##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 Form 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to.
 Commission File Number 1-9640
 MERCHANTS GROUP, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    16-1280763(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 250 Main Street, Buffalo, New York
    
    14202(Address of principal executive offices)
    
    (Zip Code)
 716-849-3333  (Registrants telephone number, including area code)
 Securities registered pursuant to Section 12(b) of the Act
 Title of each class Common Stock, $.01 par value per share  Name of each exchange on which registered American Stock Exchange, Inc.
 Securities registered pursuant to Section 12 (g) of the Ac NONE
 o þ
 o þ
  þ o
 þ
  o o þ
 o þ




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##### 



PART IITEM 1.
    
    BUSINESS.ITEM 1A.
    
    RISK FACTORS.ITEM 2.
    
    PROPERTIES.ITEM 3.
    
    LEGAL PROCEEDINGS.ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.PART IIITEM 5.
    
    MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.ITEM 6.
    
    SELECTED FINANCIAL DATA.ITEM 7.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.ITEM 7A.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.ITEM 9A.
    
    CONTROLS AND PROCEDURES.ITEM 9B.
    
    OTHER INFORMATION.PART IIIITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.ITEM 11.
    
    EXECUTIVE COMPENSATION.ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.ITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES.PART IVITEM 15.
    
    EXHIBITS AND FINANCIAL STATEMENTS.Exhibit 10(F) Property Catastrophe Excess Loss Reinsurance AgrmnExhibit 23 Consent of Independent Registered Accounting FirmExhibit 31 302 Certifications of SVP/COO & VP/CFOExhibit 32 906 Certifications of SVP/COO & VP/CFO
  2




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General
  Administration
      3




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Marketing
    4




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Insurance Underwriting
  5




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Administration
 As of December 31,2003
    
    2004
    
    2005New York
    
    
    60
    %
    
    
    63
    %
    
    
    63
    %New Jersey
    
    
    17
    
    
    
    14
    
    
    
    13New Hampshire
    
    
    9
    
    
    
    8
    
    
    
    8Pennsylvania
    
    
    6
    
    
    
    7
    
    
    
    7Rhode Island
    
    
    3
    
    
    
    3
    
    
    
    3Massachusetts
    
    
    2
    
    
    
    3
    
    
    
    4Other
    
    
    3
    
    
    
    2
    
    
    
    2Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
  o
    
    Personal automobile  full coverage of standard performance automobiles, generally
requiring drivers with good driving records during the past three years at the time of
first issuance by Merchants.o
    
    Homeowners  properties generally with no losses in the last three years that are less than
30 years old and valued between $125,000 and $500,000.o
    
    Commercial automobile  primarily light and medium duty vehicles operating in a limited
radius, with complete background information required of all drivers.o
    
    Commercial multi-peril  properties with medium to high construction quality and low to
moderate fire exposure, and occupancies with low to moderate exposure to hazardous materials and
processes.o
    
    General liability  low hazard service, mercantile and light processing businesses,
generally with at least three years of business experience and with no losses in the last three
years.o
    
    Workers compensation  risks with low loss frequency and severity, low to moderate exposure
to hazardous materials and processes, and favorable experience modification factors. Generally,
workers compensation insurance is written in conjunction with other commercial insurance.
 6




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##### Table of Contents



Year ended December 31,2003
    
    
    2004
    
    
    2005Premiums
    
    
    
    
    
    
    
    
    
    
    Premiums
    
    
    
    
    
    
    
    
    
    
    PremiumsWritten
    
    
    
    
    
    
    LALAE
    
    
    Written
    
    
    
    
    
    
    LALAE
    
    
    Written
    
    
    
    
    
    
    LALAEAmount
    
    
    %
    
    
    Ratio
    
    
    Amount
    
    
    %
    
    
    Ratio
    
    
    Amount
    
    
    %
    
    
    Ratio(dollars in thousands)PersonalAuto Liability
    
    $
    12,202
    
    
    
    19.0
    %
    
    
    87.4
    %
    
    $
    7,467
    
    
    
    14.1
    %
    
    
    59.5
    %
    
    $
    4,395
    
    
    
    9.7
    %
    
    
    21.0
    %Auto Physical Damage
    
    
    7,230
    
    
    
    11.3
    
    
    
    49.2
    
    
    
    3,873
    
    
    
    7.3
    
    
    
    42.8
    
    
    
    2,254
    
    
    
    5.0
    
    
    
    36.0Homeowners
Multi-Peril
    
    
    6,382
    
    
    
    9.9
    
    
    
    58.8
    
    
    
    5,080
    
    
    
    9.6
    
    
    
    59.4
    
    
    
    4,266
    
    
    
    9.5
    
    
    
    50.3Total
    
    
    25,814
    
    
    
    40.2
    
    
    
    69.7
    
    
    
    16,420
    
    
    
    31.0
    
    
    
    55.1
    
    
    
    10,915
    
    
    
    24.2
    
    
    
    34.5CommercialAuto Liability
    
    
    12,979
    
    
    
    20.3
    
    
    
    29.3
    
    
    
    12,542
    
    
    
    23.6
    
    
    
    51.2
    
    
    
    11,074
    
    
    
    24.5
    
    
    
    32.0Auto Physical Damage
    
    
    2,899
    
    
    
    4.5
    
    
    
    39.1
    
    
    
    2,734
    
    
    
    5.1
    
    
    
    38.1
    
    
    
    2,235
    
    
    
    5.0
    
    
    
    37.9Commercial
Multi-Peril
    
    
    17,018
    
    
    
    26.5
    
    
    
    79.7
    
    
    
    15,701
    
    
    
    29.6
    
    
    
    76.6
    
    
    
    14,926
    
    
    
    33.1
    
    
    
    63.9Workers
Compensation
    
    
    4,613
    
    
    
    7.2
    
    
    
    133.7
    
    
    
    4,536
    
    
    
    8.5
    
    
    
    72.8
    
    
    
    4,461
    
    
    
    9.9
    
    
    
    9.1Other Lines
    
    
    856
    
    
    
    1.3
    
    
    
    281.4
    
    
    
    1,169
    
    
    
    2.2
    
    
    
    75.5
    
    
    
    1,524
    
    
    
    3.3
    
    
    
    189.1Total
    
    
    38,365
    
    
    
    59.8
    
    
    
    72.9
    
    
    
    36,682
    
    
    
    69.0
    
    
    
    64.6
    
    
    
    34,220
    
    
    
    75.8
    
    
    
    50.2Total Personal &
Commercial
    
    $
    64,179
    
    
    
    100.0
    %
    
    
    71.6
    
    
    $
    53,102
    
    
    
    100.0
    %
    
    
    61.2
    
    
    $
    45,135
    
    
    
    100.0
    %
    
    
    45.9
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For the Year Ended December 31,2001
    
    2002
    
    2003(1)
    
    2004(1)
    
    2005(1)Commercial
    
    
    58
    %
    
    
    40
    %
    
    
    63
    %
    
    
    73
    %
    
    
    79
    %Personal
    
    
    42
    
    
    
    60
    
    
    
    37
    
    
    
    27
    
    
    
    21Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 
 (1)
    
    Shown on a group-wide basis for the Pooled Business. See the Administration
section of this Item for further discussion. Commercial Business
   Personal Business
  8




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Involuntary Business
   Pooling Agreement
  Claims
  9




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Loss and Loss Adjustment Expense Reserves
    10




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Year Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Reserve for losses and LAE at beginning of year
    
    $
    128,415
    
    
    $
    146,474
    
    
    $
    147,136Less reinsurance recoverables
    
    
    (15,630
    )
    
    
    (22,715
    )
    
    
    (19,380
    )Net balance at beginning of year
    
    
    112,785
    
    
    
    123,759
    
    
    
    127,756Provision for losses and LAE for claims occurring in:Current year
    
    
    29,711
    
    
    
    38,524
    
    
    
    49,702Prior years
    
    
    (3,303
    )
    
    
    (843
    )
    
    
    (90
    )26,408
    
    
    
    37,681
    
    
    
    49,612Losses and LAE payments for claims occurring in:Current year
    
    
    (10,359
    )
    
    
    (13,647
    )
    
    
    (18,441
    )Prior years
    
    
    (27,450
    )
    
    
    (35,008
    )
    
    
    (35,168
    )(37,809
    )
    
    
    (48,655
    )
    
    
    (53,609
    )Reserve for losses and LAE at end of year, net
    
    
    101,384
    
    
    
    112,785
    
    
    
    123,759Plus reinsurance recoverables
    
    
    13,807
    
    
    
    15,630
    
    
    
    22,715Balance at end of year
    
    $
    115,191
    
    
    $
    128,415
    
    
    $
    146,474
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As of December 31,1995
    
    
    1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(in thousands)Net liability for
losses and LAE:$
    113,718
    
    
    $
    126,260
    
    
    $
    130,781
    
    
    $
    126,820
    
    
    $
    127,458
    
    
    $
    131,178
    
    
    $
    132,113
    
    
    $
    127,756
    
    
    $
    123,759
    
    
    $
    112,785Liability re-
estimated as of:One year later
    
    
    120,550
    
    
    
    130,768
    
    
    
    128,636
    
    
    
    123,071
    
    
    
    128,886
    
    
    
    129,704
    
    
    
    128,328
    
    
    
    127,666
    
    
    
    122,916
    
    
    
    109,482Two years later
    
    
    128,192
    
    
    
    133,029
    
    
    
    130,498
    
    
    
    120,345
    
    
    
    123,299
    
    
    
    129,621
    
    
    
    132,674
    
    
    
    129,722
    
    
    
    122,071Three years later
    
    
    129,724
    
    
    
    132,948
    
    
    
    127,893
    
    
    
    113,661
    
    
    
    124,944
    
    
    
    133,769
    
    
    
    135,865
    
    
    
    129,254Four years later
    
    
    131,647
    
    
    
    129,210
    
    
    
    122,508
    
    
    
    114,068
    
    
    
    128,121
    
    
    
    138,538
    
    
    
    137,813Five years later
    
    
    127,183
    
    
    
    124,238
    
    
    
    122,347
    
    
    
    117,678
    
    
    
    131,977
    
    
    
    140,804Six years later
    
    
    123,521
    
    
    
    124,319
    
    
    
    125,741
    
    
    
    120,958
    
    
    
    133,913Seven years later
    
    
    123,679
    
    
    
    127,659
    
    
    
    128,998
    
    
    
    123,359Eight years later
    
    
    126,285
    
    
    
    130,280
    
    
    
    130,907Nine years later
    
    
    128,433
    
    
    
    131,887Ten years later
    
    
    129,291Net cumulative
redundancy
(deficiency):$
    (15,573
    )
    
    
    (5,627
    )
    
    
    (126
    )
    
    
    3,461
    
    
    
    (6,455
    )
    
    
    (9,626
    )
    
    
    (5,700
    )
    
    
    (1,498
    )
    
    
    1,688
    
    
    
    3,303%
    (13.7
    )
    
    
    (4.5
    )
    
    
    (.1
    )
    
    
    2.7
    
    
    
    (5.1
    )
    
    
    (7.3
    )
    
    
    (4.3
    )
    
    
    (1.2
    )
    
    
    1.4
    
    
    
    2.9Net paid
(cumulative)
as of:One year later
    
    
    38,549
    
    
    
    40,954
    
    
    
    42,433
    
    
    
    37,125
    
    
    
    40,970
    
    
    
    45,461
    
    
    
    40,843
    
    
    
    35,168
    
    
    
    35,008
    
    
    
    27,450Two years later
    
    
    64,323
    
    
    
    69,035
    
    
    
    66,477
    
    
    
    63,325
    
    
    
    69,393
    
    
    
    70,075
    
    
    
    64,959
    
    
    
    61,03
    
    
    
    56,290Three years later
    
    
    84,638
    
    
    
    86,364
    
    
    
    86,313
    
    
    
    80,142
    
    
    
    86,670
    
    
    
    85,772
    
    
    
    83,552
    
    
    
    78,109Four years later
    
    
    96,491
    
    
    
    98,300
    
    
    
    97,770
    
    
    
    89,383
    
    
    
    96,222
    
    
    
    98,053
    
    
    
    96,986Five years later
    
    
    104,063
    
    
    
    105,787
    
    
    
