During 1984, Hanover entered into a lease agreement for a 109,000 square foot home office building in Worcester, Massachusetts, with its ultimate parent company, Allmerica Financial Corporation. This lease expires in 2006. The lease provides for no further renewals, no option to buy, and no free terminations. Hanover leases an aggregate of approximately 454,000 square feet at 15 field offices located in Atlanta, GA; Bedford, NH; Chicago, IL; Dallas, TX; Kansas City, KS; Meriden, CT; New Orleans, LA; Piscataway, NJ; Portland, ME; Richmond, VA; Sacramento, CA; St. Louis, MO; Syracuse, NY; Tulsa, OK; and Worcester, MA. Hanover also leases an aggregate of approximately 109,000 square feet at claims offices in various sites across the United States.
Citizens owns three office buildings located in Howell, Michigan. One building occupies 110,600 square feet and serves as Citizens' headquarters and accommodates corporate administration, marketing, information services, claims and treasury. Citizens also owns a 175,000 square foot facility near its current headquarters which accommodates underwriting, claims and marketing functions. The third building occupies 20,000 square feet and facilitates the print, services, and supply functions. In addition, Citizens leases an aggregate of approximately 55,000 square feet in three branch offices located in Grand Rapids, MI; Gaylord, MI; and Escanaba, MI. and one branch office located in Indianapolis, IN. Citizens also leases an aggregate of approximately 96,500 square feet of space for its claims offices in various sites in Michigan, Indiana, and Ohio.
Management believes that its owned and leased office space is adequate for its current needs.
The Company's consolidated net income increased $6.3 million, to $146.4 million, or $2.44 per share in 1996, compared to net income of $140.1 million, or $2.28 per share in 1995. The increase in net income is primarily attributable to a $33.5 million increase in realized gains, primarily related to the sale of equity securities, reflecting the Company's decision during the first quarter of 1996 to increase the proportion of debt securities in the portfolio. Excluding realized gains and losses, net of taxes and minority interest, net income decreased $13.5 million, to $117.6 million. This decrease resulted from catastrophes and other severe weather related losses which contributed to a $82.2 million increase in losses and loss adjustment expenses to $1,371.9 million. Catastrophe losses increased $27.3 million, to $62.9 million in 1996 from $35.6 million during the previous year. The increase in losses and LAE was partially offset by an increase in net investment income of $25.8 million, or 12.3%, to $235.4 million, attributable to an increase in higher-yielding debt securities in the portfolio and earnings from a limited partnership. Net income during 1996 was also favorably impacted by a $5.7 million arbitrated settlement from a voluntary pool during the third quarter. Federal income tax expense decreased $15.7 million, to $36.4 million during 1996, and the effective tax rate decreased from 25.3% in 1995, to 18.4%, in 1996. Net realized investment gains, net of federal income taxes, were $31.3 million and $9.5 million in 1996 and 1995, respectively. Minority interest in Citizens' net income was $14.9 million in 1996, compared to $14.1 million during 1995.
Consolidated net premiums earned increased $35.1 million, or 1.9%, to $1,898.3 million in 1996. Personal segment net premiums earned increased $48.6 million, or 4.4%, to $1,161.9 million, reflecting the accounting effects of restructuring a reinsurance contract at Hanover, increasing both losses and net premiums earned by approximately $19.0 million. In addition, a 2.0% increase in policies in force in Hanover's homeowners line as well as moderate price increases in this line contributed to the increase in net premiums earned. The growth in Citizens' personal segment is due to increases in net premiums earned in Ohio and Indiana resulting from expansion in these states as well as price increases in the personal automobile and homeowners lines. Commercial segment net premiums earned decreased $13.5 million, to $736.4 million. This decrease is primarily attributable to rate decreases in the workers' compensation line at Hanover and Citizens and to the withdrawal from a large voluntary pool on December 1, 1995 at Hanover, as well as continued competitive market conditions in this segment.
The consolidated underwriting loss for 1996 increased $62.6 million, to a loss of $88.2 million. The increase in the underwriting loss is primarily attributable to the increases in catastrophes and severe weather related losses. These factors contributed to an $82.2 million, or 6.4% increase in losses and LAE to $1,371.9 million in 1996.
Net investment income before taxes increased $25.8 million, or 12.3%, to $235.4 million during 1996, compared to $209.6 million in 1995. The increase in 1996 is primarily the result of an increase in average invested assets, $10.0 million of income from limited partnerships, and the Company's portfolio shift to higher yielding debt securities, including longer duration and non- investment grade securities. The average pre-tax yield on debt securities was 6.4% and 6.1% for 1996 and 1995, respectively. Average invested assets increased $385.8 million, or 11.0%, to $3,891.0 million.
