The headquarters building of the Company is owned by Meridian Mutual and is located near downtown Indianapolis, Indiana. The building is a multi-level structure containing approximately 205,000 square feet of office space. Expansion efforts completed in 1995 have allowed the Company and Meridian Mutual to consolidate the two Indianapolis satellite offices, two regional claim offices, and the Meridian Citizens Mutual operation previously in Red Wing, Minnesota into the home office facility.
Statements in this annual report that are not strictly historical may be "forward looking" statements which involve risks and uncertainties. The Company's future results could differ materially from those discussed. Risk factors include: variation in catastrophe losses due to changes in weather patterns or other natural causes; changes in property and casualty reserves; developments in insurance regulations, judicial decisions or legislation that may affect the Company; technological difficulties and advancements; general economic conditions; fluctuations in interest rates or securities markets; or market and competitive changes affecting pricing or demand for insurance products or the ability to generate investment income. Growth and profitability have been and may be affected by these and other factors.
For the year 2000, the Company experienced a net loss due to increased loss and loss adjustment expenses despite an increase in revenues. Several factors contributed to the increased loss and loss adjustment expenses including higher loss cost trends in most of the Company's major lines of business, greater claim severity, adverse development of prior year losses and additional reserves for losses and loss adjustment expenses in order to take such negative claim trends into account. The increase in revenues was driven by an increase in earned premiums and net realized investment gains.
One of the Company's growing lines of business is non-standard automobile coverage. The Company began selling this product in 1998. In 2000, the pool of Meridian companies wrote approximately $28.7 million of non-standard auto premium. During 2000, non-standard automobile coverage was expanded to include the states of Missouri and Washington. Non-standard automobile insurance covers drivers with no prior insurance or with driving records that do not qualify them for standard or preferred premium rates. Non-standard policies are generally sold at higher premiums to offset increased risk of loss. The non-standard auto policies are marketed through the Company's independent agency force, select non-standard specialty agents, and directly via the internet in certain states in which the Company does not sell personal lines through independent agents.
Another source of premium growth during 2000 was the Company's relationship with GROUPadvantage. This sales arrangement made Meridian's personal lines products available through franchised independent agencies to Sam's Club members in certain states. Although the GROUPadvantage program has generated premium growth, this business has consistently failed to meet the Company's profitability objectives, and the intermediary marketing company involved in the GROUPadvantage program has suffered financial and operational failure. The Company has ceased writing new business through this sales arrangement and is in the process of non-renewing such existing business. The Company expects to substantially complete this process by the end of 2001.
The Company has been steadily expanding its operations into new states. At the end of 1994, Meridian operated in seven states, entirely in the Midwest. In recent years, the Company has significantly increased its geographic diversification and is currently licensed in 22 states.
For the year 2000, the Company recorded a net loss of $7.8 million, or $0.99 per diluted common share, down from net income of $7.3 million, or $0.90 per diluted common share for 1999. Realized net investment gains were $10.4 million, or $0.86 per diluted common share after tax, compared to $6.7 million, or $0.54 per diluted common share after tax, for 1999.
Net written premiums for 2000 increased 4.7 percent over 1999. In 2000, net written premiums for personal lines increased by 4.3 percent to $128.1 million, commercial lines increased by 5.3 percent to $76.7 million, while farm lines increased by 5.6 percent to $11.6 million.
Total investment income in 2000 increased less than one percent over 1999 reflecting a higher overall yield on a slightly lower level of average investments. Net investment income declined slightly to $16.1 million from $16.3 million for 1999. This decline is attributable to higher allocated investment expenses during the year 2000. Realized net investment gains increased to $10.4 million, or $0.86 per diluted common share after tax, compared with $6.7 million, or $0.54 per diluted common share after tax, for 1999. The increase is mainly attributable to the sale of certain equity securities. The Company has focused on increasing book yield by selling lower yielding and tax advantaged securities and reinvesting the proceeds in higher yielding fixed maturities.