    104,282
    
    
    
    94,809
    
    
    
    102,892
    
    
    
    107,913Six years later
    
    
    109,492
    
    
    
    109,639
    
    
    
    107,431
    
    
    
    99,131
    
    
    
    108,438Seven years later
    
    
    111,851
    
    
    
    111,822
    
    
    
    110,193
    
    
    
    103,180Eight years later
    
    
    113,593
    
    
    
    114,246
    
    
    
    113,200Nine years later
    
    
    114,959
    
    
    
    116,279Ten years later
    
    
    116,589Initial gross
liability for
losses and LAE:
    
    $
    120,114
    
    
    $
    134,532
    
    
    $
    141,157
    
    
    $
    136,632
    
    
    $
    133,485
    
    
    $
    145,006
    
    
    $
    151,354
    
    
    $
    147,135
    
    
    $
    146,475
    
    
    $
    132,112Initial
ceded liability for losses and LAE:
    
    
    6,396
    
    
    
    8,272
    
    
    
    10,376
    
    
    
    9,812
    
    
    
    6,027
    
    
    
    13,828
    
    
    
    19,241
    
    
    
    19,379
    
    
    
    22,716
    
    
    
    19,327Initial net liability
    
    $
    113,718
    
    
    $
    126,260
    
    
    $
    130,781
    
    
    $
    126,820
    
    
    $
    127,458
    
    
    $
    131,178
    
    
    $
    132,113
    
    
    $
    127,756
    
    
    $
    123,759
    
    
    $
    112,785Gross liability as
currently
re-estimated
    
    
    137,404
    
    
    
    142,021
    
    
    
    139,310
    
    
    
    131,801
    
    
    
    146,704
    
    
    
    172,475
    
    
    
    170,726
    
    
    
    161,139
    
    
    
    149,354
    
    
    
    132,977Ceded liability as
currently
re-estimated
    
    
    8,113
    
    
    
    10,134
    
    
    
    8,403
    
    
    
    8,442
    
    
    
    12,791
    
    
    
    31,671
    
    
    
    32,913
    
    
    
    31,885
    
    
    
    27,283
    
    
    
    23,495Net liability as
currently re-estimated
    
    $
    129,291
    
    
    $
    131,887
    
    
    $
    130,907
    
    
    $
    123,359
    
    
    $
    133,913
    
    
    $
    140,804
    
    
    $
    137,813
    
    
    $
    129,254
    
    
    $
    122,071
    
    
    $
    109,482Gross cumulative
redundancy
(deficiency):
    
    $
    (17,290
    )
    
    
    (7,489
    )
    
    
    1,847
    
    
    
    4,831
    
    
    
    (13,219
    )
    
    
    (27,469
    )
    
    
    (19,372
    )
    
    
    (14,004
    )
    
    
    (2,879
    )
    
    
    (865
    )%
    (14.4
    )
    
    
    (5.7
    )
    
    
    1.3
    
    
    
    3.5
    
    
    
    (9.9
    )
    
    
    (18.9
    )
    
    
    (12.8
    )
    
    
    (9.5
    )
    
    
    (2.0
    )
    
    
    (.7
    )
 12




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##### Table of Contents



As of December 31,2005
    
    
    2004
    
    
    2003(in thousands)Loss and LAE reserves on a SAP basis
    
    $
    101,384
    
    
    $
    112,785
    
    
    $
    123,759Adjustments:Ceded reinsurance balances recoverable
    
    
    13,807
    
    
    
    15,630
    
    
    
    22,715Loss and LAE reserves on a GAAP basis
    
    $
    115,191
    
    
    $
    128,415
    
    
    $
    146,474
 Reinsurance
     13




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Administration
 Administration
  Administration
 Investments
   14




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##### Table of Contents



As of December 31,2005
    
    
    2004
    
    
    2003Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %(dollars in thousands)Fixed Maturities (1):U.S. Government and Agencies
    
    $
    7,145
    
    
    
    3.9
    %
    
    $
    5,028
    
    
    
    2.5
    %
    
    $
    8,377
    
    
    
    4.1
    %Corporate Securities
    
    
    17,147
    
    
    
    9.4
    
    
    
    28,003
    
    
    
    14.2
    
    
    
    28,714
    
    
    
    14.2Mortgage and Asset Backed
Securities
    
    
    97,044
    
    
    
    53.2
    
    
    
    110,082
    
    
    
    55.7
    
    
    
    113,313
    
    
    
    55.8Tax-Exempt Bonds
    
    
    45,257
    
    
    
    24.8
    
    
    
    40,979
    
    
    
    20.7
    
    
    
    43,401
    
    
    
    21.4Total Bonds
    
    
    166,593
    
    
    
    91.3
    
    
    
    184,092
    
    
    
    93.1
    
    
    
    193,805
    
    
    
    95.5Preferred Stocks (1)
    
    
    4,312
    
    
    
    2.4
    
    
    
    3,509
    
    
    
    1.8
    
    
    
    5,797
    
    
    
    2.9Short-Term Investments (2)
    
    
    10,650
    
    
    
    5.9
    
    
    
    7,412
    
    
    
    3.7
    
    
    
    1,118
    
    
    
    .6Other (3)
    
    
    734
    
    
    
    .4
    
    
    
    2,696
    
    
    
    1.4
    
    
    
    2,167
    
    
    
    1.0Total Invested Assets
    
    $
    182,289
    
    
    
    100.0
    %
    
    $
    197,709
    
    
    
    100.0
    %
    
    $
    202,887
    
    
    
    100.0
    %
 
 (1)
    
    Shown at fair value.(2)
    
    Shown at cost, which approximates fair value.(3)
    
    Shown at estimated fair value or unpaid principal balance, which approximates estimated fair value. 15




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##### Table of Contents



Year Ended December 31,2005
    
    2004
    
    2003(dollars in thousands)Average investments
    
    $
    185,925
    
    
    $
    196,148
    
    
    $
    200,996Net investment income
    
    
    7,733
    
    
    
    7,881
    
    
    
    8,815Net investment income as a percentage
of average investments (1)
    
    
    4.2
    %
    
    
    4.0
    %
    
    
    4.4
    %Net gains (losses) on investments
    
    $
    
    
    
    $
    (221
    )
    
    $
    2,500
 
 (1)
    
    The taxable equivalent yield for the years ended December 31, 2005, 2004 and 2003 was 4.5%,
4.3% and 4.4%, respectively, assuming an effective tax rate of 34%.  As of December 31,2005
    
    
    2004
    
    
    2003Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %(dollars in thousands)1 year or less
    
    $
    35,259
    
    
    
    21.2
    %
    
    $
    49,275
    
    
    
    26.8
    %
    
    $
    33,243
    
    
    
    17.2
    %1 year through 5 years
    
    
    104,957
    
    
    
    63.0
    
    
    
    112,476
    
    
    
    61.1
    
    
    
    137,234
    
    
    
    70.85 years through 10 years
    
    
    18,978
    
    
    
    11.4
    
    
    
    18,870
    
    
    
    10.2
    
    
    
    21,065
    
    
    
    10.9More than 10 years
    
    
    7,399
    
    
    
    4.4
    
    
    
    3,471
    
    
    
    1.9
    
    
    
    2,263
    
    
    
    1.1Total
    
    $
    166,593
    
    
    
    100.0
    %
    
    $
    184,092
    
    
    
    100.0
    %
    
    $
    193,805
    
    
    
    100.0
    %
 Competition
  16




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##### Table of Contents



Regulation
 General
    17




---



##### Table of Contents



Rates
  18




---



##### Table of Contents



Renewal of Policies
  Insurance Holding Companies
  Involuntary Business
  Employees
  19




---



##### Table of Contents



Name of Executive
    
    
    
    
    
    Principal OccupationOfficer and Position(s)
    
    Age
    
    During the Past Five YearsRobert M. Zak Senior Vice President and
Chief Operating Officer
    
    
    48
    
    
    President and Chief Executive Officer of MNH
and Mutual since November 1, 1995; Sr. Vice
President of MNH and Mutual from 1992 to
1995; Chief Financial Officer of the Company,
MNH and Mutual from 1991 through 1996;
Vice President  Financial Services of MNH and
Mutual from 1989 through 1996; Secretary of
MNH and Mutual from 1990 through
November 1, 1995.Edward
M. Murphy
Vice President,
Chief Investment Officer and
Assistant Secretary
    
    
    55
    
    
    Vice President and Chief Investment Officer
of the Company, Mutual and MNH since
1991; Assistant Vice President of Mutual
and MNH from 1989 to 1991.Kenneth
J. Wilson
Vice President,
Treasurer, Chief Financial
Officer and Secretary
    
    
    58
    
    
    Vice President, Treasurer and Chief
Financial Officer of the Company, Mutual
and MNH since 1996; President and Chief
Executive Officer of Carbadon Corp. and its
operating subsidiary, Empire of America Realty Credit Corp., from December 1995 to
December 1996 and Chief Financial Officer from November 1992 to December 1996.
 
    If our estimates of loss and LAE prove inaccurate and if we have to make even a relatively small adjustment to our reserves, the adjustments may have a significant impact on our income.
 BUSINESS
 20




---



##### Table of Contents



The demand for property and casualty insurance is cyclical, which may adversely affect our operating results for extended periods.
  If catastrophic events affect many of our policy holders at the same time, we may experience significant extraordinary losses.
   Adequate reinsurance may not be available at acceptable prices so that we may not be able to adequately protect the Company against extraordinary losses.
 BUSINESS
 Our investment income is very sensitive to prevailing interest rates, and general decreases in interest rates will adversely affect our business.
  Government
regulation affecting casualty and insurance companies could restrict
our operations in ways that would adversely affect our business.
  21




---



##### Table of Contents



The
Companys and MNHs current operations are heavily dependent on their relationships with Mutual, and any disruption of those relationships could adversely affect our business.
 BUSINESS
 We compete with other regional and national property and casualty insurance companies, many of which have greater resources than we do.
  Our operations are relatively concentrated in one geographic region, and a large disaster in the states that we serve could adversely affect our business.
  New Hampshire state regulations limit our ability to pay dividends even when we have sufficient cash to pay them.
 st
 22




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23




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##### Table of Contents



High
    
    Low
    
    Dividend2005:Fourth Quarter
    
    $
    31.60
    
    
    $
    26.65
    
    
    $
    .25Third Quarter
    
    
    27.10
    
    
    
    24.10
    
    
    
    .10Second Quarter
    
    
    26.60
    
    
    
    24.00
    
    
    
    .10First Quarter
    
    
    26.15
    
    
    
    23.60
    
    
    
    .10
 High
    
    Low
    
    Dividend2004:Fourth Quarter
    
    $
    24.67
    
    
    $
    22.65
    
    
    $
    .10Third Quarter
    
    
    26.00
    
    
    
    23.08
    
    
    
    .10Second Quarter
    
    
    26.38
    
    
    
    24.40
    
    
    
    .10First Quarter
    
    
    25.50
    
    
    
    23.70
    
    
    
    .10
     24




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##### Table of Contents



Equity Compensation Plan Information
 Number of SecuritiesRemaining Available forNumber of Securities to
    
    Weighted-Average
    
    Future Issuance Underbe Issued Upon Exercise
    
    Exercise Price of
    
    Equity Compensation PlansOf Outstanding Options,
    
    Outstanding Options,
    
    (Excluding Securities)Plan Category
    
    Warrants and Rights
    
    Warrants and Rights
    
    Reflected in Column (a))(a)
    
    (b)
    
    (c)Equity Compensation Plans
Approved by Security
Holders
    
    
    0
    
    
    
    N/A
    
    
    
    0Equity Compensation Plans
Not Approved by
Security Holders
    
    
    13,000
    
    
    $
    21.00
    
    
    
    0Total
    
    
    13,000
    
    
    $
    21.00
    
    
    
    0
  25




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##### Table of Contents



As of December 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005(in thousands, except per share amounts)Net premiums written
    
    $
    93,973
    
    
    $
    70,528
    
    
    $
    64,179
    
    
    $
    53,102
    
    
    $
    45,135Net premiums earned
    
    $
    93,885
    
    
    $
    83,120
    
    
    $
    65,097
    
    
    $
    57,123
    
    
    $
    49,121Net investment income
    
    
    13,295
    
    
    