Net realized gains on investments before taxes were $48.1 million and $14.6 million in 1996 and 1995, respectively. Net realized investment gains in 1996 primarily resulted from sales of appreciated equity securities due to the Company's strategy of shifting to a higher level of debt securities.
The provision for federal income taxes was $36.4 million in 1996 compared to $52.1 million in 1995. The decrease in 1996 represents a decrease in the effective tax rate from 25.3% in 1995 to 18.4% in 1996. This is attributable to deteriorating underwriting results and an increase in the proportion of pre-tax income attributable to tax-exempt interest. Federal income tax in 1995 was adversely impacted by reserves provided for revisions in estimated prior year tax liabilities, including $7.2 million provided during the fourth quarter of 1995.
The Company's consolidated net income increased $40.9 million to $140.1 million in 1995, compared to $99.2 million in 1994. Excluding realized gains and losses and the effect of accounting changes, all net of taxes and minority interest, net income increased $32.4 million to $131.1 million in 1995. The increase in net income resulted primarily from favorable current year claims experience attributable to a return to more normal weather conditions in the Northeast and in Michigan. Catastrophe losses decreased $10.5 million, to $35.6 million in 1995, from $46.1 million during the previous year. The improved underwriting results were partially offset by a $48.2 million increase in federal income taxes. The effective tax rate increased to 25.3% in 1995 from 3.5 % in 1994. This increase is attributable to improved underwriting results, a decrease in the proportion of pre-tax income attributable to tax-exempt interest, and to reserves provided for revisions in estimated prior year tax liabilities. Net realized investment gains, net of federal income taxes, were $9.5 million and $2.3 million in 1995 and 1994, respectively. Minority interest in Citizens net income was $14.1 million and $7.9 million in 1995 and 1994, respectively. Net income for 1994 includes a cumulative effect charge of $2.0 million, net of federal income taxes, from the adoption of Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits."
Consolidated net premiums earned increased $71.9 million, or 4.0%, to $1,863.2 million in 1995. Personal segment net premiums earned increased $69.0 million, or 6.6%, to $1,113.3 million, in 1995, reflecting price increases in the personal automobile and homeowners lines and a modest increase in policies in force in the homeowners line. Commercial segment net premiums earned increased $2.9 million, or 0.4%, to $749.9 million in 1995.
The consolidated underwriting loss improved $74.8 million, from a loss of $100.4 million in 1994, to a loss of $25.6 million in 1995. This improvement reflects a return to more normal weather conditions in the first half of 1995 and improved claims experience at both Hanover and Citizens. Losses and LAE decreased $17.0 million, or 1.3%, to $1,289.7 million in 1995, primarily attributable to improved claims experience in both the personal and commercial segments, especially the homeowners and workers' compensation lines. Policy acquisition expenses, which consist primarily of commissions, premium taxes and other policy issuance costs, increased $18.8 million, or 4.8%, to $409.1 million in 1995, resulting primarily from the growth in net earned premiums. Other underwriting expenses decreased $4.7 million, or 2.4%, to $190.0 million in 1995. The 1994 results reflect expansion costs into Ohio and Indiana at Citizens, and higher agents' profit sharing expenses at Hanover.
Net investment income before tax increased $7.2 million, or 3.6%, to $209.6 million in 1995. This increase is attributable to an increase in average invested assets, partially offset by a decrease in the portfolio's average pre-tax yield from 6.2% in 1994, to 6.0% in 1995. This decrease resulted primarily from lower yields available on new investments relative to the yields on maturing investments. Net investment income after tax remained relatively unchanged at $170.7 million in 1995, versus $170.5 million in 1994. The effective tax rate on investment income increased from 15.8% to 18.6% during 1995. Net realized gains on investments increased $11.1 million to $14.6 million in 1995 due to increased gains on the sale of equity securities.
The provision for federal income taxes was $52.1 million in 1995 compared to $3.9 million in 1994. The increase in 1995 represents an increase in the effective tax rate from 3.5% in 1994 to 25.3% in 1995. This is attributable to improved underwriting results, a decrease in the proportion of pre-tax income attributable to tax-exempt interest, and to reserves provided for revisions in estimated prior year tax liabilities, including $7.2 million provided during the fourth quarter of 1995.
Citizens' personal segment net premiums earned increased $18.4 million, or 3.4%, to $554.6 million in 1996. This growth is attributable to price increases in the personal automobile and homeowners lines. The growth is partially offset by a 3.0% decrease in policies in force in the personal automobile line, attributable to the Company's selective reduction of writings in Michigan when rates were viewed as inadequate and to continued strong competition in Michigan. While management has taken steps to increase penetration in affinity groups and has initiated other marketing programs, heightened competition may continue to result in reduced growth in the personal segment.
