Marketing products through independent agents has been and continues to be the Company's primary source of distribution. The Company has approximately 1,400 independent agents who market the Company's core personal lines, commercial lines and farm products. Additionally, the Company markets products to members of various associations through approximately 600 independent agents specializing in this market. Thirty-one different associations have endorsed Meridian for their insurance program. Association business is desired in agricultural, contractor, appliance dealer, cosmetologist, veterinary, optometry, and funeral home associations, as well as certain other classes of business. The Company continues to build these relationships.
In addition to growth initiatives, the Company is working to increase profitability through consistent exercise of underwriting discipline, prudent pricing analyses, sound investment management, enhanced customer service and efficient cost control. Given the high level of losses in the current year, the Company has taken selective premium rate increases, generally ranging from four percent to 17 percent depending upon the state and line of business. Additionally, enhancements have been made to underwriting and agency management practices to further improve the quality of risk selection. Selected segments of the Company's business are being completely reunderwritten, resulting in the non-renewal of insurance coverage for certain risks. Several claim control programs and other actions have been implemented to improve proactive claims handling. These actions plus continued focus on operating expenses are expected to improve future profitability.
The Company's total revenues for 2000 increased by 9.8 percent to $244.3 million from $222.4 million reported in 1999. Premiums earned were up by 8.9 percent to $217.2 million in comparison with $199.4 million for 1999. During 2000, premiums earned in the non-standard automobile and GROUPadvantage products were approximately $19.4 million and $12.4 million, up from $12.8 million and $6.3 million from 1999, respectively. Premiums earned in commercial lines improved by 9.3 percent which included an increase of 13.2 percent in commercial automobile and 12.8 percent in workers' compensation. Farmowners earned premiums grew by 3.1 percent compared to 1999.
Personal lines premium growth has been primarily attributable to non- standard automobile and GROUPadvantage premiums. Non-standard automobile, which continues to be a growth area, increased approximately 34 percent over the prior year period. As announced in October of 2000, the Company has ceased writing new business through GROUPadvantage and has begun non-renewing all such existing business. In addition, the Company decided to withdraw from writing all personal lines insurance in the State of Michigan. In total, the Michigan personal lines and GROUPadvantage business represented approximately 5 percent of the Company's net written premium for the year 2000. The 5.3 percent increase in commercial lines net written premiums is a combination of rate increases and new business.
Loss and loss adjustment expenses increased from the $136.6 million reported for 1998 to $150.2 million in 1999. Relative to earned premiums, the loss and loss adjustment expense ratio increased to 75.3 percent in 1999, compared with 72.2 percent in 1998. Weather-related catastrophe losses accounted for over seven percentage points of the ratios in both years, with approximately $14.4 million of such losses in 1999 compared to $14.7 million in 1998. Due in large part to such weather-related losses, property lines of business remained unprofitable, while the casualty lines of business were profitable in both 1999 and 1998. The personal lines loss ratio of 78.6 percent increased from 75.8 percent in 1998. The 1999 commercial lines loss ratio increased to 68.5 percent from 66.3 percent in 1998. The increases in the 1999 ratios were generally due to loss costs and severity and, to an extent in certain lines, to prior years' premium rate actions. Loss frequency was not a major factor, as overall frequency comparisons changed only a small fraction of one percent between 1998 and 1999.
The Company's primary need for liquidity is to pay shareholder dividends and service debt. Its main source of liquidity is the receipt of dividends from its subsidiaries. The Company's insurance subsidiaries are subject to state laws and regulations which restrict their ability to pay dividends. Meridian Security declared and paid annual dividends to the Company of $6.0 million in 2000, compared to $5.0 million during each year of 1999 and 1998. The principal need of the Company's insurance subsidiaries for liquid funds is the payment of claims and general operating expenses in the ordinary course of business. The funds of the Company's insurance subsidiaries are generally invested in securities with maturities intended to provide adequate cash to pay such claims and expenses without forced sales of investments. The average duration of the fixed maturity portfolio is approximately 4.7 years. Over the next year, a relatively small portion of the Company's bond portfolio is scheduled to mature.