    10,403
    
    
    
    8,815
    
    
    
    7,881
    
    
    
    7,733Net investment gains (losses)
    
    
    (580
    )
    
    
    953
    
    
    
    2,500
    
    
    
    (221
    )
    
    
    Other revenues
    
    
    696
    
    
    
    635
    
    
    
    560
    
    
    
    722
    
    
    
    571Total revenues
    
    
    107,296
    
    
    
    95,111
    
    
    
    76,972
    
    
    
    65,505
    
    
    
    57,425Net losses and loss adjustment expenses
    
    
    75,144
    
    
    
    62,873
    
    
    
    49,612
    
    
    
    37,681
    
    
    
    26,408Amortization of deferred policy acquisition costs
    
    
    24,880
    
    
    
    22,227
    
    
    
    16,925
    
    
    
    14,852
    
    
    
    12,771Other underwriting expenses
    
    
    6,017
    
    
    
    5,744
    
    
    
    5,031
    
    
    
    8,291
    
    
    
    8,811Total expenses
    
    
    106,041
    
    
    
    90,844
    
    
    
    71,568
    
    
    
    60,824
    
    
    
    47,990Income before income taxes
    
    
    1,255
    
    
    
    4,267
    
    
    
    5,404
    
    
    
    4,681
    
    
    
    9,435Provision for income taxes
    
    
    434
    
    
    
    1,729
    
    
    
    1,039
    
    
    
    919
    
    
    
    2,736Net income
    
    $
    821
    
    
    $
    2,538
    
    
    $
    4,365
    
    
    $
    3,762
    
    
    $
    6,699Earnings per shareBasic
    
    $
    .35
    
    
    $
    1.19
    
    
    $
    2.07
    
    
    $
    1.78
    
    
    $
    3.17Diluted
    
    $
    .35
    
    
    $
    1.19
    
    
    $
    2.07
    
    
    $
    1.78
    
    
    $
    3.17Weighted average number of shares
outstanding:Basic
    
    
    2,343
    
    
    
    2,125
    
    
    
    2,110
    
    
    
    2,114
    
    
    
    2,115Diluted
    
    
    2,343
    
    
    
    2,129
    
    
    
    2,111
    
    
    
    2,118
    
    
    
    2,118Balance Sheet Data: (at year end)Total investments
    
    $
    213,132
    
    
    $
    209,397
    
    
    $
    202,887
    
    
    $
    197,709
    
    
    $
    182,289Total assets
    
    
    285,078
    
    
    
    265,900
    
    
    
    268,678
    
    
    
    255,704
    
    
    
    233,978Reserve for losses and loss
adjustment expenses
    
    
    151,355
    
    
    
    147,136
    
    
    
    146,474
    
    
    
    128,415
    
    
    
    115,191Unearned premiums
    
    
    50,179
    
    
    
    35,119
    
    
    
    36,176
    
    
    
    33,685
    
    
    
    29,662Stockholders equity
    
    
    68,551
    
    
    
    67,924
    
    
    
    70,259
    
    
    
    71,974
    
    
    
    75,894Dividend Data:Cash dividend per common share
    
    $
    .40
    
    
    $
    .40
    
    
    $
    .40
    
    
    $
    .40
    
    
    $
    .55
 26




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##### Table of Contents



Proposal by Mutual
   2005 Compared to 2004
    MNHPro FormaGroup-wide DWP
    
    
    
    
    
    
    ShareYear ended
    
    
    
    
    
    
    Year endedDecember 31,
    
    
    
    
    
    
    December 31,2005
    
    
    2004
    
    
    Variance
    
    
    2005
    
    
    2004
    
    
    Variance(000s omitted)
    
    
    
    
    
    
    (000s omitted)Voluntary Personal
    
    $
    40,842
    
    
    $
    50,879
    
    
    
    (20
    %)
    
    $
    12,253
    
    
    $
    17,808
    
    
    
    (31
    %)Voluntary Commercial
    
    
    131,789
    
    
    
    119,113
    
    
    
    11
    %
    
    
    39,537
    
    
    
    41,690
    
    
    
    (5
    %)Umbrella Program
    
    
    19,688
    
    
    
    17,536
    
    
    
    12
    %
    
    
    5,906
    
    
    
    6,138
    
    
    
    (4
    %)Involuntary
    
    
    2,909
    
    
    
    3,610
    
    
    
    (19
    %)
    
    
    873
    
    
    
    1,264
    
    
    
    (31
    %)Total Direct Written Premiums
    
    $
    195,228
    
    
    $
    191,138
    
    
    
    2
    %
    
    $
    58,569
    
    
    $
    66,900
    
    
    
    (12
    %)
  27




---



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28




---



##### Table of Contents



-
    
    An improvement in the accident year direct loss and ALAE ratio for each of the Companys
primary products, the most significant of which was an improvement
from 64.4% to 54.1% in
the accident year direct loss and LAE ratio in the Companys PPA product. This improvement
was due to increased fraud prevention, detection and prosecution efforts resulting from
certain legislative changes in New York State. PPA liability is one of the Companys
larger products and represents approximately 23% of the Companys net earned premiums. The
decrease in the PPA loss and LAE ratio decreased the Companys overall loss and LAE ratio
by approximately 1.6 percentage points.-
    
    Mild weather in the Companys operating territory during 2005 contributed to
significant decreases in claim frequency (reported claims per earned policy) in the
Companys homeowners and commercial property products.
  Commercial
    
    
    WorkersAccident
    
    Home-
    
    
    PPA
    
    
    Auto
    
    
    Compen-
    
    
    Commercial
    
    
    General
    
    
    AllYear
    
    owners
    
    
    Liability
    
    
    Liability
    
    
    sation
    
    
    Package
    
    
    Liability
    
    
    Other
    
    
    TotalPrior to
    
    
    
    
    
    
    
    
    
    Increases (decreases) (in thousands)2002
    
    $
    126
    
    
    $
    (172
    )
    
    $
    (43
    )
    
    $
    (1,856
    )
    
    $
    2,054
    
    
    $
    1,540
    
    
    $
    300
    
    
    $
    1,9492002
    
    
    79
    
    
    
    (568
    )
    
    
    (132
    )
    
    
    (501
    )
    
    
    (1,216
    )
    
    
    (99
    )
    
    
    21
    
    
    
    (2,416
    )2003
    
    
    211
    
    
    
    (333
    )
    
    
    (323
    )
    
    
    (36
    )
    
    
    91
    
    
    
    117
    
    
    
    (104
    )
    
    
    (377
    )2004
    
    
    (361
    )
    
    
    (926
    )
    
    
    (731
    )
    
    
    (166
    )
    
    
    4
    
    
    
    223
    
    
    
    (502
    )
    
    
    (2,459
    )Total
    
    $
    55
    
    
    $
    (1,999
    )
    
    $
    (1,229
    )
    
    $
    (2,559
    )
    
    $
    933
    
    
    $
    1,781
    
    
    $
    (285
    )
    
    $
    (3,303
    )
 29




---



##### Table of Contents



30




---



##### Table of Contents



2004 Compared to 2003
   MNHPro FormaGroup-wide DWP
    
    
    
    
    
    
    ShareYear ended
    
    
    
    
    
    
    Year endedDecember 31,
    
    
    
    
    
    
    December 31,2004
    
    
    2003
    
    
    Variance

    
    2004
    
    
    2003
    
    
    Variance(000s omitted)
    
    
    
    
    
    
    (000s omitted)Voluntary Personal
    
    $
    50,879
    
    
    $
    63,548
    
    
    
    (20
    %)
    
    $
    17,808
    
    
    $
    25,419
    
    
    
    (30
    %)Voluntary Commercial
    
    
    119,113
    
    
    
    103,262
    
    
    
    15
    %
    
    
    41,690
    
    
    
    41,305
    
    
    
    1
    %Umbrella Program
    
    
    17,536
    
    
    
    3,136
    
    
    
    459
    %
    
    
    6,138
    
    
    
    1,254
    
    
    
    389
    %Involuntary
    
    
    3,610
    
    
    
    5,197
    
    
    
    (31
    %)
    
    
    1,264
    
    
    
    2,079
    
    
    
    (39
    %)Total Direct Written Premiums
    
    $
    191,138
    
    
    $
    175,143
    
    
    
    9
    %
    
    $
    66,900
    
    
    $
    70,057
    
    
    
    (5
    %)
   31




---



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32




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##### Table of Contents



-
    
    A reduction in PPA liability net earned premium as a percentage of total Company net
earned premium to 16.7% in 2004 from 20.2% in 2003. PPA liability was the Companys
highest loss and LAE ratio product and accounted for 1.5 percentage points of the decrease.
 -
    
    An improvement in the PPA liability loss and LAE ratio to
86.6% in 2004 from 111.6% in
2003, which accounted for 4.2 percentage points of the decrease. This improvement was due
to improved involuntary loss experience, primarily from the NYAIP.
 -
    
    An improvement in the commercial package loss and LAE ratio
to 69.0% in 2004 from 81.8%
in 2003 which accounted for 3.5 percentage points of the decrease. This improvement was
the result of a reduction in loss frequency.
  Commercial
    
    
    WorkersAccident
    
    Home-
    
    
    PPA
    
    
    Auto
    
    
    Compen-
    
    
    Commercial
    
    
    General
    
    
    AllYear
    
    owners
    
    
    Liability
    
    
    Liability
    
    
    sation
    
    
    Package
    
    
    Liability
    
    
    Other
    
    
    TotalPrior to
    
    
    
    
    
    
    
    
    
    Increases (decreases) (in thousands)2001
    
    $
    (109
    )
    
    $
    455
    
    
    $
    764
    
    
    $
    533
    
    
    $
    2,183
    
    
    $
    1,119
    
    
    $
    (176
    )
    
    $
    4,7692001
    
    
    152
    
    
    
    (17
    )
    
    
    121
    
    
    
    (1,221
    )
    
    
    (450
    )
    
    
    (123
    )
    
    
    (41
    )
    
    
    (1,579
    )2002
    
    
    60
    
    
    
    (269
    )
    
    
    (1,072
    )
    
    
    (921
    )
    
    
    915
    
    
    
    59
    
    
    
    94
    
    
    
    (1,134
    )2003
    
    
    (7
    )
    
    
    (1,529
    )
    
    
    268
    
    
    
    (433
    )
    
    
    (909
    )
    
    
    (299
    )
    
    
    10
    
    
    
    (2,899
    )Total
    
    $
    96
    
    
    $
    (1,360
    )
    
    $
    81
    
    
    $
    (2,042
    )
    
    $
    1,739
    
    
    $
    756
    
    
    $
    (113
    )
    
    $
    (843
    )
   33




---



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34




---



##### Table of Contents



Critical Accounting Policies
 Reserve for Losses and LAE
    35




---



##### Table of Contents



Paid Loss Development
  Incurred Loss Development
  Bornhuetter-Ferguson with Premium and Paid Loss
  Bornhuetter-Ferguson with Premium and Incurred Loss
  Ultimate Claims and Average Loss
  36




---



##### Table of Contents



Paid ALAE Development
  Bornhuetter-Ferguson with Ultimate Loss and Paid ALAE
   
    
    How results of methods based on paid losses compare to methods based on
incurred losses.
    
    How results of paid and incurred development methods compare to results of paid
and incurred BF methods.
    