The improvement in Citizens' underwriting results reflects favorable claims activity in both current and prior accident years in the personal automobile line attributable to continued improvements in severity. This was partially offset by an increase in catastrophe losses of $6.2 million to $13.4 million, primarily in the homeowners line.
Policy acquisition expenses in the personal segment increased $20.0 million, or 8.2%, to $263.3 million and other underwriting expenses increased $0.2 million to $91.0 million in 1996. This increase in policy acquisition expenses is primarily attributable to an increase of $15.6 million, or 11.5%, to $150.8 million at Hanover resulting from a reapportionment of certain acquisition expenses to the personal segment from the commercial segment, as well as an increase in net premium earned. The $2.0 million increase in Hanover's other underwriting expenses resulted from an increase of approximately $4.0 million in expenses associated with the policy administration technology project, offset by a decrease in assessment expenses associated with the reapportionment of an involuntary pool. Policy acquisition expenses in the personal segment at Citizens increased $4.4 million, or 4.1%, to $112.5 million in 1996, reflecting growth in net premiums earned. The $1.8 million
The improvement in Hanover's underwriting results is primarily attributable to favorable claims experience on current years claims in the homeowners line resulting from a decrease in catastrophe losses from $27.2 million in 1994 to $13.4 million during 1995, and to a return to more normal weather conditions during the first half of 1995. This resulted in a decrease in losses and LAE in the homeowners line of $17.8 million, or 17.9%, from $99.2 million in 1994, to $81.4 million in 1995.
The change in Citizens' underwriting results reflects a return to more normal weather conditions in Michigan as well as favorable claims activity in both current and prior accident years in the personal automobile line attributable to improvements in severity. Citizens' underwriting results improved despite a $3.4 million increase in catastrophe losses in the personal segment, primarily in the homeowners line. Catastrophe losses were $7.2 million and $3.8 million in Citizens' personal segment in 1995 and 1994, respectively.
The increase in policy acquisition expenses in the personal segment of $17.9 million, or 7.9%, to $243.3 million in 1995, reflects the growth in net earned premiums at both Hanover and Citizens. Other underwriting expenses at Hanover remained relatively unchanged at $49.7 million in 1995, compared to $50.0 million in 1994. Other underwriting expenses at Citizens increased by $3.2 million, or 8.4%, to $41.1 million in 1995, reflecting the growth in net premiums earned in 1995.
The commercial segment represented 38.8%, 40.2% and 41.7% of total net premiums earned in 1996, 1995 and 1994, respectively.
Commercial segment net premiums earned in 1996 decreased $13.5 million, or 1.8%, to $736.4 million. Hanover's commercial segment net premiums earned decreased $12.8 million, or 2.7%, to $455.5 million. This decrease is primarily attributable to Hanover's withdrawal from a large voluntary pool on December 1, 1995, and to aggregate rate decreases of 14.6% since January 1, 1995, in the workers' compensation line. Citizens' commercial segment net premiums earned decreased $0.7 million, or 0.2%, to $280.9 million in 1996. This decrease primarily reflects rate reductions and a 1.4% decrease in policies in force in the workers' compensation line due to continuing competition in this line in Michigan. Rates in the workers' compensation line at Citizens were decreased 8.5%, 7.0% and 6.4% effective May 1, 1995, December 1, 1995, and June 1, 1996, respectively. This decrease is partially offset by an increase in policies in force in the commercial multiple peril and commercial automobile lines of 13.2% and 3.7%, respectively. Management believes competitive conditions in the workers' compensation line may impact future growth in net premiums earned.
The commercial segment underwriting loss for 1996 increased $17.1 million, or 75.7% to a loss of $39.7 million. Hanover's underwriting loss improved $20.9 million, or 33.4%, to a loss of $41.7 million and Citizens' underwriting profit decreased $38.0 million, to a profit of $2.0 million in 1996.
Hanover's commercial segment losses and LAE decreased $27.3 million, or 8.0%, to $315.5 million in 1996. This improvement is primarily attributable to a $41.5 million decrease in losses and LAE resulting from the withdrawal from a large voluntary pool. However, this decrease was partially offset by increased losses in the workers' compensation line of $17.9 million, primarily due to a $19.8 million decrease in favorable reserve development during 1996.
Policy acquisition expenses in the commercial segment decreased $6.5 million, or 3.9%, to $159.3 million in 1996 and other underwriting expenses increased $1.8 million, or 1.8%, to $101.0 million. Hanover's policy
acquisition expenses decreased $6.6 million, or 5.8%, to $107.7 million, primarily attributable to a reapportionment of certain acquisition expenses from the commercial segment to the personal segment, as well as the decrease in net earned premium. Other underwriting expenses at Hanover increased $0.2 million, to $74.0 million as a result of an increase of approximately $3.0 million in expenses associated with the policy administration technology project, which were partially offset by a net decrease in assessment expenses associated with voluntary and involuntary pools. Citizens' policy acquisition expenses in the commercial segment remained consistent between years, primarily as a result of flat net earned premiums. Other underwriting expenses increased $1.6 million, or 6.3%, to $27.0 million in 1996, due to investments in technology and increased policyholders' dividends, partially offset by reductions in employee related expenses and commissions. Management anticipates an increase in its expense levels due to further planned investment in technology.