Approximately 79 percent of the Company's investment assets are held in fixed maturities, substantially all of which are believed to be readily marketable. Within the fixed maturity portfolio, the Company holds approximately 23 percent in mortgage-backed pass-through securities and collateralized mortgage obligations. The Company has attempted to reduce the prepayment risks associated with mortgage- backed securities by investing a majority of the collateralized mortgage obligations in planned amortization and Very Accurately Defined Maturity (VADM) tranches. These investments are designed to alleviate the risk of prepayment by providing predictable principal prepayment schedules within a designated range of prepayments.
The Company's fixed income investment portfolio consists almost entirely of investment grade securities, the average quality of which is rated Aa / AA. The Company currently holds all of its fixed maturity investments in the "available-for-sale" category carried at fair value. The Company at December 31, 2000 recorded unrealized gains in the fixed maturity portfolio of approximately $1.5 million, net of deferred income taxes. At year-end 1999, the Company recorded unrealized losses on the fixed maturity portfolio of approximately $3.7 million, net of deferred income taxes. The Company's equity security portfolio, which accounted for approximately 18 percent of invested assets at year-end 2000, had unrealized gains, net of deferred income taxes, of approximately $5.0 million at December 31, 2000, compared to approximately $9.6 million at December 31, 1999. Net unrealized appreciation of investments added $0.87 to the Company's $16.07 book value per share at December 31, 2000. Net unrealized appreciation added $0.76 per share to the $17.26 book value at December 31, 1999.
On May 6, 1997, the Company announced that its Board of Directors had authorized the repurchase of up to 350,000 common shares, or approximately five percent of the Company's outstanding common stock. On February 23, 2000, the Company announced that its Board of Directors had authorized the additional repurchase of up to 400,000 common shares. As of December 31, 2000, the Company had repurchased 445,302 shares, or approximately 59 percent of the authorized total, at a cost of approximately $6.5 million.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) present fairly, in all material respects, the financial position of Meridian Insurance Group, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
December 31, 2000 1999 ASSETS Investments: Fixed maturities, available for sale at fair value (cost $232,938,000 and $232,090,000) $ 235,184,265 $ 226,431,532 Equity securities, at fair value (cost $45,039,000 and $54,282,000) 52,680,078 69,002,099 Short-term investments, at cost, which approximates fair value 6,140,534 2,822,215 Other invested assets 1,899,308 1,322,209 Total investments 295,904,185 299,578,055
Shareholders' equity: Common shares, no par value, Authorized 20,000,000 shares; issued 8,312,878 and 8,218,167; outstanding 7,867,576 and 7,926,610 at December 31, 2000 and 1999, respectively (including 10% stock dividend issued on January 11, 2000, for 721,872 shares, and January 6, 1999, for 658,493 shares) 45,850,259 44,793,300 Treasury Shares, at cost; 445,302 and 291,557 shares at December 31, 2000 and 1999, respectively (6,549,079) (4,566,809) Contributed capital 36,481,864 36,481,864 Retained earnings 43,831,835 54,112,519 Accumulated other comprehensive income 6,836,785 5,988,295 Total shareholders' equity 126,451,664 136,809,169 Total liabilities and shareholders' equity $ 398,890,860 $ 398,223,125
Collectively, the insurance companies participating in the reinsurance pooling arrangement write a broad line of property and casualty insurance, including personal, non-standard and commercial automobile; homeowners, farmowners and commercial multi-peril; and workers' compensation. Business is written primarily through independent insurance agencies in the states of Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Minnesota, Missouri, North Dakota, Ohio, Pennsylvania, South Dakota, Tennessee, Virginia, and Wisconsin.
Investments: Fixed maturity investments include bonds, notes, mortgage backed pass-through securities, collateralized mortgage obligations, other asset backed securities and sinking fund preferred stocks. The fixed maturity portfolio is invested entirely in securities classified as available for sale and is carried at estimated fair values. Equity securities, consisting of unaffiliated common and perpetual preferred stocks, are reported at estimated fair values. Short-term investments are recorded at cost, approximating fair value. Other investments include limited partnerships recorded on the equity method.