The Company's statutory combined ratio increased to 117.4 percent in 2000 from 105.4 percent in 1999, due to an increase in the loss and loss adjustment expense ratio. Loss and loss adjustment expenses increased from $150.2 million reported for 1999 to $192.4 million in 2000. Relative to earned premiums, the loss and loss adjustment expense ratio increased to 88.6 percent in 2000, compared with 75.3 percent in 1999. Net weather-related catastrophe losses of approximately $9.3 million in 2000 accounted for 4.3 percentage points of the combined loss and loss adjustment expense ratio, compared with approximately $14.4 million, or 7.2 percentage points, related to such losses in 1999. Such claims in 2000 largely resulted from May wind and hail storms in Indiana and Wisconsin. The 2000 personal lines loss and loss adjustment expense ratio of 90.5 percent deteriorated from 78.6 percent in 1999. The commercial lines loss and loss adjustment expense ratio deteriorated to 86.3 percent from 68.7 percent in 1999 while farm lines improved slightly. The overall decline in the 2000 ratios was a result of several factors, including higher loss cost trends in the automobile lines of business, greater claim severity, adverse development of workers' compensation losses, and additions to reserves for losses and loss adjustment expenses.
For the year 2000, the Company recorded an income tax benefit of $6.9 million compared to income tax expense of $1.9 million for 1999. The effective tax benefit rate for 2000 exceeds the effective tax rate for 1999 primarily from the amounts of tax-exempt interest and the dividends received deduction, relative to the levels of pre-tax income or loss.
The Company's total revenues for 1999 increased 4.1 percent to $222.4 million from $213.7 million in 1998. Premiums earned increased 5.4 percent to $199.4 million for 1999 in comparison to $189.2 million for 1998, while net written premiums were up 9.8 percent over the prior year. Most of the 1999 growth in written premiums was generated from the non-standard auto product and from the Sam's Club sales arrangement through GROUPadvantage, along with approximately 6.0 percent commercial lines growth. Farmowners production was generally flat, while core personal lines of business generated through independent agents declined by approximately 1.5 percent.
Net investment income of approximately $16.3 million for 1999 decreased by 5.3 percent in comparison to $17.2 million for 1998. This decline is attributable to a number of factors, including slight reductions in yield and in the average balance of fixed maturity investments held during the year. For the years ended December 31, 1999 and 1998, the Company realized net investment gains of approximately $6.7 and $7.3 million, respectively. The current year's realized gains resulted largely from the sale of certain equity securities, which had been trading at relatively high price/earnings multiples and had reached the Company's price targets.
The Company does have exposure to market rates and prices. The Company's primary market risk exposures are changes in price for equity securities and changes in interest rates and credit ratings for fixed maturity securities. The Company, with the Board of Directors, administers and oversees investment risk through the Finance and Investment Committee, which provides executive oversight of investment activities. The Company has specific investment guidelines and policies that define the overall framework used daily by investment portfolio managers to limit the Company's exposure to market risk.
The Company does not own or currently utilize derivative financial instruments for the purpose of hedging, enhancing the overall return of its investment portfolio, or reducing the cost of its bank debt. Meridian, through its outside professional portfolio managers, employs traditional investment management tools and techniques to address the yield and valuation exposures of its invested assets. The long term fixed maturity investment portfolio is managed so as to limit various risks inherent in the bond market. Credit risk is addressed through adequate diversification and the purchase of investment grade securities. Reinvestment rate risk is controlled through asset- liability matching practices and by addressing call characteristics in security selection. Market value risk is addressed through maturity selection. The market value of the Company's long term fixed maturity investment portfolio is sensitive to fluctuations in the level of interest rates. The impact of interest rate movements on the long term fixed maturity investment portfolio generally affects net realized gains or losses when securities are sold. The Company estimates that a 100 basis point increase in interest rates from current levels would result in a possible decline in the $235.2 million market value of the long term fixed maturity investment portfolio of approximately 5.5 percent, or $12.9 million. With regard to its $52.7 million equity security portfolio, the Company does not own nor engage in any type of option writing. A 10% decrease in the U.S. equity market prices could result in a decrease of $5.3 million in the market value of the Company's common equities. These possible declines in values for the bond and stock portfolios would, net of deferred income taxes, negatively affect the common shareholders' equity at any point in time, but would not necessarily result in the recognition of realized investment losses as long as operating cash flow and the ongoing emergence of bond maturities continued to provide sufficient funds to meet obligations to policyholders and claimants, as well as debt service and cash dividend requirements at the holding company level.