Commercial segment net premiums earned increased $2.9 million, to $749.9 million in 1995. Hanover's commercial segment net premiums earned decreased $12.1 million, or 2.5%, to $468.3 million in 1995, reflecting decreases in policies in force in all major commercial lines, particularly a $10.7 million, or 9.4%, decrease in commercial automobile net premiums earned to $103.1 million, resulting from continued competitive market conditions affecting Hanover. Workers' compensation net premiums earned at Hanover decreased $6.4 million, or 5.8%, to $104.4 million in 1995, primarily as a result of rate decreases and an increasing level of large deductible policies.
Hanover's commercial segment losses and LAE decreased by $18.4 million, or 5.1%, to $342.8 million in 1995. This improvement is primarily attributable to decreased losses and LAE in the workers' compensation and commercial automobile lines. Losses and LAE in the workers' compensation line decreased $34.7 million, or 47.6%, from $72.9 million in 1994 to $38.2 million in 1995. This decrease resulted from continued favorable claims experience for both the current and prior years. Commercial automobile losses and LAE decreased $14.9 million, or 17.0%, from $87.7 million in 1994 to $72.8 million in 1995. This decrease results from favorable claims experience in this line for both the current and prior years, and a decrease in premiums earned. Losses and LAE in Hanover's other commercial lines, which consist primarily of voluntary pools, general liability and inland marine, increased $28.9 million, or 55.0%, from $52.5 million in 1994, to $81.4 million in 1995. This segment was also unfavorably impacted by a $25.9 million loss in an industrial voluntary pool, including a $12.0 million charge during the fourth quarter of 1995.
Policy acquisition expenses in the commercial segment decreased $0.9 million, or 0.5%, to $165.8 million in 1995. Policy acquisition expenses in the commercial segment at Citizens increased $4.2 million, or 8.9%, from $47.3 million in 1994, to $51.5 million in 1995, reflecting the growth in net premiums earned. Hanover's policy acquisition expenses decreased $3.3 million, or 2.8%, from $117.6 million in 1994, to $114.3 million in 1995, reflecting the decrease in net earned premiums. Other underwriting expenses at Hanover decreased $3.8 million, or 4.9%, from $77.6 million in 1994, to $73.8 million in 1995, reflecting the decrease in net premiums written. Other underwriting expenses at Citizens decreased $3.8 million, or 13.0%, from $29.2 million in 1994, to $25.4 million in 1995. This decrease reflects the unusually high level of expenses incurred during 1994 resulting from the expansion into Ohio including the cost of preparing to write multi-state and cross-state commercial line policies, as well as a reduction in 1995 administrative expenses resulting from process improvements in the commercial segment.
Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation on the Company varies by product. Property and casualty insurance premiums are established before the amount of
to participate in various residual market mechanisms and pooling arrangements which provide various insurance coverages to individuals or other entities that are otherwise unable to purchase such coverage voluntarily provided by private insurers. These market mechanisms and pooling arrangements include the Massachusetts Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers' Compensation Residual Market Pool ("MWCRP") and the Michigan Catastrophic Claims Association ("MCCA"). At December 31, 1996, the MCCA and CAR were the only two reinsurers which represented 10% or more of the Company's reinsurance business. As a servicing carrier in Massachusetts, the Company cedes a significant portion of its private passenger and commercial automobile premiums to CAR. Net premiums earned and losses and loss adjustment expenses ceded to CAR for the years ended December 31, 1996, 1995 and 1994 were $38.0 million and $21.8 million, $49.1 million and $33.7 million, and $50.0 million and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and ceded a significant portion of its workers' compensation premiums to the Maine Workers' Compensation Residual Market Pool, which is administered by The National Council on Compensation Insurance ("NCCI"). The Company was involved in legal proceedings regarding the MWCRP's deficit which through a legislative settlement issued on June 23, 1995, provided for an initial funding of $220.0 million of which the insurance carriers were responsible for $65.0 million. Hanover paid its allocation of $4.2 million in December 1995. Some of the smaller carriers appealed this decision. The Company's right to recover reinsurance balances for claims properly paid is not at issue in any such proceedings. The Company expects to collect its reinsurance balance; however, funding of the cash flow needs of the MWCRP may in the future be affected by issues related to certain litigation, the outcome of which the Company cannot predict.