    Whether diagnostic tests cause management to favor the results of one or more
methods over the results of other methods. Such tests include:
 °
    
    closed claim to reported claim ratios°
    
    average case reserves per open claim°
    
    paid loss per closed claim°
    
    paid loss to incurred loss ratios°
    
    the reasonableness of ultimate loss & ALAE ratios and ultimate severities°
    
    managements consideration of other factors such as premium and
loss trends, large loss experience, legislative and judicial changes and changes in
underwriting guidelines and practices.
   37




---



##### Table of Contents



Range of Net Loss & LAE Reserves ($000s)Products*
    
    Low
    
    Recorded
    
    HighPersonal Auto
    
    $
    10,872
    
    
    $
    12,491
    
    
    $
    14,121Homeowners
    
    $
    2,086
    
    
    $
    2,731
    
    
    $
    3,382Commercial Auto
    
    $
    9,654
    
    
    $
    13,449
    
    
    $
    17,388Workers Compensation
    
    $
    21,066
    
    
    $
    24,709
    
    
    $
    29,072Commercial General Liability
    
    $
    34,968
    
    
    $
    43,637
    
    
    $
    54,402Commercial Property
    
    $
    2,797
    
    
    $
    4,317
    
    
    $
    6,051Other
    
    $
    40
    
    
    $
    50
    
    
    $
    60All Products
    
    $
    90,741
    
    
    $
    101,384
    
    
    $
    112,394
 *
    The products shown in this table are those used by the
Company in its loss reserving process. The Companys reserve for
unpaid losses and LAE as appears in the table that follows, are
segregated by product type as defined in the Companys Annual
Statement filed with insurance department regulators.
    38




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##### Table of Contents



December 31,2005
    
    
    2004(000s)Case reserves:PPA liability
    
    $
    6,072
    
    
    $
    10,099Homeowners
    
    
    1,899
    
    
    
    2,097Commercial auto liability
    
    
    5,384
    
    
    
    7,677Workers compensation
    
    
    14,531
    
    
    
    15,698Commercial package
    
    
    12,739
    
    
    
    13,795General liability
    
    
    505
    
    
    
    750Other
    
    
    308
    
    
    
    243Total case reserves
    
    
    41,438
    
    
    
    50,359IBNR:PPA liability
    
    
    4,372
    
    
    
    6,197Homeowners
    
    
    228
    
    
    
    257Commercial auto liability
    
    
    6,396
    
    
    
    6,154Workers compensation
    
    
    8,074
    
    
    
    9,884Commercial package
    
    
    16,965
    
    
    
    14,467General liability
    
    
    2,581
    
    
    
    1,107Other
    
    
    (407
    )
    
    
    (223
    )Total IBNR
    
    
    38,209
    
    
    
    37,843Reserve for LAE:PPA liability
    
    
    2,004
    
    
    
    2,973Homeowners
    
    
    604
    
    
    
    640Commercial auto liability
    
    
    1,622
    
    
    
    1,852Workers compensation
    
    
    2,104
    
    
    
    2,125Commercial package
    
    
    11,493
    
    
    
    13,712General liability
    
    
    3,668
    
    
    
    3,145Other
    
    
    242
    
    
    
    136Total reserve for LAE
    
    
    21,737
    
    
    
    24,583Subtotal
    
    
    101,384
    
    
    
    112,785Reinsurance recoverables
    
    
    13,807
    
    
    
    15,630Reserve for losses and LAE
    
    $
    115,191
    
    
    $
    128,415
 Deferred Policy Acquisition Costs
  Investments
   39




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Liquidity and Capital Resources
       40




---



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41




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##### Table of Contents



Off-Balance Sheet Arrangements
  Contractual Obligations
   Less than
    
    
    1  3
    
    
    3  5
    
    
    More thanTotal
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 YearsReserve for losses and
loss adjustment expenses
    
    $
    115,191
    
    
    $
    30,048
    
    
    $
    34,876
    
    
    $
    19,307
    
    
    $
    30,960
  Recently Issued Accounting Standards
  
    
    Statement of Financial Accounting Standards (SFAS) No. 154 Accounting Changes and
Error Corrections  a replacement of APB Opinion No. 20 and FASB Statement No. 3.
    
    SFAS No. 155 Accounting for Certain Hybrid Instruments.
    
    SFAS No. 156 Accounting for Servicing Assets and
Liabilities.
   Federal Legislation
  Environmental Claims
  42




---



##### Table of Contents



Inflation
  Relationship with Mutual
    43




---



##### Table of Contents



44




---



##### Table of Contents



Market Risk
    TOTALEsti-Amor-
    
    
    matedThere-
    
    
    tized
    
    
    Market2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    after
    
    
    Cost
    
    
    ValueAvailable for SaleU.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies
    
    $
    0
    
    
    $
    0
    
    
    $
    3,004
    
    
    $
    0
    
    
    $
    4,244
    
    
    $
    0
    
    
    $
    7,248
    
    
    $
    7,145Average interest rate
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    3.2
    %
    
    
    0.0
    %
    
    
    4.8
    %
    
    
    0.0
    %
    
    
    
    
    
    
    Obligations of states and
political subdivisions
    
    
    11,367
    
    
    
    3,908
    
    
    
    15,597
    
    
    
    3,906
    
    
    
    7,419
    
    
    
    3,730
    
    
    
    45,927
    
    
    
    45,257Average interest rate
    
    
    3.6
    %
    
    
    4.3
    %
    
    
    3.9
    %
    
    
    4.1
    %
    
    
    5.0
    %
    
    
    4.8
    %
    
    
    
    
    
    
    Corporate securities
    
    
    999
    
    
    
    0
    
    
    
    3,243
    
    
    
    5,975
    
    
    
    1,991
    
    
    
    5,432
    
    
    
    17,640
    
    
    
    17,147Average interest rate
    
    
    3.2
    %
    
    
    0.0
    %
    
    
    3.7
    %
    
    
    4.9
    %
    
    
    4.6
    %
    
    
    6.8
    %
    
    
    
    
    
    
    Mortgage & asset
backed securities
    
    
    23,461
    
    
    
    21,396
    
    
    
    15,473
    
    
    
    13,537
    
    
    
    8,422
    
    
    
    16,562
    
    
    
    98,851
    
    
    
    97,044Average interest rate
    
    
    4.8
    %
    
    
    4.8
    %
    
    
    4.8
    %
    
    
    4.9
    %
    
    
    5.0
    %
    
    
    5.1
    %
    
    
    
    
    
    
    Total
    
    $
    35,827
    
    
    $
    25,304
    
    
    $
    37,317
    
    
    $
    23,418
    
    
    $
    22,076
    
    
    $
    25,724
    
    
    $
    169,666
    
    
    $
    166,593
  45




---



##### Table of Contents



Three months ended3/31
    
    
    6/30
    
    
    9/30
    
    
    12/31(in thousands, except per share amounts)2005Net premiums earned
    
    $
    11,977
    
    
    $
    12,767
    
    
    $
    12,155
    
    
    $
    12,222Net investment income
    
    
    1,936
    
    
    
    1,908
    
    
    
    1,890
    
    
    
    1,999Net investment gains
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other revenues
    
    
    136
    
    
    
    114
    
    
    
    163
    
    
    
    158Total revenues
    
    $
    14,049
    
    
    $
    14,789
    
    
    $
    14,208
    
    
    $
    14,379Income before income taxes
    
    $
    1,599
    
    
    $
    4,532
    
    
    $
    2,484
    
    
    $
    820Net income
    
    $
    1,188
    
    
    $
    3,178
    
    
    $
    1,721
    
    
    $
    612Net income per diluted share
    
    $
    .56
    
    
    $
    1.50
    
    
    $
    .81
    
    
    $
    .292004Net premiums earned
    
    $
    14,069
    
    
    $
    14,364
    
    
    $
    14,161
    
    
    $
    14,529Net investment income
    
    
    2,054
    
    
    
    1,965
    
    
    
    1,935
    
    
    
    1,927Net investment gains (losses)
    
    
    377
    
    
    
    93
    
    
    
    
    
    
    
    (691
    )Other revenues
    
    
    166
    
    
    
    97
    
    
    
    185
    
    
    
    274Total revenues
    
    $
    16,666
    
    
    $
    16,519
    
    
    $
    16,281
    
    
    $
    16,039Income before income taxes
    
    $
    1,130
    
    
    $
    1,958
    
    
    $
    1,309
    
    
    $
    284Net income
    
    $
    811
    
    
    $
    1,550
    
    
    $
    1,163
    
    
    $
    238Net income per diluted share
    
    $
    .38
    
    
    $
    .73
    
    
    $
    .55
    
    
    $
    .11
 46




---



##### Table of Contents



47




---



##### Table of Contents



provided however
 
   48




---



##### Table of Contents



49




---



##### Table of Contents



(a)
    
    (1) The following financial statements of Merchants Group, Inc. are included on pages F-1 to
F-25:
 
 (a)
    
    (2) The following financial statement schedules of Merchants Group, Inc. are filed herewith
pursuant to Item 8:
 
 
 
  
 
 (a)
    
    
    (3
    )
    
    Exhibits required by Item 601 of Regulation S-K:(3
    )
    
    (a)
    
    Restated Certificate of Incorporation (incorporated by reference to Exhibit No. 3C
to Amendment No. 1 to the Companys Registration Statement (No. 33-9188) on Form S-1 filed on
November 7, 1986).(b)
    
    Restated By-laws (incorporated by reference to Exhibit No. 3D to Amendment No. 1 to the
Companys Registration Statement (No. 33-9188) on Form S-1 filed on November 7, 1986).
 50




---



##### Table of Contents



(10
    )
    
    (a)
    
    Management Agreement dated as of September 29, 1986 by and among Merchants Mutual
Insurance Company, Registrant and Merchants Insurance Company of New Hampshire, Inc. (incorporated
by reference to Exhibit No. 10A to the Companys Registration Statement (No. 33-9188) on Form S-1
filed on September 30, 1986).(b)
    
    Services Agreement Among Merchants Mutual Insurance Company, Merchants
Insurance Company of New Hampshire, Inc. and Merchants Group, Inc. dated January 1,
2003 (incorporated by reference to Exhibit No. 10b to the Companys 2003 Quarterly
Report on Form 10-Q filed on May 14, 2003).(c)
    
    Reinsurance Pooling Agreement between Merchants Insurance Company of New
Hampshire, Inc. and Merchants Mutual Insurance Company effective January 1, 2003
(incorporated by reference to Exhibit No. 10c to the Companys 2003 Quarterly Report
on Form 10-Q filed on May 14, 2003).(d)
    
    Endorsement to the Casualty Excess of Loss Reinsurance agreement between
Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire,
Inc. and American Reinsurance Company dated February 23, 2004 (incorporated by
reference to Exhibit 10(e) to the Companys 2004 Quarterly Report on Form 10-Q filed
on November 10, 2004).(e)
    
    Property Per Risk Excess of Loss Reinsurance Agreement between Merchants
Mutual Insurance Company, Merchants Insurance Company of New Hampshire, Inc. and
American Reinsurance Company dated April 16, 2004 (incorporated by reference to
Exhibit 10(f) to the Companys 2004 Quarterly Report on Form 10-Q filed on November
10, 2004).(f)
    
    Property Catastrophe Excess of Loss Reinsurance Agreement between
Merchants Mutual Insurance Company, Merchants Insurance Company of New Hampshire,
Inc. and the various reinsurers as identified by the Interest and Liabilities
Agreements attaching to and forming part of this Agreement (filed herewith).(g)
    
    Quota Share Reinsurance Treaty Agreement between Merchants Insurance
Company of New Hampshire, Inc. and The Subscribing Underwriting Members of Lloyds,
London specifically identified on the schedules attached to this agreement dated
January 1, 2000 (incorporated by reference to Exhibit 10(h) to the Companys 2000
Annual Report on Form 10-K filed on March 28, 2001).*
    
    
    (h)
    
    Form of Amended Indemnification Agreement entered into by Registrant with
each director and executive officer of Registrant (incorporated by reference to Exhibit
No. 10N to Amendment No. 1 to the Companys Registration Statement on (No. 33-9188)
Form S-1 filed on November 7, 1986).*
    
    
    (i)
    
    Merchants Mutual Insurance Company Adjusted Return on Equity Incentive
Compensation Plan January 1, 2000 (incorporated by reference to Exhibit 10p to the
Companys 2000 Annual Report on Form 10-K filed on March 28, 2001).
 51




---



##### Table of Contents



*
    
    
    (j)
    
    Amendment No. 1 to Employee Retention Agreement between Robert M. Zak and
Merchants Mutual Insurance Company originally dated as of May 31, 1999, dated February
6, 2002 (incorporated by reference to Exhibit 10(s) to the Companys 2002 Annual Report
on Form 10-K filed on March 31, 2003).*
    
    
    (k)
    
    Amendment No. 1 to Employee Retention Agreement between Edward M. Murphy
and Merchants Mutual Insurance Company originally dated as of March 1, 1999 dated
February 6, 2002 (incorporated by reference to Exhibit 10(t) to the Companys 10-K
filed on March 31, 2003).*
    
    
    (l)
    
    Amendment No. 1 to Employee Retention Agreement between Kenneth J. Wilson
and Merchants Mutual Insurance Company originally dated as of March 1, 1999 dated
February 6, 2002 (incorporated by reference to Exhibit 10(u) to the Companys Annual
Report on Form 10-K filed on March 31, 2003).(11
    )
    
    (a)
    
    Statement re computation of per share earnings (incorporated herein by reference to
Note 9 to the Consolidated Financial Statements included in Item 8).(14.1
    )
    
    
    
    Merchants Group, Inc. Code of
Conduct and Ethics (incorporated by reference to Exhibit 14.1 to
the Companys Annual Report on Form 10-K filed on
March 31, 2005).(14.2
    )
    
    
    
    Merchants Insurance Group Code of Business Conduct, amended 12/2004
(incorporated by reference to Exhibit 14.2 to
the Companys Annual Report on Form 10-K filed on
March 31, 2005).(21
    )
    
    
    
    List of Subsidiaries of Registrant (incorporated by reference to Exhibit No. 22 to the
Companys Registration Statement (No. 33-9188) on Form S-1 filed on September 30, 1986).(23
    )
    
    
    
    Report and Consent of Independent Registered Public Accounting Firm (filed
herewith).(31
    )
    
    
    
    Rule 13a-14(a)/15d-14(a) Certifications (filed herewith).(32
    )
    
    
    
    Certification Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 (subsections
(a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code (filed herewith).
 