As discussed in Note 1 to the financial statements, the Company changed its method of accounting for insurance-related assessments in 1999.
LIABILITIES AND SHAREHOLDERS' EQUITY Losses and loss adjustment expenses $ 161,772,444 $ 145,962,418 Unearned premiums 87,882,951 88,698,507 Other post-employment benefits 2,273,321 2,204,739 Bank loan payable 6,500,000 8,500,000 Reinsurance payables 8,337,027 9,142,015 Other liabilities 5,673,453 6,906,277 Total liabilities 272,439,196 261,413,956
Nature of Operations: Meridian Insurance Group, Inc. ("the Company"), was organized in 1986 as a subsidiary of Meridian Mutual Insurance Company ("Meridian Mutual"), an Indiana mutual insurance company that currently owns 48.5 percent of the outstanding common shares of the Company. The Company is a holding company principally engaged in the business of underwriting property and casualty insurance through its direct wholly-owned subsidiary, Meridian Security Insurance Company ("Meridian Security") and its indirect wholly- owned subsidiaries Meridian Citizens Security Insurance Company ("Meridian Citizens Security") and Insurance Company of Ohio ("ICO").
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Realized gains or losses on disposition of investments are determined on a specific identification basis. Unrealized gains and losses resulting from changes in the valuation of both equity securities and fixed maturities available for sale are recorded as a component of other comprehensive income, net of applicable deferred income taxes.
Goodwill: The Company's goodwill represents the excess of cost over the fair value of identifiable net assets acquired from business acquisitions and is being amortized on a straight-line basis over a 25-year period. The Company continually monitors the value of its goodwill based on estimates of future earnings of the subsidiaries that were acquired. If it is determined that changes in such projected earnings no longer support the recoverability of goodwill over the remaining amortization period, the carrying value would be reduced with a corresponding charge to expense or the amortization period would be shortened. As of December 31, 2000 no material changes have occurred. Goodwill amortization for the years ended 2000, 1999, and 1998 was $704,488, $704,946, and $704,030, respectively.
In assessing the realization of deferred income tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends upon generating future taxable income during the periods in which temporary differences become deductible. If future income is not generated as expected, deferred income tax assets may need to be written off. No such write-offs have occurred.
Earnings Per Share: The Company presents basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Impact of New Accounting Pronouncements: Effective January 1, 1999, the Company adopted SOP 97-3 "Accounting by Insurance and Other Enterprises for Insurance- Related Assessments." This statement requires that a liability for insurance-related assessments be recognized when the assessments have been imposed or it is probable that an assessment will be imposed, the event obligating the Company has occurred, and the amount can be reasonably estimated. SOP 97-3 requires that a liability for the current calendar year experience be recognized and that the initial application be treated as a cumulative effect type accounting change. The Company recorded an additional liability and a charge to the statement of income of $293,700 net of income tax, to reflect the cumulative effect of the accounting change.
2. Investments The Company's net investment income for the periods ended December 31, 2000, 1999, and 1998 are summarized as follows:
The amortized cost and aggregate fair values of investments in fixed maturity securities at December 31, 2000 and 1999, are as follows:
The amortized cost and aggregate fair value of fixed maturity securities available for sale at December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investments in fixed maturity securities during 2000, 1999 and 1998, respectively, were $36,432,627, $42,415,984, and $78,138,240. During 2000, 1999 and 1998, respectively, gross gains of $236,379, $110,779, and $2,672,721 and gross losses of $608,511, $404,864, and $44,464 were realized on those sales.
Unrealized appreciation of equity securities at December 31, 2000 totaled $7,641,379 representing $12,496,253 of gains on certain securities and $4,854,874 of losses on other securities.