The reserve for losses and loss adjustment expenses at December 31, 1996 and 1995 is shown gross of recoverable on unpaid losses of $626.9 million and $763.5 million, respectively. The significant decrease in the reinsurance recoverable on unpaid losses is primarily attributable to an overall decrease in reinsurance activity at both Hanover and Citizens. The decrease at Hanover is specifically related to a decrease in ceded losses on its servicing carrier business. The decrease at Citizens in 1996 is due to the MCCA's favorable development on prior year reserves exceeding the losses and LAE incurred during the current year. The aggregate losses and LAE ceded have no impact on the Company's consolidated statements of income. Losses and LAE ceded were $2.2 million, $229.1 million and $160.4 million in 1996, 1995 and 1994, respectively. Ceded premiums earned were $232.6 million, $296.2 million and $291.9 million in 1996, 1995 and 1994, respectively.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, Allmerica P&C's primary source of cash for the payment of dividends to its shareholders is dividends from its insurance subsidiaries. However, dividend payments to Allmerica P&C by its insurance subsidiaries are subject to limitations imposed by state regulators, such as the requirement that cash dividends be paid only out of unreserved and unrestricted earned surplus and restrictions on the payment of "extraordinary" dividends, as defined. Based on the 1996 statutory financial statements of Hanover, the maximum dividend that may be paid to Allmerica P&C at January 1, 1997, without prior approval from the New Hampshire Commissioner of Insurance, is $15.4 million, which considers dividends declared to Allmerica P&C of $105.0 million during 1996, including $80.0 million which was declared in December. On January 2, 1997, Hanover declared an extraordinary dividend in the amount of $120.0 million, payable on or after January 21, 1997 to Allmerica P&C. The dividend, which was approved by the New Hampshire Insurance Department on January 9, 1997, is to be paid in a lump sum or in such installments as Allmerica P&C, in its discretion, may determine.
Net cash used for investing activities for the Company was $87.6 million and $385.2 million in 1996 and 1995, respectively. In 1994, net cash provided for investing activities was $47.8 million. Cash used for investing activities declined in 1996 due to decreases in cash flow from operations, as well as the decision in 1995 to maintain lower cash balances which resulted in an increase in investing activity during that year. Cash used for investment activities in 1995 increased primarily from increased purchases of debt and equity securities to take advantage of the favorable investment environment during 1995.
Net cash used for financing activities for the Company was $51.2 million, $39.7 million and $16.6 million in 1996, 1995 and 1994, respectively. These changes primarily reflect incremental increases in share repurchases of 1.2 million shares of the Company's common stock in 1996 compared to 1.0 million shares in 1995 and 0.05 million shares in 1994. In addition, in 1996 a subsidiary of the Company repurchased 0.6 million shares of the subsidiary's common stock compared to 0.2 million shares in 1995.
repurchase of treasury stock and the impact of a decrease of $6.8 million due to a decrease in the fair values of available-for-sale debt and equity securities. Changes in shareholders' equity related to the unrealized values of underlying portfolio investments will continue to be volatile as market prices of debt securities fluctuate with changes in the interest rate environment.
On February 19, 1997, Allmerica Financial Corporation ("AFC") and Allmerica P&C entered into an Agreement and Plan of Merger (the "Merger Agreement") pursuant to which AFC will acquire all of the outstanding Common Stock, $1.00 par value per share, of Allmerica P&C that it does not already own for consideration consisting of $33.00 per share of Common Stock, subject to adjustment, payable in cash and shares of common stock, par value $0.01 per share, of AFC (the "AFC Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive the consideration in cash, without interest, or in shares of AFC Common Stock, subject to proration as set forth in the Merger Agreement. The maximum number of shares of AFC Common Stock to be issued in the Merger is approximately 9.67 million shares. The acquisition will be accomplished by merging a newly created, wholly-owned subsidiary of AFC with and into Allmerica P&C (the "Merger") resulting in Allmerica P&C becoming a wholly-owned subsidiary of AFC. Also, immediately prior to the Merger, Allmerica P&C's Certificate of Incorporation will be amended to authorize a new class of Common Stock, one share of which will be exchanged for each share of Common Stock currently held by SMA Financial Corp,. a wholly-owned subsidiary of AFC. The consummation of the Merger is subject to the satisfaction of various conditions, including the approval of regulatory authorities.
The Company adopted certain new accounting pronouncements in 1994 as discussed in Note 1 to the consolidated financial statements.
Boston, Massachusetts February 3, 1997, except as to Notes 1 and 2, which are as of February 19, 1997
The Audit Committee of the Board of Directors, composed solely of outside directors, oversees management's discharge of its financial reporting responsibilities. The committee meets periodically with management, our internal auditors and our independent accountants, Price Waterhouse LLP. Both our internal auditors and Price Waterhouse LLP have direct access to the Audit Committee.