The Company regularly evaluates its investments based on current economic conditions, past credit loss experience and other circumstances. A decline in a security's net realizable value below amortized cost that is not a temporary fluctuation is recognized as a realized loss, and the cost basis of that security is reduced to its estimated fair value.
Income Taxes: Deferred income taxes are provided to reflect the estimated future tax effects of temporary differences between the tax basis of an asset or liability and the basis recorded in the financial statements. The deferred tax asset or liability is measured by using enacted tax rates expected to apply to future taxable income in the periods in which the temporary differences are expected to be recovered or settled. Accordingly, changes in future tax rates cause immediate adjustments to deferred taxes.
Stock Dividend: On both December 9, 1998, and December 15, 1999, a ten percent stock dividend was declared that was effective for shareholders of record as of December 21, 1998, and December 27, 1999, respectively. The financial statements, notes, and other references to share and per share data have been retroactively restated to reflect the stock dividends for all periods presented.
4. Segment Reporting The following tables display the Company's reportable segments, a reconciliation of segment data to total consolidated financial data, and related disclosure information concerning revenues as required by SFAS No. 131. Segments were defined based upon the Company's structure and decision making processes. Personal, commercial and farm lines are segmented within all internal reporting mechanisms to aid chief decision makers in achieving profitable results within each business segment. Amortization was allocated by segment based upon a ratio of premium. Investment income is allocated based upon the relative size of each segment. Asset information by reportable segment is not reported, since the Company does not internally produce such information.
As required by SFAS No. 131, the following table delineates the Company's products and revenues in a manner which is consistent with segment reporting: 2000 1999 1998 Personal lines: Automobile $ 101,424,205 $ 91,123,405 $ 79,438,864 Homeowners 24,776,218 24,271,745 25,649,226 Other 2,619,040 2,580,806 2,718,432 Total personal lines 128,819,463 117,975,956 107,806,522
Commercial lines: Automobile 20,980,925 18,532,450 17,666,781 Worker's compensation 25,796,584 22,874,065 22,442,522 Commercial multi-peril 25,307,459 24,539,325 25,983,425 Other 4,994,503 4,563,192 4,410,290 Total commercial lines 77,079,471 70,509,032 70,503,018
Farm lines: Farmowners 11,277,127 10,935,071 10,878,882 Total farm lines 11,277,127 10,935,071 10,878,882
6. Related Party Transactions Meridian Security, Meridian Citizens Security, ICO, Meridian Mutual, and Meridian Citizens Mutual are parties to a reinsurance pooling agreement ("pooling agreement") under which essentially all premiums, loss and loss adjustment expenses, as well as other underwriting expenses are shared by the companies on the basis of their percentage participation defined in the pooling agreement. The reinsurance pool participation percentages of the Company's insurance subsidiaries total 74 percent. Other expenses are allocated on the basis of specific identification or estimated costs. Amounts either due to or due from Meridian Mutual and Meridian Citizens Mutual result from these transactions, and are normally reimbursed on a monthly basis. Management believes that such expenses would not be materially different if incurred directly by each company.
The reconciliation for 2000 shows an increase in previously established reserves of approximately $11.6 million, while 1999 and 1998 show reductions of approximately $6.9 million and $8.7 million, respectively. Adverse development, primarily in workers compensation, GROUPadvantage, and non-standard auto resulted in increasing reserves relating to prior accident years.
Catastrophe reinsurance provided coverage for multiple losses caused by a single catastrophic event such as a windstorm or earthquake. The combined retention under this contract was $6,000,000 plus five percent of losses up to contractual limits for windstorms of $65,000,000 and for earthquakes of $83,000,000. Another catastrophe reinsurance treaty provided coverage for 95% of losses sustained from multiple catastrophic events which aggregated beyond specified retentions and per event deductibles up to the contractual limits.