3. Other Comprehensive Income The Company's other comprehensive income consists solely of net unrealized gains (losses) on securities. The total net unrealized gain (losses) on securities for the years ended December 31, 2000, 1999 and 1998 consist of the following:
The principal balance of the bank loan as of December 31, 2000, approximates its market value. Interest paid on the loan during 2000, 1999 and 1998 amounted to $529,000, $550,000, and $688,000 respectively. The bank debt includes certain financial covenants, the most significant of which concern the amounts of risk based capital, statutory policyholders' surplus, total debt, debt to capitalization and debt service coverage (the relationship of dividends available from the Company's insurance subsidiaries to required principal and interest payments).
For the year ended December 31, 2000, approximately 76 percent of the Company's total premium volume was derived from its participation in the pooling agreement. In 1999 and 1998, approximately 78 percent and 86 percent, respectively, were derived from the pooling arrangement.
7. Liability for Losses and Loss Adjustment Expenses Activity in the liability for losses and loss adjustment expenses is summarized as follows:
The reinsurance purchased includes contracts under which certain types of policies are automatically reinsured up to the contract limits ("treaty reinsurance") and contracts which provide reinsurance on an individual risk basis which require a specific agreement of the reinsurer as to limits of coverage provided ("facultative reinsurance"). Meridian Mutual, Meridian Security, Meridian Citizens Mutual, Meridian Citizens Security, and ICO were each named as insured parties under the treaty reinsurance contracts, and the coverage under those contracts applied to all risks written by each of the companies. Treaty coverage was purchased to cover property and liability exposures in excess of $300,000 and $400,000, respectively, up to the limits set forth in the individual treaty. (In 1999 the exposures were $200,000 and $400,000, respectively. In 1998 the exposures were $200,000 and $350,000, respectively.) Facultative reinsurance was purchased to cover exposures on both property and liability coverages from losses over and above the limits provided by the treaty reinsurance.
Premiums written: Direct $ 232,220,942 $ 223,584,026 $ 204,046,222 Assumed 389,470 366,751 486,305 Ceded (16,247,454) (17,285,000) (16,461,276) Net $ 216,362,958 $ 206,665,777 $ 188,071,251
Premiums earned: Direct $ 233,033,955 $ 216,078,155 $ 205,534,750 Assumed 392,014 397,210 614,042 Ceded (16,249,908) (17,055,306) (16,960,370) Net $ 217,176,061 $ 199,420,059 $ 189,188,422
10. Pension Plan and Other Post-Retirement Benefits The Company maintains a defined benefit pension plan for the benefit of eligible employees. Under the plan, all employees of the Company completing more than 1,000 hours of employment in a 12-month period become eligible to participate. The plan provides for a pension annuity beginning at age 65 based on the employee's average monthly base pay during the five highest consecutive salary years out of the last ten. Provisions for delayed retirement benefits, early retirement benefits after age 55, disability and death benefits, optional methods for benefit payment, payments to an employee who leaves after a certain number of years of service, and payments to an employee's surviving spouse are also covered under the plan.
The following table presents a reconciliation of the funded status for the Company's defined benefit pension plan and the amounts recognized in the Company's consolidated balance sheet as of December 31, 2000 and 1999:
Funded Status Funded status at December 31 $ 6,324,614 $ 14,872,711 Unrecognized asset (5,951,804) (6,483,880) Unrecognized prior service cost 911,055 984,688 Unrecognized gain (loss) 102,466 (8,440,374) Accrued asset at December 31 $ 1,386,331 $ 933,145
A 7.50 and 7.75 percent weighted average discount rate was assumed for 2000 and 1999, respectively, in determining the accumulated benefit obligation and a 5.0 percent average salary increase was used to project the additional pay increase on all plans. The expected return on assets for the defined pension plan was assumed to be 8.25 percent. Net periodic pension costs for the defined benefit pension plan for the years ended December 31, 2000, 1999, and 1998 included the following components:
Net periodic pension costs for the supplemental retirement income plan for the years ended December 31, 2000, 1999, and 1998 were approximately $98,000, $114,000, and $94,000 respectively.
In addition to pension benefits, the Company provides certain health care and life insurance benefits ("post-retirement benefits") for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company also provides medical benefits for early retirees (eligible upon attainment of age 55 and five years service up to age 65) and group term life insurance that phases out over a five year period from the retirement date.
