Massachusetts law allows two years to reach the required group penetration level of 35%. Commerce has continued to maintain AAA member participation in excess of 35% through December 31, 2002, when it was estimated at approximately 43%. The two-year penetration requirement was waived by the Massachusetts Legislature for 2002, 2001 and 2000. Waiving the penetration requirements allows insurance companies to continue offering group discounts without the particular group reaching the 35% penetration level.
Commerce and the AAA clubs have agreed that Commerce shall be their exclusive under-writer of Massachusetts personal automobile group programs. A rolling three-year contract between Commerce and the AAA clubs exists, which renews automatically and may be terminated upon a minimum of three years written notice to either party.
Although the U.S. federal government does not directly regulate the insurance industry, federal initiatives often have an impact on the business. Congress and certain federal agencies continue to investigate the current condition of the insurance industry (encompassing both life and health and property and casualty insurance) in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress conducts hearings relating, in general, to the solvency of insurers and has proposed federal legislation from time to time on this and other subjects.
Through 2000, the Company offered its Massachusetts customers safe driver deviations to drivers with SDIP classifications of either Steps 9 or 10 and to only Step 9 drivers in 2001. Safe driver deviations are rate discounts based on the customer's driving record and resulting SDIP classification and must be approved annually by the Commissioner. Steps 9 and 10 are the two best driver SDIP classifications in Massachusetts, representing drivers with no at fault accidents and not more than one minor moving vehicle violation in the last six years. In 2002 and 2003, in response to the average personal automobile rate decisions over the last several years, the Company did not file for SDIP Step 9 deviations, for policies incepting in the 2002 or 2003 calendar years. The accompanying table depicts the AAA Affinity Group Discount, SDIP Deviations and their combined reduction from Massachusetts average mandated rates:
The RBC model formula proposes four levels of regulatory action. The extent of regulatory intervention and action increases as the percentage of surplus to RBC falls. The first level, the Company Action Level (as defined by the NAIC), requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The Regulatory Action Level (as defined by the NAIC) requires an insurer to submit a plan containing corrective actions and permits the Commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The Authorized Control Level (as defined by the NAIC) allows the regulator to rehabilitate or liquidate an insurer in addition to the aforementioned actions if surplus falls below 100% of the RBC amount. The fourth action level is the Mandatory Control Level (as defined by the NAIC), which requires the regulator to ehabilitate or liquidate the insurer if surplus falls below 70% of the RBC amount.
Net realized investment losses totaled $82,385 during 2002 as compared to $10,633 in 2001. Net realized investment losses during 2002 were primarily centered in to two areas, preferred stock mutual funds and other-than-temporary impairments. Declines in the market values of utility common stocks held by preferred stock mutual funds were the primary reasons for losses, totaling $44,602. The Company reflects these declines through realized losses because its significant level of ownership requires the use of the equity method of accounting for these funds. The 2002 realized losses were also impacted by write-downs for other-than-temporary declines in the market value of certain fixed maturities, preferred and common stocks totaling $32,114.
For all of the Company's insurance subsidiaries, the aggregate actuarial estimate for the loss and LAE reserves, prior to the effect of ceded reinsurance recoverable, ranges from a low of $607.3 million to a high of $700.6 million. The Company's financial statement loss and LAE reserves, based on Management's best estimate, was established at $678.3 million for year-end 2002. Management calculates its estimate independently from those amounts as calculated by the Company's actuaries and, therefore, the final results are most often not the same. Management estimates its amounts primarily by reviewing historical loss and LAE data, focusing mainly on payment data. It also reviews and compares most recent loss frequency, severity and payment data to historical trends in an attempt to determine if patterns are remaining consistent or not. Management attempts to establish its reserve estimate as close to the amount required for the ultimate future payments necessary to settle all losses. The accuracy of this estimate is reflected by the line noted above entitled "decrease in provision for insured events of prior years".