Approximately 96 percent of the Company's ceded reserves for losses and loss adjustment expenses were with Employers Reinsurance Corporation, Michigan Catastrophic Claims Association and Swiss Reinsurance America Corporation. The effect of reinsurance on premiums written, premiums earned and losses and loss adjustment expenses for the years ended December 31, 2000, 1999, and 1998 were as follows:
Losses and loss adjustment expenses incurred: Direct $ 207,003,867 $ 160,929,807 $ 151,184,461 Assumed 841,056 57,832 624,892 Ceded (15,461,120) (10,770,031) (15,189,362) Net $ 192,383,803 $ 150,217,608 $ 136,619,991
9. Deferred Policy Acquisition Costs Changes in deferred policy acquisition costs are summarized as follows:
Deferred, beginning of period $ 19,974,450 $ 17,671,856 $ 17,651,544 Additions: Commissions 35,809,955 34,870,279 31,845,030 Premium taxes 3,110,600 3,074,928 2,416,582 Other 10,006,332 9,208,481 7,972,312 Total additions 48,926,887 47,153,688 42,233,924 Amortization expense 49,184,904 44,851,094 42,213,612 Deferred, end of period $ 19,716,433 $ 19,974,450 $ 17,671,856
Reconciliation of benefit obligation: Obligation at January 1 $ 24,259,180 $ 27,117,622 Service cost 1,270,564 1,345,750 Interest cost 2,031,034 1,748,264 Actuarial (gain) loss 3,770,890 (4,679,250) Benefit payments (1,297,504) (1,273,206) Obligation at December 31 $ 30,034,164 $ 24,259,180
Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 $ 39,131,891 $ 34,401,026 Actual return on plan assets (1,475,609) 6,004,071 Benefit payments (1,297,504) (1,273,206) Fair value of plan assets at December 31 $ 36,358,778 $ 39,131,891
2000 1999 Reconciliation of benefit obligation: Obligation at January 1 $ 949,697 $ 1,050,623 Service cost 37,953 46,533 Interest cost 71,561 69,839 Actuarial (gain) loss 184,681 (217,298) Obligation at December 31 $ 1,243,892 $ 949,697
Funded Status Funded status at December 31 $ (1,243,892) $ (949,697) Unrecognized prior service cost 170,445 193,522 Unrecognized loss 214,293 29,612 Accrued liability at December 31 $ (859,154) $ (726,563)
The following table presents a reconciliation of the funded status for the Company's post-retirement benefit obligation and the amounts recognized in the Company's consolidated balance sheet as of December 31, 2000 and 1999:
The assumed rate of future increases in per capita cost of health care benefits was 10.0 percent for the first year and 5.0 percent for all years thereafter in 2000, and 9.0 percent for the first year and 5.0 percent for all years thereafter in 1999. The health care cost trend rate assumption affects the amounts reported. For example, increasing the assumed health care cost trend rate by one percentage point would increase the accumulated post-retirement benefit obligation by approximately $208,000 and the aggregate of the service and interest cost components of net periodic post- retirement benefit cost by approximately $43,000. A decrease in the assumed health care cost trend rate by one percentage point would decrease the accumulated post-retirement benefit obligation by approximately $183,000 and the aggregate of the service and interest cost components of net periodic post-retirement benefit cost by approximately $38,000.
11. Income Taxes Current tax expense for the following periods differed from the tax expected solely on pre-tax income by applying the applicable statutory corporate tax rate to the various differences identified as follows:
The net deferred tax asset/liability at December 31, 2000, 1999, and 1998, is comprised of the following:
At December 31, 2000, the Company has approximately $4,468,000 of available net operating loss carryforwards for income tax purposes, which expire in 2020. The Company also has alternative minimum tax carryforwards of approximately $2,124,000 which are available to reduce future regular income taxes over an indefinite period.
13. Statutory Information Subsidiary retained earnings available for distribution as dividends to the Company are limited by law to the statutory unassigned surplus of the subsidiaries on the previous December 31, as determined in accordance with the accounting practices prescribed or permitted by insurance regulatory authorities of the state of Indiana. Subject to this limitation, the maximum dividend that may be paid during a 12-month period, without prior approval of the insurance regulatory authorities, is the greater of ten percent of statutory capital and surplus as of the preceding December 31 or net income for the preceding calendar year determined on a statutory basis. Meridian Security declared and paid dividends to the Company of $6,000,000 in 2000, and $5,000,000 in 1999 and 1998. As of December 31, 2000, approximately $9,600,000 was available for distribution to the Company without prior approval of insurance regulatory authorities.