 *
    
    Indicates a management contract or compensation plan or arrangement.  Investor Relations
Merchants Group, Inc.
250 Main Street
Buffalo, New York 14202
 52




---



##### Table of Contents



Amount atwhich shownAmortized Cost/
    
    
    Market
    
    
    in the balanceType of Investment
    
    Cost
    
    
    Value
    
    
    sheetFixed maturities:United States Government and
government agencies and authorities
    
    $
    7,248
    
    
    $
    7,145
    
    
    $
    7,145Corporate securities
    
    
    17,641
    
    
    
    17,147
    
    
    
    17,147Mortgage and asset backed securities
    
    
    98,850
    
    
    
    97,044
    
    
    
    97,044Obligations of states and political subdivisions
    
    
    45,927
    
    
    
    45,257
    
    
    
    45,257Total fixed maturities
    
    
    169,666
    
    
    
    166,593
    
    
    
    166,593Preferred stocks
    
    
    4,248
    
    
    
    4,312
    
    
    
    4,312Short-term investments
    
    
    10,650
    
    
    
    10,650
    
    
    
    10,650Other
    
    
    676
    
    
    
    734
    
    
    
    734$
    185,240
    
    
    $
    182,289
    
    
    $
    182,289
 53




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003Receivable from (payable to)
related parties, primarily Merchants
Mutual Insurance Company (1):Balance at beginning of period
    
    $
    (5,571
    )
    
    $
    (2,090
    )
    
    $
    (3,237
    )Change during the period
    
    
    5,458
    
    
    
    (3,481
    )
    
    
    1,147Balance at end of period
    
    $
    (113
    )
    
    $
    (5,571
    )
    
    $
    (2,090
    )Retrospective commission
receivable from (payable to)
Merchants Mutual Insurance Company (2):Balance at beginning of period
    
    $
    (1,141
    )
    
    $
    305
    
    
    $
    Change during the period
    
    
    (1,449
    )
    
    
    (1,446
    )
    
    
    305Balance at end of period
    
    $
    (2,590
    )
    
    $
    (1,141
    )
    
    $
    305
 
 (1)
    
    Under a Services Agreement, Merchants Mutual Insurance Company (Mutual) provides employees,
services and facilities for Merchants Insurance Company of New Hampshire, Inc. (MNH) to carry
on its traditional insurance business on a fee basis. Under a Reinsurance Pooling Agreement,
Mutual and MNH pool or share premiums and losses on their traditional insurance business.
The balance in the intercompany receivable (payable) account indicates the amount due from
(to) Mutual for the excess (deficiency) of premiums collected over (from) payments for losses,
services and facilities provided to MNH.(2)
    
    A Pooling Agreement between the Company and Mutual provides for retrospective commission
income or expense based upon the actual cumulative experience of the pooled business since the
agreements inception, compared to a targeted loss and LAE ratio of 74%. Commissions are
settled annually, six months after the end of the calendar year. 54




---



##### Table of Contents



BALANCE SHEET
 December 31,2005
    
    
    2004AssetsInvestment in subsidiary
    
    $
    73,033
    
    
    $
    71,433Other assets
    
    
    2,974
    
    
    
    601Total assets
    
    $
    76,007
    
    
    $
    72,034Liabilities and Stockholders EquityOther liabilities
    
    $
    113
    
    
    $
    60Total liabilities
    
    
    113
    
    
    
    60Stockholders equity:Preferred stock, $.01 par value, authorized and
unissued 3,000,000 shares
    
    
    
    
    
    
    Preferred stock, no par value, $424.30 stated value,
no shares issued or outstanding at December 31,
2005 or 2004
    
    
    
    
    
    
    Common stock, $.01 par value, authorized 10,000,000 shares;
2,132,652 shares issued and outstanding at December 31,
2005 and 2,114,152 shares issued and outstanding at
December 31, 2004
    
    
    33
    
    
    
    33Additional paid in capital
    
    
    36,267
    
    
    
    35,878Treasury stock, 1,139,700 shares at December 31, 2005
and 2004
    
    
    (22,766
    )
    
    
    (22,766
    )Accumulated other comprehensive loss
    
    
    (2,540
    )
    
    
    (536
    )Accumulated earnings
    
    
    64,900
    
    
    
    59,365Total stockholders equity
    
    
    75,894
    
    
    
    71,974Total liabilities and stockholders equity
    
    $
    76,007
    
    
    $
    72,034
 55




---



##### Table of Contents



INCOME STATEMENT
 Year ended December 31,2005
    
    
    2004
    
    
    2003Revenues:Equity in net income of subsidiary
    
    $
    7,004
    
    
    $
    4,209
    
    
    $
    4,516Investment income
    
    
    27
    
    
    
    8
    
    
    
    4Total revenues
    
    
    7,031
    
    
    
    4,217
    
    
    
    4,520Expenses:General and administrative expenses
    
    
    489
    
    
    
    685
    
    
    
    177Operating income before income taxes
    
    
    6,542
    
    
    
    3,532
    
    
    
    4,343Income tax benefit
    
    
    (157
    )
    
    
    (230
    )
    
    
    (22
    )Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365
 56




---



##### Table of Contents



STATEMENT OF CASH FLOWS
  Year ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Cash flows from operating activities:
    
    $
    (179
    )
    
    $
    (655
    )
    
    $
    (161
    )Cash flows from investing activities:Receipt of subsidiary common stock dividend
    
    
    3,400
    
    
    
    1,200
    
    
    
    1,200Purchase of other investments, net
    
    
    (2,412
    )
    
    
    210
    
    
    
    (188
    )Cash flows from investing activities
    
    
    988
    
    
    
    1,410
    
    
    
    1,012Cash flows from financing activities:Cash dividends
    
    
    (1,164
    )
    
    
    (845
    )
    
    
    (843
    )Exercise of common stock options
    
    
    389
    
    
    
    84
    
    
    
    Cash flows from financing activities
    
    
    (775
    )
    
    
    (761
    )
    
    
    (843
    )Net increase (decrease) in cash and cash equivalents
    
    
    34
    
    
    
    (6
    )
    
    
    8Cash and cash equivalents, beginning of year
    
    
    6
    
    
    
    12
    
    
    
    4Cash and cash equivalents, end of year
    
    $
    40
    
    
    $
    6
    
    
    $
    12Reconciliation of net income to net
cash provided by operations:Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Adjustments to reconcile net income
to net cash provided by operations:Equity in income of subsidiary
    
    
    (7,004
    )
    
    
    (4,209
    )
    
    
    (4,516
    )Increase (decrease) in other liabilities
    
    
    53
    
    
    
    2
    
    
    
    (4
    )(Increase) decrease in other
(non-investment) assets
    
    
    39
    
    
    
    (204
    )
    
    
    (14
    )Other, net
    
    
    34
    
    
    
    (6
    )
    
    
    8Net cash used in operating activities
    
    $
    (179
    )
    
    $
    (655
    )
    
    $
    (161
    )
 57




---



##### Table of Contents



NOTES TO CONDENSED FINANCIAL STATEMENTS
   58




---



##### Table of Contents



Assumed
    
    
    
    
    
    PercentageCeded
    
    Ceded
    
    Assumed
    
    from
    
    
    
    
    
    of amountGross
    
    to third
    
    to affiliates
    
    from third
    
    affiliates
    
    Net
    
    assumedamount
    
    parties
    
    (1)
    
    parties
    
    (1)
    
    amount
    
    to netYear ended December 31, 2005
Property and Casualty Premiums
    
    $
    53,532
    
    
    $
    3,747
    
    
    $
    50,957
    
    
    $
    1,172
    
    
    $
    45,135
    
    
    $
    45,135
    
    
    
    102.6
    %Year ended December 31, 2004
Property and Casualty Premiums
    
    $
    53,900
    
    
    $
    2,967
    
    
    $
    52,452
    
    
    $
    1,519
    
    
    $
    53,102
    
    
    $
    53,102
    
    
    
    102.9
    %Year Ended December 31, 2003
Property and Casualty Premiums
    
    $
    58,233
    
    
    $
    3,077
    
    
    $
    90,596
    
    
    $
    1,412
    
    
    $
    98,207
    
    
    $
    64,179
    
    
    
    155.2
    %
 
 (1)
    
    Amounts are comprised of premiums assumed or ceded in accordance with the Reinsurance Pooling
Agreement with Mutual. 59




---



##### Table of Contents



Losses & lossDeferred
    
    Reserves
    
    Discount
    
    
    
    
    
    
    
    
    
    
    
    
    
    adjustment expenses
    
    Amortiza-policy
    
    for losses
    
    if any,
    
    
    
    
    
    
    
    
    
    
    
    
    
    incurred related to
    
    tion of
    
    Paid lossesacquis-
    
    and loss
    
    deducted
    
    
    
    
    
    Net
    
    Net
    
    (1)
    
    (2)
    
    deferred
    
    & loss ad-
    
    Directition
    
    adjustment
    
    from
    
    Unearned
    
    earned
    
    investment
    
    Current
    
    Prior
    
    acquisition
    
    justment
    
    premiumcosts
    
    expenses
    
    reserves
    
    premiums
    
    premiums
    
    income
    
    years
    
    years
    
    costs
    
    expenses
    
    writtenYear ended:December 31, 2005
    
    $
    6,527
    
    
    $
    115,191
    
    
    $
    3,651
    
    
    $
    29,662
    
    
    $
    49,121
    
    
    $
    7,733
    
    
    $
    29,711
    
    
    $
    (3,303
    )
    
    $
    12,771
    
    
    $
    37,810
    
    
    $
    53,532December 31, 2004
    
    $
    7,570
    
    
    $
    128,415
    
    
    $
    4,531
    
    
    $
    33,685
    
    
    $
    57,123
    
    
    $
    7,881
    
    
    $
    38,524
    
    
    $
    (843
    )
    
    $
    14,852
    
    
    $
    48,655
    
    
    $
    53,900December 31, 2003
    
    $
    8,623
    
    
    $
    146,474
    
    
    $
    4,920
    
    
    $
    36,176
    
    
    $
    65,097
    
    
    $
    8,815
    
    
    $
    49,702
    
    
    $
    (90
    )
    
    $
    16,925
    
    
    $
    53,609
    
    
    $
    58,233
 60




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
  
 F-1




---



##### Table of Contents



CONSOLIDATED BALANCE SHEET
  December 31,2005
    
    
    2004AssetsInvestments:Fixed maturities available for sale at fair value
    
    $
    166,593
    
    
    $
    184,092Preferred stock at fair value
    
    
    4,312
    
    
    
    3,509Other long-term investments at fair value
    
    
    734
    
    
    
    2,696Short-term investments
    
    
    10,650
    
    
    
    7,412Total investments
    
    
    182,289
    
    
    