Management recognizes its responsibility for fostering a strong ethical climate. This responsibility is reflected in the Company's policies which address, among other things, potential conflicts of interest; compliance with all domestic and foreign laws including those relating to financial disclosure and the confidentiality of proprietary information. Allmerica Property & Casualty Companies, Inc. maintains a systematic program to assess compliance with these policies.
/s/ John F. O'Brien /s/ Edward J. Parry, III - - ------------------------------------- ------------------------------------- JOHN F. O'BRIEN EDWARD J. PARRY, III President and Chief Executive Vice President, Chief Financial Officer Officer, Treasurer and Principal Accounting Officer
The consolidated financial statements of Allmerica Property & Casualty Companies, Inc. and subsidiaries (collectively, the Company) at December 31, 1996 include the accounts of Allmerica Property & Casualty Companies, Inc. (Allmerica P&C), a non-insurance holding company; The Hanover Insurance Company (Hanover); Citizens Corporation (CitCorp), a non-insurance holding company, and CitCorp's wholly-owned subsidiaries Citizens Insurance Company of America (Citizens), Citizens Management, Inc., Citizens Insurance Company of Ohio and Citizens Insurance Company of the Midwest; Massachusetts Bay Insurance Company (Mass Bay); The Hanover American Insurance Company (Hanover American); Hanover Lloyd's Insurance Company (Hanover Lloyd's); Hanover Texas Insurance Management Company, Inc. (Hanover Texas); Allmerica Financial Alliance Insurance Company ([AFAIC], formerly The Hanover National Insurance Company [Hanover National]); Allmerica Financial Benefit Insurance Company (AFBIC); Allmerica Financial Insurance Brokers, Inc.; Amgro, Inc. (Amgro), a premium finance company, and Amgro's wholly-owned subsidiary Lloyds Credit Corporation; Allmerica Employees' Insurance Agency (AEIA); and APC Funding Corporation, a special-purpose financing company. The Company owns 100% of Hanover, Allmerica Financial Insurance Brokers, Inc., and APC Funding Corporation. Hanover owns 100% of Mass Bay, Hanover American, Hanover Lloyd's, Hanover Texas, AFAIC, AFBIC, Amgro, and AEIA and approximately 82.5% of the outstanding common stock of CitCorp. Minority interest relates to 17.5% of CitCorp common stock publicly held. First Allmerica Financial Life Insurance Company (FAFLIC, formerly State Mutual Life Assurance Company of America [State Mutual]) indirectly owns 35.5 million shares (59.5%) of Allmerica P&C. Concurrent with FAFLIC's conversion from a mutual life insurance company to a stock life insurance company, FAFLIC became a wholly-owned subsidiary of Allmerica Financial Corporation (AFC) on October 16, 1995.
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and Plan of Merger pursuant to which AFC will acquire all of the outstanding Common Stock of Allmerica P&C that it does not already own. Additional information pertaining to the merger is included in Note 2, Proposed Transaction.
The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles and the general practices within the insurance industry. All significant intercompany transactions and balances have been eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted accounting principles 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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 requires that an enterprise classify debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading. SFAS No. 115 also requires that unrealized holding gains and losses for trading securities be included in earnings, while unrealized gains and losses for available-for-sale securities be
excluded from earnings and reported as a separate component of shareholders' equity until realized. The effect of implementing SFAS No. 115, as of January 1, 1994, was an increase in the carrying value of debt securities of $149.7 million and an increase in shareholders' equity of $90.5 million, net of deferred federal income taxes, which resulted from changing the carrying value of the debt securities from amortized cost to fair value. The implementation had no effect on net income.
In the normal course of business, the Company enters into transactions involving various types of financial instruments, including investments in debt and equity securities. These instruments involve credit risk and also may be subject to risk of loss due to currency and interest rate fluctuations. Financial instruments that are subject to fair value disclosure requirements are carried in the financial statements at amounts that approximate fair value, unless otherwise indicated in the notes to consolidated financial statements.
Although realization of deferred policy acquisition costs is not assured, management believes it is more likely than not that all these costs will be realized. The amount of deferred policy acquisition costs considered realizable, however, could be reduced in the near term if the estimates of investment income discussed above are reduced, and this would impact the amortization of deferred policy acquisition costs.
The Company and its subsidiaries file a consolidated tax return. Current taxes are allocated among all affiliated companies based on a written tax sharing agreement. Under this agreement, allocations are made primarily on a separate return basis with current payment for losses and other tax items utilized in the consolidated return.