Of the Company's bonds, 96.5% and 97.9% were rated in either of the two highest quality categories provided by the NAIC for 2002 and 2001, respectively. Of all the Company's other Securities, 8 with a cost of $16.3 million and a market value of $18.0 million, are private placement securities and, therefore are not rated by a rating agency.
The Company also relies upon dividends from its subsidiaries for its cash requirements. Every Massachusetts insurance company seeking to make any dividend or other distributions to its stockholders may, within certain limitations, pay such dividends and then file a report with the Commissioner. Dividends in excess of these limitations are called extraordinary dividends. An extraordinary dividend is any dividend or other property, whose fair value together with other dividends or distributions made within the preceding twelve months exceeds the greater of ten percent of the insurer's surplus as regards to policyholders as of the end of the preceding year, or the net income of a non-life insurance company for the preceding year. No pro-rata distribution of
Also in 2000, Commerce entered into a Limited Partnership Agreement with Distribution Partners Investment Capital, L.P. a Delaware Limited Partnership. This partnership agreement required a commitment by the Company to invest up to $3,500 into the partnership. To date the Company has invested $2,555 into the partnership leaving a balance of $945 for funds still committed. The partnership was formed to operate as an investment fund principally for the purpose of making investments primarily in equity and equity-related securities of companies operating in
In November 2001, the Board of Directors of the Company authorized a stock buy-back program to purchase shares of common stock of the Company. During the period from January 1, 2002 through December 31, 2002, the Company purchased 1,295,844 shares of its own common stock at an average cost of $37.67. At December 31, 2002, the Company had authority to purchase a total of 977,856 additional shares of its common stock under the current buy-back program. As of December 31, 2002, the Company held a total of 6,165,392 shares of treasury stock.
As discussed in Note A, the 2001 consolidated financial statements have been restated due to a change in accounting for stock options.
The consolidated financial statements include The Commerce Group, Inc. and its wholly-owned subsidiaries, Bay Finance Company, Inc., Clark- Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI"). The Commerce Insurance Company ("Commerce") and Citation Insurance Company ("Citation") are wholly-owned subsidiaries of CHI. Commerce West Insurance Company ("Commerce West") is a wholly-owned subsidiary of Commerce. American Commerce Insurance Company ("American Commerce") is a wholly-owned subsidiary of ACIC Holding Co., Inc. ("AHC"). AHC is owned jointly with AAA Southern New England ("AAA SNE") with Commerce maintaining a 95% common stock interest and AAA SNE maintaining a 5% common stock interest (see NOTE A17).
A focus of management's judgments and estimates relating to investments involves the potential impairment of investments for other- than-temporary declines in market values. Carrying values of investments in fixed maturities, which include taxable and non-taxable bonds, and investments in common and preferred stocks, are derived from market prices supplied by the Company's investment custodian. Unrealized investment gains and losses on these investments, to the extent that there is no other-than-temporary impairment of value, are credited or charged to a separate component of stockholders' equity, known as "net accumulated other comprehensive income (loss)", until realized, net of any tax effect. An impairment in an investment is deemed to be other-than-temporary when a security's market value has diminished to less than 75% of cost for two consecutive calendar quarters. If the contractual terms of the security are being complied with, management performs a cash flow valuation to determine the potential impairment of the security. If the security is deemed impaired, the Company adjusts the securities cost to market value through realized loss based on publicly available or, in the absence of such, to a value based on cash flow modeling. Accumulated Other Comprehensive losses of less than 25% of cost relate to interest rate changes and not to declines in a security's rating, financial situation or sector issues and are not considered impaired due to the Company's ability and intent to hold these securities to maturity. During 2002, the Company wrote down $32,114 in bonds, preferred and common stocks with impairment as determined by management to be other-than-temporary. When investment securities are sold, the realized gain or loss is determined based upon specific identification. Fair market value of fixed maturities and common and preferred stocks are based on quoted market prices. For other securities held as investments, fair market value equals quoted market price, if available. If a quoted market price is not available, fair market value is estimated using quoted market prices for similar securities. The Company has not invested more than 5% of fixed maturities in any one state or political subdivision.