Reconciliation of benefit obligation: Obligation at January 1 $ 1,939,158 $ 1,909,278 Service cost 235,816 210,680 Interest cost 147,565 121,129 Actuarial (gain) loss 40,519 (223,453) Benefit payments (72,090) (78,476) Obligation at December 31 $ 2,290,968 $ 1,939,158
Funded Status Funded status at December 31 $ (2,290,968) $ (1,939,158) Unrecognized (gain) loss 17,647 (265,581) Accrued liability at December 31 $ (2,273,321) $ (2,204,739)
A 7.50 and 7.75 percent weighted average discount rate was used for 2000 and 1999, respectively, to determine the accumulated post- retirement benefit obligation at December 31, 2000. Net periodic pension costs for the post-retirement plan for the years ended December 31, 2000, 1999, and 1998 included the following components:
The Company also provides a 401(k) plan whereby employees can contribute up to 16 percent of their compensation, with the Company contributing 50 percent of the employee contribution on the first 6 percent. Costs related to these benefit plans are allocated to each company in accordance with their percentage participation under the pooling agreement. The Company contributed $501,990, $465,442, and $468,454 to the plan during the years ended 2000, 1999, and 1998, respectively.
12. Earnings Per Share The following table reflects the reconciliation of the numerators and denominators of the Company's basic earnings per share and diluted earnings per share computations reported on the Consolidated Statement of Income for the years ended December 31, 2000, 1999 and 1998.
In November 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation". This statement encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options, and other equity instruments to employees based on the fair value method of accounting. The Company continues to account for stock options in accordance with Accounting Principles Board Opinion No. 25. Had compensation cost been determined using the fair value of the options at the grant dates in accordance with SFAS No. 123, the Company's net income and earnings per share for the periods ended December 31, 2000, 1999 and 1998 would have been reduced by the following pro-forma amounts: $46,000, $49,000, and $186,000 and $0.01, $0.01, and $0.02, respectively. The weighted average grant date fair value of options granted during the year was estimated to be $19.53, $17.45, and $17.07 using the Black-Scholes model with the following assumptions for 2000, 1999 and 1998, respectively: risk free interest rates of 6.73 percent, 5.94 percent, and 5.31 percent; dividend yield of 2.18 percent, 2.04 percent and 1.80 percent; and volatility of 42.41 percent, 30.95 percent, and 38.10 percent. As of December 31, 2000, options outstanding under these plans had an exercise price that ranged from $8.26 to $15.50 and a remaining weighted average contractual life of 8.70 years.
Stock options granted by the Company for the periods ended December 31, 2000, 1999, and 1998, are summarized in the following table:
16. Pending Merger On October 25, 2000, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") providing for the merger (the "MIGI Merger") of the Company with a newly-formed, wholly-owned subsidiary of State Automobile Mutual Insurance Company ("State Auto"). At the same time, the Company's largest shareholder, Meridian Mutual, entered into an Agreement to Merge with and into State Auto (the "Mutual Merger" and together with the MIGI Merger, the "Mergers"). As a result of the Mergers, (a) the operations of Meridian Mutual and State Auto will be combined, with State Auto as the surviving corporation of the Mutual Merger, (b) the Company will become a wholly-owned subsidiary of State Auto, (c) the public shareholders of the Company will receive in cash $30.00 per share, and (d) each holder of an outstanding stock option of the Company will receive in cash the difference between $30.00 per share and the per share exercise price of the stock option. Each Merger is conditioned upon consummation of the other Merger, receipt of insurance regulatory approvals and receipt of antitrust clearance. In addition, the MIGI Merger must be approved by the shareholders of the Company and the Mutual Merger must be approved by the policyholders of Meridian Mutual and State Auto and reapproved by the board of directors of each party. Meridian Mutual and State Auto have each agreed to vote all Company shares owned by them in favor of the MIGI Merger. Together, the mutual companies own approximately 57% of the Company's outstanding shares. The Merger Agreement also provides for the payment of a break-up fee or liquidated damages to State Auto or liquidated damages to the Company if the Merger Agreement is terminated under certain circumstances.