The cumulative effect of a change in accounting for postemployment benefits was $2.0 million, net of federal income taxes, or $0.03 per share for the year ended December 31, 1994.
value per share, of Allmerica P&C that it does not already own for consideration consisting of $33.00 per share of Common Stock, subject to adjustment, payable in cash and shares of common stock, par value $0.01 per share, of AFC (the "AFC Common Stock"). In addition, a shareholder of Allmerica P&C may elect to receive the consideration in cash, without interest, or in shares of AFC Common Stock, subject to proration as set forth in the Merger Agreement. The maximum number of shares of AFC Common Stock to be issued in the Merger is approximately 9.67 million shares. The acquisition will be accomplished by merging a newly created, wholly-owned subsidiary of AFC with and into Allmerica P&C (the "Merger") resulting in Allmerica P&C becoming a wholly-owned subsidiary of AFC. Also, immediately prior to the Merger, Allmerica P&C's Certificate of Incorporation will be amended to authorize a new class of Common Stock, one share of which will be exchanged for each share of Common Stock currently held by SMA Financial Corp., a wholly-owned subsidiary of AFC. The consummation of the Merger is subject to the satisfaction of various conditions, including the approval of regulatory authorities.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which may vary in certain respects from statutory accounting practices followed by the Company that are prescribed or permitted by the New Hampshire Insurance Department and Michigan Insurance Bureau.
The following reflects the amounts of policy acquisition expenses deferred and amortized:
Deferred acquisition costs are reviewed for each product to determine if they are recoverable. If such costs are determined to be unrecoverable, they are expensed at the time of determination. The Company evaluates recoverability of premium deficiencies separately for Hanover and Citizens on a product line basis, considering expected investment income applied separately for Hanover and Citizens on a product line basis. Deferred policy acquisition expenses were reduced by $3.8 million, $3.6 million and $3.7 million in 1996, 1995 and 1994, respectively, due to premium deficiencies.
Management believes, based on the Company's recent earnings history and its future expectations, that the Company's taxable income in future years will be sufficient to realize all deferred tax assets. In determining the adequacy of future income, management considered the future reversal of its existing temporary differences and available tax planning strategies that could be implemented, if necessary.
The provision for federal income tax expense differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate (35%) to income before federal income taxes. The sources of the difference and the tax effects of each were as follows:
The Company cedes to reinsurers a portion of its risk and pays a fee based upon premiums received on all policies subject to such reinsurance. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The
Reinsurance recoverable on paid and unpaid losses and ceded prepaid premiums were as follows:
As part of an ongoing process, the reserves have been re-estimated for all prior accident years and were decreased by $141.4 million, $137.6 million and $128.1 million in 1996, 1995, and 1994, respectively. The increase in favorable development on prior years' reserves of $3.8 million in 1996 results primarily from an $11.4 million increase in favorable development at Citizens. The increase in Citizens' favorable development of $11.4 million in 1996 reflects improved severity in the personal automobile line, where favorable development increased $28.6 million to $33.0 million in 1996, partially offset by less favorable development in the workers' compensation line. In 1995, the workers' compensation line had favorable development of $32.7 million, primarily as a result of Citizens re-estimating reserves to reflect the new claims cost management programs and the Michigan Supreme Court ruling, which decreases the maximum to be paid for indemnity cases on all existing and future claims. In 1996, the favorable development in the workers' compensation line of $21.8 million also reflected these developments. Hanover's favorable development, including voluntary and involuntary pools, decreased $7.7 million in 1996 to $82.9 million, primarily attributable to a decrease in favorable development in the workers' compensation line of $19.8. This decrease is primarily attributable to a re-estimate of reserves with respect to certain types of workers' compensation policies including large deductibles and excess of loss policies. In addition, during 1995 Hanover refined its estimation of unallocated loss adjustment expenses which increased favorable development in that year. Favorable development in the personal automobile line also decreased $4.7 million, to $42.4 million in 1996. These decreases were offset by increases in favorable development of $1.9 million and $5.6 million, to $12.6 million and $5.7 million, in the commercial automobile and commercial multiple peril lines, respectively. Favorable development in other lines increased by $8.8 million, primarily as a result of environmental reserve strengthening in 1995. Favorable development in Hanover's voluntary and involuntary pools increased $3.7 million to $4.1 million during 1996.
The increase in favorable development on prior years' reserves of $9.5 million in 1995 results primarily from a $34.6 million increase in favorable development at Citizens. Favorable development in Citizens' personal automobile and workers' compensation lines increased $16.6 million and $15.5 million, to favorable development of $4.4 million and $32.7 million, respectively, due to the aforementioned change in claims cost management and the Michigan Supreme Court ruling. Hanover's favorable development, not including the effect of voluntary and involuntary pools, was relatively unchanged at $90.2 million in 1995 compared to $91.7 million
The Company provides retirement benefits to substantially all of its employees, under two separate defined benefit pension plans. Through December 31, 1994, retirement benefits were based primarily on employees' years of service and compensation during the highest five consecutive plan years of employment. Benefits under this defined benefit formula were frozen for most employees effective December 31, 1994. In their place, the Company adopted a defined benefit cash balance formula, under which the Company annually provides a contribution to each eligible employee as a percentage of that employee's salary, similar to a defined contribution plan arrangement. The 1996 and 1995 contributions were based on 7% of each eligible employee's salary. The Company's policy for the plans is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974.