    197,709Cash
    
    
    82
    
    
    
    145Interest due and accrued
    
    
    998
    
    
    
    1,079Premiums receivable from affiliate, net of allowance for
doubtful accounts of $158 in 2005 and
$215 in 2004
    
    
    13,540
    
    
    
    15,136Deferred policy acquisition costs from affiliate
    
    
    6,527
    
    
    
    7,570Reinsurance recoverable on unpaid losses
    
    
    13,807
    
    
    
    15,630Prepaid reinsurance premiums from affiliate
    
    
    4,559
    
    
    
    4,595Income taxes receivable
    
    
    109
    
    
    
    Deferred income taxes
    
    
    5,367
    
    
    
    5,028Other assets
    
    
    6,700
    
    
    
    8,812Total assets
    
    $
    233,978
    
    
    $
    255,704
  F-2




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED BALANCE SHEET
  December 31,2005
    
    
    2004Liabilities and Stockholders EquityLiabilities:Reserve for losses and loss adjustment expenses
(from affiliate $50,239 and $44,094)
    
    $
    115,191
    
    
    $
    128,415Unearned premiums from affiliate
    
    
    29,662
    
    
    
    33,685Payable for securities
    
    
    
    
    
    
    4,751Payable to affiliate
    
    
    113
    
    
    
    5,571Retrospective commission payable to affiliate
    
    
    2,590
    
    
    
    1,141Other liabilities (from affiliate $5,044 and $4,262)
    
    
    10,528
    
    
    
    10,167Total liabilities
    
    
    158,084
    
    
    
    183,730Stockholders equity:Common stock, $.01 par value, 10,000,000 shares authorized,
2,132,652 shares issued and outstanding at December 31, 2005
and 2,114,152 shares issued and outstanding at December 31, 2004
    
    
    33
    
    
    
    33Additional paid in capital
    
    
    36,267
    
    
    
    35,878Treasury stock, 1,139,700 shares at December 31, 2005
and 2004
    
    
    (22,766
    )
    
    
    (22,766
    )Accumulated other comprehensive loss
    
    
    (2,540
    )
    
    
    (536
    )Accumulated earnings
    
    
    64,900
    
    
    
    59,365Total stockholders equity
    
    
    75,894
    
    
    
    71,974Commitments and contingencies
    
    
    
    
    
    
    Total liabilities and stockholders equity
    
    $
    233,978
    
    
    $
    255,704
  F-3




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED STATEMENT OF OPERATIONS
  Year ended December 31,2005
    
    
    2004
    
    
    2003Revenues:Net premiums earned from affiliate
    
    $
    49,121
    
    
    $
    57,123
    
    
    $
    65,097Net investment income
    
    
    7,733
    
    
    
    7,881
    
    
    
    8,815Net investment gains (losses)
    
    
    
    
    
    
    (221
    )
    
    
    2,500Other revenues from affiliate
    
    
    571
    
    
    
    722
    
    
    
    560Total revenues
    
    
    57,425
    
    
    
    65,505
    
    
    
    76,972Expenses:Net losses and loss adjustment expenses (from
affiliate $26,558, $35,137 and $49,336)
    
    
    26,408
    
    
    
    37,681
    
    
    
    49,612Amortization of deferred policy acquisition costs
from affiliate
    
    
    12,771
    
    
    
    14,852
    
    
    
    16,925Other underwriting expenses (from affiliate
$7,888, $6,433 and $4,044)
    
    
    8,811
    
    
    
    8,291
    
    
    
    5,031Total expenses
    
    
    47,990
    
    
    
    60,824
    
    
    
    71,568Income before income taxes
    
    
    9,435
    
    
    
    4,681
    
    
    
    5,404Income tax provision
    
    
    2,736
    
    
    
    919
    
    
    
    1,039Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Earnings per share:Basic
    
    $
    3.17
    
    
    $
    1.78
    
    
    $
    2.07Diluted
    
    $
    3.16
    
    
    $
    1.78
    
    
    $
    2.07Weighted average number of shares outstanding:Basic
    
    
    2,115
    
    
    
    2,114
    
    
    
    2,110Diluted
    
    
    2,118
    
    
    
    2,118
    
    
    
    2,111
  F-4




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
  Year ended December 31,2005
    
    
    2004
    
    
    2003Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Other comprehensive income (loss) before tax:Unrealized gains (losses) on securities
    
    
    (3,039
    )
    
    
    (1,926
    )
    
    
    688Reclassification adjustment for gains or
losses included in net income
    
    
    
    
    
    
    221
    
    
    
    (2,488
    )Other comprehensive loss before tax
    
    
    (3,039
    )
    
    
    (1,705
    )
    
    
    (1,800
    )Income tax benefit related to items
of other comprehensive loss
    
    
    (1,035
    )
    
    
    (419
    )
    
    
    (613
    )Other comprehensive loss
    
    
    (2,004
    )
    
    
    (1,286
    )
    
    
    (1,187
    )Comprehensive income
    
    $
    4,695
    
    
    $
    2,476
    
    
    $
    3,178
  F-5




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY
  Year ended December 31,2005
    
    
    2004
    
    
    2003Common stock:Beginning of year
    
    $
    33
    
    
    $
    32
    
    
    $
    32Exercise of common stock options
    
    
    
    
    
    
    1
    
    
    
    End of year
    
    
    33
    
    
    
    33
    
    
    
    32Additional paid in capital:Beginning of year
    
    
    35,878
    
    
    
    35,795
    
    
    
    35,795Exercise of common stock options
    
    
    389
    
    
    
    83
    
    
    
    End of year
    
    
    36,267
    
    
    
    35,878
    
    
    
    35,795Treasury stock:Beginning and end of year
    
    
    (22,766
    )
    
    
    (22,766
    )
    
    
    (22,766
    )Accumulated other comprehensive income (loss):Beginning of year
    
    
    (536
    )
    
    
    750
    
    
    
    1,937Other comprehensive loss
    
    
    (2,004
    )
    
    
    (1,286
    )
    
    
    (1,187
    )End of year
    
    
    (2,540
    )
    
    
    (536
    )
    
    
    750Accumulated earnings:Beginning of year
    
    
    59,365
    
    
    
    56,448
    
    
    
    52,926Net income
    
    
    6,699
    
    
    
    3,762
    
    
    
    4,365Cash dividends ($.55/share in 2005,
and $.40/share in 2004 and in 2003),
(to affiliate, $140, $102 and $102)
    
    
    (1,164
    )
    
    
    (845
    )
    
    
    (843
    )End of year
    
    
    64,900
    
    
    
    59,365
    
    
    
    56,448Total stockholders equity
    
    $
    75,894
    
    
    $
    71,974
    
    
    $
    70,259
  F-6




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED STATEMENT OF CASH FLOWS
  Year ended December 31,2005
    
    
    2004
    
    
    2003Cash flows from operations:Collection of premiums from affiliate
    
    $
    47,175
    
    
    $
    53,924
    
    
    $
    62,789Payment of losses and loss adjustment expenses
(from affiliate $20,413, $22,299 and $18,081)
    
    
    (36,088
    )
    
    
    (50,276
    )
    
    
    (54,043
    )Payment of underwriting expenses (from
affiliate $(17,437), $(21,946) and $(19,527))
    
    
    (18,781
    )
    
    
    (23,550
    )
    
    
    (20,594
    )Investment income received
    
    
    8,002
    
    
    
    8,259
    
    
    
    9,170Investment expenses paid
    
    
    (380
    )
    
    
    (280
    )
    
    
    (289
    )Income taxes paid
    
    
    (2,152
    )
    
    
    (376
    )
    
    
    (1,152
    )Other cash receipts from affiliate
    
    
    571
    
    
    
    722
    
    
    
    560Net cash used in operations
    
    
    (1,653
    )
    
    
    (11,577
    )
    
    
    (3,559
    )Cash flows from investing activities:Proceeds from fixed maturities sold or matured
    
    
    56,653
    
    
    
    46,124
    
    
    
    139,217Purchase of fixed maturities
    
    
    (41,962
    )
    
    
    (37,547
    )
    
    
    (140,467
    )Net (increase) decrease in preferred stock
    
    
    (850
    )
    
    
    2,000
    
    
    
    1,500Net (increase) decrease in other long-term investments
    
    
    1,970
    
    
    
    (948
    )
    
    
    1,926Net (increase) decrease in short-term investments
    
    
    (3,238
    )
    
    
    (6,294
    )
    
    
    5,302Settlement of securities transactions, net
    
    
    (4,751
    )
    
    
    5,644
    
    
    
    (1,915
    )Net cash provided by investing activities
    
    
    7,822
    
    
    
    8,979
    
    
    
    5,563Cash flows from financing activities:Settlement of affiliate balances, net
    
    
    (5,457
    )
    
    
    3,481
    
    
    
    (1,147
    )Proceeds from exercise of common stock options
    
    
    389
    
    
    
    84
    
    
    
    Cash dividends (to affiliate $140, $102 and $102)
    
    
    (1,164
    )
    
    
    (845
    )
    
    
    (843
    )Net cash provided by (used in) financing activities
    
    
    (6,232
    )
    
    
    2,720
    
    
    
    (1,990
    )Increase (decrease) in cash
    
    
    (63
    )
    
    
    122
    
    
    
    14Cash, beginning of year
    
    
    145
    
    
    
    23
    
    
    
    9Cash, end of year
    
    $
    82
    
    
    $
    145
    
    
    $
    23
  F-7




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##### Table of Contents



MERCHANTS GROUP, INC.
 CONSOLIDATED STATEMENT OF CASH FLOWS  RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATIONS
  Year ended December 31,2005
    
    
    2004
    
    
    2003Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Adjustments:Net discount accretion on investments
    
    
    (193
    )
    
    
    (83
    )
    
    
    (268
    )Net investment (gains) losses
    
    
    
    
    
    
    221
    
    
    
    (2,500
    )(Increase) decrease in assets:Interest due and accrued
    
    
    81
    
    
    
    181
    
    
    
    334Premiums receivable from affiliate
    
    
    1,596
    
    
    
    1,541
    
    
    
    (2,181
    )Deferred policy acquisition costs from affiliate
    
    
    1,043
    
    
    
    1,053
    
    
    
    194Reinsurance recoverable on paid and unpaid losses
    
    
    1,823
    
    
    
    7,085
    
    
    
    (3,629
    )Prepaid reinsurance premiums from affiliate
    
    
    36
    
    
    
    (1,529
    )
    
    
    (1,975
    )Income taxes receivable
    
    
    (109
    )
    
    
    881
    
    
    
    (424
    )Deferred income taxes
    
    
    696
    
    
    
    (113
    )
    
    
    311Retrospective commission receivable from affiliate
    
    
    
    
    
    
    305
    
    
    
    (305
    )Other assets
    
    
    1,941
    
    
    
    (1,919
    )
    
    
    (865
    )Increase (decrease) in liabilities:Reserve for losses and loss adjustment expenses
(from affiliate $6,145, $12,838 and $31,256)
    
    
    (13,224
    )
    
    
    (18,059
    )
    
    
    (662
    )Unearned premiums from affiliate
    
    
    (4,023
    )
    
    
    (2,491
    )
    
    
    1,057Retrospective commission payable to affiliate
    
    
    1,449
    
    
    
    1,141
    
    
    
    Other liabilities (from affiliate $953, $(3,807)
and $3,068)
    
    
    532
    
    
    
    (3,553
    )
    
    
    2,989Net cash used in operations
    
    $
    (1,653
    )
    
    $
    (11,577
    )
    
    $
    (3,559
    )
  F-8




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##### Table of Contents



MERCHANTS GROUP, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1.
    