Meridian Security's subsidiaries, Meridian Citizens Security and ICO, also pay dividends to their parent. Each company's retained earnings available for distribution as dividends are limited by laws in their states of domicile, Indiana and Ohio, respectively. Dividends were not paid by either subsidiary in 2000. Meridian Citizens Security declared and paid dividends to Meridian Security of $400,000 in 1999 and $600,000 in 1998. ICO declared and paid dividends to Meridian Security of $150,000 in 1999 and $300,000 in 1998.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded.
The Indiana and Ohio Insurance Departments have adopted the Codification guidance, effective January 1, 2001. The impact of adopting Codification increased the Company's insurance subsidiaries' beginning of the year statutory surplus for 2001 by approximately $8.0 million.
14. Shareholders' Equity In May 1997, the shareholders of Meridian Insurance Group, Inc. approved an amendment to the Company's Articles of Incorporation to increase the number of authorized shares from 20,000,000 to 20,500,000, with the additional shares being preferred stock. The amendment provides that the preferred shares may be issued from time to time in one or more series. The Board of Directors, without further approval of the holders of common shares, would be authorized to fix the dividend rights and terms, liquidation preferences, sinking funds and any other rights, preferences, privileges, and restrictions applicable to each such series of preferred shares. On September 8, 1998, the Board of Directors of Meridian Insurance Group Inc., adopted a Shareholders Rights Plan. Under the Shareholders Rights Plan, a dividend of one preferred share purchase right ("Right") was paid to shareholders of record on September 28, 1998 for each outstanding common share. Each Right entitles the holder to purchase one-thousandth of a share Series A Junior Participating Preferred Stock of the Company at a price of $75.00 per one-thousandth of a Preferred Share. If a person or group acquires 20% or more of the outstanding common shares (thereby becoming an "Acquiring Person"), each holder of a Right (except those held by the Acquiring Person and its affiliates and associates) will generally have the right to purchase common shares having equal to two times the purchase price of the Right. In other words, the Right's holders, other than the Acquiring Person, may purchase common shares or their equivalent at a 50 percent discount. The Board of Directors has approved the MIGI Merger and, as allowed under the terms of the Shareholders Rights Plan, State Auto is not considered an Acquiring Person. (See Note 16 - Pending Merger.) The Rights will expire on September 18, 2008, unless the expiration date is extended by amendment or unless the Rights are earlier redeemed or exchanged by the Company.
On December 15, 1999, the Board of Directors of Meridian Insurance Group, Inc. declared a ten percent stock dividend. Each shareholder of record as of December 27, 1999, received one additional share of the Company's common stock for every ten shares held on that date. The ten percent stock dividend was distributed on January 11, 2000, with the Company issuing 721,872 shares. A similar ten percent stock dividend was also declared on December 9, 1998, for shareholders of record as of December 21, 1998. The dividend was distributed on January 6, 1999, with the Company issuing 658,493 shares. In both years, fractional shares were paid by the Company in cash. All share and prior per share amounts have been retroactively restated to give effect for the stock dividend.
The Company also has a Director's Stock Plan that provides for an aggregate maximum of up to 150,000 common shares to be issued upon the exercise of stock options granted to outside directors, who are defined as non-employee directors of the Company or Meridian Mutual. Each outside director will automatically be granted an option to purchase 1,210 common shares on the date of each annual meeting of shareholders up until termination of the plan. The exercise price per share for each option will be equal to the fair market value of a common share on the date of grant. Each option will be exercisable commencing one year after the date of the grant and will expire no later than 10 years after the date of the grant. As of December 31, 2000, total options with respect to 91,960 shares have been granted.
In the fourth quarter of 2000, the Company increased its estimated liability for incurred but not reported losses and loss adjustment expenses by approximately $6.0 million due to higher loss cost trends, greater claim severity and adverse claim development.