Policy acquisition costs are calculated by line of business as a percentage of unearned premiums by multiplying the sum of current commission rates plus current premium tax rates plus an estimate of the percentage of other underwriting expenses incurred at the policy issuance. These costs are deferred and amortized over the period in which the related premiums are earned, the amount being reduced by any potential premium deficiency. If any potential premium deficiency exists, it represents future estimated losses, loss adjustment expenses and amortization of deferred acquisition costs in excess of the related unearned premiums. There was no premium deficiency in 2002, 2001 and 2000. In determining whether a premium deficiency exists, the Company considers anticipated investment income.
Earnings per diluted common share are based on the weighted average number of diluted common shares outstanding during each period. The weighted average number of diluted common shares outstanding for the years ended December 31, 2002, 2001 and 2000 were 33,028,081, 33,794,938 and 34,121,047, respectively. The Company's only dilutive instruments are stock options outstanding and dilution from these is not significant.
The following table reflects the shares held, percentage of ownership, carrying value at equity, book value, market value, and value of shares at net asset value, by fund at December 31, 2002 and 2001:
At December 31, 2002 and 2001 mortgage loans which were on non- accrual status amounted to $388 and $1,451, respectively. Allowances of $53 and $266 were set up in 2002 and 2001, respectively, as a result of these loans. The reduction in interest income associated with
Net increases (decreases) in other comprehensive income (loss), less applicable income tax expense, were as follows:
Included in the loss reserve methodologies described above, are liabilities for unpaid claims and claim adjustment expenses for environmental related claims such as oil spills, mold and lead paint. Reserves have been established to cover these claims for known losses. Because of the Company's limited exposure to these types of claims, management believes they will not have a material impact on the consolidated financial position of the Company in the future. Loss reserves on environmental related claims amounted to $5,722 and $4,281 at December 31, 2002 and 2001, respectively.
The Board of Directors of the Company voted to declare four quarterly dividends to stockholders of record totaling $1.23 per share and $1.19 per share in 2002 and 2001, respectively. On May 19, 2002, the Board voted to increase the quarterly stockholder dividend from $0.30 to $0.31 per share to stockholders of record as of June 4, 2002. Prior to that declaration, the Company paid quarterly dividends of $0.30 per share dating back to May 21, 2001 when the Board voted to increase the dividend from $0.29 to $0.30 per share.
The Company previously disclosed that a purported class action lawsuit was pending in Massachusetts state court against The Commerce Insurance Company ("Commerce"). The lawsuit, titled "Elena Given, individually and as a representative of all persons similarly situated v. The Commerce Insurance Company," alleges damages as a result of the alleged inherent diminished value to vehicles that are involved in accidents. In April 2002, the trial judge in that case entered partial summary judgment for the plaintiff on the issue of whether the Massachusetts automobile policy covers her claim, ruling that the plaintiff would be entitled to reimbursement under the policy if the plaintiff were able both to prove that her vehicle suffered "inherent diminished value" in the accident and to quantify the amount of such diminution in value. Subsequently the Massachusetts Division of Insurance issued an Advisory ruling in which it stated, among other things, its position that the policy does not cover claims for "inherent diminished value." In July of 2002, the trial judge, stayed the trial and granted the Company's motion to have the appellate court review the issue of whether the Massachusetts automobile policy provides coverage for inherent diminished value. During the third quarter of 2002, the Company applied for direct appellate review of this issue by the Supreme Judicial Court of Massachusetts ("SJC"), and this application was granted. Another Superior Court judge in Massachusetts ruled, in a similar case brought by the same plaintiff counsel against another insurer, that claims for diminution of value are not covered by the Massachusetts automobile insurance policy. The Company's and the other insurer's cases have been paired and oral arguments were heard at the SJC on March 4, 2003. A decision is expected within 120 days of the oral argument. If the SJC agrees with the Given trial judge's
THE COMMERCE GROUP, INC. AND SUBSIDIARIES COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES December 31, (Thousands of Dollars)