1.                                     LegalProceedings - None

 

Item2.                                     Changesin Securities - None

 

Item3.                                     DefaultsUpon Senior Securities - None

 

Item4.                                     Submissionof Matters to Vote of Security Holders - None

 

Item5.                                     OtherInformation - None

 

Item6.             Exhibits and Reports on Form 8-K

 

(a)      Exhibits

 
| **Exhibit No.** |   | **Title**                                                                                                                                                    |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                         |
| 3.1             |   | Articles of Incorporation of the Company(Incorporated by reference to  Exhibit 3.1 to the Company’s Registration Statement No. 333-104897 on Form  S-4) |
|            |   |                                                                                                                                                         |
| 3.2             |   | Bylaws of the  Company (Incorporated by reference to Exhibit 3.2 to the Company’s Registration  Statement No. 333-104897 on Form S-4)                   |
|            |   |                                                                                                                                                         |
| 10.1            |   | Employment  Agreement by and among Mercer Mutual Insurance Company, Bicus Services  Corporation, and David B. Merclean (filed herewith).                     |
|            |   |                                                                                                                                                         |
| 31.1            |   | Rule  13a-14(a)/15d-14(a) Certification of Chief Executive Officer                                                                                           |
|            |   |                                                                                                                                                         |
| 31.2            |   | Rule  13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                                                           |
|            |   |                                                                                                                                                         |
| 32.1            |   | Section 1350  Certification of Chief Executive Officer and Chief Financial Officer                                                                      |

 

(b)      Reports on Form 8-K - None

 

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SIGNATURES

 

In accordance with the requirements of the Exchange Act,the Registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                          |         | MERCER INSURANCE GROUP, INC. |
|-------------------------------|--------------|------------------------------|
|                          | (Registrant) |
|                          |         |                         |
| Dated: December 11, 2003 | By           | /s/Andrew R. Speaker         |   |
|                          |         | Andrew R. Speaker            |   |
|                          |         | President and Chief          |
|                          |         | Executive Officer            |
|                          |
|                          |
| Dated: December 11, 2003 | By           | /s/ David B. Merclean   |   |
|                          |         | David B. Merclean            |
|                          |         | Chief Financial  Officer     |

 

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