    Significant Accounting PoliciesPrinciples of consolidation and basis of presentationThe consolidated financial statements of Merchants Group, Inc. (the Company) include the
accounts of the Company, its wholly-owned subsidiary, Merchants Insurance Company of New
Hampshire, Inc. (MNH), and M.F.C. of New York, Inc., an inactive premium finance company which
is a wholly-owned subsidiary of MNH. MNH is a stock property and casualty insurance company
domiciled in the state of New Hampshire. MNH offers property and casualty insurance to
preferred risk individuals and small to medium sized businesses in the northeast United States,
primarily in New York, New Hampshire and New Jersey where a majority of its policies are
written. As a holding company, the Company has no operations.The consolidated financial statements have been prepared in conformity with generally accepted
accounting principles (GAAP) which differ in some respects from those followed in reports to
insurance regulatory authorities. In its Annual Statement filed with regulatory authorities,
MNH reported policyholders surplus of $66,390,000 and $61,708,000 at December 31, 2005 and
2004, respectively. MNHs net income as reported in its Annual Statement was $8,708,000 in
2005, $5,191,000 in 2004 and $4,915,000 in 2003. All significant intercompany balances and
transactions have been eliminated.The preparation of consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period.
Actual results may differ from those estimates.InvestmentsFixed maturities are classified as available for sale and are presented at fair value. Fixed
maturities consist of debt securities that management may not hold until maturity. All
preferred stocks are classified as available for sale and are presented at fair value. The net
aggregate unrealized gain or loss, net of applicable income taxes, related to fixed maturities
and preferred stock classified as available for sale is included as a component of accumulated
other comprehensive income (loss) in stockholders equity.
 F-9




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##### Table of Contents



Net premiums earned
  Deferred policy acquisition costs
  Year Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Beginning balance
    
    $
    7,570
    
    
    $
    8,623
    
    
    $
    8,817Acquisition cost deferred
    
    
    11,728
    
    
    
    13,799
    
    
    
    16,731Amortized to expense
    
    
    (12,771
    )
    
    
    (14,852
    )
    
    
    (16,925
    )Ending balance
    
    $
    6,527
    
    
    $
    7,570
    
    
    $
    8,623
 Reinsurance
  F-10




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##### Table of Contents



Reserve for losses and loss adjustment expenses
    F-11




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##### Table of Contents



Income taxesThe Company and its wholly-owned subsidiaries file a consolidated federal income tax return.
The Company follows the asset and liability approach to account for income taxes, which requires
the recognition of deferred tax liabilities and assets for the expected future tax consequences
of temporary differences between the financial statement carrying amounts and the tax basis of
assets and liabilities.Other financial instrumentsThe fair value of the Companys other financial instruments, principally premiums receivable and
certain non-insurance related liabilities, does not vary significantly from the amounts assigned
in these financial statements.Certain prior year balances were reclassified to conform to
current year classification.2.
    
    Related Party TransactionsThe Company and MNH operate and manage their business with Merchants Mutual Insurance
Company (Mutual) under a services agreement (the Services Agreement) that became effective
January 1, 2003. At December 31, 2005, Mutual owned 12.0% of the Companys outstanding common
stock. The Company and MNH do not have any operating assets or employees. In accordance with
the Services Agreement, Mutual provides the
Company with facilities, management and personnel required to operate its day-to-day business,
including the following services: administrative services, underwriting services, claims
services, and investment and cash management services. The Services Agreement contains
termination provisions that vary based on the service rendered. Underwriting services may be
terminated on one years notice, but the termination may not be effective before January 1,
2008. Claims services and administrative services may be terminated on 6 months notice. In
June 2005 the Company notified Mutual that it will terminate the investment and cash management
services annex to the Services Agreement as of June 30, 2006.Effective January 1, 2003, Mutual and MNH agreed to pool, or share, underwriting results on
their traditional insurance business (the Traditional Business) by means of a reinsurance
pooling agreement (the Pooling Agreement). It does not apply to any new endeavor of either
Mutual or MNH outside of their Traditional Business, unless the companies agree otherwise. The
Pooling Agreement applies to premiums earned and losses incurred
after the effective date. Due to the possibility of development of losses and LAE for
accident years prior to the inception of the Pooling Agreement, the
amount of net losses and LAE from affiliate for any given year may be
more or less than the amount of net losses and LAE as shown on the
Companys Consolidated Statement of Operations.
 F-12




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##### Table of Contents



F-13




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##### Table of Contents



3.
    
    InvestmentsInvestments in fixed maturities, preferred stock and other long-term investmentsThe amortized cost and estimated fair value of investments in fixed maturities available for
sale and the cost and estimated fair value of preferred stock and other long term investments
are as follows:
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost/Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair Value(in thousands)December 31, 2005Fixed maturities:U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies
    
    $
    7,248
    
    
    $
    6
    
    
    $
    109
    
    
    $
    7,145Obligations of states and
political subdivisions
    
    
    45,927
    
    
    
    
    
    
    
    670
    
    
    
    45,257Corporate securities
    
    
    17,641
    
    
    
    2
    
    
    
    496
    
    
    
    17,147Mortgage and asset backed
securities
    
    
    98,850
    
    
    
    47
    
    
    
    1,853
    
    
    
    97,044Total
    
    $
    169,666
    
    
    $
    55
    
    
    $
    3,128
    
    
    $
    166,593Preferred stock
    
    $
    4,248
    
    
    $
    118
    
    
    $
    54
    
    
    $
    4,312Other long-term investments
    
    $
    676
    
    
    $
    58
    
    
    $
    
    
    
    $
    734
 F-14




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##### Table of Contents



Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost/Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair Value(in thousands)December 31, 2004Fixed maturities:U.S. Treasury securities and
obligations of U.S.
government corporations
and agencies
    
    $
    5,028
    
    
    $
    29
    
    
    $
    29
    
    
    $
    5,028Obligations of states and
political subdivisions
    
    
    41,010
    
    
    
    100
    
    
    
    131
    
    
    
    40,979Corporate securities
    
    
    27,929
    
    
    
    136
    
    
    
    62
    
    
    
    28,003Mortgage and asset backed
securities
    
    
    110,204
    
    
    
    557
    
    
    
    679
    
    
    
    110,082Total
    
    $
    184,171
    
    
    $
    822
    
    
    $
    901
    
    
    $
    184,092Preferred stock
    
    $
    3,392
    
    
    $
    117
    
    
    $
    
    
    
    $
    3,509Other long-term investments
    
    $
    2,646
    
    
    $
    50
    
    
    $
    
    
    
    $
    2,696
  F-15




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##### Table of Contents



Less than 12 months
    
    
    12 months or moreUnrealized
    
    
    
    
    
    
    UnrealizedFair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses(in thousands)December 31, 2005Fixed maturities:U.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    2,980
    
    
    $
    20
    
    
    $
    2,915
    
    
    $
    89Obligations of states and
political subdivisions
    
    
    20,877
    
    
    
    201
    
    
    
    20,224
    
    
    
    469Corporate securities
    
    
    8,278
    
    
    
    235
    
    
    
    8,766
    
    
    
    261Mortgage and asset backed
securities
    
    
    64,509
    
    
    
    938
    
    
    
    29,071
    
    
    
    915Total
    
    $
    96,644
    
    
    $
    1,394
    
    
    $
    60,976
    
    
    $
    1,734Preferred stock
    
    $
    1,296
    
    
    $
    54
    
    
    $
    
    
    
    $
    Other long-term investments
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    December 31, 2004Fixed maturities:U.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    2,977
    
    
    $
    29
    
    
    $
    
    
    
    $
    Obligations of states and
political subdivisions
    
    
    11,943
    
    
    
    65
    
    
    
    3,502
    
    
    
    66Corporate securities
    
    
    6,996
    
    
    
    40
    
    
    
    972
    
    
    
    22Mortgage and asset backed
securities
    
    
    55,173
    
    
    
    525
    
    
    
    5,011
    
    
    
    154Total
    
    $
    77,089
    
    
    $
    659
    
    
    $
    9,485
    
    
    $
    242Preferred stock
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Other long-term investments
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
 F-16




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##### Table of Contents



EstimatedFairAmortized Cost
    
    
    Value(in thousands)Due in one year or less
    
    $
    35,705
    
    
    $
    35,259Due after one year through five years
    
    
    106,991
    
    
    
    104,957Due after five years through ten years
    
    
    19,444
    
    
    
    18,978Due after ten years
    
    
    7,526
    
    
    
    7,399Total
    
    $
    169,666
    
    
    $
    166,593
    F-17




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##### Table of Contents



Year ended December 31,2005
    
    2004
    
    2003(in thousands)Proceeds from sales
    
    $
    
    
    
    $
    10,641
    
    
    $
    11,089Gross realized gains
    
    
    
    
    
    
    479
    
    
    
    2,500Gross realized losses
    
    
    
    
    
    
    
    
    
    
    
 Net investment income
  Year ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Fixed maturities
    
    $
    7,573
    
    
    $
    7,873
    
    
    $
    8,534Short-term investments
    
    
    206
    
    
    
    64
    
    
    
    45Other
    
    
    334
    
    
    
    297
    
    
    
    525Total investment income
    
    
    8,113
    
    
    
    8,234
    
    
    
    9,104Investment expenses
    
    
    380
    
    
    
    353
    
    
    
    289Net investment income
    
    $
    7,733
    
    
    $
    7,881
    
    
    $
    8,815
 4.
    
    ReinsuranceMNH follows the customary practice of reinsuring a portion of the exposure under its policies.
Insurance is ceded principally to reduce net liability on individual risks and to protect
against catastrophic losses. Although reinsurance does not legally discharge an insurer from
its primary liability for the full amount of coverage provided by its policies, it does make the
assuming reinsurer liable to the insurer to the extent of the reinsurance ceded.
 F-18




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##### Table of Contents



2005
    
    
    2004
    
    
    2003Premiums
    
    
    Premiums
    
    
    Premiums
    
    
    Premiums
    
    
    Premiums
    
    
    PremiumsWritten
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned(in thousands)Direct
    
    $
    53,532
    
    
    $
    53,603
    
    
    $
    53,900
    
    
    $
    55,528
    
    
    $
    58,233
    
    
    $
    63,517AssumedWith third parties
    
    
    1,172
    
    
    
    1,258
    
    
    
    1,519
    
    
    
    1,814
    
    
    
    1,412
    
    
    
    1,694Pooling Agreement
    
    
    45,135
    
    
    
    49,122
    
    
    
    53,102
    
    
    
    57,123
    
    
    
    98,207
    
    
    
    65,098Subtotal
    
    
    46,307
    
    
    
    50,380
    
    
    
    54,621
    
    
    
    58,937
    
    
    
    99,619
    
    
    
    66,792CededWith third parties
    
    
    (3,747
    )
    
    
    (3,398
    )
    
    
    (2,967
    )
    
    
    (2,891
    )
    
    
    (3,077
    )
    
    
    (3,337
    )Pooling Agreement
    
    
    (50,957
    )
    
    
    (51,464
    )
    
    
    (52,452
    )
    
    
    (54,451
    )
    
    
    (90,596
    )
    
    
    (61,875
    )Subtotal
    
    
    (54,704
    )
    
    
    (54,862
    )
    
    
    (55,419
    )
    
    
    (57,342
    )
    
    
    (93,673
    )
    
    
    (65,212
    )Net Premiums
    
    $
    45,135
    
    
    $
    49,121
    
    
    $
    53,102
    
    
    $
    57,123
    
    
    $
    64,179
    
    
    $
    65,097
  2005
    
    
    2004
    
    
    2003(in thousands)Direct
    
    $
    30,986
    
    
    $
    38,392
    
    
    $
    59,326AssumedWith third parties
    
    
    1,414
    
    
    
    1,453
    
    
    
    1,631Pooling Agreement
    
    
    26,558
    
    
    
    35,137
    
    
    
    49,336Subtotal
    
    
    27,972
    
    
    
    36,590
    
    
    
    50,967CededWith third parties
    
    
    (4,209
    )
    
    
    (3,754
    )
    
    
    (8,779
    )Pooling Agreement
    
    
    (28,341
    )
    
    
    (33,547
    )
    
    
    (51,902
    )Subtotal
    
    
    (32,550
    )
    
    
    (37,301
    )
    
    
    (60,681
    )Net losses and LAE
    
    $
    26,408
    
    
    $
    37,681
    
    
    $
    49,612
  F-19




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##### Table of Contents



5.
    
    Reserve for Losses and Loss Adjustment ExpensesActivity in the reserve for losses and LAE is summarized as follows:
 2005
    
    
    2004(in thousands)Reserve for losses and LAE at beginning of year
    
    $
    128,415
    
    
    $
    146,474Less reinsurance recoverables
    
    
    (15,630
    )
    
    
    (22,715
    )Net balance at beginning of year
    
    
    112,785
    
    
    
    123,759Provision for losses and LAE for claims occurring in:Current year
    
    
    29,711
    
    
    
    38,524Prior years
    
    
    (3,303
    )
    
    
    (843
    )26,408
    
    
    
    37,681Loss and LAE payments for claims occurring in:Current year
    
    
    (10,359
    )
    
    
    (13,647
    )Prior years
    
    
    (27,450
    )
    
    
    (35,008
    )(37,809
    )
    
    
    (48,655
    )Reserve for losses and LAE at end of year, net
    
    
    101,384
    
    
    
    112,785Plus reinsurance recoverables
    
    
    13,807
    
    
    
    15,630Balance at end of year
    
    $
    115,191
    
    
    $
    128,415
 In 2005 and 2004, the Company decreased reserves for prior years by $3,303,000 and $843,000,
respectively, primarily due to favorable loss development related to private passenger auto
liability and workers compensation policies, somewhat offset by unfavorable development on its
commercial package policies.6.
    
    Demand LoanThe Company has arranged for a $2,000,000 unsecured credit facility from a bank. Any borrowings
under this facility are payable on demand and carry an interest rate which can be fixed or
variable and is negotiated at the time of each advance. This facility is available for general
working capital purposes and for repurchases of the Companys common stock. No amount related
to this facility was outstanding at December 31, 2005.
 F-20




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##### Table of Contents



7.
    
    Income TaxesThe provision (benefit) for income taxes consists of:
 Year ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Current
    
    $
    2,040
    
    
    $
    1,032
    
    
    $
    728Deferred
    
    
    696
    
    
    
    (113
    )
    
    
    311Total income tax provision
    
    $
    2,736
    
    
    $
    919
    
    
    $
    1,039
 A reconciliation of the difference between the Companys total income tax provision and that calculated using statutory income tax
rates is as follows:
 Year ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Computed provision at statutory rate
    
    $
    3,208
    
    
    $
    1,592
    
    
    $
    1,837Adjustments:State income taxes, net of federal effect
    
    
    
    
    
    
    
    
    
    
    (479
    )Tax-exempt investment income
    
    
    (368
    )
    
    
    (315
    )
    
    
    (217
    )Dividend received deduction
    
    
    (61
    )
    
    
    (47
    )
    
    
    (79
    )Adjustments to prior years taxes
    
    
    
    
    
    
    (196
    )
    
    
    Reversal of excess tax reserves
related to uncertain tax positions
    
    
    (50
    )
    
    
    (120
    )
    
    
    Other
    
    
    7
    
    
    
    5
    
    
    
    (23
    )Total income tax provision
    
    $
    2,736
    
    
    $
    919
    
    
    $
    1,039
 The provision for income taxes for 2003 includes the effect of a 2003 change in New York State
law with respect to the taxation of non-life insurance companies. This change eliminated state
income taxes for all non-life insurance companies and increased the premium tax rate from 1.3%
to 2.0%. As a result, the Company reduced its deferred tax liability with respect to New York
State income taxes to $0, and recorded a one-time benefit, net of federal income taxes, to its
income tax provision of $505,000 during 2003.
 F-21




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##### Table of Contents



Deferred tax (liabilities) assets are comprised of the following:
 December 31,2005
    
    
    2004(in thousands)Deferred policy acquisition costs
    
    $
    (2,219
    )
    
    $
    (2,574
    )Other
    
    
    (150
    )
    
    
    (182
    )Total deferred tax liabilities
    
    
    (2,369
    )
    
    
    (2,756
    )Discounting of reserve for losses and
loss adjustment expenses
    
    
    4,552
    
    
    
    5,354Unearned premiums
    
    
    1,726
    
    
    
    1,997Unrealized net investment losses
    
    
    1,295
    
    
    
    251Other
    
    
    163
    
    
    
    182Total deferred tax assets
    
    
    7,736
    
    
    
    7,784Net deferred income taxes
    
    $
    5,367
    
    
    $
    5,028
 Although realization is not assured, based upon the evidence available the Company believes that
it is more likely than not that the net deferred income tax asset will be realized. The amount
of the deferred tax asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income are not achieved.8.
    
    Stockholders EquityDividendsThe Company depends on dividends from its subsidiary, MNH, to pay cash dividends to its
stockholders and to meet its expenses. MNH is subject to New Hampshire state insurance laws
which restrict its ability to pay dividends without the prior approval of state regulatory
authorities. These restrictions limit dividends to those that, when added to all other
dividends paid within the preceding twelve months, would not exceed 10% of an insurers
policyholders surplus as of the preceding December 31. The maximum amount of dividends that
MNH could pay during any twelve-month period ending in 2006 without the prior approval of the
New Hampshire Insurance Commissioner is $6,639,000.Stock option planThe Companys stock option plan (the Plan), which reserved 200,000 shares of common stock for
issuance to the Companys and MNHs officers and key employees of Mutual, expired in 1996.
Under the Plan, qualified and non-qualified stock options were granted at amounts not less than
the fair market value of the Companys stock on the date of grant. Options granted under the
Plan have a 10 year life and vested in cumulative annual increments of 25% commencing one year
from the date of grant.
 F-22




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##### Table of Contents



2005
    
    
    2004
    
    
    2003Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageOptions
    
    
    Exercise
    
    
    Options
    
    
    Exercise
    
    
    Options
    
    
    ExerciseOutstanding
    
    
    Price
    
    
    Outstanding
    
    
    Price
    
    
    Outstanding
    
    
    PriceBeginning
of year
    
    
    31,500
    
    
    $
    21.00
    
    
    
    35,500
    
    
    $
    21.00
    
    
    
    35,500
    
    
    
    21.00Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    (18,500
    )
    
    
    21.00
    
    
    
    (4,000
    )
    
    
    21.00
    
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    End of year
    
    
    13,000
    
    
    
    21.00
    
    
    
    31,500
    
    
    
    21.00
    
    
    
    35,500
    
    
    
    21.00Options
exercisable
at year-end
    
    
    13,000
    
    
    
    21.00
    
    
    
    31,500
    
    
    
    21.00
    
    
    
    35,500
    
    
    
    21.00
  Number
    
    
    Remaining
    
    
    Average
    
    
    NumberOutstanding
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisableat 12/31/05
    
    
    Life in Years
    
    
    Price
    
    
    at 12/31/0513,000
    
    
    
    .1
    
    
    $
    21.00
    
    
    
    13,000
 Treasury stock
  F-23




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##### Table of Contents



Preferred stockThe Companys Preferred stock, no par value, $424.30 stated value, consists of 10,000 shares
authorized; no shares were issued or outstanding at December 31, 2005 or December 31, 2004. The
Company also has 3,000,000 shares of $.01 par value preferred stock which is authorized and
unissued.9.
    
    Earnings Per ShareThe computations for basic and diluted earnings per share are as follows:
 Year Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands except per share amounts)Basic:Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Weighted average shares outstanding
    
    
    2,115
    
    
    
    2,114
    
    
    
    2,110Basic earnings per share
    
    $
    3.17
    
    
    $
    1.78
    
    
    $
    2.07Diluted:Net income
    
    $
    6,699
    
    
    $
    3,762
    
    
    $
    4,365Weighted average shares outstanding
    
    
    2,115
    
    
    
    2,114
    
    
    
    2,110Plus incremental shares from assumed
conversion of stock options
    
    
    3
    
    
    
    4
    
    
    
    1Weighted average shares
outstanding-adjusted
    
    
    2,118
    
    
    
    2,118
    
    
    $
    2,111Diluted earnings per share
    
    $
    3.16
    
    
    $
    1.78
    
    
    $
    2.07
 10.
    
    Underwriting Results by ProductThe following table shows, for each of the years in the three year period ended December 31,
2005, the amount of the Companys net premiums earned for each of its major products and the
calendar year loss and allocated loss adjustment expense (ALAE) ratio for each product. The
loss and ALAE ratio is one measure of product profitability and shows the relationship of
incurred losses and allocated loss adjustment expenses to net premiums earned for a given
period.
 F-24




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##### Table of Contents



For The Year Ended December 31,(000s)2005
    
    
    2004
    
    
    2003Net
    
    
    Loss &
    
    
    Net
    
    
    Loss &
    
    
    Net
    
    
    Loss &Premiums
    
    
    ALAE
    
    
    Premiums
    
    
    ALAE
    
    
    Premiums
    
    
    ALAEEarned
    
    
    Ratio
    
    
    Earned
    
    
    Ratio
    
    
    Earned
    
    
    RatioPrivate passenger auto liability
    
    $
    5,870
    
    
    
    21.0
    %
    
    $
    9,543
    
    
    
    59.0
    %
    
    $
    13,131
    
    
    
    75.6
    %Homeowners
    
    
    4,732
    
    
    
    50.3
    %
    
    
    5,541
    
    
    
    63.6
    %
    
    
    6,352
    
    
    
    52.3
    %Commercial auto liability
    
    
    11,616
    
    
    
    32.0
    %
    
    
    12,532
    
    
    
    53.5
    %
    
    
    12,561
    
    
    
    23.9
    %Workers compensation
    
    
    4,532
    
    
    
    9.1
    %
    
    
    4,535
    
    
    
    31.4
    %
    
    
    4,619
    
    
    
    188.8
    %Commercial package
    
    
    15,343
    
    
    
    63.9
    %
    
    
    15,764
    
    
    
    76.7
    %
    
    
    16,449
    
    
    
    79.1
    %General liability
    
    
    1,147
    
    
    
    244.5
    %
    
    
    700
    
    
    
    165.5
    %
    
    
    638
    
    
    
    406.9
    %Other
    
    
    5,881
    
    
    
    37.3
    %
    
    
    8,508
    
    
    
    43.5
    %
    
    
    11,347
    
    
    
    45.5
    %Total
    
    $
    49,121
    
    
    
    45.9
    %
    
    $
    57,123
    
    
    
    59.9
    %
    
    $
    65,097
    
    
    
    70.3
    %
 11.
    
    Benefit ProgramsMutual maintains a capital accumulation plan which is a profit sharing plan under Section 401(a)
of the Internal Revenue Code that covers all employees who have completed six months of service.
Mutual matches at least 15% and up to 100% of employee contributions, based on the combined net
operating profits of Mutual and MNH. Additional contributions may be made at the discretion of
the Board of Directors of Mutual. The portion of the 2005, 2004 and 2003 service fees charged
to the Company by Mutual relating to Mutuals contribution to its capital accumulation plan were
$301,000, $213,000 and $414,000, respectively.Mutual has established a supplemental executive retirement plan covering certain employees. The
portion of the 2005, 2004 and 2003 service fees charged to the Company by Mutual relating to
Mutuals contribution to its supplemental executive retirement plan were $52,000, $36,000 and
$59,000, respectively.12.
    
    Commitments and ContingenciesMNH, like many other property and casualty insurance companies, is subject to environmental
damage claims asserted by or against its insureds. Management is of the opinion that based on
various court decisions throughout the country, such claims should not be recoverable under the
terms of MNHs insurance policies because of either specific or general coverage exclusions
contained in the policies. However, there is no assurance that
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F-26




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##### Table of Contents



Merchants Group, Inc.Date: March 31, 2006
    
    BY:
    
    /s/ Robert M. ZakRobert M. Zak, Senior Vice President and Chief Operating Officer
  SIGNATURE
    
    TITLE
    
    DATE/s/ Robert M. Zak

Robert M. Zak
    
    Director, Sr. VP &
Chief Operating
Officer (principal
executive officer)
    
    March 31, 2006/s/ Kenneth J. Wilson

Kenneth J. Wilson
    
    Vice President & CFO
(principal financial
and accounting officer)
    
    March 31, 2006/s/ Thomas E. Kahn

Thomas E. Kahn
    
    Director, Chairman
of the Board
    
    March 31, 2006/s/ Brent D. Baird

Brent D. Baird
    
    Director
    
    March 31, 2006/s/ Andrew A. Alberti

Andrew A. Alberti
    
    Director
    
    March 31, 2006/s/ Frank J. Colantuono

Frank J. Colantuono
    
    Director
    
    March 31, 2006/s/ Henry P. Semmelhack

Henry P. Semmelhack
    
    Director
    
    March 31, 2006