The Company's major subsidiaries, The Hanover Insurance Company and Citizens Insurance Company of America, have 401(k) and incentive compensation plans for their eligible employees. The Company also had a profit sharing plan which was discontinued in 1994 and a match feature was added to the continuing 401(k) plan. The total cost of the incentive compensation plans in 1996, 1995 and 1994 was $3.2 million, $3.0 million and $3.8 million, respectively. The total cost under the profit sharing and 401(k) plans in 1996, 1995 and 1994 was $4.0 million, $3.7 million and $6.4 million, respectively.
In addition to the Company's pension plans, the Company provides postretirement medical and death benefits to certain full-time employees and dependents, under plans sponsored by Hanover and Citizens. Generally employees become eligible at age 55 with at least 15 years of service. Spousal coverage is generally provided for up to two years after death of retiree. Benefits include hospital, major medical and a payment at death equal to retirees' final compensation up to certain limits. Effective January 1, 1996, the Company revised these benefits so as to establish limits on future benefit payments, restrict eligibility for current employees and eliminate eligibility for new employees. The medical plans have varying co-payments and deductibles, depending on the plan. The life insurance plan is a non-contributory plan. These plans are unfunded.
has been deducted from unrecognized loss and $2.0 million has been recorded as a reduction of net periodic postretirement benefit expense.
The components of net periodic postretirement benefits expenses were as follows:
Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112 (SFAS No. 112), "Employers' Accounting for Postemployment Benefits," which requires employers to recognize the costs and obligations of severance, disability and related life insurance and health care benefits to be paid to inactive or former employees after employment but before retirement. Prior to adoption, the Company had recognized the cost of these benefits on an accrual or paid basis, depending on the plan. Implementation of SFAS No. 112 resulted in a transition obligation of $2.0 million, net of deferred federal
The Company has agreements under which FAFLIC provides management, space and other services including accounting, electronic data processing, human resources, legal and other staff functions. Charges for these services are based on full cost including all direct and indirect overhead costs, and amounted to $59.3 million, $52.1 million and $64.4 million in 1996, 1995 and 1994, respectively.
Hanover leases office space from FAFLIC under a lease agreement which expires December 31, 2010. The annual lease cost was $1.0 million during each of the years ended December 31, 1996, 1995 and 1994, respectively. The annual lease cost of this agreement is included within the amount of charges above for 1996, 1995 and 1994, respectively. Amgro leases office space from FAFLIC as a tenant at will. The annual lease cost was $0.3 million during each of the years ended December 31, 1996, 1995 and 1994, respectively and is included in the charges above.
The Company has been named a defendant in various other legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on the Company's consolidated financial statements. However, liabilities related to these proceedings could be established in the near term if estimates of the ultimate resolution of these proceedings are revised.
New Hampshire and Michigan limit the payment of dividends and other distributions to shareholders. Under current law, extraordinary dividends and other distributions may only be paid from statutory policyholders' surplus, excluding dividends paid, as of the December 31st preceding. An extraordinary dividend or distribution includes any dividend or distribution of cash or other property, whose fair market value together with that of other dividends or distributions made within the preceding 12 months exceeds 10% of such insurers surplus as regards policyholders as of December 31, next preceding. Based on the 1996 statutory financial statements of Hanover, the maximum dividend that may be paid to Allmerica P&C at January 1, 1997, without prior approval from the New Hampshire Commissioner of Insurance, is $15.4 million, which considers dividends declared to Allmerica P&C of $105.0 million during 1996, including $80.0 million which was declared in December. On January 2, 1997, Hanover declared an extraordinary dividend in the amount of $120.0 million, payable on or after January 21, 1997 to Allmerica P&C. The dividend which was approved by the New Hampshire Insurance Department on January 9, 1997, is to be paid in a lump sum or in such installments as Allmerica P&C, in its discretion may determine.
Under the Michigan Insurance Code, cash dividends may be paid by Citizens Insurance only from earnings and policyholders' surplus. In addition, a Michigan insurer may not pay an "extraordinary" dividend to its stockholders without the prior approval of the Michigan Insurance Commissioner. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of policyholders' surplus as of December 31 of the preceding year or the statutory net income less realized gains, for the immediately preceding calendar year. At January 1, 1997, Citizens Insurance could pay dividends of $39.9 million without approval of the Michigan Insurance Commissioner.
A summary of unaudited quarterly results of consolidated operations for 1996, 1995 and 1994 is presented below: